Bankia debt issue plan splits opinion

Posted on May 28, 2012

Last year the recently formed Bankia, a fusion of seven savings banks, announced its arrival to the Spanish public with the advertising slogan “our future together”.

Following news of its €23.5bn nationalisation, at a cost of about €500 for every Spaniard, gallows humorists were quick to observe that their futures are now intertwined with Bankia like never before.

    However, if one unorthodox and highly controversial plan being considered by the Spanish government goes ahead, the stricken lenders’ future will sit not only together with the country’s taxpayers, but with the balance sheet of the European Central Bank.

    While it is known that Bankia and its parent group BFA will need the largest bailout in Spanish banking history to survive, where that money is going to come from is still unclear, with Mariano Rajoy, prime minister, refusing to elaborate on Monday.

    With the country’s borrowing costs at their highest level since it abandoned the peseta, using bond auctions to fund the capital injection into Bankia-BFA would be expensive.

    As an alternative, officials are examining the possibility of directly injecting BFA with €19bn of Spanish government debt when the recapitalisation takes place in June or July in return for equity in the bank.

    BFA could then deposit these securities, or “IOUs” with the ECB in return for liquidity. It would then pass down the €12bn in new equity needed by Bankia by subscribing to its planned rights issue in the fourth quarter.

    Details from Madrid remain sketchy, but analysts and officials argue that if followed through, it could set a potentially important precedent for other eurozone countries that want to strengthen their banks without resorting to an international rescue.

    While some officials see the idea as a possible game changer, many observers doubt it would even be possible, considering the likely unease it would trigger in Frankfurt.

    Spain said on Monday that it had not yet even spoken to the ECB about the plan, and still considered funding the rescue by tapping the bond markets as its primary option.

    Banking analysts, meanwhile, have argued that it would be little more than a short- term solution that would fail to solve Bankia’s or Spain’s problems.

    “It doesn’t change the fact that the €19bn has come from somewhere. From a sovereign perspective you have just transferred the risk to the ECB on a short-term basis,” says Daragh Quinn of Nomura.

    While it would not be the first time a euro member has used depositing securities with the ECB to provide liquidity for its banks, existing comparisons are unflattering.

    Ireland provided the failed lenders Anglo Irish and Irish Nationwide Building Society with €31bn of so-called “promissory notes”, though they were ineligible to be placed directly at the ECB as collateral and had to be put though instead by Ireland’s own central bank.

    The ECB has refused to renegotiate the terms of the notes, which force Dublin to pay €47bn with interest over 20 years, meaning they are seen as a flawed and short-term solution.

    “The Anglo situation was for a company in run-off; it was being liquidated. It is not for a company that was a going concern, which is what Bankia is meant to be,” says Mr Quinn.

    The ECB had no comment on Monday about Madrid’s plans. But the central bank would want to make a clear distinction between steps to recapitalise Bankia and the liquidity it provides through its monetary policy operations.

    ECB policymakers would be sceptical about whether an injection of Spanish government bonds into Bankia is the best way to recapitalise the bank – but would argue that such questions are for bank supervisors to resolve. The ECB does not have bank supervisory functions.

    On accessing its liquidity, the ECB would make no special concessions for any country or individual financial institution but – equally – sees its job as to provide liquidity to banks as long as they are solvent and have adequate collateral, with the aim of ensuring they can continue day-to-day operations.

    Currently, the ECB provides liquidity lasting up to three months, but in Frankfurt there was confusion about how such relatively short-term funding could be used to boost Bankia’s underlying financial strength, as Madrid seemed to envisage.

    The ECB also stresses that its overriding task is to combat inflation in the eurozone – which means it has to keep open the option of withdrawing liquidity from the financial system at any time.

    In spite of such high levels of scepticism for an idea that has been public for little more than 48 hours, some financiers still believe the plan – described by others as “off the wall” – could become the model for peripheral eurozone governments and their troubled banks.

    One senior banker described it as a “brilliant” financial solution and added: “Once this is done, you will see a lot of people looking at this and copying it.”

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