Lessons from Europe's Big Bailout

Even for a proud old bank like Belgo-Dutch giant Fortis, with nearly 300-year-old roots and Catherine the Great among its historic clients, playing a role in last fall's $100 billion takeover of Dutch rival ABN Amro was a big moment. In the largest financial services deal ever signed, Fortis — part of a consortium alongside the Royal Bank of Scotland (RBS) and Spain's Santander — put up $34 billion in return for ABN's Dutch banking business, among other assets.

By late Sunday at the latest, it was obvious that Fortis had committed a catastrophic folly. Less than a year after the blockbuster deal, the Belgian, Dutch and Luxembourg governments agreed to inject $16 billion into an ailing Fortis, laid low by ongoing uncertainty in global credit markets. In return for the lifeline, each of the three Benelux governments took a 49% share in Fortis' banking units in their own countries. The part-nationalization of Belgium's biggest lender, which, with a worldwide staff of 85,000, is Europe's largest to be bailed out so far since the credit crisis began. It was a last resort, coming after all efforts to flog the bank or its parts to rivals amounted to nothing. Fortis agreed to dump the once-prized stake in ABN, which weighed heavily on its balance sheet.

Fortis isn't alone among the banks in that once lauded consortium to fall on hard times; mighty RBS has since written off billions of dollars in sub-prime related losses, and even turned desperately to shareholders in June for some $20 billion in fresh capital. But if both lenders testify to the shaky health of many of the world's biggest banks, Santander, the third leg of the trio, seems to have gone from strength to strength. Indeed, while Fortis was receiving life support on Sunday, the Spanish bank was administering much needed first aid of its own.

Santander agreed to buy the savings deposits and branch network of the hopelessly overextended British lender Bradford & Bingley (B&B), forced into nationalization yesterday after investors and lenders lost confidence. B&B — whose share price has plummeted 93% this year — relied on the gummed-up wholesale credit markets for around half of its mortgage funding. Many of those home loans it has made, often without proof of the borrower's income, now look risky. For $1.1 billion, Santander will take on $37 billion in savers' deposits; the U.K. government, meanwhile, took on B&B's $78 billion mortgage book.

In an age of billion dollar losses and complex financial assets, Santander's fortunes speak to the advantages of a simpler approach. Spain's largest bank "lends to their clients, takes deposits from their clients, and runs a network of branches," says Antonio Ramirez, analyst at investment bank Keefe, Bruyette & Woods in London. "It's quite simple, quite traditional." Focused on retail banking, with limited investment banking operations, and with a long-buoyant domestic market to lean on, Santander side-stepped the toxic assets caught up in the collapse of the U.S. sub-prime mortgage market. Enjoying "good growth at home, they were never in the need of chasing growth in these kind of exotic instruments," says Ramirez. Santander's strategy — mirrored at rival Spanish lenders — owes much to the country's regulators. The Bank of Spain, which scrutinizes lenders in the country, has discouraged banks from setting up the kind of off-balance sheet vehicles that tripped up rival international lenders.

And though that domestic market looks wobbly — growth in Spain is set to tumble this year, with the country's red-hot real estate market, buoyed by a decade-long boom, now chilling — analysts expect Santander to emerge in decent health. Though defaults as a portion of its total loans hit 1.3% in the first half of the year, versus 0.8% over the same period last year, mortgage-lending policies in Spain are typically more conservative than in the U.K., for instance.

And here too, Spain's regulators have encouraged sensible behavior. For years, banks have been required to put aside cash to cover expected future losses, not actual ones. The Bank of Spain "thought that in the good times it makes sense to build a cushion for the bad times," says Ramirez. So while Spain enters a downturn "a significant portion of the potential deterioration [for banks] will be covered by these provisions." There are no guarantees, of course, for Santander or anyone else, in today's parlous international environment. But for now, at least, Spain offers a lesson in prudence through regulation that other countries would do well to emulate — even as they curse themselves for not doing so sooner.

with reporting by Leo Cendrowicz / Brussels

(Click here for Pictures of the Week)