Financial System Stability Assessment

This report summarizes the findings of the Financial Sector Assessment Program (FSAP) Update for Spain. Although there is a core of strong banks that are well managed and appear resilient to further shocks, vulnerabilities remain. Substantial progress has been made in reforming the former savings banks, and the most vulnerable institutions have either been resolved or are being restructured. Recent measures address the most problematic part of banks’ portfolios. Moving ahead, a further restructuring and recapitalization of some of the remaining weaker banks may be needed as a result of deteriorating economic conditions.


This report summarizes the findings of the Financial Sector Assessment Program (FSAP) Update for Spain. Although there is a core of strong banks that are well managed and appear resilient to further shocks, vulnerabilities remain. Substantial progress has been made in reforming the former savings banks, and the most vulnerable institutions have either been resolved or are being restructured. Recent measures address the most problematic part of banks’ portfolios. Moving ahead, a further restructuring and recapitalization of some of the remaining weaker banks may be needed as a result of deteriorating economic conditions.

I. Introduction

9. Spain is experiencing the bursting of a real estate bubble after a decade of excessive leveraging. Construction and real estate loans grew from 10 percent of GDP in 1992 to 43 percent in 2009, and amounted to about 37 percent of GDP at end-2011. Spanish banks funded their increasing exposures largely from external sources during the period of high global liquidity and low interest rates, rather than through the mobilization of savings. The freezing of wholesale markets and the onset of the Euro-area debt crisis exposed Spain’s vulnerabilities from accumulated domestic and external imbalances (Figure 2) and pushed the economy into a sharp recession in 2009–10. The economy is expected to contract by 1.8 percent in 2012 and unemployment is at 24 percent and rising, especially among the young (Table 2).

Figure 2.
Figure 2.

Spain: Economic Developments

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Sources: BdE; Eurostat; ECB; and IMF staff estimates.
Table 2.

Spain: Main Economic Indicators

(In percent change unless otherwise indicated)

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Sources: IMF, World Economic Outlook; data provided by the authorities; and IMF staff estimates.

Based on national definition (i.e., the labor force is defined as people older than 16 and younger than 65).

Capital account not included.

Based on data from IMF, International Financial Statistics.

10. Banks dominate the Spanish financial system and are large relative to the economy. The total assets of the Spanish banks (excluding foreign branches) amount to about 320 percent of GDP taking into account international activities of the banks, with the largest five banks accounting for more than 70 percent of total assets. Loans extended to the private sector in Spain account for 166 percent of GDP (Figure 3). In contrast, the growth of nonbank financial entities has not kept pace with the domestic banking industry and with EU peers, and this segment represents a relatively small share of the financial sector (Figure 4).

Figure 3.
Figure 3.

Spain: Market Shares of Credit Institutions as of End-2010

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Source: BdE.
Figure 4.
Figure 4.

Spain: Structure of the Financial Sector

(In millions of euro)

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Sources: BdE; and ECB.

11. A major restructuring of the savings bank sector is taking place. The reforms to the savings banks legal framework together with financial support from the state-owned vehicle, the FROB, were instrumental in starting the much needed reform process to restructure and consolidate the banking sector (Table 3). The number of institutions has been reduced from 45 to 11, through a combined set of actions including interventions, mergers, or takeovers.

Table 3.

Spain: Support Measures for the Financial Sector

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Source: MdE.

Although State guaranteed bonds have been issued for an amount of € 96.9 billion, as of 30 March 2012 only € 78.7 billion remained outstanding.

The paid in State contribution (EUR6.75 billion) comes from the unused portion of the FAAF; an additional (non paid in) contribution of 6 billion was approved under RDL 2/2012. The remaining € 2.25 billion was paid in by the Deposit Guarantee Funds.

It includes the asset protection scheme to BBK for the acquisition of Cajasur (€ 392 million) and excludes capital injection to Unnim in September 2011 (€ 953 million), which is supported by the Deposit Guarantee Fund.

It includes a capital injection or € 1.3 billion, an asset protection scheme of € 2.5 billion granted to Cajastur for the takeover, and a bridge financing of € 350 million.

