Spain steps up reforms to ward off bailout (News Feature)

By Sinikka Tarvainen Jan 25, 2011, 13:23 GMT

Madrid - Spain is stepping up economic reforms aimed at warding off an international bailout that could threaten the stability of the euro.

In the latest such move, the government announced Monday that it was accelerating a sweeping overhaul of the country's savings banks, known as cajas, which are regarded as the Achilles' heel of the Spanish banking sector.

The government was also reported to be close to an agreement with trade unions on pension reform.

Spain is the eurozone's fourth-largest economy - much bigger than that of Greece and Ireland, which have already been forced to seek bailouts, or Portugal, which is widely seen as the next candidate to do so.

Spain's borrowing costs soared after Ireland's finances caved in after a property bubble meltdown and loan losses among its banks - problems that Spain also suffers from.

If financial market trust in Spain collapsed to the point of the country needing to be rescued by the European Union and International Monetary Fund (IMF), that would require much bigger funds than the previous bailouts, and could eventually threaten the euro itself.

Prime Minister Jose Luis Rodriguez Zapatero's Socialist government has tried to shore up the economy with austerity measures worth more than 50 billion euros (68 billion dollars). It also launched labour market reforms that sparked a strike in September.

The government is currently trying to hammer out an agreement with trade unions, which oppose its plans of raising the retirement age from 65 to 67 years.

Financial markets, however, are more concerned about the state of the cajas, which hold about 40 per cent of bank assets in Spain, as well as billions of euros in bad loans after lending heavily to the housing sector before it collapsed in 2008.

The government has pumped in about 15 billion euros into the savings banks from the recently constituted bank restructuring fund, FROB, and from a deposit guarantee fund.

It also forced a wave of mergers that reduced the number of cajas from 45 to 17.

However, those measures turned out to be insufficient in solving the cajas' liquidity problems and Economy Minister Elena Salgado has now announced tougher reforms to 'dissipate any doubt' about the solvency of the Spanish banking sector.

Cajas and other banks will be required to have a minimum core capital ratio of at least 8 per cent, compared to the current 6 per cent.

That goes beyond the targets required by 2019 under the Basel III capital adequacy rules, making Spain one of the world leaders on bank reserve requirements, analysts said.

Cajas, which will be unable to raise sufficient capital on the open market by September, will be injected with liquidity by the FROB, which will take stakes in them for up to five years.

Such interventions by the FROB would imply the partial and temporary nationalization of the cajas in question. It would also oblige them them to adopt structures similar to those of traditional banks.

Such a transformation, the government believes, would reduce the influence of local politicians and increase financial transparency.

Salgado estimated the Spanish banking sector's new capital needs at no more than 20 billion euros. Some other estimates, however, have been much higher.

Most of the savings banks will end up being taken over by the state, the economic daily Expansion predicted. It hailed the reform as a step 'in the right direction.'

However, Spanish banks' shares fell Tuesday on the Madrid stock exchange, indicating that the reform had failed to convince investors.

Salgado on Tuesday estimated Spain's 2010 budget deficit at 9.2 per cent. That is down from a deficit of 11.1 per cent in 2009, but still way above the EU threshold of 3 per cent.

Spain's 20-per-cent unemployment is the highest in the EU, and the IMF predicts a growth of only 0.6 per cent for this year.

At the same time, however, market pressure on Spain eased after successful bond auctions recently. Analysts point to Spain's relatively low public debt and the growth of exports as signs that the economy is beginning to recover.