Europe’s debt problem has taken a turn for the worse.

Two months after Greece hit the wall with massive debt problems that locked its economy out of global credit markets, a new credit crisis is emerging in Spain, with the country’s banking system and major companies facing lockout by other European banks.

Spain’s Treasury secretary Carlos Ocana overnight revealed the freeze in comments made in northern Spain.

Ocana said the credit freeze affecting Spanish banks and corporations was “definitely a problem”.

The news will test the resolve of the EU and the eurozone to intervene quickly to stabilise the continent’s fourth biggest economy before it riggers another major credit crunch.

And the size of the problem cannot be under estimated. According to the Bank of International Settlements, French and German banks have more than $US400 billion in loans and credit advanced to both countries ($248 billion for France, German banks, $202 billion). This dwarfs the exposure to much smaller Greece.

Eurozone banks have more than $US700 billion of exposure to Spain. That would put a big hole in the standby support package of €750 billion (about $US900 billion).

News of the spreading freeze came as Moody’s ratings agency downgraded Greece to junk status. Spain is AA plus/negative, cut last month and in April from Triple A by Fitch and Standard & Poor’s.

Other figures overnight showed Spanish industrial output is now weakening, while unemployment in April was a chilling 19.7% and heavily concentrated in people under the age of 40.

The Financial Times reported Francisco González, chairman of BBVA, Spain’s second-biggest lender, as saying: “For the majority of companies and Spanish financial firms, international capital markets are closed.”

The comments saw Spanish government bonds sold off sharply as the government attempted to downplay German media reports that it was talking to other eurozone countries about help.

Ocana used a business conference in northern Spain to publicly deny German newspaper reports that Madrid was negotiating a Greek-style financial aid package with Brussels.

“Spain does not need additional financing from any international institution. The rumour is false and I deny it,” he said, in a story from Reuters.

The big problem for Europe is that Spain is facing a deadline; the country needs to refinance €16.2 billion of bonds in July.

If Spain can’t continue financing itself, the country will have to use the €500 billion standby package nailed down last week by the EU and eurozone and now coming into being (with a €250 billion top-up from the IMF, if needed).

The European Central bank has so far done most of the support by buying mostly Greek sovereign debt from banks wanting to sell. It would be the most logical conduit for supporting next month’s bond refinancings, if needed.

So far Spain has been able to borrow from international markets, but only at a rising premium to German bonds, just like Greece was forced to do in February and March before the markets stopped believing and froze the country out of fund raising.

The FT and Reuters reports that the liquidity freeze is affecting Spain’s sick domestic savings banks and small banks but not the country’s biggest financial institutions, such as BBVA and Santander, which is Europe’s biggest bank.

Finance ministers of the Group of Seven nations — the United States, Japan, Germany, Britain, France, Italy and Canada — held a teleconference overnight, but no one would say what it is about.

Germany’s Finance Ministry and the European Commission also denied the media reports that EU countries would hold talks on aiding Spain in Brussels this week.

Spain matters; unlike Greece. Not only is it the area’s fourth biggest economy, but the extent of bank exposure elevates it to “the big one”. A crisis there would plunge other weak economies, such as Portugal, Italy and Ireland into crisis, as many pundits have been predicting.

The latest quarterly report from the Bank of International Settlements tells us that French and German banks have lent nearly $US1 trillion to the most troubled European countries (Spain especially).

According to the report, French banks had lent $US493 billion to Spain, Greece, Portugal and Ireland by the end of last year while banks in Germany had lent about $US465 billion.

According to the report, Spain, Ireland, Portugal and Greece owe nearly $US1.6 trillion to banks in the euro zone, either in the form of government debt or loans to companies and individuals in the four countries.

Lending by French and German banks amounted to an estimated 61% of that total.

As of December 31 last year, banks headquartered in the euro zone accounted for almost two thirds (62%) of all internationally active banks’ exposures to the residents of the euro area countries facing market  pressures (Greece, Ireland, Portugal and Spain).

“Together, they had $US727 billion of exposures to Spain, $402 billion to Ireland, $244 billion to Portugal and $206 billion to Greece,” the BIS reported.

Peter Fray

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Peter Fray
Editor-in-chief of Crikey