This week (beginning on June 25) Spain is due to submit the formal request to its eurozone partners for a credit line of as much as 100 billion euros ($125 billion) to shore up its troubled banks, becoming the fourth EU country to seek bail-out, according to Reuters news agency. This bail-out was agreed two weeks ago and was the first reported by the same source, revealing the details of the deal. According to some, the news was leaked in order for the Spanish government to speed up the decision-making process regarding the bail-out request for its wounded banking sector, that had witnessed up to three demands of financial injection (particularly, the savings banks, or cajas, Bankia, Catalunya Caixa y Novagalicia Banco) in the last few weeks. According to the Spanish government, only 30% of banks are facing a crisis, whereas the remaining share of the sector still looks solid.
Around the same dates, IMF (International Monetary Fund) made public its report on the Spanish financial system, which was described as “well-managed and appearing resilient to further shocks, though vulnerabilities still remained”. The paper revealed the following figure: at least 40 billion euros ($50 billion). According to this body, that was the amount of the cash injection needed by the country’s troubled lenders; this equals to the capital shortfall for the Spanish banks after taking into account the capacity from some of the entities to cover expected losses with their own resources in case of the doomsday economic scenario.
Eventually, it was made official: the Spanish government would accept a “bail-out” (described as a “loan on very favourable conditions” by the Spanish finance minister Luis de Guindos) which could take as much as 100 billion euros, exceeding all the forecasts. In this article we provide the answers to some of the most relevant questions about the Spanish bank bail-out.
1. Why has Spain been given a bail-out?
Spanish banks have lent billions of euros, particularly to the construction sector (construction and real-estate loans grew from 10% of GDP in 1992 to 43% in 2009, according to the IMF report) which they will not be able to recover in the near future, which has created the crisis of confidence among investor and financial markets, since the scale of the losses is yet unclear (investors demand higher interest the riskier a prospect they think it is). This is why the Spanish government has imposed strict requirements on the banks, earlier ordering to set aside the total amount of 54 billion euros in provisions against property-related assets, due to the February real-estate crisis, plus 28 billion euros as a penalty established in May for the real-estate loans.
Also, the Government had to nationalise, partially or completely, several banks (including Bankia, a merged group of savings banks and its fourth-largest bank) and is expected to carry out additional rescue operations. As a result, the yield on the Spanish bonds (the current cost of borrowing in the market for the bond issuer) has increased significantly, and the risk premium (the extra return investors demand on the country’s 10-year bond compared to equivalent safe-haven German debt) in the last few weeks has hit new highs, exceeding the 500 points. On the June 21 it fell below 500 basic points- down to 498 – for the first time since June 12; but with the increased borrowing costs, that had risen to the unsustainable levels of 6%, the country was forced to request financial aid needed for funding the operations of its cash-starved banks.
2. Why did the bail-out happen in that precise moment?
There were previous bail-outs on the same weekend (beginning June 9), as the announcement of a rescue deal was expected to calm down tensions on the European and American stock exchanges and infuse some optimism into the markets.
Besides, there was a very strong pressure from the European Union for Spain to seek assistance, since the news would act as a firewall against the unforeseen reactions sparkled by two key events that took place on the following week – Greek elections and French parliamentary poll – that were keeping the foreign investors on edge.
3. What exactly is being rescued?
The bail-out is targeted specifically at the banks, rather than at the economy as a whole, particularly for those institutions with allegedly insufficient funds to face a doomsday macroeconomic scenario and the requirements imposed by the Spanish government. The first banks to benefit from the rescue deal were partly-nationalised Bankia, Novagalicia Banco, Catalunya Caixa and Banco de Valencia.
4. What is meant by ‘bail-out’?
A bailout in the euro zone basically refers to a financial assistance in form of a loan (that is to be repaid at a certain interest rate) with the resources coming from the eurozone funds set up to help its members in financial distress (particularly, the European Financial Stability Facility). The loan is typically granted to the EU state, which distributes this money to the banks in need of capital infusion.
The European rescue fund was modified to allow financial aid to the countries’ ailing banking sectors, although always supervised and executed by the state. Spain is the eurozone country to try this path, most probably via FROB (Fund for Orderly Bank Restructuring, created in 2009 to manage the restructuring processes of credit institutions and assist in the enhancement of their equity).
5. What is the cost of the bail-out?
Despite giving away the initial figure of an estimate of 40 billion euros (4% of Spain’s gross domestic product) needed to preserve the country’s financial stability, the IMF has warned that the figure did not represent the full scope of capital needs, if further “restructuring costs and reclassification of loans” were to be taken into account (both processes were still under way at the moment of accepting the bail-out). The IMF report concedes that the total required by the Spanish banks might be between “60 and 90 million” of euros
The amount offered by the EU was as much as 100 billion euros ($126 billion), far beyond the 40 million announced by the IMF, but at the same time this figure intends to calm down the markets and avoid further payments. The definitive figure will be confirmed once all the audits of the Spanish financial systems are carried out. So far the two consulting firms hired by the government to conduct stress tests on the lenders revealed the following facts: according to Oliver Wyman Ltd. banks would need between 51 billion euros and 62 billion euros, whereas Roland Berger Strategy Consultants said lenders would need 51.8 billion euros.
What are these figures based upon?
The IMF has based its calculations on the macroeconomic scenarios of real GDP growth: -4.1% in 2012 and -1.6 in 2013. Housing prices would decrease 19.8% this year and 3.6%, in 2013. The adverse scenario of the unemployment rate for 2013 is 26,6%.
