Spain’s housing boom was supported by rapid economic expansion, strong employment growth, an immigration boom, and low real interest rates. With the abrupt drying up of funding since mid-2007, these factors have eroded quickly. Through 2010, employment and value added in construction are projected to halve as peak housing starts are completed. The authorities have launched efforts to help limit foreclosures and to activate the underdeveloped rental market. In the medium term, housing market cyclicality could be reduced by fading out generous home ownership incentives.


Spain’s housing boom was supported by rapid economic expansion, strong employment growth, an immigration boom, and low real interest rates. With the abrupt drying up of funding since mid-2007, these factors have eroded quickly. Through 2010, employment and value added in construction are projected to halve as peak housing starts are completed. The authorities have launched efforts to help limit foreclosures and to activate the underdeveloped rental market. In the medium term, housing market cyclicality could be reduced by fading out generous home ownership incentives.

II. The Spanish Banking Sector49

45. This paper provides an overview of the Spanish banking sector and its recent developments. It is organized as follows: Section I presents market structure and competition in the banking industry. Section II discusses main trends. Section III provides a snapshot of the impact of the ongoing global financial turmoil. Section IV discusses a simple macro stress test based on public information, which has been carried out to gauge banks’ sensitivity to the deteriorating operating environment. Section V concludes.

A. Market Structure and Competition

46. The rapid economic convergence of Spain in the European Union in the last decade has been mirrored by an equally rapid expansion of its banking industry (Figure 1; Box 1). Over the period 1997–2007, per-capita income increased from 65 to 80 percent of the EU15 average.50 At the same time, the Spanish banking sector’s total assets over GDP expanded from 70 to 80 percent of the EU15 average. At end-2007, total assets held by the banking sector amounted to 280 percent of GDP; 110 percentage points higher than in 1997.

Figure 1.
Figure 1.

Spain: Economic and Financial Catching-up; 1997–2007

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: European Central Bank; and Fund staff estimates.

47. In Spain, banks dominate the financial market while non-bank financial institutions are less important (Figure 2). The growth of non-bank financial entities has not kept pace with banks nor with non-banks in EU15 peers. Assets of non-banks have increased from 55 to 60 percent of GDP. Relative to peers, the share of Spanish non-banks has declined from 58 to 40 percent of the EU15 average.

Spanish Credit Institutions

The Spanish banking sector comprises four types of institutions:1/

  • Commercial banks – 151 entities, accounting for 54 percent of total credit institutions’ assets, of which 53 are Spanish-owned, 18 are subsidiaries and 80 are branches of foreign institutions. Domestic banks are generally market-traded entities mostly engaged in retail banking;

  • Savings banks (Cajas) – 46 entities, with a market share of 40 percent. They are “not for profit foundations” with strong local government and/or autonomous communities’ participation. They are not listed or traded in the stock market.

  • Cooperative banks – 85 entities, with a market share of 4 percent. They are organized under the umbrella of Banco Cooperativo Español. They provide services based on membership, but can also offer some financial services to third parties as do other credit institutions.

  • Specialized credit institutions (SCIs) – 76 entitites, with a market share of 2 percent. Although carrying out most of the activities of credit institutions, they are prohibited from receiving repayable funds from the public in the form of deposits, loans, temporary assignment of financial assets, or other comparable instruments.

Figure 2.
Figure 2.

Spain: Financial Sector Breakdown

(in percent of total assets; 2005-07 average)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: European Central Bank; and Fund staff estimates.

48. Spain has witnessed some consolidation in its banking industry, although less than in the EU15 as a whole. Between 1997 and 2004 the number of credit institutions in Spain declined by 17 percent and in the EU15 by almost 25 percent. Consolidation took place mostly within each group of credit institutions, particularly banks and cooperatives (Table 1). There were few mergers among savings banks, three acquisitions of banks by saving banks, but no acquisitions of savings banks by commercial banks, reflecting asymmetry due to institutional impediments.51 In the period 2005–07 the Spanish banking industry also witnessed some new entries, mainly branches and subsidiaries from other EU member states and third countries, whose combined market share has risen to almost 11 percent (Figure 3).

Table 1.

Spain: Mergers and Acquisitions of Credit Institutions; 1999–2007

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Source: Banco de España.

The figures in brackets are the number of institutions involved where mergers/acquisitions include operations in which more than two credit institutionstake part.

Figure 3.
Figure 3.

Spain: Market Share of Credit Institutions; 1999–2007

(in percent)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: European Central Bank; and Fund staff estimates.

