Toward the end of the bailout

For the moment provisionally, but soon, it seems, definitively, Brussels is saying that the Spanish bank bailout is going to conclude with success (and in passing, the full bailout of Ireland as well). The optimistic views of the European Union’s commissioner for economic and monetary affairs, Olli Rehn, must be understood in terms of probability. Even so, it is a welcome message both for the Commission itself and for the Spanish government.

To celebrate the triumph, however, we must wait until November 15, when the final European decision will be announced. Meanwhile, the Bank of Spain is carrying on its “shadow test” of the refinancing of doubtful loans as demanded by the ECB. It would come as no surprise were the Spanish monetary authority to conclude that the system needs further provisions of between five and six billion euros, a limited amount of capital easier now to raise in the markets. Especially if the excellent conditions for debt issuance remain in place. At Tuesday’s Treasury auction, one-year bills yielded under one percent, a sign of the new, less stressful conditions for Spanish assets.

A few observations are not out of place to better understand the interplay between the ECB, the Bank of Spain and the Spanish financial system. Bank recapitalization as Brussels sees it may be concluded, but between the end of this year and the beginning of 2014 the ECB will be subjecting European banks to new solvency tests to gauge the present capital situation of the European banking industry.

This is why the Bank of Spain’s “shadow test” is being carried out. After this test, another, more important one will come. The European Banking Authority (EBA) will set in motion its “stress tests,” that is, subjecting the balance sheets of banks to a simulated deterioration of economic variables. This will be the big yardstick, which may signify a change of trend for credit.

However important the optimistic message from Brussels may be, and whatever the improvement in the capital structure of Spanish and European banks, lenders will not be prepared to re-establish the flow of credit in favorable conditions as long as there are no guarantees in place that capital reserve requisites will not be changed. If the EBA and the ECB consider that the present recapitalization is insufficient to cope with worse economic conditions, it will have to raise capital requirements, and the banks will need more capital and time before they can renew normal lending. If the test result is favorable, credit may begin to flow again within a reasonable period of time.

For these reasons, Rehn’s message is only a first step: it certifies that the Spanish banking industry has complied with the requirements demanded by the European Union. And this is why it is of great importance not only that the stress test be of unquestioned credibility, but also that the European authorities calculate with great precision exactly when to publish the results so as to give time to the banks — or to those that may find it necessary — to procure the capital they need.