When will it end? There was a time when Spain’s banking regulation, with its counter-cyclical provisioning, was hailed as a model for others. But the Spanish government’s plan to make banks set aside additional provisions totalling more than €35bn against their property exposure – on top of the €54bn it required in February – suggests that regulation is now by knee-jerk. Spanish bank shares fell sharply on Wednesday.
Madrid’s latest bolt-on reform could be approved by the cabinet on Friday. Banks may have to lift coverage of generic property loans to 30 per cent from 7 per cent. But phasing in ever higher provisions (and therefore capital need) risks perpetuating the problem. After all, Bankia, which could be part nationalised following a state capital injection of up to €10bn to cope with property loan losses, has yet to meet February’s provision requirements. True, banks have until December to do so, but Bankia is not the only one struggling to muster capital. Spanish banks, whose shares led the losers on the Ibex 35 on Wednesday, could at worst need up to an extra €55bn, Morgan Stanley estimates. That is about 5 per cent of economic output, and double the shortfall identified by the European Banking Authority, much of it as a sovereign buffer.
The bolt-on provisions suggest further Madrid procrastination. If the government wants to restore trust in its banks and sovereign debt, the solution has to be both industrial in scale and unimaginably bigger than the market expects – as Tarp was in the US. Spain’s banks trade around 0.6 times book value, but investors hardly trust the denominators. Lenders must fess up to property exposures using realistic valuations, and use any loss to inform a more credible recapitalisation. There is scope, still, under Madrid’s existing bailout fund, to do all of that. A definitive bank clean-up framework and clarity on sources of capital should top Friday’s cabinet agenda.