It excludes the asset protection scheme to be granted to Sabadell on a € 24.6 billion portfolio to cover 80 percent of the losses in excess of the accumulated provisions (€ 3.9 billion) over a ten year period.

It excludes the asset protection scheme to be granted to BBVA on a € 6.4 billion portfolio to cover 80 percent of the losses in excess of the accumulated provisions (€ 0.9 billion) over a ten-year period.

12. Despite significant consolidation and loss recognition, banks’ access to wholesale funding markets remains limited. Banks are exposed to further losses on their loan portfolios, notably to the real estate and construction sectors, due to the weak macroeconomic environment (Figure 5). The deterioration in markets’ perception of sovereign and bank risk has further increased pressure on the Spanish banks, most of which rely on wholesale markets to fund important parts of their portfolios.

Figure 5.
Figure 5.

Spain: Exposure of Credit Institutions to the Property Sector

(In percent of total loans to the private sector)

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Source: BdE.

13. The authorities are, rightly, focusing on strengthening the banking sector. There is an appropriate sense of urgency from the authorities, as well as the awareness of the need for a carefully designed strategy given the potential implications for public debt dynamics. Indeed, unless the non-viable banks are resolved, the sound banks will continue to be penalized by across-the-board tighter regulations and expensive funding, with the risk of delaying renewed growth in credit in the country, and ultimately economic recovery.

II. Risks and Vulnerabilities in the Banking Sector

14. The Spanish economy and financial system have been hit by a succession of shocks, starting with the global financial crisis, which led to the domestic real estate crisis, subsequently intensified by the European sovereign debt crisis:

  • The initial impact of the global financial crisis was relatively mild. The banking sector weathered the first wave due to robust capital and provisioning buffers. However, banks, like many of their international peers, lost access to wholesale funding markets. During this initial phase of the crisis, the authorities took measures to assist bank funding rather than to inject capital, in line with EU policies.

  • The second-round effects were severe. The domestic economy entered into a sharp recession, with construction activity collapsing, unemployment soaring, and with the contribution of foreign demand insufficiently strong to clear imbalances. This particularly affected the former savings banks, also reflecting weak lending practices during the economic upswing. In response, the authorities launched a restructuring and recapitalization scheme and tighter minimum capital requirements, thereby encouraging the transformation of these institutions into commercial banks.

  • The third phase of the global crisis is still underway, reflecting concerns about sovereign debt markets. The defining challenge of this phase is the strong interconnection between the sovereign and its banking system (Figure 6)—with the former affecting the financial health of the latter, and vice versa.

Figure 6.
Figure 6.

Spain: Sovereign Debt

(In billions of euro)

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Source: EBA stress test.Note: Accounting value gross of provisions. The exposures reported cover only direct exposures to central, regional and local governments on immediate borrower basis, and do not include exposures to other counterparts with full or partial government guarantees. The exposures to be considered are the on-balance sheet exposures (see 2011 EU-Wide Stress Test: methodological note).

15. In this difficult environment, the restructuring of the banking sector initially proceeded slowly. The depth and length of the economic crisis, and hence the latent losses in the banking sector particularly associated with real estate sector exposures, were underestimated. The institutional framework and complex governance arrangements for savings banks further delayed action. In some cases, weak entities were merged together forming larger weak entities. Regarding operational restructuring by banks, since 2008, the number of bank employees has been reduced by 11 percent (most of which occurred during 2011), and the number of branches has been trimmed by about 15 percent.

16. As a result, the quality of banks’ assets continued to deteriorate, exacerbating the credit crunch. Nonperforming loans continued to increase, particularly driven by loans to construction and real estate developers (Table 4). The stock of repossessed assets also increased, accounting for about 3½ percent of gross loans. At the same time, growth in credit to the private sector fell sharply and turned negative, reflecting the bursting of the real estate bubble, tighter lending criteria, increasing cost of risk, and deteriorating funding conditions saw banks increase their reliance on the ECB (Figure 7).

Table 4.

