No Good News on Spain's Bad Bank

Madrid clearly needs to do more to restore confidence in its banking system. Spanish banks now rely on the European Central Bank for 11% of their funding, according to UBS research. That reflects a deep loss of confidence by the bond markets--a big problem for a banking system with a deposit shortfall of €545 billion ($722 billion) relative to the value of its loans. Without access to markets, banks will continue to deleverage.

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Removing legacy assets from bank balance sheets could help revive confidence in the system. But crucial details have yet to be worked out: Who will decide which assets should be included and how they should be valued? Who will provide the equity for the new vehicle? How will it be funded? How can Madrid ensure the participation of all the Spanish banks? What if the exercise reveals deep capital holes in some institutions?

Three conclusions seem clear. First, any "legacy asset vehicle" will work only if there is a full external audit of the loan books of all the Spanish banks, as there was in Ireland. Second, the scale of the transfers should be big enough to eliminate the banking system's reliance on ECB funding. Third, the equity to fund the new vehicle needs to come from outside the system and not, as has been suggested, from the banks themselves.