15 July 2013

IMF: Spain - Financial Sector Reform: Third Progress Report

On June 25, 2012, Spain requested financial assistance from the European Financial Stability Facility (EFSF) to support the ongoing restructuring and recapitalisation of its financial sector.

Implementation of Spain’s financial sector programme remains on track. The vast majority of measures specified in the programme have now been implemented, as envisaged under its frontloaded timetable. Most notably, actions to recapitalise parts of the banking sector and the asset transfers to SAREB have provided an important boost to the system’s liquidity and solvency. Major reforms of Spain’s financial sector framework have also been adopted or are in train.

Notwithstanding this progress, risks to the economy and hence to the financial sector remain elevated. Correction of Spain’s large external, fiscal, and financial imbalances is well underway, with policy actions at both the European and Spanish levels helping to ease market pressures over the last year. Nonetheless, further adjustment remains, and the process continues to weigh heavily on domestic demand, with output still shrinking and unemployment  rising to record levels. Financial sector dynamics still contribute to recessionary pressures, with credit contraction accelerating, lending standards tightening, and lending rates to firms rising.

Looking forward, growth may remain weak for some time unless further reforms to make the adjustment process less costly are adopted at both the European and Spanish levels. Further financial sector measures can significantly assist this effort, thereby supporting economic recovery and financial stability.

The report’s main findings and recommendations in key areas are as follows:

• Bank restructuring and resolution. Much progress has been made in repairing banks’ balance sheets. Further near-term priorities in this area include timely completion of burden-sharing exercises, which the authorities now expect to complete this summer, and the choice of strategies to maximise the value out of each state-owned bank under the FROB’s control.
• SAREB. SAREB’s management is appropriately giving high priority to addressing technical challenges associated with its start-up phase, including the completion of due diligence on SAREB’s assets and ensuring that these assets are properly serviced. However, SAREB’s business plan could usefully be based on more conservative projections for house prices, as these are still falling sharply and further correction is likely. Such a change in assumptions may imply the need to adjust elements of the business strategy once the due diligence exercise has better identified the current market values of each asset. Another priority is to ensure that SAREB’s governance arrangements sufficiently mitigate potential conflicts of interest.
• Ensuring adequate provisioning. Accurate loan classification and provisioning for loan losses is key to ensuring balance sheet transparency and restoring full confidence in the system. By recognising losses on distressed assets whether or not banks sell them, adequate provisioning also ensures that banks have proper incentives to dispose of these assets, which helps free space on their balance sheets to expand lending to the growing parts of the economy.

Safeguarding financial stability and promoting economic recovery

• Continue close monitoring of financial sector health, including via rigorous and regular forward-looking scenario exercises on bank resilience to help guide supervisory decisions.
• Focus supervisory actions to bolster solvency and reduce risks on measures that, while boosting banks’ capital situation, do not exacerbate already-tight credit conditions. This includes encouraging banks to prioritise capital building over distributions of cash dividends and bonuses.
• Consider establishing a mechanism to convert DTAs into transferable tax claims, conditional on the degree to which banks take actions that have positive externalities.
• Strongly implement the current review of banks’ classification of refinanced loans so as to ensure adequate provisioning for these loans.
• Consider revenue-neutral reforms to reduce tax impediments to asset disposal.
• At the European level, move faster to full banking union and provide further conventional and unconventional monetary support.

Full paper

© International Monetary Fund