Spain
Basel Core Principles for Effective Banking Supervision: Detailed Assessment of Compliance Report

This paper assesses compliance of the Basel Core Principles for Effective Banking Supervision in Spain. Significant changes have occurred in Spain since the last Financial Sector Assessment Program (FSAP). The most serious has been the deterioration of the economy and the real estate sector. The dual legal framework governing Cajas poses the risk of potential conflicts in the exercise of supervisory and sanctioning authority. Other 2006 FSAP recommendations have been magnified with the perspective given by events from 2007 to 2011.

Abstract

This paper assesses compliance of the Basel Core Principles for Effective Banking Supervision in Spain. Significant changes have occurred in Spain since the last Financial Sector Assessment Program (FSAP). The most serious has been the deterioration of the economy and the real estate sector. The dual legal framework governing Cajas poses the risk of potential conflicts in the exercise of supervisory and sanctioning authority. Other 2006 FSAP recommendations have been magnified with the perspective given by events from 2007 to 2011.

I. Summary, Key Findings, and Recommendations

1. Significant changes have occurred in Spain since the last Financial Sector Assessment Program (FSAP). The most serious has been the deterioration of the economy and the real estate sector leading to a major decline in land values and the financial condition of developers impacting loan quality. The current crisis impacted the savings banks more severely due to their high concentrations in loans to finance land development and construction and highlighted a serious weakness in their risk management, leading to a complete restructuring of the sector and converting their vast majority into commercial banks. The commercial banks, with more diversified loan portfolios and bolstered by high levels of loan loss provisions, fared better through the initial phase but are under increasing pressure as provisioning and capital requirements continue to increase. On the regulatory side, the period was framed by the implementation of Basel II.

2. The core supervisory process at the Banco de España (BdE) is strong and is supported by qualified staff and an experienced cadre of inspectors, but there were areas of concern identified and discussed in the mission. The authorities have made progress in addressing the recommendations of the 2006 FSAP as regulatory capital and loan-loss provisioning requirements for real estate exposures have been tightened and further guidance on best practices for lending in this area has been provided. The authorities have also implemented measures to reduce incentives for equity investments in nonfinancial companies by banks and to manage related conflicts of interest; introduced reforms to strengthen corporate governance and the ability to raise capital from external sources for savings banks; enhanced coordination and cooperation between financial sector regulators; adopted additional requirements on internal controls, investment, and adequate verification of the risk management processes of insurers; and improved the functioning of securities settlement systems. However, in spite of the high technical quality of the supervisory process, the closure of the supervisory work does not seem to be sufficiently timely or effective for bank resolution. There are areas requiring attention such as timeliness of remedial action, operational independence concerning issuance of regulations and enforcement, and oversight of concentration risk and related party transactions. Some of these issues are also addressed in the crisis management technical note that is part of this FSAP.

3. A review of examples of inspection activities and reports revealed the thoroughness of the supervisory process and the identification of key risks and their communication to bank management, however, the process for requiring corrective action is lengthy and corrective action tools were not timely applied. The BdE identified at a very early stage the need for provisions and recommended corrective action, but the formal decisions were only adopted after following the deliberate BdE process and not fully employing all its available enforcement tools as it focused on broader systemic responses. This resulted in the continued accumulation of problems and losses as the bank or savings bank continued operating without major restrictions during the process. Discussions with the authorities provided context to their process and the timeliness issue. According to the authorities, the deterioration in the economy was more protracted than initially anticipated as was the deterioration in the financing of land and real estate development. As weak institutions were identified and it became apparent that a broader fix would be required rather than dealing with individual institutions, the BdE started to encourage mergers and did not close banks waiting for a market solution to achieve the lower cost option.1 As the BdE reviewed the broader solution options, the use of enforcement tools to protect bank capital and avoid asset dissipation was not widely used. For example, implementing cease and desist orders to limit or eliminate dividends, putting in place strict review requirements before continuing to fund existing projects and severely curtailing new projects. Further, these decisions took into account the information available at the time, the legal framework currently in force, the cost to the public purse, and the implications for financial stability. BdE was of the view that since the troubled institutions had significantly curtailed lending to the troubled sectors; the level of bad assets would not increase.

