Spain: Selected Issues


Spain: Selected Issues

Spain’s Insolvency Regime: Reforms and Impact1

Spain recently introduced further improvements to its insolvency regime to assist distressed businesses and households. The most noteworthy advancement is a “fresh start” for good-faith consumers and entrepreneurs, which if implemented effectively will likely have positive effects on future economic activity and a limited short-term impact on banks’ earnings.

A. Introduction

1. As part of its ongoing efforts to improve the insolvency regime, Spain introduced in 2014 and 2015 further changes to facilitate the restructuring of corporate and household debt. The reforms, passed via Royal Law Decrees (hereinafter, “RDL”) issued in September 2014 and February 2015, are designed to (i) facilitate the ability of enterprises to reach restructuring agreements in court; (ii) encourage the sale of businesses as going concerns in insolvency liquidation; (iii) improve the mediated out-of-court restructuring process for SMEs and extend it to include consumers; and (iv) provide a “fresh start” for consumers and individual entrepreneurs2 after their assets are liquidated in bankruptcy.3 The introduction of the fresh start is a particularly important achievement, as it may allow financially distressed entrepreneurs and consumers to be discharged of unsustainable debt and incentivizes future entrepreneurial behavior and consumption, thereby supporting continued economic growth and social cohesion.4

2. The reforms are significant advances, although certain features could be improved going forward. Public creditors continue to be excluded from the out of court restructuring processes and are not subject to discharge after liquidation, which hinders the deleveraging of private sector debt by (i) disincentivizing other creditors from voluntarily agreeing to restructure debt and (ii) incentivizing debtors facing financial difficulty to pay their public debts at the expense of those owed to other creditors. The “fresh start” legislation could benefit from clarification in order to facilitate wide and uniform application of the law, while minimizing misuse. Regarding the reforms to the in-court restructuring procedures, a somewhat cumbersome class voting system without specified conditions under which dissent by impaired creditor classes can be overridden (“cram-down”) may reduce the efficiency of the restructuring process. Furthermore, going concern sales may be hindered by rules designed to protect labor and social security, at the expense of value maximization.

B. Amendments to the Insolvency Law

In-court and out-of-court procedures

3. The RDL of September 2014 amended the in-court procedures to facilitate corporate restructuring (see Box 1). The reform introduced a new class voting system with up to nine distinct classes, which is intended to facilitate restructuring agreements by including secured and priority creditors in the voting process if they are to be affected by the restructuring plan (See Figure below). In order for a restructuring agreement to be binding on them, affected privileged creditors holding a qualified majority of claims in each of the classes of affected privileged creditors must vote in favor of the plan approved by ordinary creditors; subordinated and non-affected creditor classes do not vote. There is no “cram-down” mechanism by which a plan can go forward despite the obstruction of dissenting classes. The reforms also expanded the content of the restructuring plans to provide more restructuring tools and allow for more substantial write-downs.

*Source: Spanish Ministry of Economy

4. The creation of a class voting system involving priority and secured creditors is in line with best practice, but the design will have to prove itself in practice. A system in which up to nine affected voting classes must each approve a restructuring plan may often prove too involved to be workable, particularly in the absence of a “cram down” mechanism by which dissenting, affected classes could be bound by the plan provided that they were treated “fairly and adequately”.5 The system also does not aggregate creditor claims based solely on their ranking within the insolvency regime, but rather groups all priority classes within each of the four socio-economic groups into one voting class. As such, creditors within classes may have different economic incentives that prevent them from reaching majority consent.

5. The reforms also introduced noteworthy and progressive rules enabling the sale of businesses as going concerns and significant changes to the out-of-court restructuring mechanism for SMEs. The primary amendments are as follows (see Box 1):

  • Going Concern Sales: The reform allows negotiated sales of business assets (without an auction) in liquidation and the assignment of necessary licenses and contracts without the consent of counterparties.

  • Out of Court Agreements: The RDL of February 2015 amended the special procedure introduced in September 2013 by which SMEs can reach an out of court agreement on payment (“OCAP”) with their creditors, with the assistance of a mediator.

Changes to In-Court and Out-of-Court Procedures

The Royal Decree Law 11/2014 of September 5, 2014, as amended by the Law 9/2015 of May 25, 2015 and the Royal Decree Law 1/2015, of February 27, 2015 introduced changes in the legal framework for business restructuring both in and out of court, which include the following:

In court proceedings

Plan Content: The amendments eliminated the previous limitations on plan content (debt reductions of up to 50% of unsecured debt and reschedulings of up to 5 years). Now there is no limit to write downs and reschedulings can be up to 10 years.

Class Voting: A new system of class voting has been introduced: creditors are divided into four classes based on “socioeconomic” factors: labor, public, financial, and a residual category “other”, which are then further subdivided into two classes: those creditors with special privilege (security interest) and those with general privilege (priority). All ordinary creditors vote together in a separate class. A majority of 50% or 65% of ordinary creditors is required to approve the plan. The privileged creditors will be included in those percentages when they vote in favor of the plan.

Plan Approval: To bind all privileged creditors within a class, the following thresholds must be met: (a) creditors holding 60% of the total value of the claims if the plan includes write downs of less than 50% and reschedulings of up to 5 years or (b) creditors holding 75% of the total value of the claims if the plan includes higher write-downs and longer reschedulings (with a cap of 10 years).

Automatic Assignment of Contracts/Licenses: In going concern sales, the automatic assignment of executory contracts and licenses relevant for the continuation of the business/professional activity is permitted without the need for the consent of the debtor’s counterparty.

Negotiated Direct Sales of Businesses: A negotiated sale of the business can be conducted on the marketplace, without an auction procedure.

Creditors that Acquire Claims Post-Insolvency: Creditors that acquire an insolvency claim by assignment/transfer are no longer deprived of the right to vote on a plan. The only ones to lose the right to vote are those especially related persons who acquire claims after the opening of proceedings or, having acquired it before, are subordinated according to the law.

