Staring down a Spanish bank stampede

Investors dumped shares and flocked to "safe haven" investments such as US and German bonds, as they fretted that European leaders appear incapable of cobbling together a strategy to stem the region’s deepening banking crisis.

In Brussels, the European Union floated the idea of a "banking union” that allow troubled banks to borrow directly from the eurozone’s bailout fund, and would guarantee deposits in all eurozone banks.

But this idea has little support in countries such as Germany, Finland and the Netherlands, which are reluctant to have their taxpayers pick up the tab for bank failures in other countries. Overnight, a spokesman for German Chancellor Angela Merkel repeated Berlin’s opposition to allowing the bailout fund to pump money directly into banks.

European stock markets were hardest hit, with Paris dropping 2.2 per cent, Madrid losing 2.6 per cent, while Milan and Frankfurt both finished 1.8 per cent lower. At the same time, borrowing costs for Spain and Italy continued to climb. Yields on 10-year Spanish bonds hit 6.7 per cent, as investors worried that Madrid would be forced to seek a bailout in order to rescue its crippled banking sector.

The Spanish government now faces increasing pressure to conduct an investigation into the collapse of Bankia, following the troubled lender’s urgent €23.5 billion ($US29.1 billion) bailout.

Earlier this week, the head of the Bank of Spain, Miguel ngel Fernndez Ordez, who has faced intense criticism for failing to realise the magnitude of the problems that Spain’s banks would suffer following the collapse of the country’s real estate bubble, announced that he will step down from his post a month early.

Overnight, he lashed out at what he said was a ‘smear campaign’ against him in the wake of the Bankia bailout. "Nothing would be more gratifying for me than to explain the version of the Bank of Spain but I think this would not be the moment to do so,” he told Spanish parliamentarians.

The Spanish government of Mariano Rajoy has effectively admitted that it has little faith in the central bank’s ability to estimate the level of problem loans lurking on the balance sheets of the country’s banks by appointing two private firms, BlackRock and Oliver Wyman, to conduct an audit of the Spanish banks.

But questions are also being asked about the European Banking Authority, which conducted stress tests on European banks in late 2011, and which concluded that Bankia would need an extra €1.3 billion in capital.

The EBA also estimated that, in total, the Spanish banks would need an extra €26 billion in capital – roughly half the €50 billion that even Madrid now concedes they need.

At an EBA board meeting next week, Spain will be pressed to provide details on how it intends to recapitalise Bankia and other troubled Spanish banks.

Meanwhile, the Spanish banks are facing increasing liquidity problems as Spanish households and companies continue to pull their money out of local banks, and open accounts with banks located in Switzerland, the United Kingdom and Germany.

According to European Central Bank figures, retail and corporate deposits in Spanish banks have dropped €31.44 billion to €1.6 trillion, the lowest level since the eurozone debt crisis began.