49. Spanish credit institutions have expanded their physical presence in the territory, resulting in a capillary branch network. Spain has the highest number of local branches in the EU as of end-2007; for example, Germany had 2,026 credit institutions with 39,777 local branches, Spain 358 credit institutions with 45,500 local units. While in the EU15 the population per branch has increased from 2,500 in 1997 to 2,700 in 2007, in Spain it has declined to less than 1,000.

50. Despite the presence of two of the largest European banking groups, market concentration is low and competition intense. Market structure indicators, such as the Herfindahl Index or the share of total assets held by the five largest institutions, indicate that the degree of concentration in Spain, albeit increasing, has remained one of the lowest in the EU15 (Table 2). A number of studies have investigated banking competition in Spain.52 Although empirical evidence is mixed, results tend to indicate that, on average, banking competition in Spain is intense, including in comparison with that in peer countries.

Table 2.

Spain: Market Concentration and Competition

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Source: European Central Bank.

Unweighted average.

51. Alongside commercial banks, savings banks have been a major force in extending services and in fostering competition. Since reforms in late 1970s, savings banks have gradually reduced their regional specificity and expanded their range of activities.53 Many medium-sized savings banks have strengthened their national presence becoming solid competitors to commercial banks. Their market share has steadily increased from 35 percent in 1999 to 40 percent in 2007.

52. With the exception of the two largest players, the Spanish banking system remains essentially domestic (Table 3). After building up franchises in Latin America, Santander and BBVA have expanded in other markets as well. Santander is now a significant player in the U.K. (Abbey National PLC and Alliance & Leicester PLC),54 in pan-European consumer finance, and a smaller participant in the US (Sovereign Bank). BBVA has a non-negligible presence in the U.S., mainly through Compass Bankshare. Foreign activities are estimated to account for nearly half of both institutions’ earnings in 2008. Other banks have small subsidiaries outside Spain, such as Banco Popular (Portugal and Florida), Caja Madrid (Mexico), and Banco de Sabadell S.A. (Mexico and Florida), while La Caixa (caja from Catalonia) has expanded internationally with acquisitions of Mexico’s Grupo Financiero Inbursa and Hong-Kong based Bank of East Asia.

Table 3.

Spain: Foreign Business of Consolidated Groups and Individual Institutions; 2000–07

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Source: Banco de España.

B. Main Trends

53. Convergence associated with EMU entry spurred a credit boom that abruptly ended with the outbreak of the global financial crisis in mid-2007. Interest rate convergence, both in anticipation of and since EMU membership, fueled domestic credit growth (Figure 4). Over the period 1997–2007, credit to the non-financial private sector has increased at an average of 17 percent; about two-and-half times nominal GDP growth.

Figure 4.
Figure 4.

Spain: Credit and Deposit Developments; 1997-2008

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Source: Banco de España; European Central Bank; and Fund staff estimates.

54. Credit expansion was especially pronounced in the construction and real estate market. Bank activity has gradually shifted away from interbank lending and lending to the government and the manufacturing sector, to financing construction and real estate activities (Figure 5). As of end-June 2008 exposure to real estate financing amounted to 60 percent of total credit to the nonfinancial private sector, compared to 40 percent in 1997. While savings banks have the highest exposure, commercial banks are those that most significantly reoriented their domestic activity. Increased competition for lending to real estate developers has led some institutions to take on added risks by forming joint ventures with real estate developers—banks granting loans and sometimes taking an equity stake. It is estimated that this type of lending exceeds the equivalent of 5 percent of Tier 1 capital on average, and can reach as high as 80 percent of Tier 1 in specific cases.55

Figure 5.
Figure 5.

Spain: Distribution of Domestic Credit; 1997–2008

(in percent of total)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Source: Banco de España.

55. Since growth in customer deposits has not kept pace with domestic credit expansion, banks have increasingly tapped international capital markets. Between 1997 and end-2007, domestic deposits grew at an average rate of 12 percent, thus financing only part of the credit expansion of 17 percent. As a result, the loan-to-deposit ratio climbed well above the Euro-area average. Securitization facilitated access by credit institutions to foreign savings (Figure 6). Credit institutions have established securitization funds, which in turn have issued their own securitization bonds, mainly covered mortgage bonds (cédulas hipotecarias, CH). Given the soundness of the issuer, the quality and size of the mortgage portfolio, and the level of over-collateralization, resulting from sound regulation, these securities were attractive to foreign investors.56 Outstanding balances of Spanish from €18 billion (3 percent of GDP) in 2000 to €350 billion (33 percent of GDP) in 2007.57 Spanish CHs currently represent the second biggest Jumbo segment in European covered bonds after the German pfandbriefe.58

Figure 6.
Figure 6.