Sección de Calificación: The rule that defines the opening of the “sección” on liability and disqualification of directors has been amended. No such procedure will be opened if an insolvency plan is passed that envisages a write off of less than 1/3 of the claims or a stay shorter than 3 years, either for all creditors or for the creditors of one or more classes. It will thus suffice to pay 67% of the claims to only one of the classes of creditors to avoid the mandatory investigation into the behavior of directors.

Steering Committee: A steering committee has been created to supervise the effectiveness of the new insolvency system stemming from the recent reforms.

Out of Court Agreements on Payments (the “OCAP” Procedure)

Plan Content: The possible content of the plan has now been extended to encompass write downs/extensions beyond the prior limitations of a 25% write-down and a three year moratorium.

Plan Approval: The majorities needed to reach an agreement have been amended as follows: 60% of the value of the claims for plans including write-downs of up to 25% or rescheduling of less than 5 years; 75% necessary to pass a plan with higher write-downs and reschedulings (with a cap of 10 years). Secured creditors may also be bound by the plan (for the amount covered by the collateral) as long as 65% or 80% vote in favor of the agreement, depending on the extent of the write downs/rescheduling.

Process: The procedure has been streamlined, channeled through the Commercial Registry, the notaries and the chambers of commerce, made more accessible by means of pre-designed forms/templates, and facilitated by an improved system of mediators.

Eligibility: The procedure has been expanded to cover consumers as well as entrepreneurs. See Box 2.

6. However, preferential treatment afforded to public creditors and labor reduces the efficiency of the process. Public creditors continue to be excluded from any out of court restructuring processes. There is no stay on the execution of public claims once the processes begin and public creditors are left out of the collective creditor decision-making process. This may limit the effectiveness of these agreements, particularly in the case of entrepreneurs who often have tax arrears. With respect to going concern sales, the law requires the mandatory assumption by the purchaser of residual social security and labor liabilities (“successor liability”). While successor liability protects social security and labor creditors,6 it discourages potential buyers as these liabilities cannot always be accurately reflected in a discount to the purchase price. Even when this discount possibility exists, value is taken away from other creditors by granting employees and social security bodies an extra type of preference. As an additional measure to protect labor, the law also gives the judge the possibility to authorize the transfer of the business as a going concern in liquidation to the bidder that better secures the continuation of the business and the preservation of jobs, even if the bid is lower than other bids by as much as 15%. While this rule gives clarity to previously disparate judicial practice, it distorts the making of efficient choices best for the market as a whole.

The fresh start

7. The most noteworthy achievement is the introduction of a fresh start for individual entrepreneurs and consumers. With this reform, Spain has transitioned from being one of the few countries in the European Union without a fresh start policy to having one of the more liberal regimes, apart from an unusually broad exclusion of public claims.7 For details on the design, see Box 2.

The “Fresh Start” Reform

The Royal Decree Law 1/2015 introduced a specific system to deal with the insolvency of individuals. The system covers both consumers and individual entrepreneurs and generally consists of two mandatory, consecutive stages, one conducted out of court with a view to reach a plan and, if unsuccessful, an in-court bankruptcy liquidation. The main features of the system are as follows1:

Out of Court Stage

• For individual debtors with an estimated debt below 5 million euro, a prior “OCAP” procedure must be attempted. Individual professionals (empresarios according to Social Security rules and autonomos) are regarded as entrepreneurs.

• Debtors convicted of certain economic and social crimes and those who had reached an OCAP, concluded a refinancing agreement or who have undergone insolvency proceedings in the previous 5 years may not access the proceedings.

• The procedure varies depending on the type of debtor. If entrepreneur, the debtor initiates the procedure by filing a petition and requesting the appointment of a mediator. The petition will be channeled through the Commercial Registry or a Chamber of Commerce. If the debtor is a consumer, the petition will be made to a public notary, who may act as mediator or, in some cases, appoint one. Both petitions must be accompanied by relevant documents, and templates designed by the Ministry of Justice are to be used. The procedure for consumers is shorter and less costly.

• The mediator is a private professional who plays a substantial role: among other tasks, the mediator analyzes the documents; summons creditors to a meeting; drafts the plan, which will include a payment plan with reference to the resources needed to execute it; and must supervise the implementation of the plan2.

• The opening of the OCAP limits the debtor’s ability to effectively carry out legal acts outside the ordinary administration of his affairs; generally, executions are stayed, and the accrual of interest is suspended during the negotiation.

• Creditors must express their opinion on the plan or their claim will be subordinated. Public creditors are not affected by the OCAP.

If no plan is approved, the plan is declared void, the approved plan breached or, at any time during the OCAP proceedings it is apparent that no majority may be reached, in-court insolvency proceedings will be opened on the insolvent debtor.

In-Court Insolvency Stage

Following a failed OCAP, abridged, formal insolvency proceedings will be opened. In case of consumers, the proceedings will necessarily be liquidation proceedings. The main characteristics are:

• The debtor must have previously tried an OCAP (unless not legally allowed).

• Only good faith debtors may obtain a discharge. In any case, good faith will be deemed to exist when (a) the procedure has not been classified as “guilty” (culpable); (b) the debtor has not been convicted for criminal offences in the 10 years prior to the opening of insolvency; (c) the debtor has paid all administration claims, all privileged claims and 25% of unsecured claims; or, alternatively (i.e., if such payment has not happened), the debtor (d) has not breached the duty to collaborate during insolvency proceedings; (e) has not obtained a discharge in the previous 10 years; (f) has not unjustifiably rejected a job offer in the previous 4 years; (g) accepts to be included in the public insolvency register for 5 years; and (g) accepts to be subject to a post-liquidation payment plan.

• The immediate yet provisional discharge will only affect (i) all outstanding unsecured and subordinated claims, with the exception of public claims and alimonies and (ii) the part of secured claims that remains unpaid following execution of the collateral (if it is classified as unsecured).

