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11 November 2013

BoS/Restoy: European reform - Challenges for the Spanish banking sector

Restoy argued that monetary union is now unquestionably at a crossroads. Its stability and proper functioning depend directly on the adoption of far-reaching reforms to heighten the integration of the participating national economies.

Perhaps the relative novelty of the recent crisis in the monetary union is that it shows, with particular seriousness, that any delay or lack of resolve in adopting the necessary reforms would not only be harmful to European construction but would generate very pronounced risks to economic and financial stability in Europe and the rest of the world.

One of the main manifestations of the shortcomings observed is the continuing market fragmentation within the euro area. This is, namely, the existence of a country-risk component that means that markets assign different valuations to similar financial assets on the basis of the issuer's nationality. In particular, the perceived risk of financial institutions' liabilities depends to some extent on their geographical location.

The first step towards creating the Banking Union is the start-up of a single supervisory mechanism (SSM), the Regulation for which has recently been approved. Several groups made up of staff from the ECB and the national authorities have been set up in Frankfurt and are pushing ahead with the extensive groundwork.

This analysis of banks' balance sheets is three-pronged: i) an evaluation of the risks for supervisory purposes, ii) an analysis of asset quality and iii) a stress test to be conducted in collaboration with the European Banking Authority. The aim is to obtain a score for each bank as a joint result of the three parts of the analysis. On this basis, specific supervisory actions will ensue, including where appropriate the requirement of additional capital for banks that do not meet the solvency requirements set.  Strict governance arrangements have been set for conducting the analysis, so as to provide for the consistency of the work performed by the national authorities in each jurisdiction.

Yet if, as I said at the outset, we want to put an end to the current market fragmentation and to bank liabilities being valued differently depending on their location, the unified supervision of banks is not enough. These liabilities also need to be treated similarly - irrespective of the jurisdiction under which they fall - if banks experience acute solvency problems. Thus, the Banking Union requires the adoption of a single resolution mechanism (SRM) for non-viable institutions. Public authorities - at least in Europe - have tended to come to the aid of weak institutions, thus confirming the existence of an implicit guarantee for banks' liabilities. This guarantee distorts the incentive system for the managers of banks and for their creditors, generating considerable costs for the public finances of the countries concerned.

But common rules are not enough. The only way to ensure the possible homogeneous application of these rules is through the creation of a common resolution authority for all countries. Similarly, it is important to have a common resolution fund in place which ensures, under similar conditions, that there is the necessary financial support for those institutions which might need it, irrespective of the budgetary situation of the State concerned.

How is the Spanish banking system dealing with the Banking Union project?

All in all, the Spanish banking system will foreseeably not face more complex challenges than those being posed in other jurisdictions, thanks to the unprecedented reform implemented in the past year following the assessment commissioned from an external consultant within the framework of the financial assistance programme.

The significant reduction of the exposure to the real estate sector through the substantial increase in provisions and the entry into operation of Sareb made it possible to defuse one of the main sources of vulnerability of the Spanish financial system. Also, the quality of assets and, in particular, the accounting treatment of restructured and refinanced loans, were reviewed. Finally, banks' solvency ratios were notably strengthened. Currently, all banks meet the capital requirement of 9 per cent according to the EBA definition, generally by an appreciable margin. By the end of the year we expect capital levels to be above 10 per cent for the sector as a whole, both under the EBA definition and under the Basel III definition of common equity tier 1 to be used from January when the new European solvency regulations come into force.

The improved situation of Spanish banks is also apparent in the liquidity indicators and in market valuations, both in absolute terms and in relation to net book value.

In order to obtain a comprehensive assessment of the outlook for the sector, we have recently developed a supervisory tool to enable us to regularly conduct forward-looking analyses to evaluate the solvency  of Spanish banks under different macroeconomic scenarios. This tool (FLESB) is not intended to estimate banks' solvency ratios, but rather to evaluate the sensitivity of their solvency to a given set of shocks over a time horizon.  The initial results, which were published some days ago in the Banco de España's Financial Stability Report, offer some comfort as to the ability of Spanish banks to meet the minimum regulatory capital requirements with a sufficient margin, even under adverse scenarios.

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© BIS - Bank for International Settlements

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