Investors fear Spain will need to bail out more banks, and are pulling out of Spanish debt. Meanwhile, Spanish banks are the country’s biggest holder of sovereign debt, tying the health of the government closely to that of the banks.
If the economy fails to grow sufficiently, or market pressure grows, Europe may be forced to act to rescue Spain. Morgan Stanley estimates the probability of European rescue at 50 per cent, rising with Greek concerns.
That said, European recapitalization could break the feedback loop between bond yields and Spanish bank troubles. However, depending on how it is executed, it could raise fears of private subordination to public lenders.
Here’s how events could play out, from Morgan Stanley:
Photo: Morgan Stanley Research
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