The problem of preferred shares

The financial reform which the government had planned to disclose after the recent Cabinet meeting does not enjoy the approval of Brusssels. The most important obstacle is the solution it proposes for the preferred shares issued by banks now in need of public aid. The reform is in line with the demands imposed by the EU authorities for the granting of a line of credit of up to 100 million euros, to recapitalize the Spanish financial system.

The memorandum that defines the conditions of the bailout stipulates that the public cost of the recapitalization be minimized. That is, that the shareholders and creditors of the aid-receiving banks must bear the pertinent losses, before receiving funds proceeding from European taxpayers. And this rule would apply to investors in preferred shares.

These financial instruments were used by the banks to obtain funding in substitution of, or as a complement, to the intake of conventional deposits. Their extensive marketing, especially among individual customers, was not always carried out with sufficient transparency; nor was it always the case that those who signed up for them were fully aware of their nature.

Though the contracts included the information formally required on the risks associated with these shares, the fact is that in many cases the bank employees who marketed them did not sufficiently warn the subscriber of the erosion that the product’s value might eventually suffer.

Large numbers of small-scale savers were trapped in instruments of this sort, and now find that the money they invested has lost a great deal of its value. Brussels does not allow them to be compensated beyond the level set by the market. The conflict between defense of consumers, in this case small savers, and the EU’s demand that the investors share the losses, threatens to add further stresses to those already visible in some banks, as is the case in those which have been nationalized.

In this the government faces an important conflict. Regardless of whether or not the reform decree establishes new conditions for the marketing of this type of product, differentiating for example between individual and institutional clients, those who already possess preferred shares will have to be offered a form of compensation compatible with the demands of Brussels.

This is no easy matter. In the absence of bilateral agreements, under whose terms some scheme of barter for other instruments might be the most acceptable solution, a general judicialization (that is, a proliferation of lawsuits) could place further stress on the already attenuated confidence in the Spanish banking system.

It is desirable, then, that together with the financial reform it is about to announce, the government should tell us what its guidelines are going to be in arranging a solution to a problem that is more than just a minor spasm of the Spanish banking crisis.