CREDIT CRUNCH:AMID THE turmoil of the latest phase of the euro zone financial crisis, many Spanish banks have found a way to survive the drought of wholesale funding on which they relied in the past to finance their lending.

Their solution though – turning off credit taps even to solvent borrowers – smacks of desperation and has angered employers and threatens to tip the economy back into recession.

“It is impossible for the banks to access the markets, as has been the case over the past couple of months,” said one senior commercial banker. “So the only way to generate liquidity is by reducing the commercial gap – that is, the difference between loans and deposits. This means a credit crunch.”

The evidence is stark across the Spanish financial system.

According to Analistas Financieros Internacionales, a research group, Spanish lenders need to refinance €97.5 billion of maturing loans over 2011.

Of that, €31.05 billion was raised in the first five months of the year, although no debt has been raised since a poorly received €1 billion covered bond from Santander, the country’s biggest bank, two months ago.

Of the remaining €66.45 billion, banks had covered €30.27 billion by the end of May simply by cutting loans faster than they lost deposits to generate a so-called positive gap.

“All the generation of the ‘positive gap’ is being achieved through the reduction of credit,” said Alfonso García, Afi managing director.

The credit squeeze by the banks explains in part why Spanish banks did not, in the first half of the year at least, increase their recourse to liquidity provided by the European Central Bank. They kept their demand below €50 billion in June.

Another reason was greater reliance on repurchase transactions through clearing houses such as LCH.Clearnet, where banks can increase short-term liquidity using government bonds as collateral.

The danger with this option is that if sovereign bond prices fall again, LCH.Clearnet could increase margin requirements, thereby restricting access to banks in search of liquidity and triggering the need for a bailout, as happened in the cases of Ireland and Portugal.

In the longer term, Spanish banks that cut credit lines to corporate borrowers risk throttling the Spanish economy and hurting their own business, even if bank executives feel they have little choice but to try to attract more deposits and reduce lending to plug their funding gaps. – Copyright The Financial Times Limited 2011.