Spain to approve new financial reform

The Spanish government was expected to unveil a new reform package for its troubled banks Friday in a desperate bid to convince investors that the sector is solvent and the country has a strategy to avoid the bailout fate of Greece, Ireland and Portugal.

The package, the second by the new conservative government in three months and Spain's fourth in three years, is expected to include measures obliging banks to increase provisions against bad loans. Plans for the creation of a new entity that would act as a "bad bank" and allow troubled banks to set aside their most problematic assets are also expected to be announced.

The government in February told banks to set aside €50 billion ($64.8 billion) in rainy-day funds to protect them against losses in the property market and elsewhere. Analysts say this could be raised to €80 billion, and believe the government might also oblige banks to increase provisions for healthy real estate loans.

Because the government is strapped for cash, it has little room to help rescue the country's banks. Fears that public finances might be overwhelmed by bailing out banks have led investors to consider Spain the next most likely European country to need an international bailout.

The government is also expected to disclose details on its nationalization this week of Bankia SA, the country's fourth-largest bank and the one with the highest exposure to bad property loans and other assets following a crash in the construction sector in 2008.

The Bank of Spain estimates that Spanish banks are sitting on some €184 billion in 'problematic" assets, either loans or foreclosed property. Bankia alone is estimated to hold €32 billion ($41.4 billion) of these assets.

On Wednesday, the government said it was taking control of Bankia by converting into shares the €4.5 billion ($5.9 billion) in loans it gave the entity in 2011 to fund its creation through a merger of regional savings banks. On Friday, the government is expected to announce a further injection of up to €10 billion to help keep the bank operating. That move could stir popular anger against the government, which has been making painful austerity cuts in key areas such as education and health.

Analysts welcome the measures but accuse the government of reacting too late to a problem that was diagnosed years ago.

Eduardo Martinez-Abascal, professor of Financial Management at IESE Business School said the Bankia move was a necessary step but one that should have been taken several years ago as other countries had done.

"Less money would have been needed and the confidence generated could have generated growth," he said.

Antonio Barros, Europe analyst for Eurasia Group, said that while the Bankia move and the reform will likely represent an important effort by the government to try dispelling doubts about the strength of Spanish banks, more needs to be done to regain market confidence.

"The successive rounds of financial system reform have not helped to build the necessary credibility for the system, and short of a big bang solution that specifies where the money to recapitalize the banks is going to come from, today's (Friday's) reforms might disappoint markets," Barroso said in a note.

Spain, the eurozone's fourth-largest economy, is in its second recession in three years and is battling to reduce a swollen deficit and 24.4 percent unemployment. The government is under intense pressure to reduce the deficit from 8.5 in 2011 to 5.3 percent this year and to Europe Union limit of 3 percent in 2013.

But the European Union painted a grim picture of Spain's economy hours ahead of the reform, saying the country's GDP will shrink 1.8 percent this year — compared with the 1.7 percent drop predicted by Madrid — and that the deficit will come in at 6.4 percent of output, not 5.3 percent, because of overspending by regional governments.

However, Olli Rehn, the EU's monetary affairs chief, said the European Commission has full confidence in the determination of the Spanish government to meet the fiscal targets.

He said that the key to restoring confidence and growth for Spain was to tackle the immediate fiscal and financial challenges with full determination.

"This calls for very decisive action in order to recapitalize the savings bank sector and restore its viability," said Rehn in Brussels. "This calls for a very firm grip to curb the excessive spending of regional governments."

Spain's stocks have been battered in recent months on growing worries that banks' bad real estate assets will hurt their earnings for a long time or even cause some of the weaker lenders — such as the regional savings banks, or cajas — to collapse.

On Friday, the benchmark Ibex index was down 1 percent. The index has fallen almost every day for more than a week.

Meanwhile, the yield on the country's 10-year bond remained near the dangerously high level of 6 percent. Yields are a direct measure of investor wariness of a country's finances. Rates of above 7 percent are seen as unsustainable in the long-run.


Daniel Woolls in Madrid and Rafael Casert in Brussels contributed to this report.