Outside of Greece, the most worrying developments in the ongoing euro zone crisis have been in Spain. Although it must be hoped that Greece will find a way of stepping back from the brink of default, financial collapse very likely forcing an exit from the euro zone, it is clear that preparations must be made for the possibility that Greece does leave and the contagion implications for other countries. Since Portugal and Ireland are covered by euro zone and IMF rescue packages with whose conditions they are expected to continue to comply, the most vulnerable country looks like Spain
It should be remembered that unlike Greece and Italy, the Spanish crisis is not to do with poor management of public sector accounts. On the contrary up to 2007 Spain was a model with a debt less than half of Germany’s and an annual surplus. Spain’s problem like Ireland’s originates from private sector imbalances fuelled particularly from a housebuilding boom leading to over-supply and consequent problems for banks which had lent to builders and property companies. In Ireland virtually the whole banking sector collapsed in 2010 and the costs to the state of rescuing the sector forced it into asking for a loan facility from the euro zone and IMF. In Spain by contrast it is less than half the banking sector that is severely affected and Spain has not so far needed outside financial assistance. But the news on May 12th that a medium sized bank, Bankia (formed from a merger of seven regional savings banks), needed to be provided with capital by the government and that the government had instructed banks to increase provisions on property loans not already regarded as distressed from 7% to 30% has engendered fears that further bad news could be expected from the property exposure of banks. The problems of some of Spain’s regional savings banks have been known for at least two years, but action to tackle the problems has been slow and reactive rather than proactive. Given the sensitivity of financial markets to bad news and continuing uncertainty the need to draw a convincing line under the matter is urgent. At last on May 21st, the Spanish government appointed two independent auditors—Roland Berger (a German consultancy company) and Oliver Wyman (a US consultancy)—to assess the scale of the problem posed by property loans throughout the Spanish banking sector. They are expected to produce preliminary reports in a month and more detailed ones in three months. It must be hoped that the report within a month provides a fairly clear indication of the scale of further support that the Spanish government may have to provide. According to most unofficial estimates (official estimates are still much lower) this should not to be than €100bn or about 10% of Spanish GDP. With the Spanish debt to GDP ratio at 68% of GDP at the end of 2011 and likely excluding bank refinancing to amount to about 75% at the end of 2012 this would put the ratio up to 85% which should still be manageable. Even the much higher €262bn estimate by Nouriel Roubini should not itself make Spain unsolvent but anything substantially over €100bn would be alarming given the worries about the euro zone as a whole and the continuing decline of the Spanish economy.
It should however be pointed out that, despite recent downgradings by Moody’s, the two large international commercial banks, Santander and BBVA, still look robust with capital ratios comfortably above those required and continuing profitability in first quarter 2012 of €1.6bn and €1bn respectively, despite the deep double-dip recession in Spain. While more information is urgently needed, the evidence so far available does not suggest that the Spanish banking sector is in such a bad position as to require an external rescue in the short term. In the longer term the key question is whether the economy is near to bottoming out or whether job losses on a large scale will continue. The losses of Spanish savings banks have been almost entirely to property and building companies. There is also an estimated €656bn of individual mortgage debt in Spain. At present the rate of non-performing loans in this sector is below 3%, but it is not likely to immune should the Spanish economy deteriorate further.