05 March 2013

IMF: Spain - Financial Sector Reform - Second Progress Report

The main finding of this report is that major progress has been made in implementing financial sector reforms. The programme remains on track: the clean-up of undercapitalised banks has reached an advanced stage, and key reforms of Spain’s financial sector framework have been either adopted or designed. Indeed, the bulk of all of the  measures for the entire programme have now been completed.

Going forward, it will be essential to maintain this reform momentum. This includes completing programme measures that remain in progress and implementing reform plans that were drawn up as measures under the MoU (e.g. the BdE’s recently completed report on measures to strengthen its supervisory procedures). Vigilant oversight will also be essential, as risks to the economy and hence to the financial sector remain elevated as Spain continues to undergo a difficult process of correcting pre-crisis imbalances.

With further near-term headwinds from recession elsewhere in the euro area, Spain’s economy is expected to  contract for a second straight year in 2013, keeping the unemployment rate over 26 per cent and likely prompting a further rise in the non-performing loan ratio. However, banks are stepping up provisions to help cushion this outcome. More generally, the difficult macro-economic outlook remains better than the adverse scenario that underpins estimates of banks’ capital shortfalls under the programme’s stress test.

The report’s main findings and recommendations in key areas are as follows:

• Bank recapitalisation and resolution: Action is being taken to address banks’ capital shortfalls: of note, restructuring plans have been approved for all banks receiving state aid, and a first round of capital has been injected (filling about two-thirds of the total capital shortfall), with the second round of public capital injections expected by early March. This progress toward cleaning up the weakest banks is a major achievement that  should strengthen confidence in the system and improve its ability to support the real economy. Remaining elements of the recapitalisation and burden-sharing exercise should be completed in a timely manner and in ways that minimise taxpayer costs. To help optimise the value of the state’s investment in nationalised banks, the FROB’s governance arrangements and ownership policies should continue to be strengthened.  
• SAREB: Important progress has been made. Key achievements include the establishment of the company and the receipt of real estate-related assets from the weakest banks. Servicing agreements with participating banks to manage the transferred assets are also being finalised. Going forward, policy priorities to address remaining challenges include the completion of an updated and comprehensive long-term business plan and robust implementation of strong servicing agreements to safeguard the value of SAREB’s assets. Addressing these and other near-term challenges should take precedence over a search for further equity participation, as the terms of such participation are likely to be more favourable to SAREB once it has established a solid track record of profitability.
• Ensuring adequate aggregate credit supply: Banks’ wholesale funding costs have dropped in recent months, but so far there are only tentative signs of this translating into an easing of the tight credit conditions faced by most households and businesses. Against this background, the planned compilation of all major banks’ Funding and Capital Plans (essentially banks’ projections of their quarterly balance sheets) will provide  a useful vehicle for assessing the likely near-term evolution of credit, the forces driving its rapid contraction, and the need for any remedial measures.
• Monitoring and maintenance of financial stability: To safeguard the programme’s gains, it will be important to continue closely monitoring the health of the financial system and refine the financial sector reform strategy if needed. Any risks that such monitoring may identify should be addressed at the earliest possible stage through strong supervisory action. Any further actions to strengthen solvency should focus mainly on measures— such as restrictions on cash dividends and bonuses and requirements to issue equity— that boost the numerator of capital ratios rather than cut the denominator (i.e. credit  contraction) if possible, given the already tight credit conditions.
• Regulatory and supervisory framework: To support stronger financial sector oversight, the authorities have completed several benchmarks aimed at enhancing the BdE’s regulatory (i.e. rule-making) and supervisory powers, including the transfer of licensing and sanctioning powers from the Ministry of Economy and Competitiveness to the BdE. To strengthen the BdE’s operational independence further, the authorities should  consider transferring all remaining supervisory powers to the BdE and, where necessary, establish consultative processes to allow for appropriate checks and balances. An action plan should also be drawn up to implement the BdE’s recent proposals to strengthen its supervisory procedures, with specific timelines and taking into account the forthcoming Single Supervisory Mechanism (SSM).
• Savings bank reform: The draft law to reform the savings bank system is a welcome step aimed at enhancing these banks’ governance and reducing risks to financial stability. It will be important to ensure that the draft law sets effective incentives for former savings banks gradually to divest their controlling stakes in commercial banks.
• Addressing personal debt distress: The authorities are designing new measures to  extend the protection of socially vulnerable mortgage borrowers. Many proposals are steps in the right direction, though it will be important to ensure that measures are well-targeted so that assistance is focused on those most in need and to minimise moral hazard. Going forward, further study of ways to strengthen the insolvency framework to address personal insolvency more efficiently, while maintaining strong credit discipline and the payment culture in Spain, would be useful.

Full paper

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