Capital injection into Spanish banks is a 'sticking plaster' solution

The Telegraph fired the first volley by the mainstream media saying that the Spanish bank bailout is not credible.

Regular readers are not surprised by the conclusion that the bailout lacks credibility as in the absence of ultra transparency no one knows how large the hole is on the Spanish bank balance sheets.

In fact, no matter how much capital is unnecessarily injected into the banks, no one will think it is enough in the absence of ultra transparency.  If it were enough capital, then the banks would provide ultra transparency and disclose on their current asset, liability and off-balance sheet exposure details so market participants could independently confirm that fact.

No ultra transparency equals confirmation that the policymakers, bank regulators and banks have something to hide.

With Spain's property bust far from bottoming out, any capital injection being discussed by European leaders for Spain’s banks is merely a sticking plaster.... 

the situation that is now playing out in Spain is one that risks the very firmament of the entire European financial sector. Although at the time of writing the early stages of a plan to rescue the Spanish banking system appeared to be coming together, there is no guarantee that the capital that will be injected will be enough. 

Without this guarantee, why would anyone care about the capital injection.  In fact, if a bank receives a capital injection it is a sure sign to depositors that they should run to the bank and withdraw their money as quickly as possible.

Over the weekend we learnt the true extent of the problems within the banks themselves as a result of the International Monetary Fund’s own detailed investigations.

The IMF does not have any information that Spain's national regulators are not privy to so their detailed investigations are meaningless.

On top of that, two further probes are looking at specific issues within the country’s financial system with the hope of devising a bail-out that will not only plug the current gap, but account for further losses.

Ireland has tried this several times without success.  There is no reason to believe that Spain will be any more successful.

The Spanish predicament is, as was the case in the US with the subprime mortgage collapse that fuelled the 2008/9 financial crisis, property-led. 

Recent data from the Knight Frank Global House Price index shows that Spanish residential properties fell by 7.3pc in the year to the end of March. Official Spanish data state that prices are down 20pc from the peak, but those figures are based on bank valuations, rather than actual sales. 

Anecdotal evidence suggests that the fall from the top of the market is closer to 30pc, but how much further can prices go?

In spite of the small but growing number of articles in the British media that ask whether now is the time to buy Spanish property, it is likely, if the case of Ireland is anything to go by, that values will fall by as much as 50pc from the peak before they begin to bottom out.

If Ireland is an example, the decline from the top of the market has already reached 60pc.  Since the Irish banks have not cleared their balance sheet of their non-performing real estate, it can be safely assumed that the decline in real estate has much, much further to go.

As a result, an increasing number of critics believe that the capital injection being discussed by European leaders for Spain’s banks is merely a sticking plaster, rather than the deep and detailed stitches and wound care its financial system clearly needs. 

In a recent research note, economists at investment bank JP Morgan estimated that despite the €40bn (£32.4bn) or so that many in the market believe Spain’s banks need to be adequately recapitalised, the full requirement could be as much as €350bn once all is said and done.

Please note, that Spain's banks do not need to be recapitalized today.  Nobody believes that their current book capital levels are accurate.

So long as the Spanish banks have deposit guarantees and can access central bank funding, they can continue to operate and support the real economy.

What Spain should do is to require its banks to recognize all their losses and provide ultra transparency.  Subsequently, the Spanish banks can rebuild their book capital levels by retaining 100% of pre-banker bonus earnings.