4. A review of the legal framework identified areas where the BdE authority can be increased to expedite corrective action. The BdE lacks authority to issue prudential regulations, except in areas specifically delegated by law or the Ministry of Economy (MoE). Having the authority to issue prudential regulations would enable the BdE to address at an earlier stage developments of a systemic nature. In addition, enforcement action is shared with the MoE, with the BdE having to send to the Ministry the more grave issues for enforcement. Having a flexible enforcement regime enables the supervisor to quickly adjust a course of action should original assumptions prove incorrect, and a more intense use of sanctions should work as deterrent to imprudent risk management.

5. The regulatory framework and oversight over concentration risk and related party transactions were not sufficient to address significant build-up of weaknesses in the system, some of them derived from the peculiar corporate governance structure for savings banks. In the case of savings banks, the issue may have been aggravated by the division of responsibilities with the Autonomous Communities (CCAA).2 Although the number of savings banks has been drastically reduced and their banking business transferred to commercial banks, the shareholder and corporate structure of the new banks is complex and the BdE will need to apply particular attention to make sure deficiencies in the previously existing structures do not contaminate the banking organizations.

A. Introduction

6. This assessment of the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in Spain has been completed as part of a FSAP update undertaken by the International Monetary Fund (IMF) during February 2012. It reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. It is not intended to assess the merits of policy and implementation issues regarding European Union (EU) regulatory framework. In addition, it is not intended to represent an analysis of the restructuring processes of the savings banks sector, which is addressed in the broader FSAP exercise.

7. An assessment of the effectiveness of banking supervision requires a review of the legal framework, and detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. In line with the BCP methodology, the assessment focused on the BdE as the main supervisor of the banking system, and did not cover the specificities of regulation and supervision of savings banks, which is a shared responsibility with the CCAAs and would have needed to involve the analysis of local authorities’ legislation and supervisory practices. Insofar as prudential regulation of the banking sector and supervisory processes of the BdE are also applied to the Caja segment, this assessment is also applicable to the prudential supervision of Cajas, which is conducted by the BdE. It must be noted that as of the date of this BCP assessment, almost all the Cajas, with two small exceptions, have transferred their banking activities to commercial banks (although the ownership structure of the new banks may still retain some characteristics of the Caja governance), therefore the role of CCAA supervision in the financial sector could at this point be considered reduced, and this assessment should provide a clear picture of the current supervisory process applicable to the whole banking sector.

B. Information and Methodology Used for Assessment

8. The Spanish authorities agreed to be assessed according to the Core Principles (CP) Methodology issued by the BCP (Basel Committee) in October 2006. The current assessment was thus performed according to a revised content and methodological basis as compared with the previous BCP assessment carried out in 2006. It is important to note, for completeness’ sake, that the two assessments will not be directly comparable, as the revised BCP have a heightened focus on risk management and its practice by supervised institutions and its assessment by the supervisory authority, raising the bar to measure the effectiveness of a supervisory framework.

9. To assess compliance, the BCP Methodology uses a set of essential and additional assessment criteria for each principle. The essential criteria (EC) are the only elements on which to gauge full compliance with a CP. The additional criteria (AC) are suggested best practices against which the Spanish authorities have agreed to be assessed. AC are commented on but are not reflected in the grading. The assessment of compliance with each principle is made on a qualitative basis. A four-part grading system is used: compliant; largely compliant; materially noncompliant; and noncompliant. This is explained below in the detailed assessment section. The assessment of compliance with each CP is made on a qualitative basis to allow a judgment on whether the criteria are fulfilled in practice. Effective application of relevant laws and regulations is essential to provide indication that the criteria are met.

10. The assessment team reviewed the framework of laws, rules, and guidance and held extensive meetings with officials of the BdE, and additional meetings with the MoE, rating agencies, auditing firms, and banking sector participants. The authorities provided a self-assessment of the CPs rich in quality and comprehensiveness, as well as detailed responses to additional questionnaires, and facilitated access to supervisory documents and files, staff and systems.