6. Where does the money for this bailout come from?
There are two eurozone funds set up to help members in financial distress. The first one is The European Financial Stability Facility (EFSF), mechanism which is currently in place, whose capacity to extend new loans expires in 2013. Another one is European Stability Mechanism (ESM), a permanent crisis management mechanism. It will enter into force on 1 July 2013, following an amendment to the Treaty on the Functioning of the European Union and the signing of an ESM treaty by the euro area countries. These funds are financed by the European countries’ contributions and issuing bonds or other debt instruments, backed by guarantees given by the euro area member states in proportion to their share in the paid-up capital of the European Central Bank (ECB). So basically, these institutions are funded by the public money coming from the EU citizens.
The IMF’s role will be merely that of supervising, without any financial contribution.
7. What would be the impact of the bail-out?
The EU would be in charge of supervising and managing the rescued banking institutions. In order to be eligible for the EFSF financing of the recapitalisation, the national government would have to prove a sound state of its financial institutions, introducing restructuring and resolution measures when needed. In addition, as this type of assistance is considered as state aid, it will therefore have to comply with European state aid rules and competition rules. Finally, additional conditions should also be envisaged in the domains of financial supervision, corporate governance and domestic laws relating to restructuring/resolution.
The received aid is regarded as debt and not deficit. The institutions to obtain assistance from FROB (in its turn, relying on the EFSF funds) will have to repay the loans to the Spanish government. This means that the taxpayers will be partially liable for the cost of the bail-outsince the interest rate Spain will have to pay on the loan is regarded as deficit, that means that the new wave of cuts is under way, in order to be able to return this money to Europe .
Recently Brussels proposed six country specific recommendations for Spain for economic and structural reform policies which are expected to be implemented in the light of the bail-out:
1) Additional structural fiscal efforts (that is, additional cuts): adopting measures at regional level (comunidades autónomas (autonomous communities), or self-governeing regions) and setting up an independent fiscal institution
2) Retirement age: accelerate the increase in the statutory retirement age.
3) Broadening the tax base for VAT: Brussels suggests increasing the VAT rate by suppressing the wide range of exemptions, reduced rates (8%) and superreduced rates (4%) applied to some products. VAT revenue represented only 5.5% of Spanish GRP in 2010, the lowest figure among the EU states. The regular VAT rate (18%) is also among the lowest ones, according to the European Commission.
4) Implementing the reform of the financial sector: define a clear position on the funding and the use of backstop facilities.
5) Implementing the labour market reforms: the Commission was somewhat skeptical regarding the new contracts for the SMEs and training contracts.
6) Youth employment and education: implementing the Youth Action Plan, in particular as regards the quality and labour market relevance of vocational training and education.
8. Is the Spanish bailout going to be similar to that of Greece, Portugal or Ireland?
In principle, no. With the current economic rules, Spain could not be subjected to the strict conditions of economic policy, such as those imposed on Greece, Portugal or Ireland. But the rules also say that the the beneificiary state should also adopt consistent budgetary policy and prove its solvency to repay the EU funds; it will be subject to enhanced and continued monitoring and reporting and will comply with the EU recommendations for the correction of the excessive deficit. There will be no intervention in pure form, but the room for maneuver on economic policy will be significantly reduced. The reference to complying entirely with the ECOFIN Council decisions (the Economic and Financial Affairs Council of the EU) and the recommendations for the correction of the deficit raises many questions about the possible extent of the intervention.
9. What are the benefits of the bail-out?
Until the final loan conditions are disclosed, Spanish finance minister Luis de Guindos has assured it would be “a loan on very favourable conditions, more favourable than in the market”, with an interest rate between 3 and 4 percent. On June 18 the Spanish 10-year bond yields reached a euro-era high of 7.285%. That was the biggest decline in the past 6 months; whereas two-year notes stay close to the 5% level.
At these rates, the cost of the bank bail-out, estimated in between 40 and 100 billion euros would be nearly impossible to assume for the country, which this year is going to dedicate around 30 billion euros of its budget to pay back the loan interests. All this provided the martkets are willing to purchase these billions of Spanish notes the Treasury did not even consider printing.
10. How will the bail-out affect the Spanish taxpayers?
The bail-out will have positive impact on the clients of the beneficiary banking institutions , since the received money will reinforce its capital structure and guarantee customers’ deposits. The shareholders of these banks will see the profitability of their shares paid out in dividends reduced. Among the conditions imposed by the EU institutions on the affected banks and savings banks will be that of the reduction of the dividends might be the one that the funds concede can not then be given as a dividend to banks shareholders.
For the rest of the taxpayers, as already outlined in the question 7, the rates that the Government will have to pay on these 100 billion will be considered as budget deficit, which will imply further fiscal consolidation measures (spending cuts and raising taxes).
What is the current state of Spain’s economy?
The Bank of Spain has recently confirmed that Spanish economy shrank by 0.3% in the first three months of 2012, suffering a double-dip recession. Madrid published a new economic stability plan that predicted that GDP would shrink by 1.7% in 2012
Currently Spain has the highest unemployment rate in Europe (24% for the adult population and more than 50% for the under 25-s). Spain had already announced it wouldn’t be able to meet the budget deficit target of 4,4% of gross domestic product, previously set by the European Commission. This year the country is expected to slash its government deficit to around 5.3% of GDP (from about 8.5% of GDP in 2011).
Translation of the original article in Spanish by Victoria Shevela.
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