On March 30, the Spanish banking system experienced its first significant rescue since the government took control of Banesto in 1993. The Bank of Spain dismissed the management board of Caja Castilla La Mancha (CCM), and named new supervisors to take over the institution. As part of the deal, the government of José Luis Rodríguez Zapatero approved guarantees from the Public Treasury that enable the government to provide a maximum of 9 billion euros in guaranteed loans to CCM, so it can meet its obligations to depositors and creditors.

Until that moment, Spain had not undergone any baking rescue operations during the current crisis, but it had approved various measures for supporting the liquidity of the sector — particularly government guarantees of up to 100 billion euros in 2009. The situation has been different from other countries in the euro zone, where governments were obliged to intervene much earlier in order to save some of their banks. The German government, for example, will buy an 8.7% share in Hypo Real Estate Holding, the first step toward nationalization, after that commercial real estate institution recorded a loss of 5.46 billion euros, which was more than anticipated.

A Very Unfavorable Environment

Spain’s delinquency rate has tripled since the outset of the financial crisis in 2007, which put an end to the country’s real estate boom and raised the unemployment rate to 15.5%, the highest in the European Union. The economy is undergoing its worst recession in half a century, and the Bank of Spain itself is forecasting that the economy will contract by 3% this year.

Because of CCM’s high exposure to the real estate business, this intervention plan was worked out following the failure of negotiations to merge CCM with Unicaja, an Andalusian institution. That deal would have triggered a process in which certain savings institutions in healthier condition would have absorbed other institutions that are weaker. According to Juan Antonio Maroto Acín, professor of financial economics at the Complutense University in Madrid, “From a political point of view, intervention means changing the system which small savings institutions [normally] use in order to resolve their problems; namely, being taken over by another institution of greater size that absorbs the institution in trouble so their ‘dirty laundry’ is not aired in public. From a financial point of view, the intervention in CCM reapplies the system used during the Spanish banking crisis of the 1980s: dismissing the management and naming provisional supervisors from the Bank of Spain itself.”

Consequences of Intervention

Miguel Ángel Fernández Ordóñez, governor of the Bank of Spain, explained that the intervention in CCM was made in order to avoid a “convulsion” of the financial system, which was facing risks in the bond market and a withdrawal of deposits that could have provoked a “collapse in liquidity.” Nevertheless, Maroto believes that the intervention is, above all, “related to [Spain’s] image because, financially speaking, [CCM] represents, on average, less than 1% of the total assets of the Spanish banking system.” Maroto argues that the message sent by the national regulator is important: “The Bank of Spain is keeping watch over the solvency of the system, while also applying a solution that has been proven and successful on similar occasions, and whose temporary character permits it to avoid possible criticism of interventionism.”

Along the same lines, Juan Mascareñas, professor at the Complutense University of Madrid and an expert in mergers and acquisitions, believes that the intervention “should not have any significant consequences for the Spanish financial system, apart from the usual ups and downs of the market whenever there is intervention in an institution.” According to Mascareñas, “The financial market recognizes the condition of Spanish banks and savings banks quite well, and already counts on the possibility and probability that various savings banks can be involved in interventions.” He notes that the reason for this is that “[CCM’s] management took on too much risk and they had to pay for their excesses…. They knew this or, at least had a reasonable idea that it would happen.”

For José Ignacio Galán, director of the University of Salamanca’s chair for management of Latin American companies, intervention “is a warning that shows the situation is real.” From the viewpoint of the financial system, this deal is marginal but it makes clear the necessity for professionalizing activity in savings banks, and for finding an optimum scale of operation. “This will demand the updating of current legislation, which is obsolete and behind the times, in a way that provides incentives for transparency, professionalism and efficiency that are compatible with [a bank’s] raison d’être and its fundamental goals, which are social goals and the sustainable development of the [geographical] areas where it is active.”

For months, CCM, which operates in Castile and La Mancha, attracted attention among analysts because of its high rate of delinquency and its high exposure to the troubled real estate and homebuilding sectors. In 2008, CCM’s rate of non-performing loans was about 5%. Its consolidated net profits dropped 87% for the year to 30.6 million euros. According to CECA, the Spanish Confederation of Savings Banks, CCM ended January with 16.953 billion euros in deposits, compared with loans of 19.643 billion euros. According to CECA, CCM suffered customer withdrawals amounting to 312 million euros in the last month.

With the intervention, the Bank of Spain takes total executive control of CCM, since its entire board of directors has been let go. Spanish regulators don’t have any detailed roadmap for how to move forward under these circumstances. There are various options for the future of CCM. Mascareñas explains, “For now, the institution will be managed in a technical way, although since this is such a bad situation, this does not guarantee its future long-term viability; the Bank of Spain is not going to permanently manage [CCM] because that is not what its mission is. The ultimate result can be that another saving institution absorbs CCM or that CCM liquidates its assets and disappears because commercial banks cannot be owners of savings banks.”

A system That Is in Doubt

The intervention of CCM has reignited debate over the validity of the Spanish savings bank system, which plays a large role in the country’s financial markets. The 46 savings banks in Spain, whose management and governance boards participate in local communities and city councils, are not traded on the stock market, with the exception of CAM, the Mediterranean Savings Bank, which issued shares during the summer of 2008. According to the CECA, the entire savings bank sector ended January with a balance of customer loans of 911.894 billion euros, compared with customer deposits of 786.717 billion euros.

