This Selected Issues paper analyzes household savings ratio in Spain. The household savings ratio has fallen to its lowest historical rate in 2012, as households cut back savings to support consumption in response to negative income shocks. Household savings fell across all households, but the declines were likely more material among lower income and highly indebted groups. Declining household income and savings slowed deleveraging and put household balance sheets under pressure. Looking ahead, households may need to restrain consumption further to free resources for repaying debt. Household savings rates will likely stay below historical levels for some time then slowly increase.

Abstract

This Selected Issues paper analyzes household savings ratio in Spain. The household savings ratio has fallen to its lowest historical rate in 2012, as households cut back savings to support consumption in response to negative income shocks. Household savings fell across all households, but the declines were likely more material among lower income and highly indebted groups. Declining household income and savings slowed deleveraging and put household balance sheets under pressure. Looking ahead, households may need to restrain consumption further to free resources for repaying debt. Household savings rates will likely stay below historical levels for some time then slowly increase.

Does Spain’s Insolvency Framework Need Further Reforms to Address Debt Distress in the Non-Financial Private Sector?1

Spain has an insolvency law that is generally in line with international best practices for corporate insolvency. However, although designed to facilitate restructuring of viable firms, in practice most proceedings end in liquidation after costly and lengthy court proceedings. Also, while the law applies to individuals, Spain does not have a personal insolvency regime providing for a “fresh start” for financially responsible debtors as in most other EU jurisdictions. Recent measures to strengthen the insolvency regime are certainly steps in the right direction, but shortcomings remain, impeding effective deleveraging of the highly indebted nonfinancial private sector. To address this, the corporate insolvency regime should be further strengthened to support early rescue of viable firms, preferably through out-of-court workouts, and swift liquidation of unviable ones. Consideration should be given to complementing these reforms in the future by introducing a special personal insolvency regime with a fresh start, applying strict conditions in order to maintain the strong Spanish payment culture and ensure financial stability.

The Spanish Insolvency Regime: Overview

1. The 2004 insolvency law applies to debtors (legal or natural persons) who are facing actual or imminent insolvency. Insolvency proceedings can be initiated by either the debtor (“voluntary insolvency”) or its creditors (“compulsory insolvency”). While such proceedings are court driven, the insolvency administrators play a dominant role and creditor participation is very limited. The law governs both pre-insolvency mechanisms and formal insolvency proceedings. The pre-insolvency mechanisms are primarily conducted after a ‘pre-insolvency court communication’, which allows a debtor a grace period before obligatory filing for insolvency, to negotiate with its creditors either a ‘refinancing agreement’ or an ‘early composition agreement.’ The formal insolvency proceedings can be either simplified or regular. The simplified insolvency proceedings, which apply, inter alia, when the debtor has fewer than 50 creditors and the debtor’s assets and liabilities do not exceed €5,000,000, are mostly used by SMEs and individuals now. The regular insolvency proceeding starts with the common phase upon the declaration of insolvency, after which the proceeding will move to either reorganization or liquidation.

2. The law is designed to foster reorganization of viable firms with going concern sale as the residual option. The reorganization phase is anchored in a ‘reorganization plan’, which can be presented by either the debtor or its creditors. Once approved by the relevant majority of creditors based on value of claims, the reorganization plan needs to be approved by the court, and once approved, binds all unsecured creditors (ordinary and subordinated), as well as those secured and other privileged creditors who consented to it. If no reorganization plan is proposed or approved, the proceeding enters into the liquidation phase. This phase aims to dispose of the business (or a part of it) as a going concern. To this end, the insolvency administrator needs to devise a liquidation plan that seeks to maximize the value of the enterprise. Following liquidation, the proceeds from the sale of the business/assets are distributed to creditors in accordance with their ranking and size of their claims.

Shortcomings in the Spanish Insolvency Regime

3. On corporate insolvency, despite the intended aim of the law, most insolvency proceedings end in liquidation rather than in restructuring. The causes for this appear to be, partially, issues of legal design, but more importantly, the following:

  • Structural. Since creditors are mainly secured, they have no incentives to file for insolvency as they can foreclose on the collateral (mainly real estate), which is perceived as a more effective procedure. Unsecured creditors in turn have no incentives to participate in insolvency proceedings given their low expectations of recovery since the debtor’s main assets are normally used as collateral.

  • Cultural. Despite corporate debtors’ duty to file under the law, the apparent stigma associated with insolvency makes debtors delay petition for voluntary insolvency proceedings until it is too late to rescue the firm.

  • Institutional. The overloaded courts and the lack of expertise of insolvency administrators with reorganization of viable firms render the system inefficient. Also, the costly, lengthy and cumbersome procedural structure constitutes a disincentive for potential users of the system.

