Once again, Spain finds itself grappling with the prospect of a bank recapitalisation. This time the target of furious speculation is Bankia, whose chairman has quit ahead of what markets expect will be a hefty injection of capital.
In the past, the Fund for Orderly Bank Restructuring (Frob), has propped up Spain’s banks by selling them contingent capital instruments. This format has the advantage of being a security that the state can exit at par if the bank manages to turn itself around in a defined timeframe. If not, it would switch to equity, diluting existing shareholders as it did so.
At the same time, it would help the bank in question return to the funding market by reassuring senior and covered bond investors that the institution had a decent capital cushion.
But that doesn't mean contingent capital should be considered the default option. While Spain will be reluctant to copy the Irish government's handling of its own banking crisis, Ireland's use of a promissory note has some merit.
Ireland bailed out Anglo Irish Bank, Irish Nationwide Building Society and EBS in 2010 with promissory notes. The device can be counted as core capital for the bank that receives it — but has the benefit of spreading the cost to the state over a long period of time.
That matters, because a big concern for investors is where Spain would get the cash from to prop up its financial institutions. After all, analysts have recently raised doubts that the country would ever be able to muster the firepower to back a "bad bank" scheme.
But whether it be through a bail-out in the traditional sense, or through loans (which look less like a cheque being written from a state with 25% unemployment to an institution with well-paid bankers), if the Spanish government or the Frob were to put in cash it would have to come from somewhere.
The worry is that if Spain or the Frob tapped international markets for that funding (so that it could then on-lend through cocos as before), the only subscribers would be the country’s banks. It would be a cute trick — but would do little to assuage international investors that Spain was exiting the crisis.
That is where the promissory note comes in. The €31bn of promissory notes that the Irish government sold in 2010 were painful for that year’s figures, adding roughly 20 points to the country’s deficit. But they did the job they were designed to do: the country was able to spread out the funding of the note over 10 to 15 years — it planned to tap markets for around €3bn a year until it had raised all the cash.
In Spain’s case, that could help to lessen the worries about the circularity of Spanish banks lending money to the Spanish government to bail out Spanish banks. Sure, for the next couple of years the issues will still be mostly domestically funded. But the hope is that a credible bank restructuring will be an important step towards convincing international institutional investors back in. And that means thinking beyond the coco.