El Diluvio: The Spanish Banking Crisis, 2008–2012

This paper offers a narrative of the Spanish banking crisis between 2008 and 2012, from the early stages of the crisis to the request offinancial assistance by Spain to its European partners. It centers in particular on the management of the crisis by the Spanish authorities. Though non performing loans were widespread, solvency concerns were concentrated in a particular segment of the Spanish banking system, the cajas sector. This sector was the anomaly of the Spanish banking system. The cajas had, one, faulty governance institutions, which made them subject to capture by the powerful political regional elites, and two, unclear procedures for private recapitalization, which made access to equity markets an impossibility. Crisis management suffered from an internal contradiction. The strategy was informed by two principles. First, debt holders, independently of their seniority, would suffer no losses and, second, tax payer funds available for recapitalization would be minimized. Given that private capital was not forthcoming, bank debt was not to be bailed-in and tax payer funds were to be minimized the solvency crisis could never be credibly closed. Spanish authorities operated under two tight constraints. First, the cajas brought unique political economy issues to crisis resolution. Second, Spain's membership in the monetary union meant that Lender of Last Resort (LOLR) tools were not directly controlled by the Bank of Spain. In addition, banks and cajas depended on foreigners to refinance a substantial fraction of their liabilities, which made them subject to sudden stops. The combination of these constraints and the internal contradictions of the strategy allowed the solvency crisis to morph into a liquidity crisis, which Spain could not successfully meet given its membership in the monetary union. As a result Spain had to request a financial assistance package on June 25th, 2012.