“It’s unfair that this examination has only been applied to Spanish banks”

Economy Minister Luis de Guindos has not won many friends among Spain's bankers. The discontent in the sector because of the harshness of the stress tests applied to the banks by independent consultant Oliver Wyman is considerable. Above all, in the case of those banks that have seen their future plans truncated by the capital requirements the audit indicates they need, and even more so for those lenders that will be forced into mergers or are nationalized as a result.

Only five years ago Spain had 57 savings and commercial banks. After Oliver Wyman's examination of the books of 14 lenders, the ongoing process of consolidation is expected to leave only eight to 10 players in the sector.

The habitual comment among bank executives is that if the same tests were applied to other European countries under the extreme macroeconomic scenario used by Oliver Wyman, many of them would fail. "It's unfair that this examination has only been applied to the Spanish banking system and not those of Germany, France, the Netherlands, Austria, etc.," Intermoney chief economist José Carlos Díez says. "A significant reclassification and valuation of the toxic assets they hold would mean many of these banks would require big amounts of capital. But as you know, big countries do not break the rules; they simply change them."

The problem facing Spain is that in order to sanitize its banking system, which has been so badly damaged through its exposure to the now moribund real estate sector, it has had to borrow money to do so. Britain, the Netherlands and Germany refloated their damaged lenders with their own money.

In Europe, there are too many skeletons in the cupboards of the banks"

When you ask for a loan, lenders attach conditions for granting it, and those contained in the Memorandum of Understanding when Spain signed up for a bailout of up to 100 billion euros from Europe are very tough. The banking crisis in Spain has been in effect for three-and-a-half years and Europe doesn't want any more delays, because what is ultimately at stake is the future of the euro itself.

The European Commission also does not want to see the banking sector remain paralyzed, restricting lending to companies and households amid international investor fears that their balance sheets are rotten with toxic real estate assets. Robert Tornabell, a professor of banking and finance at the ESADE Business School, likes to recall the comment of José Viñals, the director of the IMF's Monetary and Capital Markets Department, who said: "In Europe, there are too many skeletons in the cupboards of the banks."

Viñals should know what he's talking about when it comes to Spanish skeletons because he was deputy governor of the Bank of Spain between 2006 and 2009.

"The Oliver Wyman tests are a form of remedial surgery," laments the director of a bank with insufficient capital. "Probably after them, half of the institutions in the financial system will disappear. It's unfair because at the start of the crisis only 30 percent of the banks were in a bad situation, but with the provisioning requirements imposed by the government, we have suffered more than what is reasonable."

It's like taking a very aggressive medicine before falling sick"

The Economy Ministry's position is that at this stage of the crisis, after so much incorrect or absurd information, the markets will only accept drastic measures. Whether or not this helps restore confidence is still up in the air for some. "I doubt confidence will return in the short term," says Jordi Palafox, professor of economic analysis at the University of Valencia. "The banks have a problem with their reputation and this is not going to be resolved overnight. What is needed is a good run of quarterly earnings. The government is looking for a miracle and international investors don't believe in miracles."

In 2006, Palafox resigned from the board of Bancaja, one of the Spanish lenders most badly hit by its exposure to the property sector.

Alfonso García Mora, a partner at the Analistas Financieros Internacionales (AFI) think-tank, believes the key lies in getting the economy going again and to finding a floor for the deterioration in bank assets. The government expects the economy to contract 0.5 percent this year, but some experts believe the fall in activity will be more than double that.

One of the bankers most critical of the stress tests is Banco Popular Chairman Ángel Ron, who believes the whole process will weaken rather than strengthen the banks and add confusion to the situation. "I don't know if it is the right medicine," he says. "It's like taking a very aggressive medicine before falling sick." Some analysts attributed Ron's response to the fact that Oliver Wyman identified capital shortage at Popular of 3.223 billion euros. Popular has insisted it does not need a bailout from the state and can meet the requirements itself by selling off assets.

The next phase of nursing the banks back to health will be the creation of a bad bank

However, the University of Valencia's Palafox says: "Ron's remarks forget what brought us to the situation: lethal parsimony in dealing with the problems on the part of the banks, and serious errors of analysis on the part of the Economy Ministry as well as the Bank of Spain."

Analysts doubt Popular's ability to meet the capital requirements by selling off assets or attracting investors, particularly since the wholesale markets are virtually closed to all but the biggest lenders, which are precisely those that do not need more capital. "It's going to be difficult for them to achieve this," Intermoney's Díez says.

AFI's García Mora agrees, but with a significant rider. "It's going to be hard in the short term but the established timeframe [for meeting the requirements] - until June - is sufficiently ample to allow for some window of opportunity if the situation in Europe improves. You have to bear in mind that the banks are currently trading at very attractive ratios, so that if there is visibility in the medium term, it could be an interesting moment for investors."

The other problem facing the banks in terms of their capital requirements is that the preference shares they hold on their books will be subject to a significant haircut.

The next phase of nursing the banks back to health will be the creation of a bad bank to absorb the toxic assets on their books, a process that is expected to be up and running by December. Only assets that have been provisioned for or are valued at a level above the book value dictated by the government will be transferred. The process could take as long as 15 years.

"After the creation of the bad bank, lending will still cease to grow because the levels of private indebtedness are still high. The prices of assets will keep falling, as happened in Britain and Ireland," one expert says. "Banks that sell lots of toxic assets to the bad bank won't become viable overnight."

ESADE's Tornabell, who has closely studied the Swedish banking crisis, advises Spain to follow the same steps as those taken by the Scandinavian country. "The Swedish government put real estate salespeople in charge, not banking executives. In eight years they recovered the capital invested and taxpayers did not have to bear any losses. It's not important that Spanish real estate companies lose money. What's important is cleaning up the balance sheets of the banks so that they can start lending again."