4. On personal insolvency, there is no special regime with a ‘fresh start’ for financially responsible individuals as in other EU jurisdictions. While insolvent individuals may resort to insolvency proceedings (normally under the simplified proceedings), this does not provide them with the possibility to rehabilitate after fulfilling certain requirements (e.g., payment plan) within a specified period of time (e.g., 3 to 5 years) as in other EU jurisdictions. Instead, following liquidation of all assets in an insolvency proceeding, debtors who are natural persons remain obliged to fully repay the remaining debt with their present and future income.2 Recognizing the importance of a fresh start, the authorities recently amended the mortgage law to provide a limited ‘partial discharge’ after foreclosure of the primary residence of an individual debtor. Although a step in the right direction, this measure only provides ‘residential mortgage debtors’ a partial discharge (20 to 35 percent) after they have paid a considerable part of the remaining debt (80 percent or 65 percent) within a relatively long period of time (5 or 10 years). Moreover, the part of the debt that is forgiven in this partial discharge regime is currently considered to be taxable income for the debtor. Further, this partial discharge regime does not take into account the debtor’s overall ability to pay as a basis for such discharge.

5. While out-of-court workouts are now more widely used, their effectiveness is limited. In practice, banks, as key creditors, are leading such workouts (when the debtor is considered viable), as part of a multi-creditor scheme in case of the larger corporates. However, its effectiveness is limited because of legal uncertainty (e.g., risk of avoidance in case of ex post insolvency), lack or limited participation of certain creditors (e.g., tax authority), and high costs (e.g., applicable taxes, lawyers and registration fees for new collateral, etc.) Further, under Spanish corporate income, tax debt forgiveness gives rise to taxable income for the debtor to the extent such income is not offset with tax losses carried forward.

Elements of an Effective Insolvency Regime

6. International experience shows that effective insolvency regimes are critical to facilitate the rescue of viable firms and speedy exit of nonviable ones. Insolvency law should allocate risks among market participants in a predictable, equitable and transparent manner. This strengthens the credit system, thereby fostering economic growth for the benefit of all stakeholders. The insolvency system is heavily dependent on an adequate institutional framework.

  • Effective corporate insolvency laws aim to support orderly rehabilitation (e.g., fast track court approval or prepackaged procedures) and swift liquidation (e.g., flexibility in the liquidation modalities). Key features are: clear filing criteria, support for rehabilitation of viable firms; automatic stay on enforcement actions; priority status for new financing; speedy liquidation of non-viable firms; and procedural rules on cross-border insolvency.3

  • Special personal insolvency regimes aim to help rehabilitate individual debtors after a reasonable time and the fulfillment of certain requirements, enabling them to return to economic life. While no international best practices yet exist in this area, key principles for an economically efficient personal insolvency law have emerged from cross-country experience, including strict entry requirements, discharge of liabilities for financially responsible debtors (typically after 3-5 years); and repayment terms that accurately reflect the debtor’s capacity to repay to ensure an effective fresh start only after confirmed satisfactory behavior of the debtor.

  • Notwithstanding the above, it is worth noting that a special personal insolvency regime alone is sometimes not enough to address widespread residential mortgage debt distress. International experience shows that in such cases, even the most developed court system would be unable to handle the large number of cases through insolvency proceedings. Thus, complementary mechanisms such as government-sponsored out-of-court debt workouts (e.g., mediation) have been used to convert troubled loans into performing ones.

  • Out of court restructurings are also important to provide a speedy, cost-effective and market friendly alternative to court supervised insolvency proceedings. This tool is particularly useful where the institutional capacity is distrusted. However, achieving effective out of court restructuring requires a robust insolvency regime and adequate incentives for debtor and creditors’ participation (e.g., tax disincentives for debt write-downs or transfer of distressed loans should be removed).

7. In the aftermath of the global financial crisis, several European countries have reformed their corporate and personal insolvency regimes. A recent cross-country study conducted by Fund staff4 of selected European countries’ experience identified corporate insolvency reforms in Estonia, Germany, Greece, Iceland, Italy, Latvia, Lithuania, Moldova, Portugal, Romania, Serbia and Spain5 since the crisis. The key element of these reforms was to better facilitate debt restructuring of viable debtors (e.g., introducing “fast track” court approval procedures) and expedite the liquidation proceedings for unviable ones (e.g., flexibility in sale modalities). Some European countries (e.g., Greece, Portugal) also adopted special measures to address household debt overhang. Some of these measures are of ad hoc nature designed to tackle unsustainable residential mortgage debt subject to very strict eligibility criteria, while a few provide for a mechanism to facilitate out-of-court settlement of distressed mortgages. A number of countries (e.g., Ireland, Italy, Latvia and Poland) adopted or improved their personal insolvency laws.

