Busch: Madrid we Have a Problem

The 10 yr German-Spanish debt spread has widened to 218 pts after a reports have circulated regardingSpanish banks massive borrowing from the ECB and the potential for an IMF, EU and US led $250 billion loan to the country (later denied).

Yesterday, the European Union warned Spainthat it would have to be more aggressive with their austerity measures to cut their deficit 11.2% of GDP to 3% in 2013. Then the chairman of the country's second largest bank BBVA, Francisco Gonzalez had this startling comment: "Financial markets have withdrawn their confidence in our country….For most Spanish companies and entities, international capital markets are closed."

These developments point to continued stress in the region with the spotlight shifting from Greece to Spain/Portugal. As the BIS recently reported, banks headquartered in the euro zone area had $727 billion of exposures to Spain vs $206 billion to Greece. Clearly, “snowballing” problems in Spain would have larger consequences than Greece.

Who has the largest exposures?

Debtor Nations
Debtor Nations

At the end of 2009, French and German banks had $958 billion of exposure to the residents of Greece, Ireland, Portugal and Spain.

This was 61% of all reported euro area banks’ exposures to those economies according to the BIS.

“French and German banks were most exposed to residents of Spain ($248 billion and $202 billion, respectively), although the sectoral compositions of their claims differed substantially. French banks were particularly exposed to the Spanish non-bank private sector ($97 billion), while more than half of German banks’ foreign claims on the country were on Spanish banks ($109 billion).”

Another fun fact, Germany had $33 billion and France had $48 billion of exposure to public sector of Spain.

Since regulators around the world are focusing on increased capital requirements for banks, let’s take a look at the joint Tier 1 capital exposures to the region. The combined exposures of German, French and Belgian banks to the public sectors of Spain, Greece and Portugal amounted to 12.1%, 8.3% and 5.0%. The combined exposures of Italian, Dutch and Swiss banks to the same public sectors were equal to 2.8%, 2.7% and 2.0%. For Japan, the ratios are 3.4% Spain, 1.2% Greece and 0.7% Portugal. The killer stat: the exposures of US banks to Spain, Greece and Portugal were less than 1% of their Tier 1 capital.

The emphatic point is that Europe is exposed to Europe with France the poster child for exposure to Spain. The excessive central bank borrowing by Spanish financial institutions from the European Central Bank highlights the stress. As Spanish Deputy Finance Minister Carlos Ocana succinctly said, “The situation is a problem." Europe needs to rigorously stress test their banks and release their findings as soon as possible. Then, they need to inject capital to shore up the ones that need it and close the ones that can’t be saved.

This is the best way to reduce uncertainty and restore stability to the financial system. Until then, we’ll continue to see spreads widen, bank borrowing from the central bank increase and fears over an impending collapse of a major European financial institution rise.

Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.