11. The team appreciated the very high quality of cooperation received from the authorities. The team extends its thanks to staff of the authorities who provided excellent cooperation, including extensive provision of documentation and access, at a time when staff was burdened by many initiatives related to the domestic situation, as well as European and global regulatory initiatives which are in progress.

12. The standards were evaluated in the context of the Spanish financial system’s structure and complexity. The CP must be capable of application to a wide range of jurisdictions whose banking sectors will inevitably include a broad spectrum of banks. To accommodate this breadth of application, a proportionate approach is adopted within the CP, both in terms of the expectations on supervisors for the discharge of their own functions and in terms of the standards that supervisors impose on banks. An assessment of a country against the EC must, therefore, recognize that its supervisory practices should be commensurate with the complexity, interconnectedness, size, and risk profile and cross-border operation of the banks being supervised. In other words, the assessment must consider the context in which the supervisory practices are applied. The concept of proportionality underpins all assessment criteria. For these reasons, an assessment of one jurisdiction will not be directly comparable to that of another.

13. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team.3 The Spanish banking system was undergoing a deep reform when the assessment took place, and while much of the supervisor’s attention was focused on these circumstances, the reform was prompting further evolution of the already advanced practices for supervision. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the Spanish authorities with an internationally consistent measure of the quality of its banking supervision in relation to the CPs, which are internationally acknowledged as minimum standards.

14. To determine the observation of each principle, the assessment has made use of five categories: compliant; largely compliant, materially noncompliant, noncompliant, and non-applicable. An assessment of “compliant” is given when all EC are met without any significant deficiencies, including instances where the principle has been achieved by other means. A “largely compliant” assessment is given when there are only minor shortcomings, which do not raise serious concerns about the authority’s ability to achieve the objective of the principle and there is clear intent to achieve full compliance with the principle within a prescribed period of time. A principle is considered to be “materially noncompliant” in case of severe shortcomings, despite the existence of formal rules and procedures and there is evidence that supervision has clearly not been effective, the practical implementation is weak or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. A principle is assessed “noncompliant” if it is not substantially implemented, several EC are not complied with, or supervision is manifestly ineffective. Finally, a category of “non-applicable” is reserved (though not used in this case) for those cases that the criteria would not relate the country’s circumstances.

C. Institutional and Macroeconomic Setting and Market Structure—Overview4

15. Spain is experiencing the bursting of a real estate bubble after a decade of excesses. 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 in capital markets and abroad. The reversal of the domestic expansion and the onset of the Euro area debt crisis exposed Spain’s vulnerabilities from accumulated domestic and external imbalances and pushed the economy into a sharp recession in 2009–10, and unemployment is over 21 percent.

16. The rapid economic expansion in the last decade has been mirrored in the banking industry. Banks play a pivotal role in the Spanish financial system. The total assets of the Spanish banking sector amount to about 320 percent of GDP, with five banks accounting for more than 70 percent of total assets. Commercial and savings banks dominate, with more than 90 percent of deposits and loans. Nonbank financial entities represent a small share of the financial sector (less than 5 percent of total assets).

17. Significant consolidation has taken place in the savings bank sector. The reforms to the legal framework together with financial support from the state-owned recapitalization vehicle, the Fondo de Reestructuración Ordenada Bancaria (FROB), were instrumental in reform process. The number of institutions has been reduced from 45 to 18, through intervention, mergers, or takeovers. Tighter capital requirements led many savings bank groups to spin off their banking activities into newly created commercial banks. The FROB has taken over five institutions (8 percent of the system); one intervened bank was recently auctioned off, another is in the pipeline, and the takeover of a small, ailing bank is underway.

18. Despite the reform measures and balance sheet repair by banks, the sector remains under severe pressure. Spanish banks have been able to raise capital from private sources, some of which through the exchange of convertible instruments, in response to the requirements of the European Banking Authority (EBA), but profitability has deteriorated. The uncertainty surrounding the valuation of real estate collateral has led the government to issue a new set of measures in February, while the mission was in the field, requiring additional capital and provisioning for problematic exposures to real estate and new measures to encourage further consolidation in the financial sector.

