The pain in Spain - FT.com The Spanish banking system, split between large, solid international banks and the politicised regional cajas, defies categorisation. While the banks" domestic outlook continues to worsen, the policies governing them are going from good to better. If Europe ever fixes its banking system, it may be because Madrid has shown the way. For much of the Spanish financial system, access to market funding remains hard to come by. Central bank liquidity can ease the pinch. But it cannot remedy the cause, which is the continuing rot in Spanish bank assets, especially real-estate loans and repossessed collateral whose value collapsed with the construction bubble. The government counts more than half of €323bn in real-estate assets as troubled. Even as successful a bank as Santander, which has gone through years of crisis without making a loss, set aside €1.8bn for bad Spanish property loans just in the last quarter. Things could have been worse. Spain's rules for loss provisioning left it better equipped than other countries with similar housing bubbles. Even so, banks" losses have been underestimated. The worsening recession, partly self-inflicted by Spain's effort to outdo the general eurozone fiscal masochism, will make them worse still. The new centre-right Spanish government is wise to tighten the screws on the banks. In this it follows the good work of its socialist predecessor, which in 2010 pushed for tougher stress tests than the rest of Europe wanted. Consolidating the caja sector through shotgun marriages showed more courage than other European states in tackling a highly politicised sector. Spanish banks still need the further reform prescribed by Madrid's new government. They must find at least €50bn this year to hold provisions against possible losses ranging between 35 per cent and 80 per cent depending on the asset. A slight time extension is given as a carrot to banks that merge. The caja sector will come out transformed for the better. Still, Spanish authorities cannot rest easy. The recession will take a toll on non-property assets that have not been cleansed as scrupulously, such as personal loans. And although Madrid claims that taxpayers are not put at risk, banks with no other options will be able to tap the state restructuring fund, which the government is topping up. Madrid should be prepared to write down unsecured bondholders in the case of truly hopeless banks. That would make Spanish banking policy an even better example for the rest of Europe to follow.