After passing a budget 2013 that stipulated €40 billion in austerity cuts, Spain released the results of an institution-by-institution audit of its banks. These stress tests revealed a capital shortfall of €59.3 billion, which is in line with speculation over the last couple of days. With the road cleared for a recapitalization of its banks and a budget that was designed along with Brussels in order to comply with “strict conditionality,” Spain is set to formally request a bailout from the ECB and the European authorities.
The blocks keep on falling into place. Friday brought one of the final and most important ones for Spain, the results of the financial sector stress tests. Under an adverse scenario, the Spanish banking system would face a €59.3 billion capital shortfall, with major institutions like Bankia (already bailed out) needing to raise €24.7 billion, Catalunya Caixa requiring €10.8 billion, and Novagalicia €7.2 billion, among others.
There seems to be no reason now why Prime Minister Mariano Rajoy will delay the formal bailout request further. ECB chief Mario Draghi understood the inherent risk in rapidly rising Spanish borrowing costs, and developed a bond-buying program that required troubled sovereigns to adhere to conditionality (i.e. further austerity); to tap this funding, troubled sovereigns would have to formally request it and accept this conditionality.
Rajoy, in order to avoid losing face with his constituency that is already suffering the slings and arrows of an intense economic crisis, developed a budget that took into account recommendations from European authorities and further austerity.
Having given Brussels and Draghi what they asked for, Spanish authorities were waiting to get a clearer image of the health of its financial system. The EU had pledged €100 billion to recapitalize Spain’s ailing banks, but Madrid needed the results of a stress test to figure out how much each institution needed. A previous, bird’s eye audit executed by Oliver Wyman and Roland Berger revealed a capital shortfall of between €51 and €62 billion.
European authorities have already given Spain their blessing. In the aftermath of the budget release, the EU’s economic chief, Olli Rehn, said Brussels liked Madrid’s “concrete, ambitious and well-focused” plans. On Friday, the EU Commission welcomed the result of the stress tests, noting that bank recapitalization could begin in November, according to Trade the News. The release, minutes after the announcement of the stress tests results, also noted government aid would be determined in coming months. This suggests that Madrid has been working with the Commission and other European authorities behind the scenes to figure the whole thing out.
The recapitalization of the financial sector is an integral part of fixing Spain’s problems. Just like the U.S., the Spanish economic crisis came from a housing bubble. In the depth of the financial crisis that brought the global economy to its knees, U.S. authorities conducted stress tests on major banks including JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Morgan Stanley and Goldman Sachs. Then Treasury Secretary Hank Paulson forced the banks to take capital. With the recapitalization of its banks, Spain will attempt to curb the vicious cycle that formed between its financial sector and its deteriorating sovereign debt.
The next step appears to be a formal bailout request to the ECB and the European Commission. This will probably take the form of a bond buying program using the Emergency Stability Mechanism and the ECB to help push down borrowing costs via both primary and secondary purchases of Spanish sovereign debt. The timing is now uncertain, but previous speculation by Barclays’ analysts indicated it should occur by October 19, if not before.