8. Cross-country experience shows that a comprehensive approach to non-financial private sector debt restructuring is more effective than a piecemeal approach. Measures to protect debtors may undermine creditors’ rights to a certain extent. This requires a balanced approach that protects debtors without threatening the stability of the financial sector, which can only be achieved by means of a consistent set of measures that: (i) take into consideration all parties (individuals, firms and banks); (ii) do not contradict each other, and (iii) include both legal and institutional changes. This can only be done properly by a comprehensive strategy that aims for a clear objective. Financial and social crises create a conflict and thus, the aim of the reform ought to be to solve the conflict in accordance with the objective set. Patchwork generates legal uncertainty and creates a risk of overprotection of some to the detriment of others.

The Macroeconomic Relevance of Insolvency Regimes and the Case of Spain

9. Insolvency regimes contribute to re-initiating growth following the impairment of balance sheets and thus, revisions of insolvency frameworks have been part of the structural reforms undertaken by several European countries in the aftermath of the global financial crisis. Insolvent households who do not get debt relief have a very strong incentive to remain permanently in the informal sector. In addition, entrepreneurship is harmed by the absence of a fresh start, especially as banks increasingly request personal guarantees (and in absence of those, lending rates are much higher). Although self-employment has grown in Spain as employment prospects worsened, surveys indicate that potential entrepreneurs worry more in Spain than in other advanced countries about the risk of bankruptcy. Finally, the risks for financial stability are overplayed as an effective insolvency regime makes the process of recognition of losses that would happen anyway shorter, predictable and thus less costly.

uA06fig01

Fear of failure in OECD countries

(Percentage of 18-64 population with positive perceived opportunities who indicate that fear of failure would prevent them from setting up a business)

Citation: IMF Staff Country Reports 2013, 245; 10.5089/9781484371312.002.A006

source: Global Entrepreneurhsip monitor 2012

10. The ad hoc measures introduced by the government may in the end not provide the adequate solution envisaged in a personal insolvency regime due to their partial approach. Household surveys indicate that around half a million households are at risk of debt distress (their mortgage payments are higher than 60 percent of income). This number is much larger than the current number of households that are applying for relief under the code of good practices.6 In addition, many of these vulnerable households also owe several thousand of euros in non-mortgage debt (consumer credit debt), which are not covered by the current code of good practice. With respect to non-vulnerable households with a mortgage, whose typical debt is around €40,000 but whose financial wealth is much smaller (around €6,000), these can benefit from the partial discharge established under Law 1/2013 after foreclosure. However, these debtors may become unable to comply with the terms of the restructuring agreement with the bank (especially if default interest continues to be applied at high rates despite the recently established legal cap—i.e., 12 percent) and thus, continue to be liable for the remainder for the debt. In these circumstances, the existing ad hoc measures for residential mortgage debtors in distress would not provide a solution for their over-indebtedness. Moreover, except for the partial discharge regime, entrepreneurs who are natural persons7 would remain liable for any remaining debts due to the lack of a fresh start.

Recommendations for Strengthening the Spanish Insolvency Regime

11. The Spanish insolvency regime could be further improved to better support effective debt restructurings in the nonfinancial private sector. In particular, the law should be further refined to provide adequate incentives for early rescue of viable firms and to eliminate the rigid and burdensome procedural framework to expedite liquidation of unviable firms. Consideration should also be given to introducing a fresh start for financially responsible individuals as part of the personal insolvency regime, which would be complemented by the ad hoc measures already in place for addressing residential mortgage over-indebtedness. The key benefits from implementing these reforms include: (i) increasing the number of rescues of viable businesses, preserving value and saving jobs thereby; (ii) fostering a swift liquidation of unviable firms thus, cleansing the market from unproductive participants and allowing a more efficient reallocation of resources; (iii) incentivizing out of court workouts to alleviate the burden on the overloaded court system and decrease the costs of debt restructuring; (iv) fostering responsible borrowing and lending decisions; and (v) providing deserving debtors a second chance so as to tackle individual over-indebtedness in a comprehensive and effective manner.

12. In order to strengthen the effectiveness of the corporate insolvency regime, consideration should be given to:

  • Establishing an ‘automatic stay’ on enforcement actions against the debtor during the three-month period after the pre-insolvency court communication, to facilitate the debtor’s negotiation of refinancing agreements or early composition agreements.