Spain: Selected Financial Soundness Indicators for the Banking Sector

(In percent unless indicated otherwise)

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Sources: BdE; ECB; WEO; Bloomberg; and IMF staff estimates. Data are on a consolidated basis for all resident credit institutions in Spain, including foreign ones.

Starting 2008, solvency ratios are calculated according to CBE 3/2008 transposing EU Directives 2006/48/EC and 2006/49/EC (based on Basel II). In particular, the Tier 1 ratio takes into account the deductions from Tier 1 and the part of the new general deductions from total own funds which are attributable to Tier 1.

Including real estate developers.

Liquid assets include cash and holdings of securities different from equity shares and participations.

Sum of main and long-term refinancing operations and marginal facility; end of period.

Ratio between loans to and deposits from other resident sectors.

Senior 5 years in euro.

Figure 7.
Figure 7.

Spain: Banking Sector Developments

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Sources: BdE; and IMF staff estimates.

17. The ECB’s three-year Long Term Refinancing Operation (LTRO) has provided significant temporary relief, but has also increased the interconnectedness between banks and the sovereign. Although banks, mainly the largest ones, had been able to exploit windows of opportunity in the wholesale markets, as in early 2012, market access remains very expensive, also reflecting the growing interconnectedness between bank and sovereign risk (Figure 8). Retail deposits have declined slightly (4 percent on a y-o-y basis) reflecting also portfolio reallocation towards higher yield bank commercial paper and government securities. Against this backdrop, Spanish banks have drawn extensively from the ECB, with refinancing reaching almost 11 percent of total assets. Most of this funding has been used to “defensively” substitute short-term repo funding, repay debt, buy sovereign paper, and build up precautionary cash buffers.

Figure 8.
Figure 8.

Spain: Financial Market Indicators

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Sources: BdE; Bloomberg; and IMF staff estimates.1/ Include Unicredit, Intesa-San Paolo, Commerzbank, Deutsche Bank, HSBC, Barclays, UBS, Credit Suisse, Societe Generale, BNP, and ING.2/ Include Banco Popular, Bankinter, Banco Sabadell, and Banco Pastor.

18. Since the beginning of the crisis, the banks and the authorities have taken measures to strengthen the banking sector:

  • Banks increased loan loss allowances by € 112 billion (11 percent of GDP) and raised their tier 1 capital ratio from less than 7 percent to more than 9 percent by end-2011, including capital injections by the state.

  • The total gross direct intervention by the government (excluding bond issuance guarantees) amounted to about € 34 billion (3 percent of GDP) as of April 2012, of which more than half has already been recovered, reducing net fiscal costs.

  • The industry has contributed, through the Fondo de Garantía de Depósitos (FGD), to the funding of the FROB and the resolution of three intervened institutions a total of about € 13 billion, which could rise up to € 34 billion (3.2 percent of GDP) if the recently granted asset protection schemes are fully called.

19. The authorities have recently accelerated the financial sector reforms:

  • In February 2012, higher provisions and specific capital buffers for banks’ outstanding real estate exposures were introduced through the Royal Decree Law (RDL) 02/2012. Banks have submitted plans to comply with the new requirements by end-2012 through earnings, asset sales, conversion of preferred shares and bonds into equity, and paying dividends in the form of new shares (Figure 9).

  • In May 2012, provisions on performing real estate developer loans were further increased from 7 percent to 30 percent in the RDL 02/2018. Banks that are not able to comply with their own means will be supported with a public capital backstop (issuance of equity or contingent capital to FROB).

  • A comprehensive review of banks’ loan books and real estate assets will be conducted by auditors to increase transparency.

  • In May 2012, the government committed to a capital injection of € 19 billion (about 2 percent of GDP) to the fourth largest bank, which will become state owned.

Figure 9.
Figure 9.

Spain: Banks’ Plans for Complying with the Provisioning Requirements of Royal Decree Law 02/2012

(In millions of euro)

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Source: BdE.Note: Groups are based upon mergers up through March 2012.