Spain: Securitization; 2000–07

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Bank of Spain; and JP Morgan-Chase.1/ Based on JPMorgan-led transactions in 2006/07.

56. In recent years, the Spanish banking industry has enjoyed significantly higher profitability than EU peers, despite lower leverage (Figure 7). While high volumes of intermediation have contributed to this result, higher trading and fee income as well as enduring cuts in operating costs have been important drivers.

Figure 7.
Figure 7.

Spain: Banking Sector Profitability; 2003–07

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Banco de España; and Global Financial Stability Review.

57. To gauge the contribution of different factors, an algebraic breakdown of banks’ return on equity (ROE) has been undertaken (Box 2, Figure 8). The results indicate that while savings banks’ financial strength (net income over net operating income) has remained broadly unchanged, commercial banks and cooperatives have experienced some decline in this indicator in the last years, mainly reflecting provisioning expenses and write-downs. In the case of commercial banks, this development has been partially compensated by continuous improvements in cost efficiency whereas savings banks and cooperatives have witnessed some increase in the burden of their administrative expenses, consistent with the expansion of their branch networks. While increasing leverage ratios may have weighed on credit institutions’ vulnerability to shocks, improving (or undiminished) risk-adjusted asset productivity, more prudent risk strategies (as indicated by declining risk-weighted to total assets), and lower contribution of debt in regulatory capital (as shown by a declining regulatory capital to equity ratio) have sustained credit institutions’ financial soundness.

Breakdown of Banks’ Return on Equity

Banks’ ROE can be decomposed as follows:1/


where NI = net income; NOI = net operating income; GI = gross income; RWA = risk-weighted assets; TA = total assets; RK = regulatory capital (Tier 1 + Tier 2); and E = equity.

The first ratio is an indicator of financial strength. An increase in this component indicates lower deductions from income to cover different risks and extraordinary losses. However, it may also be the result of a one-off increase in extraordinary profits and hence the improvement in ROE will prove to be temporary.

Changes in the second ratio capture changes in bank efficiency. In fact, it may be rewritten as follows:

Net operating incomeGross income=1-AdministrativeGross income=1-Efficiency ratio

Therefore, an increase in this ratio indicates progress in the way banks carry out their business activity.

The third ratio is a measure of asset productivity adjusted for risk. A raise in this ratio denotes that banks have improved the allocation of their investment portfolio and hence they can earn a higher return per unit of assets adjusted for the risk assumed.

While the fourth factor provides an indication of the risk profile of banks’ balance sheet, the fifth ratio measures the bank’s leverage ratio. A shift of banks’ portfolio toward riskier activities or an increase in their leverage makes banks more vulnerable to shocks, thus weakening their financial soundness.

The sixth ratio offers a measure of the quality of banks’ capital. Since the numerator includes subordinated debt, a rise in this ratio implies that banks increase their indebtedness within their regulatory capital. This implies a worsening of their risk exposure and hence of their financial soundness.

1/See Banco de España (2004) “Financial Stability Report,” May.
Figure 8.
Figure 8.

Spain: Banks’ Return on Equity Breakdown; 2002–08(H1)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Banco de España; and IMF staff estimates.

58. Because of strong forward-looking prudential regulation, Spanish banks have had strong capital and provisioning buffers. At end-2007, the average capital adequacy ratio stood at 11.4 percent (Figure 9). Although this indicator is slightly below the EU average (11.9 percent), it does not include the effects of the adoption of dynamic provisioning, which forced Spanish banks to accumulate significant additional buffers. At end-2007 banks’ provisions were over 200 percent of non-performing loans (NPLs). The system of dynamic provisioning increased reserves during the phase of rapid credit growth that preceded the current financial crisis. Back-of-the-envelope calculations indicate that the Spanish banking sector entered the financial turmoil with an extra provisioning cushion of some €24 billion (Figure 10).59

Figure 9.
Figure 9.

Spain: Banking Sector’s Soundness Indicators; 2003–07

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Banco de España; and Global Financial Stability Report.
Figure 10.
Figure 10.

Spain: Credit Growth, Non-Perfoming Loans and Loan-Loss Provisions; 1999-2008

(12-moth growth rate; in percent of total credit)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Banco de España; and Fund staff estimates.

