Spanish banks avoid writing down toxic loans to reach capital requirements

What happens when regulatory forbearance meets higher capital requirements?  Bank capital ratios become completely meaningless.

The latest example of this is a CNBC report that Spanish banks are not writing down their bad debt in order to report higher capital ratios.

The proposed solution is the adoption of the Swedish model and the recognition today of the losses on the banks' balance sheets.  In proposing the solution, the speakers clearly indicate that the market can deal with bank continuing in operation that have negative book capital levels.

Spanish banks like BBVA are meeting regulators’ capital ratio targets by avoiding writing down toxic property loans, Anthony Fry, chairman of Espirito Santo Investment Bank U.K, told CNBC. 

Spain’s second-biggest bank BBVA released earnings on Wednesday which showed it had achieved a core capital ratio of 10.7 percent without tapping public money, as its profit fell 13 percent in the first quarter. 

“We are back in a slightly ‘smoke and mirrors’ situation, as these banks are strengthening their capital ratios as required but finding it extremely hard to do the write-offs they need to, because those write-offs have a direct impact on their capital ratios,” Fry told CNBC’s ‘Squawk Box Europe’ on Wednesday.... 

Moorad Choudhry, treasurer of RBS’s corporate banking division, said Spanish banks were yet to “reap out” the country’s real estate crash. 

“These banks have still got on their balance sheets, valued at par, property loans whose real value is probably less than 30 cents on the euro. So I think the Spanish banking sector hasn’t reaped out in full this real estate crash. That’s why we should be a little more concerned about Spanish banks,” he toldCNBC. 

Espirito's Fry said worse capital ratios and a "more realistic" appreciation of the value of the underlying assets would be preferable. 

“I think it is a real problem within the euro zone that some of the capital ratios required are actually unrealistically high for the state of the current markets,” he added.