• The dischargeable claims are provisionally discharged upon liquidation. All other claims (except public claims) are subject to a payment plan that can last up to 5 years.

• A final discharge will be granted upon compliance with the payment plan unless any of the following occur:

  • The debtor incurs any of the causes that would have prevented him or her from obtaining the provisional discharge (see definition of “good faith” above).

  • The debtor enjoys certain fortuitous gains (inheritance or lottery) such that he or she is able to satisfy all discharged claims and alimonies.

  • Undeclared assets or revenues are discovered.

  • The payment plan is not complied with.

• In spite of having breached the payment plan, the judge may confirm the discharge if, given the circumstances of the case and having heard the creditors, the debtor has devoted 50% of her non-exempt income to the satisfaction of the plan.

1 In June 2015, the Parliament approved amendments to RDL 1/2015 to (i) clarify that the discharge can be revoked during the period of the payment plan upon fortuitous gains such as lottery or inheritance (and not other economic success); (ii) include a provision that the guarantor gets no recourse action against the discharged debtor (provided it is not revoked) (iii) reduce the threshold from 50% to 25% for those debtors subject to the Code of Good Practices; and (iv) clarify that the grounds for revocation shall occur during the term of the payment plan (except for revocation based on the discovery of undisclosed assets or revenues (if they are sufficiently material), which can occur any time within the five-year period). The amended version of the law is still subject to confirmation by the Senate.2 Concerning the content of the plan and the majorities necessary for its approval, see Box 1.

8. The reform is a crucial step to encourage individuals to engage in productive economic activity in the formal sector. A “fresh start” regime incentivizes the start of new businesses and risk-taking, as entrepreneurs know that they will not be forever tied down repaying unsustainable debt. It may also deter grey market activity, as individuals will have less incentive to conceal future earnings and savings for fear they will be perpetually subject to pursuit by creditors. More broadly, it has the important societal effect of recognizing that economic failure—in either a business venture or with respect to personal finances—should not be a life sentence, but a temporary setback.

9. Spain’s regime takes a unique approach designed to balance the need to quickly deleverage individuals with the desire to minimize moral hazard. The result is a system that stands out from its European peers and other advanced economies (see Box 3). Its design is an amalgam of modern insolvency systems, such as the U.S. bankruptcy discharge (“Chapter 7”), which allow the debtor an immediate and generally irrevocable fresh start after liquidation, and many European systems, which require a period of “good faith efforts” after liquidation, whereby the debtor’s nonexempt income must be dedicated to the payment of pre-insolvency creditors for a period of several years, after which discharge is granted. While the Spanish system does not fully avail itself of the benefits of an immediate and generally unconditional fresh start, it could maximize these effects in its own system by increasing the post-discharge certainty for the debtor. This could be done by remedying the lack of clarity with respect to the post-liquidation payment plan and revocation of the discharge. In addition, while the Spanish system does not have the disciplining effects of a post-liquidation commitment period of court-supervised “good behavior,” the potential for misuse can be minimized by careful monitoring. If evidence of widespread abuse arises, areas in which the law could be strengthened in this regard include expanding the “good faith” criteria for entry and ensuring discharge is not granted in the event of fraudulent behavior.

10. As with the other reforms to the insolvency regime, a number of arguments speak in favor of including public creditors in the “fresh start” reform. The exclusion of public creditors may take away from the intended positive impact of the fresh start by (i) leaving debtors with potentially significant residual debt after discharge and (ii) creating incentives for debtors to strategically pay public creditors at the expense of others when in financial difficulty, as follows:

  • Residual Debt: After bankruptcy liquidation, all residual debt owed to public creditors (even to those public law debts that enjoy no privilege in the insolvency law) 8 will not be extinguished or included in the post-discharge payment plan. As a result, individuals—particularly individual entrepreneurs—may be saddled with sizeable public debt even after having liquidated their assets, leaving them with fewer resources to start and grow businesses, earn income, and consume. This is likely to negatively impact tax revenues in the longer term. In the post-liquidation period, public creditors may enforce arrears in the applicable administrative processes, including by garnishing wages. This may obstruct the debtor from complying with his payment plan, including by preventing him from dedicating 50 percent of his non-exempt income to the payment plan, and thereby preventing him from receiving a final discharge.

  • Unintended Incentive Effects: A potential effect of the broad exclusion of public creditors is that rational debtors in distress may be incentivized to pay public creditors preferentially and default strategically on their other liabilities before petitioning for mediation and bankruptcy. This may have a negative effect on payment culture and take away value from other creditors, e.g., financial and trade creditors of an entrepreneur, thereby undermining the entrepreneurial incentives desired from a fresh start policy.

Personal Insolvency Regimes: Cross-Country Survey

The following provides a description of the approach in the personal insolvency regimes in selected modern jurisdictions: Germany, Italy, the United Kingdom, and the United States to two key design issues: (i) Immediate Discharge v. Commitment Period and (ii) Scope of Dischargeable Claims.

Immediate Discharge v. Commitment Period

Germany: Discharge is granted only after a commitment period that generally lasts 6 years (it is reduced to 5 years upon payment of all costs of proceedings and 3 years if there is 35 percent recovery for creditors). During the commitment period the debtor assigns or transfers all nonexempt income to a trustee for the ratable payment of all unpaid (residual) administrative, priority, general, and subordinate claims, which are paid by the trustee following bankruptcy priority rules. All pre-insolvency creditor actions are stayed during the commitment period, including for creditors with non-dischargeable claims.

Italy: In Italy, individuals in debt distress have a number of procedures available to them, including a creditors agreement (for persons with an economic activity), a consumers’ insolvency plan (which does not require creditors’ consent), and bankruptcy liquidation. After bankruptcy liquidation, discharge can be granted four years after the initiation of insolvency procedures, subject to the debtor’s good conduct during that period.