A. The Condition of the Financial Sector

20. The resilience of individual banks to the crisis has been markedly different, largely attributable to the varying business models and the differences in management quality and risk management philosophies. Thus, any analysis of the Spanish banking sector should necessarily differentiate the characteristics underpinning banks’ financial strength. This section aims to provide such an analysis, using supervisory data—banks are categorized into four groups covering about 83 percent of the banking sector excluding foreign bank branches (Table 5):

  • Large internationally active banks (G1). The two banks in this group are well-diversified in terms of their geographic footprints and business models. On a solo basis (Spain activities only) they account for about 33 percent of banking assets and almost half of the system at a consolidated level, with only one third of their net profits are generated domestically.

  • Former savings banks that have not received any state support (G2). These seven banks account for approximately 17 percent of domestic banking sector assets, and most of their lending is focused on the residential housing market.

  • Former savings banks that have received state support (G3). The seven banks in this group account for about 22 percent of sector assets; they rely significantly on the government/FROB for capital and liquidity support. Most of the banks included in this group show a high share of mortgage lending relative to their average balance sheet size, but most importantly, they are heavily exposed to real estate and construction-related lending.

  • Medium and small private sector banks (G4). This group accounts for approximately 11 percent of domestic banking assets. Their main lending activities are concentrated in the corporate sector, with exposures to the real estate and construction sector being second only to G3.

Table 5.

Spain: Overview of Diagnostics and Stress Test Sample, as at End-2011

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Sources: BdE; and IMF staff estimates.Note: The symbol “√” indicates that an institution is included in a particular stress test, “o” indicates its exclusion.

21. The groups differ in terms of loan exposures (Table 6). Banks in G3 has the highest exposure to the real estate developer sector, with 19 percent of its loans made to this sector, and with the highest proportion in land loans (that are the hardest hit). G1 and G2 have the lowest exposures and mainly to finished buildings. G3 also has the largest proportion of foreclosed assets.

Table 6.

Spain: Bank Profitability and Financial Soundness

(In percent)

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Sources: BdE; and IMF staff estimates.

Some banks may absorb the impact of the capital add-ons with their capital principal as well.

22. The profitability of the system has been adversely affected by provisioning needs, and capitalization is uneven across groups. G1 profitability is augmented by diversified international businesses, which contribute some 75 percent of profits. G3 has the lowest capital base, is loss making, and least efficient in terms of cost to revenue ratio. The groups are distinct also in terms of capital quality—G3 banks have a higher proportion of Tier 1 instruments (FROB 1 injections), which are not considered accounting capital.

23. Meeting the increased provisioning requirements could pose challenges for some banks (Table 5 and Figure 9). G1 banks appear to be able to cover the February provisioning requirements, particularly leveraging off the relatively high group-wide pre-provision profits, and are expected to be able to absorb the additional May provisioning requirements on performing loans. In contrast, some of the banks in G2 and G4 will likely come under pressure even without taking into account the latest requirements, with a risk that some of them may record overall losses in 2012. G3 banks clearly face the biggest challenge.

24. The composition of funding sources of the banks provides some insight into how loans are being financed (Table 7):

  • Deposits represent about half of total system-wide funding. G1 and G4 have the highest loan-to-deposit (LTD) ratios at 143 and 150 percent, respectively (Table 6).

  • Banks also place significant reliance on the issuance of covered bonds (cédulas hipotecarias), which serve as an important source of long-term funding of mortgages, particularly for banks in G2 and G3. However, with a few exceptions, most recent issues have been retained by banks for ECB refinancing purposes.

  • There was a significant take-up of the ECB LTRO facility across most banks, which has improved their liquidity profile. G3 and G4 banks are the biggest borrowers relative to their total funding needs.

Table 7.

Spain: Funding Liquidity Sources of the Banking Sector

(In percent of total)

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Sources: BdE; and IMF staff estimates.

Excludes LTRO funding.

25. In other parts of the financial sector, the insurance industry has weathered the financial crisis well. Going forward, key challenges are the transition to Solvency II and the management of exposures to sovereign and corporate debts.

  • Despite the financial crisis, insurers have remained profitable, maintaining a return on equity at around 15 percent. The profitability of several players is all the more important given the well established and highly profitable bank-assurance model.