C. The Impact of the Financial Turmoil

59. The outbreak of the financial crisis in summer 2007 has severely affected the operating model of the Spanish banks. With wholesale funding drying up, Spanish banks have started restructuring their balance sheets. On the asset side, credit institutions have slowed lending growth and tightened credit standards. On the liability side, they have tapped more extensively ECB refinancing facilities by doubling access from €22 billion in the pre-crisis period to €49 billion recently. Since other banking systems also expanded their recourse to the ECB, Spain’ access has remained broadly in line with that of Euro-area total assets (Figure 11). Banks have also competed fiercely for customer deposits, largely at the cost of redemptions from mutual funds.

Figure 11.
Figure 11.

Spain: Refinancing Operations with the Euro-system; 2006-08

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Banco de España; Bundesbank; European Central Bank; and Fund staff estimates.

60. Banks’ operating environment has deteriorated more rapidly and severely than expected. Given their retail-oriented nature, Spanish banks have not been directly affected by the US subprime crisis and its ramifications.60 Nevertheless, they have to face with the bleak economic situation. Domestic economic slowdown and banks’ deleveraging have been mutually reinforcing. Households and the corporate sector are highly indebted. Unemployment is rising. The housing market is rapidly cooling off. The corporate sector is facing increasing cash-flow and liquidity problems. Several large real estate developers have filed for bankruptcy. Against this environment, NPLs have increased rapidly but from a very low base.61 Loans to the construction and real estate sectors have witnessed the most marked deterioration (Figure 12). As a result, savings banks have been most affected owing to their large exposure to the real estate sector. While banks’ provisions are still at a comfortable level, the extra cushion provided by dynamic provisioning is falling rapidly.

Figure 12.
Figure 12.

Spain: Non-Performing Loans Developments; 1999–2008

(quarterly data; in percent)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Source: Banco de España.

61. As a consequence, and despite broadly positive results in 2008, market sentiment on Spanish banks has turned mixed. While Santander and BBVA continued to record high net income in line with market expectations, their stock prices have declined significantly, reflecting generalized market risk aversion and in anticipation of very difficult market conditions yet to come (Figure 13). When the financial turmoil heightened in the autumn, their CDS spreads trended above those of (retail) peers (investment banks fared much worse), mainly owing to the sharp deterioration in the Spanish economic outlook and their large exposures to emerging markets, especially in Latin America. Since then, however, CDS spreads have returned in line with those of retail peers, in part helped by the two institutions’ successful market-based capital increases.62 Small banks and savings banks have been penalized more severely, reflecting expected asset quality deterioration due to the downturn in the housing market (Figure 14). The markets’ increasing concern about the Spanish economic and property outlook has driven spreads on residential mortgage backed securities above peers (Figure 15). As indicated by the 2006 FSAP, some of the larger credit institutions have significant equity investments in non-financial companies (“industrial participations”), concentrated in a few sectors or companies including real estate. Losses associated with the stock-market downturn can thus further affect banks’ profitability and capitalization through these holdings as well.

Figure 13.
Figure 13.

Spain: Santander and BBVA; 2007-09

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Bloomberg; and Fund staff estimates.1/ Peers include Unicredito, Commerzbank, HSBC, ING, BNP Paribas.
Figure 14.
Figure 14.

Spain: Small Banks and Cajas; 2007-09

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Bloomberg; and Fund staff estimates.
Figure 15.
Figure 15.

Spain: Residential Mortgage Backed Securities

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Source: J.P. Morgan.

62. Like other European countries, the Spanish government has taken a number of exceptional measures to shore up confidence in the financial system (Box 3). As part of the package, the Spanish government established a €30 billion fund (which may be raised to €50 billion)—Fondo para la Adquisición de Activos Financieros (FAAF)—to provide liquidity to the banking sector by purchasing, on an outright or temporary basis, high quality bank liabilities (asset-backed securities with 3–5 year maturity).

D. A Simple Macro Stress Test of the Spanish Banking Sector

63. To gauge the sensitivity of banks to the deterioration in the operating environment, staff has conducted a simple macro stress tests based on public information. To identify the key macroeconomic determinants of NPLs, staff estimated a logit transformation of bank NPLs over the period 1988–2008. This period includes the episode in the early 1990s, during the previous significant housing downturn. First, the focus is on NPLs for the banking sector as a whole.

