It took a priest in southern Spain to remind the world that the European banking industry might be on the verge of another disaster.
The Rev. Santiago Gomez Sierra, the chairman of CajaSur, a regional savings bank in Cordoba, began his last board meeting last week with a prayer. Several directors performed the sign of the cross. No miracle happened. Within hours CajaSur, controlled by the Roman Catholic Church, was seized by the Bank of Spain.
When the markets reopened on Monday, something close to investor panic set it. Bond and equity markets sank. Bank shares plunged, and the euro took another beating. By the end of the week, the markets had stabilized, but the message was clear: All was not well in the Spanish banking industry and the pain in Spain, the euro zone's fourth largest economy, could delay, even wreck, Europe's recovery.
While CajaSur itself is small, representing just 0.6 per cent of Spain's banking assets, it is part of the wider system of 45 savings banks that together control half of the country's banking assets.
The country's cajas - a group of 45 regional savings banks - matter to Spain, the euro zone (the 16 European Union countries that share the euro) and the wider international markets because credit growth is closely linked to economic growth. Without the credit provided by the ailing cajas, Spain's recession-stricken economy might not improve, or may improve only slowly. If that happens, the quality of Spanish assets could deteriorate even more.
Fitch Ratings on Friday cut Spain's credit ratings to double-A-plus from triple-A, saying its economic recovery would be more muted than the government forecast due to strict austerity measures passed this week. The downgrade follows a cut last month by another agency, Standard & Poor's, and heaps more pressure on the government, battling to reassure markets that its fiscal, political and social woes will not end up in a Greek-style debt crisis.
The cajas lent freely during Spain's boom years, but are now weighed down by excessive exposure to the country's busted real estate and construction market.
The banks are finally being restructured, a full two years after it was apparent to any investor or economist paying attention that Spain's property market, once Europe's hottest, was ruined. Two cajas, including CajaSur, have been seized by the Bank of Spain. A third of the 45 cajas are merging. A few will probably get bought by the big banks. A government fund called Frob, worth up to €99-billion ($128-billion), will help them fund the merger costs and reinforce their equity.
The delayed response could cost Spain, and the rest of Europe.
"If the current restructuring process is slow, or the problems within the financial institutions are not addressed, we run the risk of having a sizable chunk of the Spanish banking system acting as a zombie for the next three to five years," said Jose Manuel Amor Alameda, a partner in Madrid with AFI, a financial and economics consulting firm. "This would have enormous repercussions for the macro picture in Spain and in the euro zone."
Mohamed El-Eiran, chief executive officer of Pimco, one of the world's biggest bond funds, has a similar view. "A small bank in a small country has indicated to the rest of the world that the whole European banking system is under pressure," he told the Financial Times.
Spain's go-go years, which ended even before the Lehman Bros. collapse in September, 2008, were funded in the capital markets by the sale of almost €1-trillion of securities, some of them mortgage-backed bonds issued by the banks. Forty per cent or more of these securities are owned by European banks, pension funds and other institutional investors. "That is why Spain is so important to the euro zone," Mr. Amor said. "Even though there is no political or fiscal union, the links between the financial systems and economies are so deep."
By European banking standards, the cajas are odd little beasts. Their roots go back to 16th-century Italy, where Franciscan monks set up Mounts of Piety - not-for-profit pawnshops - where advances were made against collateral such as jewellery. They were replicated throughout Europe and eventually evolved into savings banks, where the focus was on giving inexpensive loans to the masses and helping community development. In Britain in later years, they would become known as building societies; in France they were the caisses d'epargne; and cajas de ahorro in Spain.
The modern cajas are supervised and run like commercial banks but have no private owners and do not issue public shares. Instead, they are mutually owned by stakeholders such as regional and city governments (CajaSur was the only Church-controlled caja) and distribute some of their profits to charities and community projects.
According to a report by three Spanish economists - Antonio Cabrales, Juan Dolado and Jose Garcia-Montalvo - the cajas were instrumental in stoking the property bonanza that ultimately got them into trouble. Traditionally, home ownership was not part of the family asset mix in Spain. The cajas helped to change that by using ultracheap mortgages to compete with the big banks, such as Santander and BBVA, and extend their reach into communities. At times they offered house loans at a mere half a percentage point above Libor - the London interbank offered rate. The theory, said the economists, was to get customers for life: "The nearly zero gains made on mortgages could be compensated via commission on other financial products."
The construction boom bankrolled by the cajas made Spain Europe's job creation engine in the first six or seven years of the last decade. Research by Morgan Stanley said Spain added 2.8 million houses over five years. Then came the bust, leaving 1.5 million unsold. In the suburbs of the big cities, fully built housing estates remain abandoned. Spain's official unemployment rate, at 20 per cent and rising, up from 11 per cent in late 2008, is a direct result of the housing collapse.
The cajas are feeling the pain. As a whole, they are thought to be solvent, but there is no doubt the dud housing collateral is hurting them. The Bank of Spain says banks overall held doubtful assets worth €97.5-billion or 5.3 per cent of total credit. The figure doesn't seem outrageous, but may mask the true extent of the problems at the cajas, which are heavily exposed to real estate. Total loans by all banks to real estate companies is €454-billion, or almost half of Spain's gross domestic product. Of those loans, the non-performing loan ratio is about 10 per cent.
Opinions vary about Spain's ability to skirt a banking crisis, one that could cripple the Spanish economy. Some say the cajas will muddle through. Others think the cajas' problems will deepen as real estate values keep sinking, potentially resulting in their inability to fund themselves. That scenario could trigger Europe's second banking crisis on a continent already reeling from the Greek debt horror.
With files from Reuters
Cajas in a bind
Number of Spanish savings banks (cajas)
Total number of caja employees
Portion of total Spanish banking assets controlled by cajas
Total Spanish banking assets
Up to €99-billion
Value of restructuring fund for cajas
Total Spanish bank loans (regular banks and cajas) to real estate companies
Ratio of non-performing loans to real estate companies
Total mortgage loans to households
Spanish GDP in 2009
Spanish unemployment rate
Sources: Morgan Stanley, AFI