  • The industry has a healthy solvency margin of around 200 percent above the required capitalization in the life sector and 350 percent in the non-life sector under the current Solvency I regime. The introduction of Solvency II will impact the solvency margin of the sector, albeit to a still unknown magnitude, but the industry should remain comfortably solvent, as suggested by the latest QIS 5 exercise.

  • On the asset side, about a quarter of the investment assets are in sovereign debt and about 30 percent in corporate debt. Many Spanish investment-type insurance policies contain a market value adjustment provision, which effectively transfers market risk to policyholders. Thus, market risk affects policyholders’ interest even if it may not affect insurers’ solvency position.

B. Risks and Vulnerabilities

26. The economic environment increases the risks to corporate and household balance sheets and consequently, to the soundness of the banking sector. The economy has fallen back into recession (GDP is expected to contract by 1.8 percent in 2012) and unemployment is 24 percent and rising (Table 1). The outlook is challenging given: large-scale fiscal consolidation to come, market concerns and sovereign spread widening caused by external and domestic events (e.g., the difficult financial situation of the regions), house prices sliding further, and substantial bank and private sector deleveraging. On the positive side, the current account deficit has fallen sharply and exports have been robust. Moreover, important structural weaknesses are being tackled—the labor market has been made more flexible, while the fiscal framework has been strengthened to bring autonomous communities’ budget under tighter central control.

27. House prices have declined sharply, but inventories still remain large (estimated 700,000–1 million units). Market estimates suggest that these will take about four years to clear. Sales prices are still 20–25 percent below asking prices and banks need to offload their repossessed assets (estimated 200,000 units), increasing the risk of further price corrections.

Corporate and household sectors1

28. Though not the highest in the Euro Area, household debt increased rapidly during the boom years to around 90 percent of GDP, in line with the housing cycle (Table 8). Mortgage nonperforming loan (NPL) ratios have held up well considering the tensions on household incomes, in particular, given the large increase in unemployment. There are several potential mitigating factors:

  • the overall sharp drop in Euribor rates since the onset of the crisis (Figure 10), which has helped to moderate debt service relative to income (98 percent of mortgages are at variable rates);

  • the uptick in interest rates over the past year has been offset by the continuing contraction in new mortgages (minus 42 percent year-on-year in March);

  • restructuring of loans by banks and policy initiatives to lower debt service for the most vulnerable households;

  • full recourse by banks (borrowers are liable for the full value of the loan including penalties and fees, and not only for the value of the house that was mortgaged);

  • relatively low loan to value ratios (on average 58 percent);

  • high and relatively (compared to other countries) well distributed wealth, albeit very concentrated in housing, an illiquid asset during crisis periods; and

  • country-specific factors that may alleviate the weight of debt service despite economic distress and high unemployment rates (such as family support and additional income provided by grey economy activities).

Table 8.

Spain: Financial Soundness Indicators of the Non-banking Sectors

(In percent unless indicated otherwise)

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Sources: BdE; and the IMF Corporate Vulnerability Utility on a consolidated basis.

Available solvency margin over required solvency margin.

Debt includes securities other than shares and loans (excluding inter-company loans). Calculated with information obtained from Financial Accounts of the Spanish Economy and National Accounts.

Calculated using the information in the CBA and CBB databases (derived from the Balance Sheet Data Office’s anual survey and balance sheet information deposited in the Spanish Mercantile Registries).

Earnings before interest and tax over interest expenses.

Since 2004, Bankruptcy Proceedings Statistics replace the Suspensions of Payments and Bankruptcy Declarations Statistic.

Assessed housing prices per square meter in the free housing market as published by the Ministry of Housing. Average year-on-year growth.

Including de-recognized loans.

Figure 10.
Figure 10.

Spain: Interest Rates and Household Loans

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Source: BdE.

29. The debt servicing ability among households has deteriorated since 2008. It is expected to weaken further due to the difficult economic situation. Sensitivity analysis of household indebtedness (Box 1) shows that:

  • Households are most vulnerable to rising interest rates, particularly on their mortgages (given the high share of variable rates); the shares of vulnerable households and debt-at-risk increases fairly sharply under rising interest rate scenarios, with stronger impact on lower income households.