64. NPLs are modeled to be related to a set of macroeconomic variables (X) as:


By performing the logit transformation, this provides:


Spanish Government Assistance to Banks

Following the common framework agreed by euro-area countries, the Spanish government has taken the following exceptional measures:

  • The limit of the deposit guarantee was raised from € 20,000 to € 100,000.1/

  • A € 30 billion fund (which may be raised to € 50 billion) was established to purchase high quality asset-backed securities issued by credit institutions: the FAAF.2/ The operations can take the form of outright purchases or long-term swap operations (12 months or longer). Asset eligibility is slightly different in the two cases. In particular, outright purchases can be carried out for CHs and securities backed by CHs issued before October 10, 2008, traded (or in the process of being traded) in a regulated market, carrying a triple-A rating, and with a maturity no longer than the one specified in the auction. In the case of swap operations eligible assets comprise CHs and securities backed by CHs, or credit to individuals or non-financial companies and institutions provided that these securities have been issued after August 1, 2007, meet the ECB’s eligibility requirements, and carry at least a rating of double-A. The FAAF consists of two separate portfolios; one for each type of operations. To safeguard a sufficient diversification, the FAAF cannot allocate more than 10 percent of its resources in each portfolio to a single entity. The FAAF’s operations are conducted through an American-Type Auction; a fraction may also be allocated through non-competitive auctions. In each auction, individual allotments cannot exceed the lowest between the above-mentioned 10 percent limit of FAAF’s portfolio and the result of the product between 2.5 times a credit institution’s share in total credit to the domestic non-financial private sector and the amount offered.

  • Government guarantee may be provided for credit institutions’ new debt issues. The amount of the scheme approved in 2008 is € 100 billion to be used by mid-December 2009.3/ A possible additional € 100 billion might be allotted in 2009 if market conditions do not improve. As agreed within the EU, the pricing depends on debt maturity, CDS spreads, and rating of the originators:

  • If necessary, credit institutions’ re-capitalization may be carried out through the government’s acquisition of non-diluting instruments such as preference shares.3/

Table 4.

Spain: Pricing of the Government Guarantee

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1/Royal Decree 1642/2008, October 10, 2008.2/Royal Decree Law 6/2008, October 10, 2008.3/Royal Decree Law 7/2008, October 13, 2008.

65. Possible explanatory macroeconomic variables are: the change in nominal house prices (hs); the unemployment rate (une); the real interest rate (rr); and the private sector debt-to-GDP ratio (psd). This yields the following equation:


66. The equation has been estimated for the period 1989Q2 to 2008Q2 and the results are reported in Table 5. They suggest that NPLs are:

  • A positive function of unemployment, private debt, and the real interest rate. An increase in these variables reduces borrowers’ repayment capacity. Unemployment and private debt affect NPLs with a short lag, whereas the impact of the real interest rate is delayed, consistent with the experience of monetary policy lags.

  • A negative function of house prices. Since house price developments enter without a lag, it suggests that they are an indicator of the current health of the economy.

  • Finally, the results also reflect a marked inertia of NPLs as indicated by the significant lagged dependent variable.

Table 5.

Spain: Results of the Regression on Non-Performing Loans

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Logit transformation of non-performing loans.

Variables are in first difference; in parenthesis the time lag in quarters.

67. The estimated equation fits the data well for the whole sample, but in later quarters underestimates the actual increase in NPLs (Figure 16). This is confirmed by a stability test of the estimated coefficients with recursive residuals. One can speculate why the model underperforms on recent data. One explanation might be that the externally imposed credit crunch, originating in the US subprime crisis, has come suddenly and virulently. With very large borrowing requirements, Spain had built up vulnerability in funding markets. The virtual drying-up of the wholesale secured markets and the simultaneous downturn in the real estate market have triggered a rapid deleveraging and risk repricing by Spanish banks—unlike that experienced in previous episodes. This, in turns, has contributed to a sudden and marked increase in NPLs.63

Figure 16.
Figure 16.

Spain: NPLs Regression result and Stability

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

68. With these estimates, we can now explore potential developments in NPLs under stress circumstances. To do so, we specified the following main assumptions (Figure 17):

  • Nominal house prices decline by 16 percent from mid-2008 to end-2009 (declining at a slower pace after that for a cumulative total drop of some 30 percent in real terms);

  • The unemployment rate reaches 15 percent by end-2009;

  • The real interest rates increases to 4 percent by end-2009 reflecting persistent funding difficulties and elevated risk pricing, combined with a decline in inflation;

  • CPI inflation declines to just below 2 percent by end-2009.

  • Private sector debt remains constant in percent of GDP.

Figure 17.
Figure 17.

Spain: Macro Assumptions; 2008Q3—2009Q4

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Bank of Spain; IFS; WEO; and staff estimates.