United Kingdom: The U.K. has various procedures available to individuals in debt distress that provide debt reduction, including bankruptcy. In a bankruptcy liquidation, discharge is generally granted one year after the opening of the liquidation (called a moratorium period) although the debtor may be required to pay excess income for up to three years. During the moratorium period, the debtor is subject to various restrictions (e.g., informing a credit provider of the bankruptcy when applying for credit of £500 or more, being barred from being a director of a company or taking part in its promotion, formation or management unless court permission is obtained, etc.). These restrictions can continue for up to 15 years if the debtor was reckless or otherwise culpable in causing the bankruptcy.

USA: Depending on their income, debtors may choose between Chapter 7 liquidation with immediate discharge and Chapter 13 debt adjustment (which allows debtors to avoid liquidation and retain assets (e.g. their home) in exchange for submitting to a trustee-monitored debt adjustment plan). Under Chapter 7 of the U.S. Bankruptcy Code, a debtor receives an immediate discharge (in practice this generally takes place about 4 months after closing of liquidation). Chapter 13 plans have a min. three year plan period, which can be extended to five years for debtors with greater income. During the plan, there is a stay on pre-petition creditors’ actions, and there is no minimum creditor recovery prescribed; “zero recovery plans” are not uncommon.

Scope of Dischargeable Claims

Germany: Discharge excludes claims for intentional torts, intentional evasion of alimony and maintenance, and interest-free loans for costs of proceedings. These claims are accelerated upon bankruptcy and can be enforced after the conclusion of the commitment period. Public law claims are included in the discharge, including VAT, except taxes or social security contributions criminally evaded or withheld (non-dischargeable only after final criminal verdict).

Italy: The discharge does not cover the debts for alimony, tort debts, pecuniary sanctions and tax liabilities for acts preceding the insolvency process but assessed after its commencement. All other tax claims are dischargeable.

United Kingdom: Discharge excludes debts arising from fraud, debts incurred in family proceedings, damages arising from personal injuries and debts which weren’t included in the bankruptcy itself (e.g. a debt to the Student Loans Company). There is no special priority afforded to public claims and they are subject to discharge after the one year moratorium period.

United States: In Chapter 7, discharge does not include priority tax claims (non-priority tax claims are discharged), claims incurred by fraud, intent to deceive, or false pretenses, domestic support obligations, willful or malicious injury (tort) claims, fines and penalties, educational benefits and loans, and certain intentional personal injury claims. Chapter 13 has a very similar scheme of nondischargeable debts. It also requires that the plan pay all priority claims. Ordinary claims, e.g., trade and nonintentional tort claims, may be classified separately and receive different technical treatment.

C. Maximizing Effectiveness of Reforms

10. Maximizing the effectiveness of the reforms will require sufficient resources and active monitoring. In the near future, judicial resources should be dedicated to ensure the law is implemented effectively, which may include strengthening IT capacity, improving case management by speeding the process of digitalization of files, the development of standard forms and templates, and an investment in dissemination and capacity building of the relevant stakeholders. The use of the regime—particularly the new fresh start mechanism—should be carefully monitored, including by the gathering of relevant statistics, so that informed adjustments can be made.

11. As an urgent priority, remaining areas of uncertainty in the law regulating the fresh start should be clarified. In order for the market to take full advantage of the benefits of the system, the bases for revocation should be minimal and made explicitly clear in the law to create maximum certainty for the debtor. Widely-held misunderstandings about the law include the following: (i) which non-discharged liabilities are included in the payment plan and whether such liabilities, if any, are forgiven completely after successful completion of the payment plan or dedication of 50 percent of income to the plan; (ii) the length of the payment plan (whether it is up to or fixed at five years); (iii) under what circumstances the discharge can be revoked; and (iv) in what circumstances the judge would exercise his discretion not to revoke the discharge when the debtor used 50 percent of disposable income for compliance with the plan.9 To minimize potential abuse, it should be made clear that the ex-ante requirement of good faith should be strictly applied and broadly interpreted so that the listed criteria are clearly illustrative and not exclusive.

12. Public claims should be included in bankruptcy discharge, at least to the extent that they are ranked as ordinary or subordinated claims.10 As a second best option, public claims should be included in the payment plan, their enforcement stayed during the plan period, and the accrual of interest and penalties stopped, and eventually be finally discharged like all other claims included in the plan. This is a crucial measure to really give distressed debtors a “fresh start” and create the appropriate incentives to engage in productive activity in the formal economy.

13. In due course, when reliable data on judicial practice and empirical impact become available, consideration could also be given to further improvements as outlined below. These are designed to address remaining obstacles to facilitate in-court and out-of-court agreements to rehabilitate viable firms, facilitate going concern sales in liquidations, and achieve the most effective function of the fresh start mechanism:

In-court and out-of-court procedures:

  • Public creditors: Public creditors should be included in, and be affected by, the OCAP procedure as well as in the refinancing agreements.

  • Cram down: To overcome obstruction by voting classes, particularly given the multiplicity of voting classes, a “cram-down” mechanism could be introduced allowing for the disregard of the majority dissent of one or several classes provided they receive fair value under the plan, including, as a minimum, the net present value of the payout they would likely receive in a liquidation.

  • Successor liabilities: Social security and labor liabilities should not be transferred to the acquirer with the business in a sale of all or substantially all business assets as a going concern sale in an insolvency procedure. Rather, such liabilities should be included in the restructuring plan. To protect against possible misuse, the law could require disclosure and control of sales to insiders or their “straw men” by a creditors’ committee and/or require a public auction for such sales. The rule that gives the judge the possibility to authorize the transfer of the business as a going concern in liquidation to the bidder that better secures the continuation of the business and the preservation of jobs, even if the bid is lower than other bids by as much as 15 percent, could also be reconsidered.

  • Pending bilateral contracts: The regulation of the treatment of executory contracts in insolvency proceedings continues to run against best international practice. Claims of counterparties of rejected terminated executory bilateral contracts should be classified as ordinary insolvency claims (instead of claims against the estate). This would facilitate business restructuring.

