Setting BANKIA as the standard for provisioning might lead to disaster

MADRID | Bankia’s Chairman brilliant performance in transforming the hole he found in his company as an opportunity to ransack the public coffers, has turned him in government’s shadow financial policy maker. His recipe to cure banking ills will receive little praise in economic circles. But it sounds extremely simple and effective. Writing down bad loans resorting to taxpayers’ money amounts to a rather dull endeavour. Bur indulging in such a practice for building up a solid buffer to cover potential contingencies you might, or not, incur in future, stands as a sharp idea.

The shortcoming of this rather unconventional wisdom lies in the devastating effect it might have on the financial system should it be put into practice by everyone. Just think about residential mortgages. They currently show a rather outstanding repayment ratio, doubtful loans amounting to less then 3% on average. And yet, fresh provisions planned in BANKIA for this safe-end portfolio implies that up to 10% might eventually go wrong.

Similar precautionary measures are implemented for corporate lending. All

in all, should others follow this path, extra requirements would represent no less than 15% in GDP terms.

Such a move would imply massive public involvement transferring the onus to sovereign risk premium. In the same shot, it would also put under severe stress  even the most solid institutions around. Such a bleak scenario hardly provides the faintest hope for the country to avoid resorting to bail out. But once the idea has been floated and apparently well received by government, one fears it might lead to a general enforcement of the BANKIA model. Even if such a standard is not introduced on a mandatory basis, it will set a precedent for future restructuring schemes.

Increasing provisioning beyond reasonable levels only can provide the false sentiment to ring-fence the financial system against any kind of potential threat. In fact it would dig its graveyard by sharply reducing its lending capacity and trimming down its margins. Only economic recovery can put banking solidly back on track, especially if efforts are also undertaken to prop up productivity, reducing operating costs and enhancing its obsolete business model. Entrenching yourself deep under the surface in a stubbornly defensive stance has hardly ever proved the good strategy to win a war.

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About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.