19. In Spain, the regulation and supervision of financial institutions and securities markets is performed by three main agencies. Oversight of credit institutions is the responsibility of the BdE (although regional governments retain some regulatory and supervisory powers over the savings banks operating in their jurisdictions); securities markets are supervised by the Comisión Nacional del Mercado de Valores (CNMV); supervision of insurance companies and pension funds is under the mandate of the Dirección General de Seguros y Fondos de Pensiones (DGSFP) within the MoE. Oversight and supervisory responsibilities regarding payments and settlements systems are the purview of the BdE and the CNMV, respectively.

20. In 2006, the authorities established a financial stability committee, Comité de Estabilidad Financiera (CESFI), in which the three agencies are represented, together with the State Secretary for Economic Affairs acting as Chair. The objective was to strengthen coordination and exchange of information among the three institutions; the CESFI does not have any decision-making powers of its own.

D. Preconditions for Effective Banking Supervision5

21. The legal and regulatory framework for transparency and governance of publicly traded institutions has improved significantly in recent years.6 In particular, since 2006, for traded companies and issuers whose securities are traded on an official secondary market, financial statements must be prepared in accordance with International Financial Reporting Standards (IFRS) for consolidated statements and domestic Spanish standards for individual financial statements. Domestic Spanish standards are almost fully assimilated to IFRS, with differences only in that Spanish standards allow capitalizing research expenses and do not provide options available under IFRS, in connection with the valuation of certain assets (mainly real state and intangible assets).

22. Instituto de Contabilidad y Auditoría de Cuentas (ICAC) is the body responsible for setting Spanish accounting standards and providing interpretation and guidance on their use. It is a government entity, attached to the MoE. Any proposal to change the accounting standards must be subject to consultation with the Consultative Committee on Accounting Standards of ICAC, where the CNMV, the BdE, the DGSF participate along with representatives from the professional bodies, issuers and investors. The final decision belongs to the Accounting Council of ICAC, which is composed of the President of ICAC and representatives from the CNMV, the BdE, and the DGSP. BdE has the delegated authority from the MoE to establish accounting standards for banks, in which they coordinate with ICAC.

23. The BdE as a member of the Eurosystem may provide Emergency Liquidity Assistance (ELA) within the restrictions of the System. ELA may only be provided to an individual credit institution which is considered solvent but which faces temporary liquidity problems. A national central bank which provides ELA must supply the ECB with a predefined set of information. While granting the ELA remains a decision of the national central bank, carried at the risk of said bank, liquidity support through ELA is subject to consultation with the ECB Governing Council when the amount of the ELA is above a predefined threshold. During the recent crisis there was one case of ELA use, after which the BdE has fine-tuned its protocol for the provision of liquidity in emergency situations.

24. The financial safety net institutional framework is complemented by two other agencies, Fondo de Garantía de Depósitos (Depositor Guarantee Fund - FGD) and the FROB. The FGD does not act as a mere pay-box but it has in conjunction with the BdE a wide range of intervention powers and it has been the main crisis management “instrument” until the creation of the FROB, which was created in June 2009 to assisting and fostering the reorganization of the Spanish banking industry, especially savings banks.

25. The FGD is a private legal entity wholly prefunded by the member credit institutions. Originally, there were three FGDs; one for each sector of the banking industry (commercial banks, savings banks, and credit cooperatives). With the Royal Decree-Law 16/2011 of October 14, 2011, the three sectoral funds were merged into a single fund and the premiums have been made uniform. The Management Board of the FDG consists of 12 members: six from the BdE and two from each of the commercial bank, savings bank and cooperatives sectors; the chairman is the Deputy Governor of the BdE. Certain major decisions—such as on provision of financial assistance in resolution and on the collection of extraordinary premiums—are subject to a two-third majority of its members. Members’ contributions are the main source of funding but the FDG may also be funded by extraordinary contributions; and by issuing bonds or by borrowing from third parties, including the Government or the FROB.