Fresh start

  • Revocation: Revocation may not be the most appropriate sanction for subsequent fortuitous gain. An appropriate alternative would be to distribute substantial fortuitous gains (even when they make up for less than the full amount of residual claims) ratably to pre-insolvency creditors. This could be achieved easily on the basis of the final list of bankruptcy claims.

  • Preventing Misuse: A greater measure of misuse control in the final stage of the discharge process (post-liquidation) could be warranted if evidence of abuse surfaces after experience with the law develops. While the provision setting forth revocation of discharge for a debtor who concealed his assets is crucial, other kinds of fraud committed in the post-insolvency period could also be bases for revocation. The law could also state that certain liabilities are never dischargeable.11

  • Co-debtor joint case management: Related parties, such as household members, frequently give personal guarantees or supply collateral. Following practice in other modern jurisdictions, for a coherent resolution of household debt it could be considered to enable joint case administration in the same forum and by the same judge in the insolvencies of debtor and household co-debtors.

D. Estimated Scale of Impact

14. The analysis below attempts to estimate the impact of post-liquidation discharge on debtors as well as creditors, including banks and the government. It is subject to considerable uncertainty due to lack of clarity regarding some provisions of the law and data limitations. It assumes that the reform is effective in promoting discharge of debtors and the recommendations above are followed. It does not model potential changes in the behavior of borrowers or lenders as a result of the legislative reforms. For example, there is a risk, albeit small, that borrowers might become less inclined to service their debt obligations and lenders might tighten lending volumes and raise interest rates to compensate for higher lending risks. Details of the methodology and assumptions appear in the annexes.

15. The results suggest that the reform could offer significant relief to debtors following liquidation. According to our estimates, the law could eventually reduce about €30–44 billion of private sector liabilities, or nearly half of the total liabilities of distressed borrowers if the entire stock of banks’ NPLs were liquidated (table below). Based on our understanding of the law, these debtors are assumed to include consumers and “individual entrepreneurs”.12 In the calculation, we estimate average recovery from liquidation of between 45–55 percent on loans of consumers, which include mortgage and auto loans, credit card debt and other personal loans, and a similar recovery rate on loans to individual entrepreneurs. Since banks only report broad NPLs arising from the corporate sector, a key uncertainty relates to the size of debt of individual entrepreneurs. This figure is estimated using two different approaches: (i) based on debt liability data for small enterprises in the ORBIS database and (ii) adding together aggregate BdE data on banking sector NPLs for industries in which individual entrepreneurs are active. In practice, the discharge would be expected to occur over a number of years depending on the effectiveness of the reform and the speed at which debtors would make use of it.

Table 1.

Spain: Estimated Size of Private Sector Liabilities Affected by RDL, March 2015

(Billions of euros)

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Sources: BdE, Haver Analytics, ORBIS, IMF staff estimates (June 2015).

Estimated Impact on Banks

16. The law is expected to have a relatively small impact on banks’ earnings. The bulk of the relief offered to debtors will come from cancelation of banks’ remaining claims after liquidation. These are estimated as between €30–44 billion (see the table above). However, due to banks’ provisions, at 55 percent of NPLs, and other benefits accruing from cancellation of non-performing debt, for example lower carrying costs of NPLs, the RDL is expected to lower banks’ earnings in Spain by only about 1–2 percent per year at the current pace of liquidation; and the corresponding impact on banks’ overall capital is estimated as less than 1 percent versus what it might have been at the end of a 3-year period. It is important to note that even before the reform banks would have been able to collect only a small portion of the full residual amount owed by debtors after liquidation.

17. The impact of insolvency reform on banks’ earnings and capital was estimated using a bottom-up approach. For this purpose, 10 years of annual filings data on Spain’s largest 5 banks by consolidated assets are used to project forward balance sheets, earnings, and capital for a three-year period. For each bank, an iterative procedure is used to maximize loan growth and thereby earnings subject to constraints on capital and funding. The first of these constraints is that any capital raised through reinvested earnings and equity issuance must equal or exceed market expectations of target capital requirements over 2015–17. The second constraint is that funding raised through growth of deposits, from the interbank market, debt issuance or via ECB facilities should equal or exceed the funding needs related to projected loan growth.

Table 2.

Spain: Banks Post-Reform

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Sources: BdE, bank statements, IMF staff estimates (May 2015).

Credit Supply

18. Our base scenario suggests that the law is unlikely to be a significant impediment to credit supply. This is primarily because the estimated scope of its balance sheet impact is relatively small and the largest banks appear to have adequate capital and provisioning buffers as well as ample funding—both in terms of market access and continued availability of ECB liquidity, including targeted long-term refinancing operations (TLTROs), despite the modest loss of private deposits since the start of the recovery for the banking system as a whole. These estimates assume that discharge is not revoked within the five-year period after having been granted.

Estimated Impact on the Government

19. Amendment of the reform to include a discharge of public claims would have a relatively small impact on the public finances. Public claims are estimated to range from €7–9 billion cumulatively or 3–4 percent of annual tax revenues, which would likely be spread out over several years depending on the pace of liquidation. This estimate assumes that net earnings of distressed consumers and entrepreneurs are at most similar in magnitude to their debt servicing costs then applying estimated average income tax and social security contribution rates for consumers and entrepreneurs to these earnings. The potential loss to the government from discharge of these public claims could potentially be compensated, partially if not wholly, by higher tax revenue from firms entering the formal economy but this potential compensation is not included in this analysis. Also, it is important to note that much of these claims are uncollectible.

Estimation Uncertainty

20. Any such estimate comes with considerable uncertainty, and the impact could well be higher or lower.

  • Scope of the reform. Key uncertainties relate to the size of debt of individual proprietorships that would be affected by discharge and the extent of recovery on the debt of consumers and entrepreneurs. If banks’ NPLs due to entrepreneurs were cut by half, for example, because of the use of an OCAP or a refinancing agreement, then private sector debt relief related to discharge would fall by nearly 20 percent. On the other hand, if the recovery rate on this distressed debt were 10 percent higher, the discharge from debt relief would be 20 percent lower.

