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Spain shows the cost of postponing pain

Allowing crippled banks to fudge their loan losses is not the way to deliver a healthy banking market.
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About two years ago, an investment banker told this magazine that the €30bn loan losses then being disclosed for Spain’s cajas (savings banks) were a gross underestimate. He estimated the actual losses at €150bn to €200bn.

An understandably nervous press officer asked us to take the comment on background. But today, the official figure acknowledged by Spanish regulators has vindicated our nameless banker, reaching €180bn.

What did Spain gain from postponing the revelation of the full extent of losses? In theory, time to repair the damage with fresh earnings, and to spread the cost of state intervention. But as the US discovered during the Savings and Loan crisis in the 1980s, leaving crippled banks to continue their business can be like doubling up on positions in a falling stock market – the losses just keep getting bigger. Spain has still been forced to seek outside help, despite the delay.

Any possible gains have been far outweighed by what was lost. First, the chance to tackle the problem at a time when the global economy was recovering rather than slowing, and before Greece had started to exhaust the patience and resources of the German taxpayer. Second, and perhaps far more important, confidence. The confidence of depositors now removing their savings from the savings banks. And the confidence of financial markets now unwilling to trust pronouncements from the cajas or the Spanish authorities.

In this year’s Reith Lectures for the BBC, economic historian Niall Ferguson argued for a more Darwinian approach to policy on financial institutions – less regulation, more extinction. Managed extinction would certainly have been preferable to artificially prolonging the existence of too many cajas chasing too few lending opportunities.

But better regulation can also help. As our researchers found when preparing this year’s Top 1000 World Banks ranking, the rules for reporting and impairing non-performing assets are unclear, with huge variations between jurisdictions. This opens the door to the doubling-up trap – avoiding impairments today in the hope that asset and collateral values will recover in the future.

Unlike the dinosaurs, human beings are aware of the evolutionary process, and those threatened by it will always attempt to slow it down. The Basel committee has a long to-do list, but tougher and more standardised rules on the measurement of bad assets should be high up that list. Depositors, regulators, investors and bankers alike all need to recognise the dinosaurs earlier, before they start to drag down the mammals.

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Read more about:  Analysis & opinion , Western Europe , Spain