Spain’s Economy Is Main Risk for Nation’s Banks, EU Says

Spain’s economy is weighing on Spanish banks and is the “main risk factor” as lending shrinks and real estate prices fall, the European Union said.

“Lending to the real economy is still contracting at a rapid pace against the backdrop of weak solvent demand for new lending and a large increase in the banks’ holdings of government securities,” the European Commission, the EU’s executive arm, said today in its fourth review of Spain’s compliance with terms of a banking industry bailout. The government needs to keep pressing for changes, and the banks should continue to improve their solvency to underpin lending, the report said.

Spain took 41.3 billion euros ($55.8 billion) in European aid last year as real estate linked losses at former savings banks such as the Bankia group threatened government finances. Rising bad loans and shrinking lending at Spanish banks show they still face challenges to profitability after a property crash that led the industry to take 87 billion euros of impairment charges last year.

The report, after a joint European Commission and European Central Bank team visited Madrid in September, said that Spain’s compliance with the program, together with government changes designed to enhance growth, was accompanied by a return of investor confidence. Shares (POP) in Spanish lender Banco Popular Espanol SA have jumped almost 80 percent since the end of June.

‘Positive Trends’

Even so, “a continuation of the positive trends is needed for the successful completion of the program according to the planned timetable,” the report said. European finance ministers said last week they supported Spain’s decision not to request more bank aid after the program ends in January.

Spain needs to continue efforts to make the economy run more efficiently “to reap fully the expected positive growth and competitiveness effects from the reforms,” the report said, noting there are still risks to the government meeting its 2013 deficit target.

Given weak economic growth, banks need to “follow prudent policies” to maintain or increase capital ratios, the report said, adding that limitations set by the Bank of Spain in June on cash dividends paid by banks was “very welcome.” While banks have benefited from improved funding costs, they haven’t passed on their lower costs to customers, the commission said.

The report called the level of deferred tax assets on bank balance sheets an “area of concern.” Under new regulations known as Basel III, the deferred tax assets, which built up during Spain’s financial crisis, will have to be deducted over time from capital ratios. The Spanish government is working to avoid the banks having to take the deduction, the report said.

Spain still needs to tighten governance of savings banks, as required by Spain’s bailout accord, said the report. The terms of the bailout oblige Spain to give incentives to the savings banks, known as cajas, to gradually divest their controlling stakes in the lenders that they still own.

To contact the reporter on this story: Charles Penty in Madrid at cpenty@bloomberg.net

To contact the editor responsible for this story: Frank Connelly at fconnelly@bloomberg.net

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