  • Banks’ capital and funding buffers. The capital requirements in the calculations are set at fully-loaded Basel III CET1 capital ratios of 11, 11.5, and 12 percent over 2015–17 for SIFIs and 2 percentage points lower each year for non-SIFIs, in line with market expectation, which are higher than the Basel III schedule. Nevertheless, future regulatory developments concerning treatment of DTAs or TLAC requirements could raise capital needs well above the assumed targets. On the funding side, banks are assumed to take full advantage of ECB’s facilities, including TLTROs, as needed, and deposits are assumed to remain stable going forward.

Credit Demand


Non-Financial Corporate Credit and Leverage

(billions of eur, percent)

Citation: IMF Staff Country Reports 2015, 233; 10.5089/9781513529059.002.A004

Source: Haver, BdE

Household Credit and Leverage

(billions of eur, percent)

Citation: IMF Staff Country Reports 2015, 233; 10.5089/9781513529059.002.A004

Source: Haver, BdE

21. Allowing for a “fresh start” is likely to increase credit demand over time. The intuition is that discharged debtors would eventually become re-integrated into the formal economy, seek new credit for new investment themselves and contribute to higher output and credit demand from others. While the data provides some support for this notion, a precise estimate of the aggregate response of credit demand over time to the debt relief received by consumers and individual entrepreneurs is difficult.

  • Our analysis suggests that debt relief could amount to €22–28 billion for consumers and€9–18 billion for entrepreneurs. For consumers, this amounts to about 3–4 percent of the current total level of household debt and between 35–50 percent of the flow of new credit to households during 2014.13 For individual entrepreneurs, it amounts to about 1–2 percent of the current level of corporate debt and between 35–65 percent of the flow of new credit to firms for loan sizes below €1 million during 2014. 14

  • Debt relief of this order of magnitude is expected to lead to a pickup in household consumption and a modest increase in corporate investment depending on the pace of liquidation. For example, our estimates suggest a pickup of 0.9–1.3 percent in annual consumption and 0.4–0.9 percent in annual investment, which could be spread out over 5 years or more, depending on the pace of liquidation.15

  • If this increase in overall consumption and investment were only partially-financed by new borrowing, the implied increase in credit demand arising from insolvency reform alone would be in the range 0.3–0.6 percent over this period. Alternative approaches for estimating household and corporate credit demand in response to changes in leverage also suggest a similar impact on overall credit demand (see Annex II). Aggregating the results of the various approaches described above, the insolvency reform impact on credit demand from household and corporate borrowers is anticipated to approximate an increase of 0.5 to 1.0 percent, which would be spread out over a number of years based on the pace of liquidation.

Annex I. Estimation of Banking Sector Impact of Recent Insolvency Reform1

A. Introduction

The objective of this estimation exercise is to determine the impact of the insolvency reform of February 2015 on banks’ asset quality, earnings, capital and their ability to extend credit over a three-year period going forward. The key legal reform assumed in this exercise relates to the cancelation of any residual debt left after liquidation for some types of borrowers of banks’ loans. Borrowers subject to discharge are understood to include consumers and “individual entrepreneurs”.

B. Data

The estimation exercise uses balance sheet and earnings data on individual banks’ from 10 years of annual filings through 2014 as well as the latest quarterly filing for the first quarter of 2015 available from SNL and Bankscope. Spain’s top 5 banks by size of consolidated assets were used in the exercise. While the top 2 banks, classified as systemically important financial institutions (SIFIs), are globally active with relatively small exposures in the domestic market, 23 percent and 50 percent of their consolidated assets respectively, the top 5 banks still represent close to 60 percent of domestic assets of the banking system. For the insolvency reform analysis, corporate sector data is obtained from ORBIS, while household sector data is from the OECD as well as Haver.

C. Approach

The basic approach is to estimate potential credit supply (or loan growth) from each of the top 5 banks independently from credit demand based on banks’ capital and funding constraints. Each bank’s entire balance sheet structure and earnings are projected forward for a 3-year period based on a set of assumptions described below. Two main scenarios are considered, which concern banks’ ability to recover on NPLs after liquidation: (i) before and (ii) after the passage of recent insolvency reform. The process of estimating potential credit supply also identifies the impact of reform on banks’ asset quality, earnings and capital.

D. Methodology

For each bank, an iterative procedure is used to maximize loan growth and thereby earnings subject to constraints on capital and funding. The first of these constraints is that any capital raised through reinvested earnings and equity issuance must equal or exceed market expectations of target capital requirements over 2015–2017 (defined in assumptions below). The second constraint is that funding raised through growth of deposits, from the interbank market, debt issuance or via ECB facilities should equal or exceed the funding needs related to projected loan growth. The starting point for the iterative procedure is to set annual loan growth to the pace of annual deposit growth based on latest available data. The impact of the reform is estimated by reducing the recovery amounts on banks’ NPLs from consumers and individual entrepreneurs.

E. Assumptions

To simplify the calculations, the exercise necessarily involves certain assumptions on individual banks’ capital, funding, earnings, and assets; as well as on the debt subject to discharge under the recent insolvency reform. These are summarized below.

Banks-related assumptions:

  • Capital. The requirement is that banks equal or exceed market expectation defined as fully-loaded Basel III CET1 capital ratios of 11, 11.5 and 12.0 percent over 2015–2017 for banks considered SIFIs (the two largest in the system) and 2 percentage points lower each year for non-SIFIs. Market issuance of Basel III CET1 qualifying capital includes only equity and excludes, for simplicity, contingent convertible securities (CoCos) and other subordinated debt. Equity issuance is that announced already.