26. The FGD resources may be used for preventive measures and bank reorganization under specific safeguards. When a problematic situation in a bank is detected, the BdE will inform the FGD. The bank must present an Action Plan to the BdE on the measures needed to resolve the problem. If the BdE accepts the Action Plan, the Management Board of the FGD will decide whether to provide any financial support aimed at restoring the viability of the bank. The range of financing mechanisms that the FGD can deploy is broad and includes both liquidity and solvency support. RDL 16/2011, of October 14, 2011, (as amended by Royal Decree-law 19/2011), has further widened the FGD’s options for supporting bank resolution, as it authorizes the FGD to make nonrefundable contributions in the process of restructuring and resolution of viable and nonviable institutions, including those intervened or recapitalized by the FROB. In case of bank liquidation, neither the FGD nor depositors enjoy any preferential rights over the estate of a failed bank.

27. The explicit objective of the FROB is to assist and foster the reorganization of the Spanish banking industry (Royal Decree Law 9/2009). The FROB has legal personality and full public and private capacity. The FROB received its initial capital from FGD and from the state. The FROB can issue securities guaranteed by the state (and/or it can seek other funding) up to three times its capital, but it can leverage up to six times with the approval of the Minister of Finance and Public Administrations. With the recent Royal Decree Law 2/2012 the resources of the FROB have been raised. The FROB is administered by a governing committee named by the MoE, formed by nine members: four are proposed by the BdE, including the deputy governor who acts as chairperson, two members are from the MoE; and three members representing the FGDs.

28. The resolution and intervention framework is shared among these authorities. BdE is the triggering authority, determining that the solvency and liquidity of a bank is jeopardized, and activating intervention. When BdE determines that the entity is not viable, it appoints FROB as administrator, with managerial powers over the entity. FROB makes an inventory of the bank’s condition, prepares and submits to the BdE a restructuring plan, spelling out all the possible measures to restore the viability of the institution or to resolve it (mergers, P&As—which may be subject to shareholders/creditors’ consent). The plan needs to be approved by the BdE in order to be carried out. At any point in time, the FROB may provide financial support to the problem bank (the same could be done by the FGD once the restructuring plan has been approved). At the same time that the FROB submits to the BdE the restructuring plan, it provides also a report to the MoE and the Minister of Finance and Public Administrations analyzing the impact of the plan on the public finances. The Minister of Finance and Public Administrations may object to the plan, based on its evaluation of such impact. If the restructuring plan is not successful, the alternative would be the revocation of the bank license (by the Council of Ministers) and, in case of insolvency of the entity, the initiation of a court-driven bankruptcy process.7 The resolution authorities, in principle, BdE, FROB and MoE, cannot fully allocate losses to shareholders and creditors, or revoke a license (except the MoE in specific cases provided in law), which makes the resolution process somewhat convoluted.

E. Main Findings

Objectives, independence, powers, transparency, and cooperation (CP 1)

29. As noted in the previous FSAP, the dual legal framework governing Cajas poses the risk of potential conflicts in the exercise of supervisory and sanctioning authority. Some areas where responsibilities overlap between BdE and CCAA—for instance, governance and sanctioning, are directly related to reputational risk and risk management, which affect solvency. The fragmentation of CCAA supervision over such issues may have played a role in the deterioration of the situation of saving banks sector. The lack of clarity brings reputational risk to the BdE, and the 2006 FSAP recommendation that the legal regime be reinforced is still valid. It must be noted that since all but two Cajas have transferred their banking activities to commercial banks, the issue will become less relevant as the governance of the new institutions become closer to that of listed commercial banks and CCAA role in the supervision of banking activities diminishes.