  • Income shocks have a moderate impact on households’ debt servicing ability, which is consistent with the similarly muted impact from rising unemployment. One possible explanation is that the shock is being partially absorbed by the income of other household members and unemployment benefits, which may dry up in a prolonged recession resulting in second round effects.

30. A difficult economic outlook in 2012 and 2013 is expected to further weaken households’ financial positions. A sharp decline in output growth would cause an increase in debt-at-risk, with an impact that is most severe for borrowers among the poor and the young, which have already been hit hard, and bear a relatively high burden of debt.

31. Corporate debt poses a significant threat to financial stability, largely as a result of the weight of real estate and construction assets on banks’ loan books and the continuing adjustment in these sectors (Table 8). The deleveraging process will continue but will likely take a long time to complete, which means that financial stress and corporate vulnerability will remain elevated for some time. At 186 percent of GDP, corporate debt in Spain is the highest in the Euro Area after Ireland (Spain would be close to the Euro Area average if real estate and construction sectors are excluded); excluding trade credits, corporate debt would amount to 135 percent of GDP. Sensitivity analysis of the sector (Box 1) indicates that:

  • The corporate sector is vulnerable to interest rate shocks.

  • Small and medium-sized enterprises (SMEs) are exposed to domestic developments, due to their less-diversified sources of income. The recent decree creating a mechanism for the payment to suppliers of sub-national governments (up to 3.5 percent of GDP) goes in the direction of alleviating liquidity tensions at SMEs that depend on (already stretched) sub-national budgets for their business.

  • Macroeconomic shocks would have the biggest impact on the construction and real estate sectors while the export sector remains resilient.

Banking sector

32. The IMF’s central case (baseline) growth scenario projects a recession in 2012 and a modest recovery in 2013. Declining housing prices, strong headwinds from fiscal consolidation, and the ongoing de-leveraging of household, corporate, and bank balance sheets is expected to continue to weigh on domestic demand (see Risk Assessment Matrix in Appendix I). Led by net exports, real GDP growth is expected to accelerate gradually to around 1.8 percent over the medium term. The recent labor market reform will help contain costs and support the export-led recovery. Lower and stable inflation combined with productivity gains will help Spain keep its world share of goods exports.

33. Stress tests were conducted to assess solvency risks under baseline and two adverse scenarios. The tests covered over 96 percent of the domestic banking sector (by total assets, excluding foreign branches), over the 2012–13 risk horizon using end-2011 supervisory information (Appendix II). The additional provisioning requirements introduced in February and May are incorporated (Appendix III). Given the significant ongoing restructuring in the banking sector, a longer horizon for the stress test was not viewed as useful although the estimates are based on lifetime losses. The baseline growth projections are consistent with the IMF’s World Economic Outlook Update (January 2012), while the adverse scenarios comprise:

  • A “double-dip” recession scenario of one standard deviation from the baseline GDP growth trend over the two-year horizon (“IMF adverse”). In this scenario, most of the shock to economic growth occurs in the first year resulting from a sharp decline in output, further declines in house prices close to levels observed in 2002, and rising unemployment (Figure 11 and Table 9). Although the cumulative GDP shock under this scenario of 5.7 percentage points would be extreme by historical standards, it represents a plausible tail risk under current circumstances.2

  • An alternative adverse scenario (“BdE adverse”) where the shock to the two-year real GDP growth is more modest (i.e., reduced by 2.5 percentage points relative to the “IMF adverse” scenario.

Figure 11.
Figure 11.

Spain: Macro Scenarios for the Solvency Stress Testing Exercise

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Sources: BdE; and IMF staff estimates.
Table 9.

Spain: Macroeconomic Scenarios for Solvency Stress Tests

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Source: BdE.

Fourth quarter average.

34. The scenarios are designed with a specific focus on real estate prices, which are likely to decline further. In Spain, the fall in house prices of more than 20 percent in real terms is close to the average depreciation of house prices in the U.K. and in the Euro Area countries that have experienced similar real estate bubbles, but less than in Ireland and the United States. It is likely to continue to decline in nominal terms. This risk is reflected in the scenarios, with cumulative additional nominal declines for the period 2012–13 ranging between an additional 8 percent for the baseline to 23 percent for the IMF adverse scenario.