  • Clarifying the definition of ‘refinancing agreements’, lowering the majority required for creditor approval; and establishing a special priority ranking for the full amount of the refinancing granted under these agreements (e.g., “fresh money”)

  • Extending the period for the debtor to negotiate early composition agreements and revisiting the creditor voting provisions.

  • Eliminating the higher burden of proof for filings by creditors and establishing a clear insolvency test to be used by creditors when filing for insolvency petitions.

  • Providing for a “creditors committee” to enhance creditors’ role and control and oversight of the proceedings and alleviate the current burden on the judge.

  • Streamlining the appeals procedure against the insolvency administrator’s list of creditors by either setting up ‘expedited procedures’ for resolving challenges to the insolvency administrator’s list or allowing to close the common phase and move to the next stage despite the challenges, where the challenges/appeal will be treated as a parallel procedure.

  • Eliminating the limit of a maximum 5 year extension and write off of 50 percent within ordinary composition agreements (i.e., restructuring agreements); revisiting the rules for submitting and approving a reorganization plan, and reducing debtors’ powers to block a swift liquidation.

13. With regard to personal insolvency, consideration should be given to complementing the existing ad hoc measures with introducing in the future a personal insolvency regime with a fresh start. In this context, the following key elements of a personal insolvency law should be considered: (i) a pre-insolvency stage to allow debtors to settle their obligations with creditors via a pre-insolvency agreement/plan with the aim of avoiding the initiation of an insolvency proceeding; and (ii) an insolvency stage that includes strict entry requirements to avoid strategic defaults and abuses of the system; an automatic “stay” on enforcement actions by creditors upon approval of petition; liquidation of debtor’s non-exempted assets; definition of debtor’s disposable income to support future payments; the establishment of a ‘payments plan’ and how it would be made binding on dissenting creditors; limited exception for treating debtors with no capacity to repay; repayment period under payment plan (e.g., 3-5 years); rules for debtor’s exit due to lack of capacity to implement a plan; and formal discharge and rehabilitation, including a mechanism to avoid stigmatizing debtors after discharge (e.g., delete debtor’s name from insolvent list in credit bureaus after discharge).

14. To promote corporate out-of-court workouts, consideration should be given to:

  • Issuing centralized guidelines for out-of-court workouts between banks and corporates (e.g., Latvia).

  • Establishing tax incentives or eliminate disincentives to promote debt restructuring.

  • Introducing a special regime for restructuring SMEs (e.g., Portugal, Italy, Iceland).

15. To support out-of-court debt restructurings for individuals, consideration should be given to:

  • Issuing centralized guidelines for out-of-court workouts between banks and individuals.

  • Establishing a system of mediation (e.g., Iceland’s Debtors Ombudsman).

16. To strengthen the institutional framework, consideration should be given to:

  • Strengthening commercial courts capacity by (i) increasing the number of judges (through new appointments or the reassignment of judges from other courts, and (ii) improving case management by supporting and speeding the process of digitalization of files.

  • Adopting measures to increase the professionalization of insolvency administrators. The creation of a specific professional body of insolvency practitioners with a system of internal and external controls and oversight could contribute to increase efficiency in their performance and provide for permanent education and adequate system of supervision of the profession.

References

  • IMF (1999), “Orderly and Effective Insolvency Procedures”, Washington. DC

  • Liu, Y. and C. Rosenberg (2013): “Dealing with Private Debt Distress in the Wake of the European Financial Crisis”, IMF Working Paper, WP/13/44

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1

Prepared by Katharine Christopherson (LEG)

2

The government has also put in place a mechanism that supports a voluntary system (opt in by banks) for out -of-court workouts for residential mortgage debtors, which only applies to the most vulnerable (the so called “Code of Good Practices”). This mechanism, which has recently been reformed to expand its coverage to allow a larger group of individuals to qualify, sets up a framework that includes restructuring of the debt, dacion in pago (‘datio in solutum’ or ‘deed in lieu of payment’) if the debt after restructuring is unviable. Separately, the authorities also established a mandatory suspension of evictions of up to 2 years.

5

The Spanish insolvency law entered into effect in 2004, and was substantially reformed in 2009 and 2011. Despite the recent reforms aiming primarily at supporting reorganization of viable firms, the system in practice is still not working as effectively as envisaged, as the majority of insolvency filings in Spain end in liquidation.

6

Official data reported that in 2012 around 8 percent of outstanding mortgages were restructured.

7

The authorities are preparing a draft entrepreneur law that would also include a discharge mechanism.

Spain: Selected Issues
Author: International Monetary Fund. European Dept.
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    Fear of failure in OECD countries

    (Percentage of 18-64 population with positive perceived opportunities who indicate that fear of failure would prevent them from setting up a business)