69. With these assumptions, we can calculate two potential paths for future NPLs (Figure 18):

  • In the first path, the out-of-sample forecast through 2009Q4 suggests that NPLs could reach 5 percent by end-2009, from 1.7 percent in June-2008.

  • In the second path, if we take into account that NPLs already were 2.2 percent as of July 2008, the estimated NPLs could instead reach 6.3 percent by end-2009.

Figure 18.
Figure 18.

Spain: Non-performing Loans Projections

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

70. Thus, risks in an adverse scenario could be significant. NPLs could reach well above the peak reached during the previous Spanish housing downturn in 1993–94. But such downturns are not unprecedented as this would resemble the experience of the Nordic countries during their housing and banking crisis in the early 1990s. Moreover, the result can not be dismissed out of hand considering the current very high level of indebtedness of the private sector compared with previous housing downturns (Figure 19), the severity and abruptness of the global crisis, and the fewer degrees of policy freedom under the current fixed exchange rate regime.

Figure 19.
Figure 19.

Spain: Comparing Crises (1994 vs. 2008) Corparate sector debt (% GDP)

Citation: IMF Staff Country Reports 2009, 129; 10.5089/9781451812299.002.A002

Sources: Bank of Spain; WEO; and staff estimates.

71. We can now use the estimated NPLs to carry out a stress test on bank-by-bank data as of end-2007. The sample comprises 53 banks (8 commercial banks; 40 savings banks; and 5 cooperative banks). Loan portfolios are divided in three categories: mortgages, loans to construction and real estate companies, and other loans.64

72. We constructed two scenarios. In the first, we assumed NPLs to rise to 6.3 percent of loans (the above “July” scenario). Within this total, and based on the experience of the housing downturn in early 1990s, NPLs could then reach 12.9 percent for construction and real estate companies, 3 percent for mortgages, and 7 percent for other loans. In the second scenario, we stressed total NPLs up to 10 percent. For sake of simplicity, NPLs for each loan category were increased proportionally. Also, in all two scenarios, we assumed a 50 bp decline in net interest rate margins reckoning that banks are unable to transfer fully to borrowers increasing funding costs.65

73. To calculate banks’ required provisions, we needed an estimate of loss-given-defaults (LGDs). To this end, we considered the results of other studies, namely the 2006 FSAP, Jimenez and Mencia (2007), and the Basel Committee’s Results of the Fifth Quantitative Impact Study (QIS 5). This information is summarized in Table 6. Although the 2006 FSAP stress test attempted to factor in economic downturn LGDs, more recent LGD estimates tend to be higher for some loan categories, particularly mortgages.

Table 6.

Spain: Loss Given Default Estimates for Different Portfolios

(in percent)

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Sources: FSAP Technical Note on Stress Testing: Methodology and Results; Gabriel Jimenez and Javier Mencia (2007) “Modelling the Distribution of Credit Losses with Observable and Latent Factors,” Banco de España, WP 0709; Basel Committee on Banking Supervision (2006) “Results of the Fifth Quantitative Impact Study (QIS 5),” Bank for International Settlements, June.

Results were presented for different country group banks. For commercial loans, SME retail exposures are reported.

Refers to corporate loans.

74. The unfolding of the worst financial crisis in decades has created a situation that remains highly uncertain. Estimates based on past history could be refuted by events. Against this background, we considered two sets of LGDs (Table 7). The first group is broadly in line with the economic downturn LGDs estimated by the Bank of Spain, although our loan portfolio breakdown is simpler, as noted. The second set of LGDs assumes some worsening in the recovery rates.

Table 7.

Spain: Hypothesis on Loss Given Defaults

(in percent)

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75. While higher NPLs translate into an increase in banks’ specific provisions, we have to bear in mind that Spain has implemented a system of general dynamic provisioning.66 Banks are required to maintain a minimum level of general provision equal to 33 percent of the products obtained by multiplying outstanding exposures in each of the six risk categories in which banks’ loan portfolios are divided by their related provisioning coefficients, ranging between 0 and 2.5 percent.67 Since the risk-breakdown of loan portfolios is not available, we estimated the general provision floor by applying the simple average of the provisioning coefficients (1.4 percent).

76. Moreover, we sought to factor in additional capital charges due to an increase in the loan-to-value (LTV). A downturn in house prices increases the LTV ratio of a fraction of the mortgages above the 80 percent threshold. In that event, credit institutions would need to build up additional provisions and capital. Under the assumption of a 16 percent nominal decline in house prices, mortgages having a pre-shock LTV ratio between 67 and 80 percent would require, in principle, additional provisions and capital. To gauge the magnitude of these additional requirements, we assumed that the LTV distribution of mortgages granted until 2006 has remained broadly unchanged since then. Therefore, the share of mortgages to be reclassified was assumed to be equal to about 25 percent of total mortgage loans.