  • Funding. The projected pace of annual deposit growth matches that during the past year. Debt issuance comprises only rollover of existing debt. Banks take full advantage of ECB’s TLTRO facility if eligible. Eligibility requirements and maximum allowable TLTRO funding follow those in the relevant ECB circular.2

  • Earnings. During 2015–2017, the following income statement items, as applied annually, are constant from latest available data (2015 q1): net interest margin (NIM) spread earned by banks, fee-based income, expenses, the tax-rate, and the provisioning ratio versus NPLs. The constant NIM spread effectively assumes that any changes in banks’ deposit costs are passed on fully to customers (of bank loans). Banks’ dividend policy also remains constant unless a change has been announced.

  • Assets. During 2015–2017, banks’ fixed assets remain unchanged from latest available data. The refinancing of loans does not count towards credit growth. Liquidated NPLs reduce banks’ risk-weighted assets.

  • Asset Impairment. The recovery rate on secured NPLs, assumed to be mainly mortgages, is estimated at 50 percent. This is based on taking the pre-crisis LTV ratio of 80 at origination of mortgage loans for borrowers that subsequently became distressed, and applying a haircut of 60 percent to the foreclosure value of their home, of which 40 percentage points is owed the overall real estate price decline (since the peak) and 20 percentage points to transaction costs. The recovery rate on unsecured NPLs inferred from banks’ filings varies widely. For simplicity, this was set to 15 percent of the par amount of the written-off loan to match the average level for the top 5 banks.

Insolvency reform-related assumptions:

  • Affected NPLs. The reform only affects banks’ NPLs from consumers and individual entrepreneurs.

  • Residual debt. The residual debt of affected borrowers includes any debt left after liquidation for both secured and unsecured loans. The discharge of any residual debt after liquidation is not revoked.

F. Details of Insolvency Reform Impact

The primary channel through which the recent insolvency reform affects banks’ balance sheets and earnings is assumed to be through reduced recovery amounts from banks’ NPLs after liquidation. This only affects NPLs that come from certain types of borrowers, specifically those related to consumers and individual entrepreneurs.

While data is readily available for NPLs of households, the first step is to estimate NPLs of individual entrepreneurs within the broad non-financial corporate universe. One estimate can be obtained from Banco de España (BdE) data on the breakdown of non-financial corporate sector NPLs by industry and using only those NPLs that relate to industries in which individual proprietorships dominate, such as wholesale/retailing, agriculture, hotels and restaurants and other services. While NPLs resulting from individual entrepreneurs are over-estimated in these industries, they are under estimated in others, such as manufacturing, transport and real estate. This approach results in a rough estimate for NPLs of individual entrepreneurs that is slightly less than one-quarter of non-financial corporate sector NPLs. 3

The second step is to estimate the overall debt of borrowers affected by the insolvency reform of February 2015. This can be done by applying estimates of bank financing as a proportion of the total to banks’ NPLs for consumers and individual entrepreneurs.

The third step is to calculate the amounts that would be recovered in a liquidation of these NPLs. For consumers, two types of NPLs are assumed, those that are secured by housing, and others that are unsecured. In the former case, the recovery is estimated as 50 percent of NPLs (as described in the asset impairment assumption above); while in the latter, the recovery is estimated as roughly 15 percent of NPLs as inferred from banks’ filings.

At this stage, the residual debt after liquidation may be calculated by subtracting estimated recovery amounts at liquidation from estimated total debt. Banks’ share of this residual debt is simply in proportion to banks’ financing of total consumer or individual entrepreneur debt. Before RDL of February 2015, banks may have been able to collect a portion of this residual debt after liquidation, perhaps 10–15 percent of it (based on banks’ filings). But after the reform, banks may not collect even that portion of residual debt.

Annex II. Estimation of Impact on Credit Demand of Recent Insolvency Reform1

A. Introduction

This annex outlines methodologies to estimate the impact of recent insolvency reform concerning post-liquidation discharge on overall credit demand from consumers and firms. These approaches were developed by other authors and the results are simply adapted and used here as described below.

B. Data

The estimation of the impact on credit demand from consumers uses cross-country data from BIS over 2000–14 on consumer leverage and credit; while that from firms relies on Banco de España’s confidential data over 2002–2010 for loan applications received by banks and the characteristics of the lending institutions, which approved or denied those applications.

C. Consumer Demand

An admittedly crude way of gauging the broad order of magnitude of what this might mean for the future development of household credit demand is to construct a least-squares linear fit of the inverse relationship between real consumer credit and the level of their debt to GDP (see text figure). Under this approach, an elasticity of -0.47 with a standard error of 0.14, implies that a decline in overall consumer leverage by about 1.5 to 3 percentage points resulting from discharge would lead to an increase in overall credit demand by 0.7–1.5 percent over a period of time corresponding to the liquidation of banks’ end-2014 NPLs that would be covered by the law.2


Credit growth and household debt to GDP


Citation: IMF Staff Country Reports 2015, 233; 10.5089/9781513529059.002.A004

Sources: BIS, IMF Staff Calculations.

D. Demand from Firms

To estimate demand from firms, we turn to a model that links the approval of firms’ loan applications to the key fundamentals of those firms as well as the characteristics of lending institutions Jimenez et al.3 This approach measures the success of a loan application as 1 (granted) or 0 (not granted) and constructs a least-squares linear fit versus variables for a firm’s size, capital ratio, liquidity ratio, past history of delinquency, and age of relationship with a lending institution along with similar variables for banks. It distinguishes between good times defined as the period 2002–(July) 2007, when banks were fully capable of lending, and a crisis period corresponding to (August) 2007–2010, when banks faced capital constraints arising from weak loan quality.

Since this approach uses confidential data on loan applications available only to the BdE, it cannot be replicated. However, the authors’ results are presented for several different situations, which makes it possible to use these results in this analysis. In good times, 39 percent of firm’s loan applications were accepted on average; while during the crisis period, the acceptance rate dropped to 30 percent.

