Deposit flight from Spanish banks reaches new highs

As previously discussed and predicted by your humble blogger, deposit flight from the Spanish banking system continues to accelerate so long as the threat of deposits being converted to a less valuable currency hangs over depositors' heads.

The Telegraph reports that the Spanish banking system lost deposits equivalent to 7% of GDP or 74 billion euros last month.

Halting this deposit flight requires two policy changes.

First, the Spanish government must force the Spanish banks to absorb the losses on the excess debt in the Spanish financial system.  With the burden of the bad debt taken off of the Spanish economy, like Iceland's, the economy can resume growing and the possibility of needing to leave the EU recedes.

Second, the EU must use the bailout funds to backstop the Spanish deposit guarantee.  This increases the Spanish banks' access to central bank funding in euros and further reduces the threat of an involuntary conversion of deposit accounts to a less valuable currency.

Data from the European Central Bank shows that outflows from Spanish commercial banks reached €74bn (£59bn) in July, twice the previous monthly record. This brings the total deposit loss over the past year to 10.9pc, replicating the pattern seen in Greece as the crisis spread. 

It is unclear how much of the deposit loss is capital flight, either to German banks or other safe-haven assets such as London property. The Bank of Spain said the fall is distorted by the July effect of tax payments and by the expiry of securitised funds. 

Julian Callow from Barclays Capital said the deposit loss is €65bn even when adjusted for the season: “This is highly significant. Deposit outflows are clearly picking up and the balance sheet of the Spanish banking system is contracting.” 

Economy secretary Fernando Jimenez Latorre said Spain is in the eye of the storm right now with the “worst falls” in economic output yet to come in the second half of the year. 

Meanwhile, the Spanish statistics office said the economic slump has been deeper than feared, with lower output through 2010 and 2011. The economy slid back into double-dip recession in the third quarter of last year, three months earlier than thought.

Further evidence that the real economy of Spain is unable to carry the burden of the excess debt in the Spanish financial system.