The Spanish and Italian banks have used the ECB’s cheap three-year loan to buy government debt, which ostensibly is a carry trade – borrow cheap and lend at a higher rate.
Spanish banks have borrowed €220 billion under the ECB’s LTRO program and between December and April purchased €85 billion in sovereign papers. Some of the cash has been used to refinance private debts falling due, leaving the region’s banks with €82 billion in free cash. That is twice the €41 billion Madrid would still require to raise this year. If domestic lenders agree to swap maturing government debts, Spain may actually require €20 billion in new funding.
However, Spanish banks must refinance €65 billion in maturing debts (govt. and private combined) and there’s little hope that they can tap the wholesale debt market anytime soon.
So, Spain has some time before it is forced to seek bailout money from the ECB or IMF. An alternative to this could be Spain borrowing from the region’s bailout fund – the Emergency Financial Stability Facility. Unfortunately, Germany is not open to the idea now and hence that option remains uncertain.
The Italian situation a little trickier; Rome has borrowed €140 billion under the LTRO program and has bought €77 billion of sovereign papers. Unfortunately, Rome faces a bigger budget deficit and even if domestic investors swap maturing government debts, the budget deficit will still be higher at €70 billion. The bottom line, the LTRO measures will wear out soon and fresh funding will be required for Italy and Spain.
Megan Greene, Senior Economist at Roubini Global Economics LLC talks about the Spanish banking industry and the effect of the government’s austerity measures on the country’s economic recovery. You can watch the video here.