On a wing and a prayer: Spain bank deal 'doomed'

Madrid failure to do enough is pushing the country closer to a bailout, say analysts

Spain's attempts to prop up its ailing banks are insufficient and Madrid will ultimately have to tap the European Union bailout funds in order to recapitalise its financial sector, analysts warned yesterday.

The Spanish Prime Minister, Mariano Rajoy, will announce plans today to require the country's banks to set aside an extra €35bn against bad loans made to its collapsing construction sector, on top of the €54bn they have already provisioned this year. The government is also set to establish a "bad bank" to remove some of the toxic assets from its lenders' balance sheets.

This follows its injection of €4.5bn in public equity into Spain's third largest lender, Bankia, this week. The Spanish stock market rallied yesterday in response, with the Ibex rising by 3.5 per cent. The hope among Spanish government officials is that these efforts will restore private sector confidence in the banking sector.

But analysts last night said that the latest package of measures are unlikely to calm investor nerves over Spanish banks since bad loans are likely to multiply as the wider economy continues to contract. "Private capital isn't going to touch Spanish banks with a ten-foot barge pole," said Nicholas Spiro of Spiro Sovereign Strategy. "The markets don't believe the provisioning requirements. The bigger the downturn, the less credible they seem. Spain almost certainly needs external help."

Marchel Alexandrovich of Jefferies investment bank also said that the bad loan provisioning move would not meet the concerns of investors. "All these things are predicated on an economy expanding and unemployment not rising and commercial property prices stabilising," he said. "People will look at it and question whether there will need to be a new rescue. Next week we'll be back to square one."

The Spanish central bank estimated earlier this year that the size of the hole in the balance sheet of Spanish banks arising from "problematic" property loans could be as high as €170bn, equivalent to 17 per cent of GDP.

Other private sector financial analysts have put the capital needs of Spain's banks at between €50bn and €100bn, still significantly more than the Madrid government is taking action to fill. One German official source yesterday indicated that Spain could, in extremis, tap the European Financial Stability Facility for funds to recapitalise its banks. "That's what it's there for. You can't set it up and then say it can't be used," said the source.

But Spain is believed to be resisting such a move for fear of losing control of its economy and financial sector to Brussels and Washington. "They don't want to be bounced into a bailout," said Mr Spiro. "They're terrified of the stigma and conditions."