Draghi’s realism

The European Central Bank (ECB) has left its key intervention rate unchanged when some thought it would lower it, given the deterioration in the economic prospects for 2012. It also failed to announce a new round of three-year liquidity injections as it had done in December and February, although it guaranteed unlimited short-term funding for 2012. Mario Draghi’s appearance to explain this dearth of initiatives has served to make the ECB’s discontent with how the Spanish banking crisis is being handled manifest. Draghi’s take on the situation is simple and intimidating. Any request on the part of the Spanish government for a bailout should be based on a “realistic assessment” of the Spanish banks’ needs, and, of course, accompanied by the imposition of conditions. This would also be the case even if Germany’s idea of a “soft bailout” for the Spanish banking system prevails.

The definition of a “soft bailout” is a euphemism that signifies that strict conditions will be demanded of the Spanish banks. It is likely that they will not be as demanding as the conditions imposed on Portugal, Ireland and Greece, but will undoubtedly impose restrictions on economic policy. And that’s without mentioning the demands that will be made for further fiscal consolidation, a reduction in the debt levels of the banks, and strict controls on pay in the sector. Germany and the European Commission will have to define how the injection of capital is to be carried out.

The idea of a soft bailout coincided with Economy Minister Luis de Guindos’ clarification that any request for external funding would be decided after the International Monetary Fund (IMF) and the independent auditors have delivered their reports on the Spanish banks. This interval, which should not be drawn out because of the financial limbo in which it finds itself, is nonetheless to be welcomed because of the accumulation of confusing and contradictory messages that have weighed upon impressions of Spain’s solvency.

The Spanish government, by dint of comments by Prime Minister Mariano Rajoy and De Guindos, has moved from a position of unconditioned support for German Chancellor Angela Merkel’s insistence on austerity at whatever cost — and a rejection of a European bailout for the Spanish banks — to one of lavish declarations in support of a European banking union, a direct injection of capital into Spain’s banks and the creation of eurobonds. But a banking union is a long-term project that will require, among other things, complex negotiations to unify European legislation. The financial reform that Brussels envisages in the long term calls for the creation of a European version of Spain’s Orderly Bank Restructuring Fund (FROB), funded by the banks themselves.

Spain’s banks need funding with a certain degree of urgency. Regulations governing the use of the European Stability Mechanism (ESM) do not permit the direct injection of capital in financial institutions, and time, therefore, will be needed to agree the necessary legal amendments to make this possible. The government is giving the impression that it believes an urgent problem can be resolved through long-term measures. In that it is misleading people.