77. The results of the stress test scenarios are only indicative given that more detailed data are needed for a precise assessment, but they help point toward several considerations (Table 8):

  • Spanish banks appear to enjoy sufficient capital buffers to withstand quite severe shocks, even by historical standards. Sound prudential regulation, in particular the system of dynamic provisioning has served the Spanish banking sector well.

  • Nonetheless, buffers can erode rapidly. Even in the least severe scenario (Scenario 1—LGD 1), the need for additional specific provisions absorbs, on average, three quarters of the banks’ pre-shock profits. A few banks record losses. However, capital buffers remain adequate. The picture tends to deteriorate when we consider larger shocks Scenario 2). The number of banks falling below the minimum capital requirement (of 8 percent) increases. However, the amount of new capital needed to restore compliance with prudential minimum requirements is relatively small.68 relatively small.69 Nevertheless, if a number of banks are perceived to be problematic, confidence could erode and distressed financial conditions in a few institutions could then escalate to a wider problem with nonlinear effects on confidence. In this context, the banking system may need to go through consolidation to safeguard stability. Indeed, this process has already started with some recent mergers among Spanish banking institutions.

Table 8.

Stress Test Results

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Scenario 1, NPLs breakdown: mortgages = 3 percent; construction and real estate = 13 percent; other loans = 7 percent.Scenario 2, NPLs breakdown: mortgages = 4.5 percent; construction and real estate = 19.3 percent; other loans = 10.4 percent.LGD 1: mortgages = 20; construction and real estate = 45; other loans = 40.LGD 2: mortgages = 25; construction and real estate = 50; other loans = 50.

E. Conclusions

78. The Spanish banking sector has weathered well the first impact of the financial turmoil. Cautious regulation, sound supervision, and strong retail-oriented business models have served Spanish banks well. They entered the ongoing crisis with robust capital and exceptional provisioning buffers.

79. However, the outlook continues to be very challenging. Persistent difficult external conditions (dislocation of funding markets) together with increasing costs of funding as competition for deposits intensifies, may force banks to deleverage further their balance sheets. Additional tightening of credit conditions would feed back to slow activity and continue to push the Spanish economy into a severe recession—accelerating the banks’ asset deterioration. A sharp fall in banks’ capacity to generate earnings might be offset, at least in part, by restrictive cost strategies. Lower profitability and higher capitalization demanded by markets will weigh on banks’ outlook and drive consolidation in lending capacity.

80. Staff stress test results suggest that banks may face capital needs. Even in moderately severe scenarios, a number of banks could fall below the minimum capital requirement standards, although, based on the information available to staff, the needed capital injections are estimated to be relatively small. Nevertheless, if a significant share of the banking system is perceived to be problematic, confidence could erode and distressed financial conditions in a few institutions could then escalate to a wider problem. While the likelihood of some assumptions is open to question, the very high level of private sector’s indebtedness as well as the severity and suddenness of the ongoing crisis suggest that a cautious approach, coupled with continuous close monitoring, is necessary. Indeed, the authorities have taken appropriate measures to assist banks, including with the possibility for capital injections, if this were necessary.

81. Needed consolidation in the wide-spread banking system could be facilitated with some policy options. To foster market-based consolidation, institutional hurdles holding up mergers between savings banks of different autonomous regions as well as their acquisition by commercial banks ought to be removed.


Prepared by Alessandro Giustiniani.


Owing to data constraints, we exclude new member states.


Mergers of savings banks, or cajas, are subject to respective regional governments’ approval. Cajas cannot be purchased by private individuals or institutions due to their legal nature, but they can acquire other companies and credit institutions. Nevertheless, cajas’ assets and branches can be purchased by individuals, private companies and commercial banks. For more details, see FSAP (2006) “Technical Note on Regulation, Supervision, and Governance of Spanish Cajas,” (IMF Country Report No. 06/215).


See Claessens S. and L. Laeven, 2004, “What Drives Bank Competition? Some International Evidence,” Journal of Money, Credit, and Banking, 36, 563–83; Luis Gutiérrez de Rozas, 2007, “Testing for Competition in the Spanish Banking Industry: The Panzar-Ross Approach Revisited,” Banco de España, Documento de Trabajo No. 0726; Michiel van Leuvensteijn, Christoffer Kok Sørensen, Jacob A. Bikker and Adrian A.R.J.M. van Rixtel, 2008, “Impact on Bank Competition on the Interest Pass-Thorugh in the Euro Area,” European Central Bank Working Paper No. 885, March.


