Investors and economists fear Slovenia will become the next victim of a bank blow-up, the latest in a string of banking woes in small European countries that have had a nasty habit of spinning out of control.
Slovenia, one of the smallest members of the 17-country euro zone, was one of the region's miracle economies that fell apart after the 2008 housing bust and recession. Its new government is now scrambling to raise money through privatizations and higher taxes to shore up its banks and avoid an international bailout.
It may not work. Mai Doan, economist in London at Bank of America Merrill Lynch, said there is a "meaningful risk" of a combined Slovenian sovereign and banking bailout worth €6-billion ($7.9-billion) to €8-billion ($10.5-billion), a big figure for a country with a gross domestic product of about €45-billion.
The amount might have to be partly financed by a Cypriot-style "haircut" on bank depositors.
"I wouldn't discount it entirely," Ms. Doan said, noting that a haircut on the senior debt at Slovenia's leading banks would not make a meaningful contribution to any bailout because the amount outstanding is too small.
Slovenia is not Cyprus – the assets of its banking sector are only 140 per cent of GDP, compared to 700 per cent for the Cypriot banks, which were rescued in March by a €10-billion bailout and a haircut on depositors' bank accounts that may reach 60 per cent. But the Slovenian banks could still pose a grave risk to the economy and deliver another blow the tentative euro zone recovery if the rescue goes wrong.
Bank rescues have been land mine fields in small European countries. Last year, a slow-motion bank run in Greece greatly accelerated just ahead of the June general election, threatening to cripple the lenders, bankrupt the country and send it hurtling out of the euro zone. The Greek banks, which are merging, were saved by emergency liquidity injections from the European Central Bank and postelection political stability.
Spain's banks were next. The Spanish government requested a €100-billion credit line from the euro zone countries to recapitalize its weakest banks, victims of Europe's biggest property collapse. In late 2012, Spain drew down €40-billion of the amount.
Then came the Cypriot rescue, which broke the bailout pattern by imposing a tax on deposits over €100,000. The Cypriot bailout, which came far too late, was so damaging financially and politically that it is expected to end Cyprus's status as the Mediterranean's premier financial services sector and keep the economy in recession for years.
Slovenia is under international pressure to accept a bailout for fear that the government's go-it-alone strategy will backfire, boosting the costs of a rescue and destabilizing the wider European markets. The Institute of International Finance, the global banking lobby, has urged the country to seek support from the European Stability Mechanism, the region's permanent bailout fund.
On Friday, Olli Rehn, the European Commission's economic chief, said Slovenia might be able to avoid a bailout if it moves quickly to get its financial house in order. "The stock of problems is not as vast as for many countries," he said at a new conference. "Slovenia's economic situation is still manageable provided decisive action is taken without delay."
Slovenia was hit particularly hard by the financial collapse and recession, in good part because of plunging property values and sharp economic downturns among its top trading partners – Italy, Hungary, Croatia and Serbia. The economy contracted by 2.3 per cent last year, and is expected to shrink 2 per cent this year and stay in recession in 2014.
The banks, largely owned by the government, are suffering from burgeoning portfolios of non-performing loans as the recession deepens. Moody's recently said that the banks' "bad" loans have reached 28 per cent of total loans. The non-performing loans likely will be hived off before the banks are fully recapitalized. A bailout is probably not imminent, if only because Slovenia managed to raise $3.5-billion (U.S.) in a bond sale last Thursday, even thought Moody's had cut the country's sovereign debt rating to junk on the previous day.
To buy more time, the government is pushing ahead with privatizations and tax increases, with uncertain outcomes. The government wants to unload Telekom Slovenia, the largest telecom company with a market value of about €650-million, and NKBM, the money-losing bank.
But the combined value of Telekom and NKBM is well less than €1-billion, meaning their sale will not go far to cure Slovenia's bank bailout shortfall. To raise more income, the government will boost the sales tax and launch a "crisis" tax on wages, even if the tax hikes risk deepening the recession. "Fixing the banks is our main priority since they are essential for an economic recovery," Prime Minister Alenka Bratusek said on Sunday.
There are considerable doubts whether Slovenia will be able to raise enough money to fix its banks and keep its debt under control. Ms. Doan said Slovenia has "meaningful structural problems, low appetite for reform and high social resistance to austerity." In other words, an international bailout may be coming.