30. Other 2006 FSAP recommendations have been magnified with the perspective given by the events from 2007 to 2011. Since the last FSAP, and given the saving banks restructuring process in Spain, some market participants have expressed concerns about BdE’s independence, particularly due to the apparent delays in implementation of corrective actions and sanction. This concern is triggered as the market is well aware of the thoroughness of BdE’s supervision—while the sanctioning proposals are made by the Governing Council of BdE to the Minister of Economy, who has sanctioning power for very serious infractions and resolution capacity. The legal framework also establishes the MoE as the principal agency charged with issuing financial regulation. Assessors have not seen any evidence of government or industry interference in the operation of supervision and budget of supervision in BdE. However, the presence of a government member in the governance structure of the BdE, combined with the legal framework for sanctions and regulation powers, does not create an environment conducive to independence. It is striking that the law clearly distinguishes the independence and regulatory capacity of BdE in its monetary authority role from its supervisory role. As prudential regulation in Spain depends on governmental action, changes in the regulatory framework tend to follow the political cycle and may result in delays in the issuance of critical regulations. The broad presence of the MoE in the supervisory and regulatory hierarchy clouds the independence of a well conducted and highly technical supervisory body, and ultimately undermines the credibility and effectiveness of the supervision.

Licensing and structure (CPs 2–5)

31. The ongoing restructuring process in the financial sector will bring challenges to supervision with respect to structure and governance of banks. The MoE is the licensing authority, based on an analysis by BdE of the compliance with the licensing criteria established in law. The BdE is then responsible for supervising the ongoing compliance with the licensing criteria in the life of the institution. On the other hand, BdE is the authority responsible authorizing and monitoring significant transfers of ownership and major acquisitions. The framework has improved since the last FSAP and a closer monitoring of the structure of banks is carried out, in particular given the expansion of seguimiento continuado approach to more financial institutions. In that sense, the peculiar situation of new commercial banks created as the result of the reform of the Cajas should be carefully followed by authorities, insofar as the new shareholder entities (no longer conducting banking business) have no identifiable ownership and frequently have close links to the local industrial and political environment given their social services objectives. This situation has the potential to create detrimental influence over the bank’s operations and soundness. Supervision of such institutions needs to be tailored to these special characteristics.

Prudential regulation and requirements (CPs 6–18)

32. Pillar 2 implementation has been a significant focus for the BdE. A standard format was designed for the banks to report on their Internal Capital Adequacy Assessment Program (ICAAP). The reporting was initiated in 2008 and has been revised to capture additional information and provide further guidance to the banks. The BdE staff meets with the banks annually to discuss the report. The results of the report are used in evaluating the banks’ risk profile. There has been significant consolidation in the financial system creating challenges for banks to integrate risk management systems.

33. Concentration risk and related party lending played a significant role in recent cases of distressed financial institutions, in particular Cajas de Ahorros. These Cajas, given their local characteristics and business nature, presented both high sectoral (real estate) and geographical concentration, but economic sector concentration also affected many banks. In addition, in Spain many linkages between industrial companies and banks remain, and the organizational structures are often complex and related parties difficult to detect. Related party lending was an important source of lower quality credit that played a role in the savings banks crisis, due to both exposures to non-consolidated real estate enterprises and in certain cases, exposures to public entities or organizations linked to members of governance bodies of the Cajas. The application of an enhanced regulatory framework within Pillar II and more intensive monitoring and control of such risks under seguimiento continuado is recent, and is not yet fully applied to all institutions in the system. Going forward, the complex organizational and governance structures of the new commercial banks presents particular challenges to supervision of these risks.

34. Loan loss provisioning has been robust but had to be supplemented in February 2012 due to the continued economic decline. At the start of the crisis existing provisions, built through the dynamic provisioning framework, enabled banks to meet the increased specific provisions required by a deteriorating loan portfolio but the continued crisis has prompted additional provisioning. The decline in real estate prices and the dearth of transactions highlighted weaknesses in the real estate appraisal methodology, which becomes very difficult in the absence of market transactions, resulting in valuations that were based in too optimistic discount rates and execution periods. To address these issues a Royal Decree Law was issued imposing extraordinary provisioning levels on substandard and doubtful loans secured by land of by real estate developments.

35. A new law on anti-money laundering and combating the financing of terrorism (AML/CFT) was adopted in 2010. The responsibility for enforcing and monitoring compliance with AML/CFT regulation rests with Servicio Ejecutivo de la Comisión de Prevención del Blanqueo de Capitales (SEPBLAC). However, the BdE also plays an important role as in its compliance inspections; it also reviews the banks’ systems for AML/CFT and follows up on deficiencies. The BdE and Sepblac collaborate closely and perform joint inspections when warranted.

