Bankia Bailout Shows Conflicts for ECB as Supervisor

In December 2010, Bank of Spain inspectors delivered a report to their bosses about Caja Madrid savings bank that was grim: The bank faced losses of almost 5 billion euros ($6.8 billion) and needed new leadership.

By the time the central bank’s top policy makers delivered their recommendations to Caja Madrid, they no longer mentioned new management -- and the amount of losses had been pared by almost 2 billion euros.

The diagnosis was crucial because Caja Madrid was the biggest part of a nearly completed state-sponsored merger that would create Bankia SA, an entity so big that troubles there could -- and did -- cascade through the entire financial system. The result was a 41 billion-euro bailout for Spain’s banks, a bill that the country’s taxpayers will have to pay.

The incident, set out in previously unreported Bank of Spain documents, is critical now because applying the lessons from such banking disasters is at the core of one of the biggest projects in European policy making since the euro was founded. Mario Draghi’s European Central Bank will take over supervision of euro-region banks from national regulators in November this year in a bid to avoid a rerun of a crisis that nearly destroyed the common currency.

“Bankia is one of those instances which highlights why a super national regulator is really needed,” Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington, said in a phone interview. “Taking on what would become a political confrontation with Bankia was something that the regulators chose not to do.”

Crisis Snapshot

The analysis of Caja Madrid’s health in late 2010 provides one snapshot in the story of Bankia, whose rise and fall was one of the most dramatic episodes in the euro crisis. A National Court criminal investigation into Bankia’s collapse is due to focus in coming weeks on the Bank of Spain’s role, with four of its inspectors due to testify, court documents show.

Documents charting the issue include a 101-page report that the central bank’s inspectors filed with their supervisors on Dec. 3 after visits to Caja Madrid between March 2009 and September 2010; a Dec. 9, 2010, six-page summary they submitted to the Bank of Spain executive committee chaired by Governor Miguel Angel Fernandez Ordonez; and the four-person committee’s final recommendation to Rodrigo Rato, then-chairman of Caja Madrid, dated Dec. 14, 2010.

Inspectors’ Concerns

The documents show the inspectors had a range of concerns, which were trimmed from the central bank’s overall assessment as the health check of Caja Madrid progressed.

Ordonez, 68, who has not been accused of wrongdoing, declined to comment when contacted by Bloomberg News. Rato, who went on to become Bankia chairman, was named an official suspect on charges of false accounting, price fixing, fraud and embezzlement in the probe of Bankia’s collapse, in a 2012 court ruling. Rato, 64, has denied the charges.

One of the key tasks facing officials in late 2010 was coming up with an estimate of Caja Madrid’s bad loans as they figured out how to combine it with six other regional savings banks, or cajas. The idea was that the merged entity would be large enough to absorb the losses at the individual banks.

Both the inspectors’ complete report and the brief dated Dec. 9, projected 4.983 billion euros of previously unforeseen losses at Caja Madrid over the following two years, including 3.02 billion euros from the bank’s most problematic borrowers.

Loss Estimates

At its Dec. 14 meeting, the executive committee decided on its official recommendation to Rato: the loss estimate was 3.02 billion euros, stemming from the most troubled clients. The reference to 4.983 billion euros of losses was gone.

Another 2 billion euros of losses would have potentially wiped out Bankia’s reserves and eaten into the lender’s capital. When it filed for a July 2011 initial public offering, the prospectus said that after factoring in the loss forecast, reserves totaled about 1 billion euros.

Asked why the bigger forecast-loss number was removed at the Dec. 14 meeting, a senior official present said that the executive committee tended to include only its most solid concerns in advice to banks to avoid being challenged by a lender’s management.

Executive-committee members -- then-Deputy Governor Javier Ariztegui, Angel Luis Lopez Roa and Vicente Salas -- declined to comment on what happened at the meeting on Caja Madrid. They are barred from discussing the content of committee meetings under Spanish law, said a Bank of Spain spokesman, who also declined to comment. Other officials can attend meetings and join in discussions though they don’t get to vote.

Regulators’ Transparency

While declining to comment on the decisions that went into the health assessment of Caja Madrid, Ordonez provided a transcript of testimony on June 10, 2013, to the regional parliament of Valencia, where Bankia is based. He said regulators were consistent and transparent.

