Banks told to use earnings to clean up balance sheets

The government has indicated to Spain's banks that it wants them to use the earnings they generate to increase provisions for potential losses on the value of real estate assets they hold.

In an interview last week with the Financial Times, Economy Minister Luis de Guindos estimated the country's banks needed to make further provisions worth some 50 billion euros to cover their exposure to the real estate sector. "In the majority of cases, lenders can make these provisions using earnings [...] through a number of years," the minister said.

De Guindos' remarks were in line with those of Prime Minister Mariano Rajoy, who has expressed objections to setting up a so-called bad bank to absorb the potentially toxic assets of the banks.

The Bank of Spain, which estimates the country's lenders' exposure to the ailing property sector at 176 billion euros, in 2010 also insisted on the banks using earnings to increase their provisions for potential losses.

Increasing provisions would most likely force banks to cut down on dividend payments, a move that would go down badly in the sector. However, José Manuel González-Páramo, a member of the European Central Bank's governing council, and a candidate to take over as governor of the Bank of Spain, last year said banks should stop paying dividends in order to increase their capital. "I don't see anything sacrilegious in that," he said.

Lowering profits to increase provisions would also affect the remunerations of top management, another sore subject in the sector.

Banks unable to make sufficient provisions by drawing on earnings face the threat of nationalization. "Nobody wants to have the state sitting in on board meetings. Currently, given the depressed state of the stock market [to raise capital], it is more practical to make provisions, cut earnings and avoid public control," a top executive, who asked not to be named, said.

The first indication of the extent to which local banks heed the call for greater provisions could emerge on Thursday when Banco Santander unit Banesto is due to release its earnings report for last year.