Why it’s hard to shut down a Spanish bank

June 18, 2012

By Fiona Maharg-Bravo

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Joaquin Almunia, the vice-president of the European Commission, has prematurely weighed into the debate on possible conditions attached to the country’s 100 billion euro bank bailout. Before the rescue operation even began, he opined that liquidating a bank could make sense if the costs of keeping it alive with public money exceed the costs of shutting it down. This sounds sensible in theory. But in Spain, it’s not that simple.

Spain does not have a specific bank resolution scheme to deal with bank liquidation. The central bank’s preferred route has always been to intervene, clean it up, and then sell the troubled lender to a third party. However, it is technically possible for a bank to declare bankruptcy. The last to so this was the tiny Eurobank, nearly nine years ago.

Shutting down a bank in Spain would raise three problems. Shareholders are the first to suffer losses, followed by holders of preferred equity and subordinated debt. A large chunk of these subordinated instruments – 62 percent – is in the hands of depositors, according to Barclays estimates. In most cases they are the bank’s best clients, some of whom complain that the risks of these instruments weren’t properly explained. Wiping out retail holders risks triggering the deposit flight.

There may still be some ways of imposing pain. Some weak banks have stopped paying the coupon. Some others have been more creative. Holders of preference shares in bailed-out CAM, later bought by Sabadell, have been offered an exchange of Sabadell shares – at a 39 percent premium to the current share price – plus a cash bonus to be paid over four years.

The second problem is that imposing losses on senior debt holders without hitting depositors as well isn’t easy either. Senior debt holders in Spain, like elsewhere in the European Union, currently rank on a par with depositors.

Finally, winding down one nationalised lender might provoke panic in the banks currently on state support, hitting confidence in the entire system.

Little wonder the International Monetary Fund, in its recent report on Spanish banks, urged Spain to introduce a framework that can ensure an orderly liquidation. This is fair. But in the short term, not practical.

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