The Bank of Spain has ordered the country's lenders to face up to bad debts and set aside reserves of up to 30pc on
property for sale in Spain holdings in a bid to restore global confidence in the Spanish financial system after weeks of investor flight.
Caja Cantabria, one of the four Spanish regional banks forced to merge after the Bank of Spain took control of CajaSur. The new rules target the savings banks or cajas that account for the lion's share of the €445bn (£377bn) of property debt accumulated during the credit boom, when real interest rates were negative.
The authorities acted after severe strains in the inter-bank market had begun to raise questions about the ability of Spanish lenders to access routine funds from global peers. Deutsche Bank said Spanish lenders need to refinance €125bn by late 2011. "Liquidity is our main area of concern. Savings banks are in a very weak and risky position," it said.
No Spanish bank has raised money on the capital markets for a month. They are relying on the European Central Bank's lifeline. ECB funding has reached €89bn, the highest level since the Lehman Brothers crisis.
The new rules will force lenders to write down bad debts within a year instead of stretching out the pain for up to six years. They must set aside reserves on €60bn of foreclosed property still sitting on their books at face value, using a rising scale of up to 30pc. Santander and BBVA have already done this.
"Spanish accounting was completely out of line with the rest of Europe," said Hans Redeker, currency chief at BNP Paribas. "It had reached a point where investors no longer believed in Spanish balance sheets because equity ratios are distorted by overvalued holdings of real estate. This move was absolutely the right thing to do. You can't camouflage bad debts any longer. Those days are over," he said.
The Bank of Spain risks opening a Pandora's Box since nobody knows how many cajas are insolvent once loans are marked-to-market. Last weekend it seized CajaSur, a 150 year-old lender in Cordoba controlled by the Catholic Church. The lender lost €596m last year, much of it on holiday homes on the Costa del Sol.
The regulator said the measures would cut bank earnings by 10pc on average but warned of a "very heterogeneous" effect, a polite way of saying that it will purge cajas that ran amok. The crackdown will bring matters to a head rapidly, forcing cajas to disgorge property holdings onto the market. This is a gamble, risking a house-price crash that could tip Spain deeper into debt deflation.
Caixa Catalunya said the stock of unsold homes reached 926,000 last year. Madrid consultants RR de Acuña are gloomier, saying buildings in the pipeline will push the overhang to 1.6m and will take six years to clear. New home starts have fallen 90pc from their peak in 2007.
Santiago Lopez from Credit Suisse said the new rules may prove "the last straw" for weak cajas but praised the central bank for "finally deciding to get tough".
He said the non-performing loan rate in Spain is 5.33pc but past interventions by the central bank revealed "dramatic" rises in NPL ratios after a fresh audit. Once the full truth comes out on CajaSur we will know how bad the picture is for others.
Mr Lopez said Spain's Achilles Heel is private debt of 211pc of GDP. This is much like Britain (213pc), but takes places in the very different context of deflation. Spain cannot easly grow its way out of the crisis because it is structurally overvalued within the EMU.
Regulators are hoping to break the political resistance to shotgun mergers or debt restructuring. Four other cajas have been ordered to merge already. The policy of throwing banks together entails its own dangers, risking a repeat of the Lloyds TSB deal with HBOS or a string of 1990s mergers in Japan where bad banks polluted good banks. There is no magic wand to conjure away a stock of bad debt.