35. The scenarios include valuation haircuts on sovereign debt held in trading and available for sale portfolios. Banks hold about two-fifths of Spanish central government debt (about 8 percent of total banking system assets). Market-implied valuation haircuts are applied to sovereign debt holdings other than those in the held-to-maturity books (banks can repo these assets with the ECB and are thus not forced to sell them on-market). The haircuts were estimated based on the impact of the forward term structure of sovereign credit default swap (CDS) spreads on sovereign benchmark bonds as at end-2011 (Appendix III).

36. A three-pronged approach is used in the solvency stress testing exercise. The BdE runs two top down tests, using confidential supervisory data and based on guidelines provided by the FSAP team and agreed-upon assumptions (Appendix II), which are then cross-checked by the FSAP team using market data (Figure 12). These approaches consist of:

  • A top-down, balance sheet stress test conducted by the BdE on prudential data (“IMF TD model”);3

  • A top-down, balance sheet stress test conducted by the BdE (“BdE TD model”), applying its own panel regression model (Appendix III); and

  • Stress tests using the Systemic Contingent Claims Analysis (SCCA) approach.4 Using market information, capital needs are assessed based on perceived solvency and its implications for banks’ resilience to simultaneous shocks to multiple banks (“IMF SCCA model”).

Figure 12.
Figure 12.

Overview of the Spain FSAP Update Stress Testing Exercise

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

37. The findings suggest that while the core of the system appears resilient, there are vulnerabilities that need to be addressed. Lender forbearance—which the supervisory authorities have indicated they are monitoring closely—is not explicitly addressed in the stress test due to lack of comparable data across institutions, and this may understate the extent of credit risk in some institutions. The results (Tables 10 and 11) suggest that:

  • The banks in G1 appear sufficiently capitalized and profitable to withstand further deterioration in economic conditions. This reflects the solid capital buffers and the robust earnings of the internationally-diversified operations.

  • G2 banks are resilient to adverse shocks up to a point. As a group, they comply with core tier 1 capital hurdle of 4 percent under the adverse scenario but show some capital need in the case of a 7 percent hurdle rate (see below).

  • For the banks in G3 and those administered by FROB, the vulnerabilities seem highest and public support most critical. Under the adverse IMF stress scenario, these banks’ core Tier 1 capital (almost € 27 billion) would be essentially wiped out (Table 11). These banks have already received state support—five have been acquired or merged with stronger entities and the rest are in varying stages of restructuring. In May, the largest bank in this group requested capital support from the government (conversion of € 4.5 billion of FROB preference shares into equity). The new management team subsequently asked for capital support of € 19 billion from the government, of which about € 13.5 billion (post-tax) are earmarked to comply with the new provisioning requirements and to cover potential future loan losses.

  • The banks in G4 would also be affected, but to a lesser extent, under the adverse IMF scenario. Post-shock, these banks would require about € 2 billion to comply with a core Tier 1 capital ratio of 4 percent.

  • The impact of sovereign risk on non-banking income does not appear significant. However, the widening sovereign CDS spreads for Spain since end-2011, commensurate with the rising risks to the economic outlook, are not reflected in the haircuts given the cut-off point for the stress tests. This means that banks could be affected by additional losses beyond the prescribed haircuts projected as at end-2011.

Table 10.

Spain: Solvency Stress Test Results, with RDL 02/2012 and RDL 18/2012 Impact

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Source: BdE estimates based on IMF stress test guidelines.
Table 11.

Spain: BdE Top-Down Stress Test Results by Bank Grouping

(Incorporating New Provisioning Requirements)

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Source: BdE estimates based on IMF stress test guidelines.

These amounts should be added to available capital as at end-2011 to determine the level of capital that banks would have to maintain currently if they were to recapitalize before any shock has occurred.

