Spain to Give Up Control of its Banking System

By FX Empire Analyst - Barry Norman
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Spain will be forced to secede most of the control over its banks to European institutions—and will be required to impose losses on local investors—in return for a bailout €100 billion ($123 billion), according to the draft agreement accompanying the rescue.

The requirements, some of which can be to remain explosive politically, recommend that holders of junior bonds and preferred shares issued by bailed-out banks will incur losses. Analysts said a significant proportion of such investors in Spain are small depositors who bought the securities through the banks' branches.

The conditions absolutely are a first glimpse into what would be the brand new framework for euro-zone banks once a new, powerful supervisor is established—as leaders of the 17 euro countries agreed with a summit in June.

The leaders said for the summit that the stricter euro-zone oversight system for lenders would be a precondition for allowing their bailout fund to directly inject money into struggling banks, rather than funneling the cash through the government—a move that could eventually help Spain avoid an even-larger rescue.

In the short run, however, the bailout agreement, a copy of which was seen by The Wall Street Journal and on which finance ministers are required to sign off by on July 20, gives a taste of the existing level of control that governments should give up in exchange for euro-zone assistance.

Policy makers say they hope stringent stress tests and tighter oversight coming from the European Commission, the EU's executive, and the European Central Bank will force banks to finally resolve a brutal meltdown of real-estate prices in Spain and recognize the losses from mass defaults they manufactured.

After the stress tests, which should be accomplished by early autumn, banks which have capital shortfalls will either have to raise that cash on the market or request help from the government, which by then will have use of the bailout money.

But crucially, the banks won't get taxpayer funds until they have come up by having burden-sharing arrangement with investors. According to the draft document, those investors include simply not only equity holders, but additionally owners of hybrid capital and subordinated debt. 

The idea behind this exercise, for which Spain still maintains to produce a legal basis, usually is to limit how much taxpayer-funded bailout money that has to be pumped into the banks. 

However in the case of Spain, such arrangements may still hit ordinary citizens directly, as hundreds of thousands of them bought preferred shares in local banks. Holders of senior debt aren't mentioned in the document, implying that they may escape losses for now—as they've in other large bank rescues in Europe in recent years.

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