Monday, June 11, 2012

Spain bank recapitalisation

European leaders are getting better at acting decisively.  The weekend’s announcement that Europe would provide up to 100 billion to recapitalise Spain’s banks was only held up by the reluctance of Spain to ask for assistance.  In the end the agreement came before the results of an independent audit of the bank’s needs: the government will confirm the amount required once that process is complete in about a few days time. 

The 100 billion allocated will likely be sufficient.  It’s well in excess of the 40 billion estimated by the IMF, although that estimate was based on historical data.  More recent private sector estimates put the capital requirement at around 80 billion.

It is yet to be determined whether the funds will come from the temporary European Financial Stability Facility (EFSF) or the permanent European Stability Mechanism (ESM).  Our preference is for the funds to come from the EFSF, as that would leave the full 500 billion available through the ESM intact.

The only downside to the plan is the (German) insistence that the recapitalisation funds are channelled through the Spanish Government via the Fund for Orderly Bank Restructuring (FOBR or FROB in Spanish).  As a result Spain’s sovereign debt-to-GDP ratio will likely rise by over 10 percentage points depending on the final amount required.  That raises the possibility that the market shifts its angst from the banks to the sovereign, especially given the current recessionary environment.

That brings us back to the perennial growth vs. austerity debate.  Spain’s more recent woes are largely related to the weak housing market and the impact on bank balance sheets.  The preferred government fiscal response is an orderly but timely return to fiscal sustainability and structural economic reform to support long-term growth.  There is a strong case to be made for shifting Spain’s fiscal targets out in return for agreed structural reform in labour and product markets.  That should be on the agenda at the next EU Summit at the end of June. 

More immediately, it was important this element of uncertainty was dealt to before potentially disruptive elections in Greece this weekend.  We also take it as a further sign of Europe’s capacity and willingness to (eventually) do whatever it takes to save the euro.