World Crisis Online

At the start of the financial crisis, Spain enjoyed a reputation for keeping banks on a tighter leash than others. If any smugness was felt, it was swept away as panic in sovereign debt markets spread to cut Spanish savings banks off from wholesale funding. But Madrid’s efforts to right the sector put it a head above the rest of Europe – and are beginning to show results.

Like Dublin, Madrid’s economic mistake was to let cheap foreign capital fuel a real estate boom. As in Ireland, the risk was piled on through banks – specifically the opaque, politicised caja sector. But Spanish regulators never abdicated responsibility as their Irish counterparts did. Counter-cyclical loss buffers and conservative provisioning in general prevented the most toxic corrosion of balance sheets.

The government has just made another move to clean out any outstanding rot in the cajas. After raising transparency requirements, last Friday it passed a decree that forces savings bank to recapitalise themselves by the end of the year, to equity ratios of up to 10 per cent of risk-weighted assets – stricter and prompter than Basel III.

More capital is the best medicine against losses. The task is to find it. The Bank of Spain now has tools to force the unlisted cajas to raise equity, and subject them to greater outside control that comes with such a move. But if private investors do not show up, the government itself will put up capital.

The prognosis both for the cajas and the public purse thus depends on how bad the losses turn out to be. The Bank of Spain is making a valiant effort to calm the nerves of markets with an honest account of the cajas’ holdings. There is much good to say about this, not least that it is refreshing to see a government realise that markets must be told the truth. The numbers are also encouraging: Madrid makes a fair case that needed public funds are unlikely to go much beyond the €12bn already provided.

But there is room for scepticism. The default and loss assumptions used to estimate remaining writedowns are taken from last year’s risibly lax European stress tests. It is also optimistic to argue that conservative standards make mortgages much safer than loans for real estate development.

To avoid the Irish error of blank taxpayer cheques to banks, Madrid must be willing to let cajas fail and creditors share losses above what it thinks probable. This would add to the healthy shake-up Madrid is already dispensing to the outdated world of politically controlled local banks. European nations with similar sectors could learn a lesson.