3rd Oct 2022

Spanish finance sector to face reforms in return for aid

  • Madrid has been pressing to have the loans go directly to the banks. Berlin says No. (Photo: cuellar)

The European Commission on Monday (25 June) said it would begin preparations to bail out Spain's banks after a formal request by Madrid, with Brussels expecting financial sector reform and a fixing of the budget deficit in return.

"I have instructed our staff to step up their work to provide a clear assessment of the sector and its needs, as well as a proposal for the necessary policy conditionality that shall accompany the assistance," said EU economics commissioner Olli Rehn.

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Estimates by independent auditors suggested that Spain's banks will need up to €62 billion "are a good starting point for this work," he noted.

Initially the experts will make an assessment of the banks' needs, with Madrid's eurozone partners having recently offered to stump up €100 billion in loans.

The assessment will be followed by the drafting of the conditions - including the exact amount and interest rate - of the agreement. This is expected to be wrapped up at a meeting of eurozone countries on 9 July.

"I cannot tell you how the conditionality will be drafted," said Rehn's spokesperson.

He added that it "will affect the whole financial sector in Spain in terms of supervision and its regulatory framework." Officials from the European Central Bank and from the International Monetary Fund (providing technical expertise) will also work on the programme.

The country's banks got into trouble through the inflated property sector.

When the property bubble burst they were left with huge loans on their books. The power of local politicians over regional banks meant that the scale of the problem was for a long time obscured.

Spain - which made the request for help in a letter to eurozone chief Jean-Claude Juncker - has been insisting that its bank bail-out will not infringe on its national sovereignty, with past full-blown bail-outs to Greece, Ireland and Portugal resulting in every aspect of their economic decisions being determined by their international creditors.

But the strings attached to the bail-out are set to extend further than just to the financial sector.

Rehn noted that Madrid will be expected to ensure there are "sustainable finances" at both the national and regional level and bring its budget deficit within EU rules.

"Progress in these areas will be closely and regularly reviewed in parallel to the financial assistance," he said.

However, the fact that the EU aid will go via the Spanish state - and so onto its debt books - to the banks will make Madrid's attempts to reduce its budget deficit even harder.

Prime Minister Mariano Rajoy had been pushing for a change in the rules to allow the bail-out to go directly banks.

But Germany has been resisting. Last week, German Chancellor Angel Merkel said recapitalising the banks directly would mean outsiders would have no say over how the money is spent.

This means markets remain nervous and Spain's borrowing costs continue to be high.

Which bail-out fund?

Another uncertainty in the Spanish situation is which eurozone bailout fund will be used - the current temporary fund (EFSF) or its successor the permanent ESM, whose treaty may not be ratified in time.

Rehn's spokesperson said they were being "pragmatic" and using the instruments "at [their] disposal."

But there are differences between the two funds. ESM creditors have senior creditor status meaning that their loans get pay-back priority over other loans to the Spanish government, making Spanish government debt less attractive to private investors.

The EFSF, on the other hand, does not have this inbuilt seniority mechanism.

However, using this fund may cause problems in Helsinki, with Finland having indicated it wants collateral from Spain in return for its share of the loan from the temporary fund.

Merkel under pressure to move on Spain and Italy

With borrowing costs in Spain and Italy at unprecedented highs, Germany's Angela Merkel came under pressure at the G20 summit to let eurozone bail-out funds help them out.

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