To study the impact of the February RDL on the approval of loan applications using this model, we focus on two firm-specific variables: firms’ capital ratio and past history of delinquency. The first of these, measured as the natural log of the ratio of firms’ own funds to assets, is closely related to firm leverage. During good times, firms granted credit had on average 13 percent of own funds relative to assets; while during the crisis period, banks became more selective requiring on average 17 percent of own funds from firms. The second variable is a measure of the number of firms applying for credit while having other delinquent loans.

For firms’ capital ratio, we assumed that a 1–2 percent decrease in firms’ debt due to the law, would translate to a proportionate increase in firms’ own funds relative to assets. This leads to an increase in loan approvals by 0.3–0.5 percentage points relative to the assumed baseline of 39 percent for good times when banks face no capital constraints.

E. Caveats

For the methodology to estimate consumer demand, the difficulties relate to the use of cross-country data with banking systems in different states of development and wide variation in macro conditions.

For the methodology to estimate demand from firms, one caveat is the change that occurred in the in the structure of the Spanish banking system in the immediate aftermath of the financial crisis, when many savings banks were consolidated and a number of banking relationships were lost. This would suggest that the elasticities of loan approvals and banking sector variables would have been altered.

The impact on demand from firms due to discharge appears small according to the model because the sensitivity is being analyzed in isolation. Typically, a debt discharge would also lead to a reduction in the numbers of firms that would have delinquent NPLs at the time of a new credit application. While this impact of the law on the firm subprime variable is intuitively clear, is not easy to model in the absence of data on the number of firms that would be affected. A decrease in these subprime firms by half, would alone raise loan approval by 0.9 percentage points and complete resolution of all the subprime firms’ NPLs leaving no history of these in credit applications would increase loan acceptance by nearly 2 percentage points, an impact that would be spread out over time.

F. Results

Aggregating the results for these two approaches for credit demand by consumers and individual entrepreneurs suggests a pickup of 0.5–1.0 percentage points over a period of several years depending on the pace of liquidation.


Prepared by Chanda DeLong (LEG), Mustafa Saiyid (MCM), and Manfred Balz and Ignacio Tirado (LEG external experts).


The debt discharge is available, after liquidation of their personal assets, to all natural persons, i.a., sole proprietors of unincorporated businesses, consumers, individual general partners of partnerships, and individuals who gave personal guarantees, or provided collateral, for debt of another.


See Royal Decree Law 11/2014, of September 5, 2014, on urgent measures in insolvency matters, and Royal Decree Law 1/2015, of February 27, 2015, on second chance mechanisms, reduction of financial burden and other measures of social order. The Royal Decree Law 11/2014 was subsequently approved by the Parliament, with minor amendments, as Law 9/2015 of May 25, 2015.


These reforms follow those made in March 2014, which made significant amendments to out of court refinancing agreements between enterprises and their financial creditors. For a discussion of these reforms, see: Spain: Selected Issues, “Strengthening the Insolvency Framework for Spanish SMEs”, IMF Country Report No. 14/193.


In a cram-down system based on absolute priority, dissenting classes can be impaired without their majority consent as long as no junior class receives anything, no senior class receives more than 100%, and members of the dissenting class receive at least liquidation-value. The relative seniority is based on the ranking of claims for distribution in liquidation.


This rule also disincentivizes owners or shareholders of the debtor from shedding debt and repurchasing the business debt free from out of liquidation.


See Spain 2014 Article IV—Staff Report, IMF Country Report No. 14/192.


Within formal insolvency proceedings, including the liquidation stage, public claims rank as follows (arts. 90–93): arrears for withheld tax and Social Security contributions rank in the second tier of generally privileged claims; public claims and 50% of tax and Social Security claims rank in the fourth tier of generally privileged claims; the remaining 50% are considered ordinary unsecured claims, with the exception of those claims that are subordinated; claims for interest (ordinary and default interest) rank in the third tier of subordinated claims, and claims for fines and sanctions, in the fourth tier. Public law claims are subject to general rules concerning security rights: notwithstanding the classification above, if the public claim is secured with collateral, it will be classified as specially privileged and will rank ahead of all other creditors concerning the proceeds of the collateral.


See footnote 8, above. In June 2015, the Parliament approved amendments to RDL 1/2015 to clarify certain issues, including that the discharge can be revoked during the period of the payment plan upon fortuitous gains such as lottery or inheritance (and not other economic success). The amended version of the law is still subject to confirmation by the Senate.


See Box 3 for examples of countries that include a discharge for public claims.


For example: claims incurred by false pretenses, claims for willful or malicious injury to another person or entity, certain domestic support claims, and criminal fines and penalties.


More specifically, sole proprietors of unincorporated businesses, consumers, individual general partners of partnerships, and individuals who gave personal guarantees, or provided collateral, for debt of another.


BdE data on the flow of new credit has only become available since March 2014, so the estimated figures above do not capture the full year. See BdE Financial Stability Report, May 2015, pp 22–23.


This proportion appears large because of base effects since new credit flows in 2014 were still relatively small.


These estimates are derived based on the methodology discussed in Chapter 2 of the Selected Issues Papers for the IMF Staff Report for the 2015 Article IV Consultation with Italy and are also noted in Box 1.


Prepared by Mustafa Saiyid (MCM).


See “Modalities of the targeted longer-term refinancing operations”, ECB, July 3, 2014.


An alternative approach is to use the size of firms as a guide. If all SMEs are assumed to be individual proprietorships, ORBIS data indicates that their liabilities are about one-tenth of those for the overall non-financial corporate sector. This might suggest a corresponding proportion for NPLs. However, private databases do not include all SMEs and it is also possible that SMEs may be disproportionately represented in NPLs compared with larger non-financial corporates.


Prepared by Mustafa Saiyid (MCM).


See: Annex to 2015 Cyprus Article IV Staff Report, Ruchir Aggarwal, May 2015.


“Credit Demand Forever?” On the Strengths of Bank and Firm Balance-Sheet Channels in Good and Crisis Times, G. Jimenez et al., SSRN, October 2014. See:

Spain: Selected Issues
Author: International Monetary Fund. European Dept.