It is only when the banks have to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details that market participants can tell if the banks have really addressed the problem with their real estate exposures.
It is only when banks provide ultra transparency that they do not need to be recapitalized immediately, but rather can recapitalize over years through retained earnings and equity offerings.
While they are recapitalizing, market participants will exert market discipline to ensure that the banks do not increase their risk profile.
According to a Guardian article,
[Spain's new premier Mariano]Rajoy admitted there was a worrying hole in the Spanish banking system with "latent and hidden losses" left by a burst housing bubble.The same is true for virtually every bank in the global financial system.
The new government would oblige banks to reveal the full extent of toxic real estate assets, valuing land and properties they have received from bankrupt builders at realistic prices.To do this requires the government to take two steps that the banking industry feverishly opposes.
First, it requires the banks to actually realize losses.
Second, it requires the banks to provide ultra transparency.
"There are still serious doubts about their balance sheets," he said. "We must clear up doubts about the value of certain assets, especially in real estate, which make access to the markets for the financial sector more difficult and also damage the credibility of our public debt."Clearly, Premier Rajoy understands that only ultra transparency can end the doubts about the banks' balance sheets.
Banks would be encouraged to sell off their growing property portfolios, a move that threatens to flood the market and drive down house prices. The property collapse has already left 750,000 newly built homes unsold.
He remained unclear, however, as to whether he favoured a state-backed "bad bank" to mop up all the toxic assets, or whether some banks might have their most toxic assets split off into individual bad banks.
A restructuring of the finance sector would probably involve a further round of consolidation. Restructuring would be completed by the summer, Rajoy said.Actually, by simply requiring the banks to provide ultra transparency, there is no need for banks to set up bad banks or for Spain to acquire all the bad assets from the banks.
Market participants can assess the risk of each bank and the bank can work to maximize the value of the troubled real estate assets (this might include restructuring the loans, auctioning the property....).
What is important is that the doubts about the bank are removed when ultra transparency is provided.