Methods of ongoing banking supervision (CPs 19–21)

36. The BdE has a risk-based supervisory model supported by a strong technical staff and a well-developed information technology system. Onsite and offsite staff is integrated and both participate in onsite inspections. The primary supervisory instruments are the onsite inspection and permanent onsite presence at many of the banks (at the time of the assessment, there was permanent onsite presence at 16 of the banks).

37. A risk-based matrix is developed for each bank. The supervisory team assigned to a bank develops a risk matrix by rating the level of risk in a number of categories of banking activity. The matrix also includes elements of corporate governance, concentrations risk and operational risk. The matrix also describes the risk direction as stable, increasing or declining. Based on the results, the annual supervisory plan is developed.

38. The informational technology infrastructure greatly enhances supervisory efficiency and risk monitoring. The supervisory staff has access to a vast amount of information with systems that facilitate the manipulation of the data. In addition to financial information, there is an electronic file system where an audit trail is available of all the supervisory reports, activities and issues related to a bank, including all inputs by inspectors.

Accounting and disclosure (CP 22)

39. The BdE is the body responsible for issuing accounting standards and has a working relationship with the audit industry. The BdE meets annually with auditors and discusses issues of concern and audit scopes. The annual audit produces a report for the BdE addressing the banks’ compliance with BdE requirements and an evaluation of the loan portfolio. Disclosure in Spain is extensive and in recent stress tests there has been transparency in result reporting. accounting and disclosure

Corrective and remedial powers of supervisors (CP 23)

40. The BdE has a broad range of supervisory enforcement authority. However, the adoption of new regulations to implement Pillar 2, the current crisis and the pace at which deterioration can occur in the integrated global market indicate the need for flexible actions that can be applied at an earlier stage to effect corrective action. The enforcement practice employed by the BdE follows a deliberate, well-documented approach that has reduced the need for sanctions. In the current environment, it is unclear whether implementation of all the enforcement tools available to the BdE while it searched for a systemic solution, was held in abeyance in expectation of a quick resolution of the weak banks or underestimation of the duration and depth of the economic crisis.

Consolidated and cross-border banking supervision (CPs 24–25)

41. The BdE has broad authority to conduct consolidated supervision. BdE is empowered to supervise banks on a solo and consolidated basis, including all the offices or entities within the group, irrespective of their location or legal structure.

42. Consolidated supervision is primarily based on the information compiled by the parent bank in order to manage the risks and controls of the group as a whole. Parent banks are subject to mandatory detailed regular reporting to the BdE, which also covers internal global risk management and information on internal controls. Additionally, the BdE coordinates and exchanges information with domestic and foreign supervisors to accomplish a full view of risk.

43. Through supervisory colleges and on a bilateral basis, the BdE collaborates with home-host supervisors. The BdE conducts supervisory colleges for its two largest banks and for a medium-sized bank and has signed MOUs with relevant supervisors. The BdE coordinates the supervisory activities of these three banking groups with host supervisors and relies on their reports.

Table 1A.

Summary Compliance with the Basel Core Principles—ROSCs

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Table 1B.

Summary Compliance with the Basel Core Principles—Detailed Assessments

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F. Recommended Actions and Authorities’ Response

Recommended actions

Table 2.

Recommended Actions to Improve Compliance with the Basel Core Principles

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Authorities’ response to the assessment8

44. The Spanish authorities (Spanish Treasury and Banco de España) want to express their appreciation to the IMF and its assessment team for this comprehensive assessment of Spain’s compliance with the Basel Core Principles for Effective Banking Supervision. The Spanish authorities strongly support the FSAP as a means of promoting the soundness of financial systems as well as of improving supervisory and regulatory practices all over the world. For this reason the authorities welcome this opportunity to comment on the important regulatory reforms Spain is undertaking to improve the soundness of its financial system.