As part of the deregulation process, savings banks were allowed to carry out universal banking activities starting in 1977.


Amid the U.K. banking crisis, Santander also bought the branches and deposits of Bradford & Bingley.


Moody’s April 2008.


The new Mortgage Law (Law 41/2007) further strengthens the regulatory framework of CH; in particular: (1) it creates a special register for all mortgage loans and credits forming the collateral; (2) it reduces the loan-to-value ratio for commercial mortgage loans from 70 to 60 percent while keeping the one for housing loans at 80 percent (both ceilings may rise respectively to 80 and 95 percent if there are appropriate and sufficient additional guarantees); (3) it increases the minimum legally required over-collateralization from 11 to 25 percent; and (4) it provides for the possibility of including specific liquid and low-risk assets in the pool of collateral underlying the CH issue (up to 5 percent).


It is important to note that the Bank of Spain has adopted stringent criteria regarding risk transfer and control of special purpose entities. Both steps have reduced drastically the incentives for off-balance sheet securitization and the resulting capital relief opportunities.


Jumbo issues amount to at least a billion euros.


A notional level of bank provisions has been calculated by assuming that Spanish banks’ coverage ratio would have otherwise trended towards the EU average (a full convergence is assumed by end-2007).


Spanish banks’ total direct gross exposure to Lehman was estimated at US$700 million, with BBVA having the largest exposure with US$100 million. However, both Santander and BBVA were caught off guard by the Madoff fraud scandal. While Santander’s direct exposure was reportedly minimal (€17 million), Santander’s clients who invested in the bank’s Optimal Strategic hedge fund, had an exposure of €2.3 billion. BBVA reported € 300 million losses from its activities related to Madoff Investment Securities.


As of end-2007, NPLs amounted to less than 1 percent of total loans; half of the EU average.


In late 2008, Santander increased capital by €7.2 billion (equivalent to about 130 bps of Core Tier 1 capital) and BBVA by €1 billion (preferred shares) on market terms without government enhancements.


This development may be also explained by the regulatory changes introduced by the Accounting Circular 4/2004 that entail the earlier and fuller recognition of doubtful assets. As a result, for same pace of economic downturn, higher levels and faster rate of increase in doubtful assets will be recorded than in the past (Banco de España, 2008, “Financial Stability Report,” November). However, the coefficient of a dummy variable, which was included in the estimated equation to take into account this discontinuity, did not result statistically significant.


In discussing this exercise, the Bank of Spain noted that the category “other loans” may be too broad for our purposes since it contains asset classes with different NPL and loss-given default experience. In their own stress tests, the Bank uses more detailed unpublished data to differentiate between these categories. The Bank believes that this could bias upward the staff’s stress test findings.


The Bank of Spain pointed out to staff that banks have held their intermediation margins stable so far.


Circular 4/2004. To calculate the latter, banks’ standard loans are subdivided into six risk categories with corresponding provisioning coefficients, determined by historical experience of impairment and loss given default. In each quarter, banks are required to set aside general provisions equal to the difference between a notional amount of provisions and the amount of specific provisions accumulated during the period. The notional level of provisions is a function of both the flow and the stock of banks’ exposure in each risk category multiplied by the respective provisioning coefficient.


The exercise was carried out before the BdE revised the regulation on general provision (Circular 6/2008). Currently, the BdE maintains an indicative minimum level of general provision equal to 10 percent.


This result is explained by the fact that Tier 2 capital is limited to 100 percent of Tier 1 capital. Therefore, if losses bring a bank’s Tier 1 capital below the pre-shock level of its Tier 2 capital, the amount of supplementary capital in excess cannot be included in the calculation of the minimum capital requirement. However, the replenishment of Tier 1 capital allows a proportional reinstatement of those financial instruments as Tier 2 capital.


This result is explained by the fact that Tier 2 capital is limited to 100 percent of Tier 1 capital. Therefore, if losses bring a bank’s Tier 1 capital below the pre-shock level of its Tier 2 capital, the amount of supplementary capital in excess cannot be included in the calculation of the minimum capital requirement. However, the replenishment of Tier 1 capital allows a proportional reinstatement of those financial instruments as Tier 2 capital.

Spain: Selected Issues
Author: International Monetary Fund