Mascareñas summarizes the peculiarities of the Spanish savings bank system: “The savings banks have practically the same characteristics of the [major] banks except that while the banks try to maximize value for their shareholders, savings banks try to maximize the value of their ‘social activity.’ This value is targeted to projects that are socially interesting, and which don’t try to achieve financial returns. Nevertheless, the savings banks are controlled by the political power of the Autonomous Community in which they operate, as well as by the politicians of the specific party that influences them (or which they influence); that is where they are going to dedicate their funding for social activity. Finally, they have become a financial tool of whichever party governs the region. In addition, part of that money can be used to buy shares of private-sector companies. This indirectly enables the governing political power to wind up influencing the control of the private companies whose shares they control,” he asserts.

For Maroto, “The advantages of a savings bank are the advantages of any neighborhood retail bank that has close ties with the area where it is established, and which deals with the financial needs of individuals, and of small and midsize companies.” Its shortcomings, however, are “the concentration of risks in any institution that has a smaller scale of operations, and its excessively close ties to the public administration of cities and localities that wind up thinking that the savings bank in their territory is ‘their savings bank.’”

The advantages of a savings bank system, according to Galán, are its close ties to the area where it is established and its commitment to social activity in its respective geographical area. However, Galán says, its challenges are “the absence of the incentive of ownership [in the bank] when decisions are made; and the mixture of economic and political interests that generate a margin for [excessive] managerial discretion and the loss of efficiency.” All of this, he says, “damages competitiveness and any possibility of competing with private banks in a way that is increasingly more global, and that benefits from the strong incentive of financial markets and ownership.” This problem “will become more accentuated after the economic and financial crisis, and the necessary restructuring that the sector is experiencing.”

Options for the Future

Amidst this debate about the pros and cons of the savings bank system, Spanish politician Miguel Ángel Fernández Ordóñez has demanded a legal change that would enable these institutions to broaden their financial base “at least with as much facility as the [commercial] banks can do that.” When Ordóñez appeared in front of the congressional committee for the economy and finance in order to explain the Bank of Spain’s intervention in CCM, he noted that several regulatory modifications need to be made in the financial sector in order to improve its functioning, and to avoid new problems similar to what happened with CCM. Among those changes, he said, was the possibility that savings banks can more easily expand their financial base. He considered it “fundamental” to exhaust “all private solutions” to the problem of an institution “before asking taxpayers for money.” In the opinion of Ordóñez, “We have to move toward a convergence” in the way savings banks and banks function.”

Mascareñas recalls that “the topic of privatizing savings banks has been under consideration in some of Spain’s political parties but this subject remains locked up in a back drawer whenever they win the elections.” Mascareñas advocates removing politicians from the management boards of savings institutions. “Politicians, as a general rule, are bad managers of the money of savers because they forget where the money they manage came from. They think that it is their money, not the money of citizens, so the first thing to do should be to remove politicians and labor unions from the management of savings banks. You have to remember that the managers of savings banks aren’t scrutinized in the marketplace; they cannot be fired when they do a poor job of managing because the only people who are aware of their bad results are [working for] the Bank of Spain.” In his view, the possible solutions to this peculiar situation would be “to give control to depositors; something like mutual aid societies,” as well as “to eliminate the savings banks and convert them into private banks.”

When it comes to the option of consolidating the savings banks, Maroto argues, “the fact that a financial institution is small doesn’t mean that its decisions are wrong or that the bank’s are too concentrated.” According to Maroto, “The problem comes when these decisions are affected by political considerations that alter the technical decision-making.” He adds, “The question is not, therefore, one of greater concentration but of less political intervention, and of recovering the balance between interest groups defined by LORCA (the Organic Law for Regulation of Savings Banks). [That balance] has been altered by earlier legislatures of various local governments.”

Maroto believes that “political managers must not play any role in financial institutions.” Nevertheless, “If they have to do so from afar, they should be vigilant that their resources are managed efficiently and that results are governed by transparency, profitability and social utility through taxes or endowments to society, as in the case of savings banks.”

Galán believes that “it is probably inevitable” that there will be a merger process within the savings bank sector. However, he recognizes that this is “a complex and controversial topic because of the mixture of economic, geographical and political interests.” He explains that “in comparison with banks and from the viewpoint of the marketplace, the consolidation of savings banks can lead to synergies and economies of scale, which would lead to a more focused and efficient structure.”

Regarding the future of the Spanish financial system, Galán notes that, on the one hand, “banking institutions will continue with their ownership and decision structure but will become gradually more sensitive to the social realities that surround them.” On the other hand, “savings banks will gradually become more professional and will have management structures that are more and more robust and further removed from political interests, and which maintain the important and noble goal of social activity.

“This is the world toward which we are converging,” he predicts. “Given the idiosyncrasies of each kind of institution, both [kinds of institutions] will survive and coexist in the future. Any financial institution that neglects one of the key aspects will not survive either because the marketplace ousts it from competition or because society finds it unacceptable.”