Spanish worries mount as bank hoards cash

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A major Spanish savings bank has drastically increased its cash reserves in preparation for a sharp increase in loan defaults, it emerged yesterday, adding to increasing worries that the Spanish economy is set for a fall after a decade and a half of growth.

The cash-hoarding move by Caja Mediterraneo (CAM), one of the nation's biggest savings banks, came to light just two days after Llanera, a Valencia property developer, became the country's first major victim of the global credit crunch. The latter declared insolvency because it could not make payments on ¿748m (£518m) in debt it owed to Lehman Brothers and other international banks. Like Northern Rock, the developer was dependent on the short-term money markets that have seized up in recent months.

CAM's decision to park the entire ¿168m (£116m) profit it made from the sale of its stake in Metrovacesa, another property firm, into a reserve account rather than banking it as profit, is understood to have been made because of the company's expectation of a major increase in corporate and personal loan defaults.

The move, which nearly tripled CAM's cash reserves, will increase worries about Spain's economic prospects after 15 years as the eurozone's star economic performer. A CAM spokesman declined to make a comment.

In its latest review of the Spanish economy, the bank Caja Madrid predicted that the expected economic slowdown would be "more intense" than previously thought. The risk of recession had "increased notably" due to the effects of the global credit crunch and forced the bank to slash its GDP growth projections to 2.7 per cent for the year, as opposed to the 3.1 per cent being predicted by the Bank of Spain.

The Bank of Spain's governor, Miguel Angel Fernandez, has remained broadly optimistic about the economy's prospects and has repeatedly expressed the view that Spain's major financial groups, inherently more conservative than US and European peers, would emerge largely unscathed from the credit crunch. At a parliamentary hearing last month, he reassured Spanish MPs that the economy was on a solid footing and that it was set for a soft rather than a hard landing.

But he is looking increasingly lonely in his optimism. Worries have increased in recent months that the raging housing market that has fed the construction boom over the last decade is coming to a halt. House-price appreciation has slowed drastically since the beginning of the year and begun to fall in some regions.

The likelihood of knock-on effects is high. More than 800,000 homes were built in Spain last year, more than four times the 160,000 constructed in the UK. More than a third of those remain on the market, as increases to the Euribor interest rate have made it harder for Spanish buyers to get on the property ladder.

New housing starts have already dropped off from the high they reach last year. This could have serious repercussions for the banking sector – a third of the loans that banks have outstanding, about ¿280bn (£194bn), are to property and construction companies. These companies are the primary driver of the skyrocketing levels of corporate indebtedness that has many economist worried. Since 1995, corporate indebtedness has quintupled to more than ¿1,000bn (£693bn) – a sum greater than the country's entire gross domestic product, according to research from La Caixa bank.

Standard & Poor's, the credit rating agency, said that Spain was among the most vulnerable to the turbulence in the financial markets and that higher borrowing costs put its "overall growth prospects... at greater risk" than other European countries.

It added: "Higher mortgage costs may weigh on consumers' budgets, especially in countries such as Spain where household debt is particularly high."