In dealing with the cajas, the Bank of Spain “applied to all the same strategy approved by parliament” and informed them of the problems it detected, Ordonez said. Officials were committed to “using transparency,” he said.

Some of the inspectors’ broader concerns about Caja Madrid had already been omitted in the senior supervisors’ Dec. 9 summary for the executive committee.

Missing from the summary were inspectors’ conclusions that Caja Madrid, then the nation’s second-biggest savings bank, understated its bad-loan ratio, broke an agreement with supervisors over reporting its impairments and needed a chief executive to compensate for the lack of experience of its chairman, Rato, a former finance minister.

Bankia Writeoffs

In the end, even the inspectors’ assessment fell short.

The bank rescue fund in 2011 wrote off all of the 4.5 billion euros of public funds it paid out to Bankia two weeks after the executive committee reduced its estimate for the lender’s losses; it also wrote off about half of the 18 billion euros it paid to save the lender in 2012. Investors in the 3 billion-euro IPO were wiped out.

Ordonez resigned in June 2012, a month before the end of his term -- and a month after Rato was pushed out -- as Bankia’s collapse forced Spain to seek the bailout.

The decisions taken by Spanish officials in late 2010 were made as politicians scrambled to reassure financial markets that Spain could survive without a European bailout. That may have encouraged some to downplay the threat to the financial system, said Alvaro Cuervo, director of the University College of Financial Studies in Madrid who has been a visiting professor at University of California, Berkeley, and New York University.

‘Political Weight’

“The Bank of Spain didn’t have the political weight to recognize the facts,” Cuervo, who has advised governments from both parties, said in an interview. “When the prime minister and finance minister are saying there is no crisis, it takes someone with a special character and self-confidence to break through that.”

Jose Luis Rodriguez Zapatero, the premier who stepped down in December 2011 after two terms, rejects any suggestion that Ordonez wasn’t his own man.

“Anyone who thinks you can pressure Miguel Angel Fernandez Ordonez doesn’t know him,” the former premier said in a Dec. 27 interview. “He’s one of the most independent people you could meet.”

Regulatory failings aren’t unique to Spain. Italy’s Banca Monte dei Paschi di Siena SpA has required 4.1 billion euros in rescue funds since 2009 after running into trouble under the leadership of former Chairman Giuseppe Mussari, a political appointee with no prior experience of running a bank.

ECB Challenge

The Spanish affair highlights the challenge facing Draghi as he assumes the role of banking supervisor. The Frankfurt-based ECB remains reliant on information from national officials, a relationship fraught with conflict in the struggle over the life and death of financial institutions.

One of its key concerns is the tension between local political interests and European overseers.

“I hope that European supervision, involving teams of supervisors from various nations, will provide a new paradigm that incorporates the best elements of each nation’s approach to supervision,” Sabine Lautenschlaeger, vice chairwoman-elect of the ECB’s supervisory board, told the European Parliament on Feb. 3. “This new approach will leave no room for a ‘home-biased’ supervisory regime.”

Ordonez’s successor at the Bank of Spain, Luis Maria Linde, said Oct. 28 that Spanish lenders can approach ECB stress tests this year with confidence after the government cleaned up the industry under the bailout program’s scrutiny.

Declining Risks

Investors are showing signs they share that faith. Spain today sold a 7.5 percent stake in Bankia for 1.51 euros per share, or 1.3 billion euros; the lender last month sold 1 billion euros of five-year bonds, double the amount planned. The cost of insuring against default has plunged, with Bankia’s credit-default swaps down to about 200 basis points from as high as 1,574 basis points in July 2012.

Spain is nevertheless still digesting the cost of the crisis as it recovers from nine straight quarters of economic contraction that ended in the second half of 2013.

Three years after they were issued, Rato cited the Bank of Spain’s official recommendations in his defense. During a November hearing on Bankia in the Catalan Parliament, lawmaker Josep Vendrell asked Rato to address the view that he must have known the lender was insolvent at the time of Bankia’s IPO.

“If you look at not just the reports of the auditors, but the reports that the Bank of Spain gave to the boards of those savings banks in December 2010 you wouldn’t reach that conclusion,” Rato said. “The forecasts for future losses that Bankia applied in its accounts in 2011 were those that the Bank of Spain set out. They couldn’t apply any others.”

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