38. Consistent with other recent FSAP assessments, the stress tests also consider the readiness of the banking system to accommodate Basel III capital requirements, which will take the minimum core Tier 1 capital ratio from 3.5 percent in 2013 to 7 percent by the end of 2018. Post-shock, the Spanish banking system’s capital needs to comply with a 7 percent core Tier 1 ratio would amount to an aggregate € 37 billion, 80 percent of which are attributable to the banks in G3 and those being auctioned by FROB. In an international context, recent stress tests conducted by the EU and U.S. authorities were respectively based on a hurdle rate of core Tier 1 and Tier 1 common capital ratio of 5 percent under the adverse scenario, and on a core Tier 1 ratio of 6 percent in the Irish 2011 stress tests. Market analysts’ estimates for Spain, on the other hand, tend to be based on higher hurdle rates (Box 2).5

39. Important caveats attach to these FSAP stress test results:

  • As in all other stress testing exercises, any feedback between banking system distress and economic performance cannot be fully captured. This consideration is especially pertinent in the context of the current crisis. Further bank strains, for example, that force a severe loan contraction that cause a self-reinforcing cut in domestic demand, deterioration in loan quality, and further bank funding pressures, are not captured in existing models.

  • As a result of the ongoing restructuring, one third of the banks in the stress test sample no longer exist as stand-alone entities as of May 2012. The financial strength of the merged entities may be different from the sum of its individual parts, which is not captured by the stress tests.

  • Moreover, other considerations need to be taken into account in the case of a bank under resolution/restructuring, especially if public funds are to be used. Indeed, as evidenced in the case of the fourth largest bank, some costs additional to provisioning for potential losses may be unknown ahead of time and are therefore not possible to incorporate in the stress tests. In this case, the industrial participations are marked-to-market in preparation for sale, as part of the restructuring plan, and the proceeds will likely be used to retire debt and thus improve the funding position.

40. Some banks have significant exposures to the banking and non-bank private sectors abroad (Figure 13). As a result, these banks may be susceptible to cross-border risk arising from shocks to a country to which they have made substantial loans or through the ring-fencing of profitable and liquid bank subsidiaries by host countries. Spillover analysis using the network approach indicate that the domestic banking system is most exposed to the realization of extreme credit and funding shocks to the United Kingdom and the United States, and to some extent to France and Germany (Box 3). Separately, analysis of cross-border shocks from partial ring-fencing of profits in key host countries to Spanish banks outside Europe suggest that the impact would be limited (0.5 percentage points of banks’ Core Tier 1 capital ratios or less).

Figure 13.
Figure 13.

Spain: Banks’ Foreign Exposures

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Source: Bank for International Settlements.1/ Other potential exposures include: credit commitments, guarantees extended and derivative contracts.2/ Other countries signifies the claims that Spanish banks have on the rest of the world, excluding the eight countries shown in the chart.
Figure 14.
Figure 14.

Spain: Structured Finance Market

Citation: IMF Staff Country Reports 2012, 137; 10.5089/9781475504231.002.A001

Source: CNMV.

41. The results of the SCCA analysis validate the stress test findings. As a complement, the SCCA model was used to estimate the joint solvency risk of seven large (and publicly-listed) banks (covering about 40 percent of the system and mainly in G1 and G4). Consistent with the findings in the other two stress test approaches, the severe double-dip recession scenario has the biggest impact on the banking system (Table 12):

  • Under baseline conditions, potential joint solvency pressures from the realization of lower profitability, rising credit losses and risks to sovereign debt holdings would be relatively benign, resulting in joint potential capital losses averaging € 0.3 billion over 2012–13.

  • In the event that the severe adverse scenario were to be realized, sample banks would experience a total expected loss of more than EU14 billion on average (with a peak in excess of € 21 billion at end-2012) at a statistical probability of five percent or less (expressed as “tail risk”). The resulting capital levels, however, remain comfortably above all stress test hurdle rates.

Table 12.

Spain: Joint Market-Implied Expected Losses below End-2011 Capital Levels (with Sovereign Risk) Based on Systemic Contingent Claims Approach 1/

(Average values in each forecast period, in billions of euro)

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Source: IMF staff estimates.

The sample comprises seven publicly listed banks (see Table 5 for sample details).