Spanish Banks Resist Idea of ‘Bad Bank’ Bailout

As investors raise the pressure on Spain to clean up its banking sector, some of the largest and healthiest financial institutions in the country are fretting over the impact that a bailout would have on their own valuations.

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In recent days, the conservative government of Prime Minister Mariano Rajoy and the Bank of Spain have been studying whether to allow banks to transfer toxic assets to a state asset management company, along the lines of the government-backed agency that Ireland set up for its troubled banks in late 2009.

The exact structure and size of such a transfer is being debated, as well as whether it would be guaranteed by Spain, or would need to be bolstered by rescue funds from international lenders, as part of a broader recapitalization of the Spanish banking sector.

Yet such a rescue plan is being resisted by the largest Spanish commercial banks, Santander and BBVA, whose exposure to the Spanish market is comparatively small thanks to hefty investments overseas, particularly in Latin America.

On Friday, Emilio Botín, the chairman of Santander, said at a conference in Murcia, in southeastern Spain, that he opposed allowing toxic assets to be parked in a “bad bank.” Such a strategy, he argued, was “not the solution” and would not improve the banking sector’s lending capacity. With Spain suffering its second recession in three years, some companies are closing or downsizing because credit has dried up.

A bad bank, Mr. Botín said, “would be something that would cost the taxpayer money and will not lead to providing more loans.” Instead, he called for “completing the restructuring” of the sector.

Many economists, however, consider that keeping afloat the most troubled savings banks, or cajas, will require fresh capital rather than more mergers and cost cutting. Bankia, a caja that is the result of a seven-way merger, is sitting on about 32 billion euros, or $41.9 billion, of troubled assets. Overall, the consolidation has already cut the number of cajas to 15 from 45 in the past two years.

Such mergers, however, “don’t remove the holes but simply pass them on from one institution to another,” Xavier Sala-i-Martín, an economics professor at Columbia University in New York, wrote recently on his blog. “The only thing that will work is fresh money, to recapitalize some banks that have no capital left, and since it’s clear that banks cannot raise sufficient private capital, that means there are only two solutions: bankruptcy or public money,” he added.

In February, Luis de Guindos, the Spanish economy minister, ordered banks to make an additional €50 billion in provisions against bad loans. Lenders are facing a sharp rise in mortgage defaults, with overall nonperforming loans recently reaching their highest level since 1994.

Last week, the credit ratings agency Standard & Poor’s downgraded11 Spanish banks, notably cutting to junk level Banco Sabadell, a commercial bank that took over a troubled caja as part of the government’s consolidation drive.

Meanwhile, in a report published last month, the International Monetary Fund warned that 10 banks—widely believed by analysts to include Bankia—needed “swift and decisive measures to strengthen their balance sheets and improve management and governance practices.”

The I.M.F. also encouraged Spain to consider taking over toxic assets from troubled banks.

Robert Tornabell, a professor of banking at the Esade business school in Barcelona, estimates that a state agency will need to take over and guarantee at least 130 billion euros of assets from Spain’s ailing banks.

By comparison, Ireland’s national asset management agency was set up to take over as much as 90 billion euros of toxic loans.

“The big commercial banks, Santander and BBVA, don’t want to be linked to the creation of a bad bank, and the government is clearly under their influence,” Mr. Tornabell said. “Instead of delaying further, Spain should bail out its banks as soon as possible to avoid further problems, not only for its banks but also for its reputation and overall economy.”

Indeed, the Spanish government is struggling on other fronts, notably how to enforce stricter fiscal targets on regional governments that accounted for two-thirds of Spain’s budget deficit slippage last year.

On Friday, S.&P. downgraded nine regional governments, including Catalonia, whose rating was cut by four notches to BBB- from A, bringing it close to junk status.

Some analysts, meanwhile, are warning that, even if Spain can salvage its banks alone, it must also ease the pressure on its sovereign borrowing costs by convincing international investors that their investments will not be threatened by a Greek-style bailout.

“Managing the fiscal imbalances and the banking-sector fallout of the ongoing credit cycle alone does not, in our view, require external official support,” analysts at Barclays Capital wrote in a report published Friday. “However, what the Spanish authorities cannot manage on their own is sustained, large capital outflows of the sort that have recently been experienced. If foreign investors continue to reduce their exposure to Spain at an economically disruptive rate, the country will require external financial support to manage this adjustment.”