Q How will this bailout work?
A It is not entirely clear, but Madrid is considering a plan where, instead of buying a 90 per cent stake in Bankia for cash, the Spanish government will hand over billions of its bonds instead.
Q How will that help when Bankia needs cash?
A That’s where the European Central Bank comes in. The ECB will accept government bonds as high quality collateral in return for giving out cash. So Bankia will go straight to the ECB, post Madrid’s debt as collateral and get a big cash injection.
Q As the rest of Europe’s banks did earlier this year?
A Not quite, because the ECB is no longer offering three-year cash – though many analysts think it will do so again. Instead, Bankia will tap its monthly lending facility.
Q What is the advantage of doing the bailout this way?
A It means that Spain will not have to tap private markets for the billions required to bail out its banks. That is vital because bond investors are now demanding a punitive 6.5 per cent interest rate to lend to Madrid on a ten-year basis.
Q What makes this unusual?
A It is not that unusual to bail out a bank via a debt-for-equity swap. What is unprecedented is the role of the ECB. The key part that could make this plan work is that the ECB is prepared to treat Spanish bonds differently from how markets treat them. Rather than classing them as an increasingly risky asset, the ECB still classes Spanish debt as high quality collateral. So this is, in effect, another kind of sovereign bailout by Frankfurt, only it is taking place via the ECB’s collateral specifications rather than through direct bond purchases.