IMF: Spain's Weak Banks Need 40 Billion Euros

Spain's weak banks need at least 40 billion euros ($50 billion) in new capital to strengthen against severe financial shocks, the International Monetary Fund said.

Stress tests performed by the IMF on the country's battered banking sector indicated the top two banks, BBVA and Banco Santander, were solid.

But the rest of the banking sector could not measure up to official banking capitalization standards in the case of a sharp continuing contraction of the Spanish economy.

"Under the adverse scenario, the largest banks would be sufficiently capitalized to withstand further deterioration, while several banks would need to increase capital buffers by about 40 billion euros in aggregate to comply with the Basel III transition schedule," the IMF said in a statement Friday.

But that would not be enough to cover other restructuring costs and loan portfolio downgrades, the statement said.

"Going forward, it will be critical to communicate clearly the strategy for providing a credible backstop for capital shortfalls -- a backstop that experience shows it is better to overestimate than underestimate," said Ceyla Pazarbasioglu, deputy director of the IMF's Monetary and Capital Markets Department and leader of the IMF's stress test team.

Speaking on background, an IMF official said the banks would likely need a lot more to ensure there was a "credible backstop" in worst-case scenarios.

"In our view the stress tests are a good indicator but they are basically a floor for what you would probably need," the official said.

Often, the official said, in order to convince markets of the strength of the banks they would need a buffer of 1.5 to two times the level of new capital mandated under the stress test.

"Usually you come up with a buffer ... large enough to convince markets so that people don't say, oh well, what if this happens, what if the growth is even worse?"

The stress test results were originally scheduled to be released on Monday, but were moved ahead as European diplomats said Spain would likely move Saturday to begin crafting a deal for an EU rescue of its banks.

The banks are hobbled with heavy losses mainly on real estate, with analysts predicting their asset values will continue to decline, and their recourse to commercial markets for capital have dried up.

As the banks rely heavily on short-term liquidity funding from the European Central Bank, Madrid's own ability to provide them with long-term capital has also come under heavy strain.

Ratings agency Moody's warned Friday that even if there is a more direct rescue of the banks, it could possibly downgrade Spain's credit rating due to the "increased risk to the country's creditors."

The IMF tests challenged the banks to meet standards under the internationally agreed Basel III capital rules, in a severe recession scenario over the next two years -- a 4.1 percent contraction this year and a 1.6 percent contraction in 2013.

Details of how each of the banks performed were not released, but the total needed to measure up to the standards in the study was 37.1 billion euros.

The official said the IMF rounded the estimate up to 40 billion euros, adding that "stress tests... are not a science, they are indicative."

The IMF Executive Board, after reviewing the stress test report, commended Spain for moving quickly to consolidate the banking sector and launch into financial sector reforms.

But, with Spain and the euro area still under crisis conditions, they urged Spain's authorities "to act swiftly and spare no effort to restore confidence in the financial system and to preserve financial stability."

Earlier Friday, U.S. President Barack Obama called for urgent, decisive action by Europe's leaders to beat back the economic crisis.

Obama said the ongoing weakness in the Eurozone was a concern for the U.S. economy's own health.

But he was confident EU leaders appreciated the severity of a crisis, which also weighs heavily on his prospects of reelection in November.

"The leaders understand the seriousness of the situation and the urgent need to act," Obama told a press conference at the White House. "The decisions required are tough but Europe has the capacity to make them."