Saturday, September 1, 2012

Bankia provides lesson in how to make a bad situation worse

Regular readers know that a modern bank is designed to continue in operation and support the real economy even if it has negative book capital levels.

The reason this is true is that through deposit insurance, the taxpayers are the bank's 'silent' equity partners.  So while the 'balance sheet' might show a negative number, effectively the taxpayers are filling the shortfall through the deposit guarantee.

For their part, the deposits are stable.  This stability is independent of the solvency of the bank and reflects a belief that the government will honor its deposit guarantee.

So what happened to Bankia over the first half of the year?

For those who might have forgotten, Bankia is the subject of a bailout by the Spanish government.

Complicating matters is the simple fact that Bankia sold equity investments to many of its depositors arguing that these investments were as safe as guaranteed deposits.  Now, it turns out, that these investments are going to lose money.

Further complicating matters is the simple fact that Spain does not have access to the financial resources to bailout Bankia.  It has turned to the EU.  The last country to do so was Greece.

So what are the implications of these complications for Bankia?

Since Spain is following in Greece's footsteps, the concern that depositors have is that their deposits might be revalued into a currency worth half as much as the euro.  Spanish depositors see the efforts that Germany is making to kick Greece out of eurozone and cause it to return to the drachma and they are justifiably worried that Spain will also be kicked out and forced to return to the peseta.

Rather than wait to see if that will happen, Spanish depositors are taking their money and sending it abroad.  Last month, almost 5% (74 billion out of 1.5 trillion euros) of the deposits in the Spanish banking system left the system.

Since many of the Bankia depositors feel that they were duped into buying the Bankia equity investment, there is also the additional incentive not to trust the Bankia or the authorities and pull one's deposits.

I cannot tell you whether it is fear of loss from currency conversion or distrust, but according to the Guardian,
Bankia posted a first half loss of €4.5bn. Private sector deposits fell by €12.8bn, while client funds fell a whopping €37.6bn...
This is not a bank jog, but rather a bank run that Bankia is experiencing.

Please note that this bank run reflects the fear of forced currency conversion and the mis-selling of equity securities.  Both of these were easily preventable.

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