45. The authorities share the main views of the assessment team and appreciate its recommendations. The strength of the Spanish regulatory and supervisory framework was subject to stress during the crisis. The IMF broadly recognizes the determination and effort of the Spanish authorities to address the challenges posed by the crisis. Spain is committed to continue its effort to respond to the crisis and to overcome it successfully. Spain has a long tradition of adherence to the highest international regulatory and supervisory standards and works to improve compliance with the Basel Core Principles on an ongoing basis.

46. Some of the regulatory and supervisory practices commented in this report have actually been improved in parallel to the development of the FSAP missions. The financial reform has been accelerated recently. As a consequence improvements are only partially reflected in the final draft of the assessment. A deep and unprecedented process of restructuring of savings banks is on its way. Professional management teams have been ensured and transparency has been improved. Spain is fully involved in the international efforts to reinforce bank resolution regimes through the implementation of the Financial Stability Board Key Attributes for Effective Resolution Regimes and of the European Commission proposals on crisis management and bank resolution. The Spanish response to the crisis is active, constant and multi-dimensioned. At the same time it is adapted to the special features of the Spanish banking system.

47. The Spanish authorities look forward to continuing their dialogue with the IMF beyond the FSAP exercise. An important experience in the field of cooperation, transparency and best practices has been acquired and must be now appropriately cherished. Spanish authorities are aware of their role in the promotion of international financial stability and declare their willingness to continue working with international counterparts in order to grant it.

48. In addition, the Banco de España would like to add that although it recognizes that the restructuring process has not been sufficiently timely, as is suggested both in the assessment of some of the principles and—more significantly—in the section “Summary, key findings, and recommendations” there are several factors responsible for this, which the Banco de España considers need to be explained in order for the recent restructuring process to be understood:

  • First, it is important to take into account that adequate instruments for resolution were not introduced until 2009.

  • Second, it is only now with hindsight that we know that the deterioration in the economy was more protracted than initially anticipated by all national and international institutions.

  • Third, the successive Spanish governments in power over the period decided and reconfirmed that only limited public funds should be used to rescue banks, thus discarding the ‘bad bank’—type alternatives. Other options were considered more appropriate, in part taking into account that the large Spanish banks were not affected, unlike large banks in other countries. This decision was taken not only due to the need to contain the public deficit, but also—and especially—due to the fact that a huge increase in the deficit could lead to an acute sovereign crisis, as has already happened in other countries. The decision to implement the restructuring through private solutions has many advantages but is inevitably slower and much more complex and cumbersome to implement than those that—however being more expeditious—involve huge amounts of public resources.

  • Fourth, the implementation of a private solution has proven particularly difficult and slow during this crisis because the large international institutions that could have participated in mergers and acquisitions of Spanish institutions were not in a position to do so. For this reason, the private solution was constrained to the domestic level.

  • Fifth, during this systemic crisis it was not possible to use the traditional resolution tool of winding-down a bank with write-downs for bondholders. If Spain had been the only country to impose losses on bond holders of medium-sized institutions, the funding for other healthy Spanish institutions would have been seriously impaired. Therefore, the benefits derived from the liquidation of a good number of credit institutions would not have compensated the potential damage to the banking system as a whole and especially to healthier institutions.

  • Sixth, the governance of the Cajas also added to the complexity of the restructuring process and affected its speed, due to the strong presence of political and trade union interests in their boards of directors and general meetings. This problem has been mitigated with the transformation of Cajas into banks, but will only disappear if the Cajas lose control over their participated banks.

  • Seventh, the fact that the Comunidades Autonomas exercised their power to approve the mergers of Cajas during the restructuring process significantly slowed down the process, given the need to hold long, complex and difficult negotiations with regional governments to reach adequate agreements. This problem has already disappeared thanks to the transformation of Cajas into banks.

49. These are some of the factors that explain why the whole restructuring process was slow and why, against this complex backdrop, the Banco de España had to conduct a large amount of work and was able to take actions only after following a very laborious and cumbersome process.

II. Detailed Assessment

Table 3.

Detailed Assessment of Compliance with the Basel Core Principles

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