What's wrong with Spanish Banks? (part 1)

Spain’s world class and much lauded banking system begins to crack. Why?

After 18 months of insisting that Spain’s banking system is one of the best in the world, superbly regulated, well provisioned and with no exposure to toxic debt, the truth is out – they need help!

So what has happened? Well, while the regulators did indeed successfully manage to limit Spanish banks’ exposure to the US sub-prime market, and other forms of international “toxic” debt, they failed to adequately regulate their banks’ domestic lending, thus creating their very own sub-prime crisis.

Spain, like the UK 15-20 years ago, has a two tier retail banking system: traditional banks and regionally based mutual savings banks (“cajas”), i.e. building societies. It is with the latter where the biggest problems now arise.

The problems are twofold – liquidity and credit risk. On the first point, Spanish banks and cajas have traditionally issued long term mortgage backed securities “titulaciones” to finance their mortgage lending. However, as the domestic property and credit boom gathered pace they also relied increasingly on the short term wholesale money markets to finance their long term loan and mortgage portfolios – shades of Northern Rock!

The advent of the euro made access to these markets easier while cheap money fuelled a consumer led boom. The credit crisis effectively closed both sources of funding and it is a fact that over the last eighteen months Spanish financial institutions have been the biggest users of the European Central Bank liquidity window, regularly borrowing more than €40bn. The Spanish government has also been guaranteeing the bond issues of a number of banks and cajas – an action that seems to contradict re-assurances that the Spanish banking system is in rude health.

However, while the liquidity crisis may finally be easing, the emphasis has now shifted to the asset side of the balance sheet. The Spanish banks and cajas fuelled the country’s property boom by lending vast sums of money to property developers – recent estimates put the sum at €318bn, and then to consumers to buy their finished products.

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