IMF says Spanish bank recapitalization plan flawed

A Wall Street Journal article describes how the IMF is saying that the Spanish bank recapitalization is flawed because funds go through the government and not directly to the banks.

Channeling the money through the Spanish government is the least of the flaws in the recapitalization plan.

The more important flaws are

• In a modern banking system with deposit guarantees and access to central bank funding, banks do not need to have governments bail them out by injecting capital.  Banks are capable of absorbing all the losses on the excesses in the financial system today and rebuilding their book capital levels through retention of 100% of pre-banker bonus earnings.  The IIF suggested that this would take 4 years for the Spanish banks to do.

• Bailing out the banks is never accompanies with the requirement that the banks recognize all their losses.  As a result, the banks continue to support zombie borrowers to the detriment of creditworthy borrowers and the real economy.

• Governments have scarce resources and these resources should be used to support economic growth.  Bailing out banks is of no value if the economy goes into a depression.

• In the absence of ultra transparency and the requirement that banks disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, market participants will never believe the banks are adequately capitalized.  The absence of ultra transparency is a guarantee that the banks have something to hide.

From the article,

Spain said its crisis-hit banks will need as much as €62 billion ($78.75 billion) in new capital to absorb losses from a real-estate meltdown, as the International Monetary Fund warned that the euro-zone plan to aid the country may not work. 

Spanish lenders have been pummeled by a dive in property prices that hasn't yet bottomed out, as loans to households are going bad amid record-high unemployment. 

The cost of bailing out the banks will drive up Spain's debt load and threatens to freeze the country out of international markets, which could send shock waves across the euro zone. 

The currency bloc has promised Spain as much as €100 billion in aid, but because it will ultimately add to the government's debt load, investors have been dumping the country's bonds, driving up its funding costs. 

The IMF, which is a contributor to the European rescue programs and is providing technical assistance for the Spanish bank support, on Thursday came out sharply against the euro zone's insistence that any aid be channeled through the government. 

The euro zone needs to quickly set up a mechanism that allows it to directly recapitalize weak banks, "in order to break the negative feedback loop that we have between banks and sovereigns," IMF Managing Director Christine Lagarde said after a meeting with the bloc's finance ministers in Luxembourg....

A negative feedback loop that only exists because bankers need bailouts if they are to continue receiving their bonuses.

Earlier in the day, Spanish officials presented the results of stress tests by Oliver Wyman, a U.S.-based consulting group, which estimates that under an adverse economic scenario, Spanish banks would need between €51 billion and €62 billion through 2014, and by German consultancy Roland Berger, which estimates they would need €51.8 billion..... 

In an effort to shore up international confidence in its battered banks and to pave the way for euro-zone financial aid, the Spanish government hired the two consultancies to conduct stress tests on the sector's overall loan book to determine potential losses in base and adverse economic scenarios through 2014. The tests analyzed the sector's ability to absorb those losses and provided estimates of possible capital shortfalls in both scenarios. 

"The analyses are accurate, they're credible and they are manageable," said Spanish Prime Minister Mariano Rajoy at a meeting with local business leaders in São Paulo, Brazil.....

Just like the analyses there were done in Ireland, Greece,....

The latest plan to clean up the banking sector is Spain's fifth in three years. Some analysts questioned whether the new effort will be sufficient to shore up investor confidence. 

Phoenix Kalen, a macro credit strategist at Royal Bank of Scotland Group, said the €62 billion figure was lower than generally expected for worst-case scenarios. "Investors may have concerns that the stress tests weren't adverse enough," she said. "If investors could see the macro situation deteriorating more than is assumed in the worst-case scenario, they will question the [tests'] credibility."

Regular readers know that the only way to restore credibility is to provide ultra transparency.  With this information, market participants can independently assess the banks.  Confidence flows because market participants trust their own assessment.