Report on Spanish Banks Underestimates Cost of Potential Bailout

Report on Spanish Banks Underestimates Cost of Potential Bailout

Stress Test Calculation Is Up to 60 Billion Euro Lower Than Real Cost of Rescue
October 01, 2012

WASHINGTON, D.C., October 1, 2012 — A report last week said Spain’s banks could require as much as 53.74 billion euro in bailout funds, but an investigation by Matthew Melchiorre, the Warren Brookes Journalism Fellow at the Competitive Enterprise Institute, found the cost to be more than twice that much.

In a post at OpenMarket.org, Melchiorre discussed two fundamental problems with the findings of Oliver Wyman, the U.S.-based consulting firm that conducted the tests:

1) The report changes the capital adequacy requirement between simulations of different economic conditions. Oliver Wyman offers two different scenarios spanning the course of 2012-2014 — one baseline and one adverse. The report uses a 6 percent tier 1 capital adequacy requirement for the banks under the adverse scenario but uses a 9 percent requirement for the baseline case. Changing the capital adequacy requirement between simulations creates incomparable results. The switch is also unrealistic. The European banking regulator requires 9 percent now, which almost certainly will become even more institutionalized under the proposed Eurozone banking union. Wyman’s 6 percent requirement underestimates the banking system’s capital shortfall in an adverse economic situation.

2) The report is overgenerous in estimating the profitability of Spain’s banks. In 2011, total profit generation by Spanish banking groups was 11.43 billion euro. That’s an almost 50 percent decline from the previous year’s figure of 20.3 billion. If this trend continues through 2014, which seems likely given Spain’s growing financial problems, total profit generation will amount to a mere 12.09 billion euro. Yet Wyman’s analysis estimates total profit generation at 59 billion euro—a 46.91 billion euro difference.

After accounting for these discrepancies, Melchiorre recalculated the potential bailout figure at 113.31 billion euro. The most optimistic scenario, in which profits are higher, calls for a bailout of 90.86 billion euro.

“The Wyman report is a gross underestimation of Spain’s financial needs,” Melchiorre wrote. “As political leaders rejoice and neglect to question the flawed assumptions underlying the report’s predictions, their cognitive dissonance towards the bust Spanish banking system will become increasingly apparent.”

>> Read Melchiorre's full commentary here.