1. The past four years have witnessed a crisis in the Spanish financial sector unprecedented in its modern history. While external factors contributed to the turmoil, a domestic real estate boom-bust exposed weaknesses in the savings bank sector, shortcomings in the policy and regulatory framework, and an over-reliance on wholesale funding.
2. A major and much-needed restructuring of the banking sector is now under way (Figure 1). This has involved an important reform of the savings banks’ legal framework together with financial support from the state-owned recapitalization vehicle Fondo de Reestructuración Ordenada Bancaria (FROB). Substantial progress has been made in addressing balance sheet weaknesses and recently announced measures show promise of further progress.
3. The team’s stress tests show that while the core of the system appears resilient, vulnerabilities remain. Although important caveats attach to the team’s assessment, including the extent to which lender forbearance—which the supervisory authorities have indicated they are monitoring closely—may have affected the underlying data and the risk of an even more severe downside shock than embodied in the analysis, the results suggest that:
The largest banks appear sufficiently capitalized and have strong profitability to withstand further deterioration of economic conditions. This reflects their solid capital buffers and the robust earnings of the internationally-diversified institutions.
There are a group of banks where vulnerabilities seem highest and where public support seems most critical. Most of these banks have been acquired by other solvent
entities or are in varying stages of restructuring. Recently, the government committed to a capital injection of about 2 percent of GDP to the fourth largest bank (which will become state owned) to effectively support its restructuring.
Continued efforts are needed to rebuild capital buffers. Although liquidity positions have improved and European Central Bank (ECB) long-term funding brings a
reprieve, Spanish banks need to continue to bolster their balance sheets to enable them to re-access private funding markets.
4. Recent measures aim to address these vulnerabilities and provide targeted support where needed. The May 2012 decision to increase sharply provisioning rates on performing real estate developer loans (from 7 percent to 30 percent) should provide adequate coverage for potential future losses of this portfolio, and banks that are highly capitalized and have limited real estate exposures are expected to be able to meet these requirements. Other banks that need additional time will be supported with a public capital backstop (injected either in the form of common equity or contingent capital).
5. Notwithstanding these measures, further restructuring of the weaker banks are likely to be needed. Although the most problematic part of banks’ portfolios—real estate developer loans—appear now to have been addressed, the extent and persistence of the macroeconomic deterioration may imply further losses in the rest of the loan portfolio. The authorities committed to undertaking a comprehensive review of banks’ asset portfolios, with third-party participation. This is a welcome step and should provide the basis for determining further restructuring needs. The experience of this FSAP and the announced restructuring of the fourth largest bank illustrates that stress tests can provide a useful indication of the magnitude of these needs, but should be supplemented by a more granular due diligence especially if public funds are to be used.
6. The full implementation of reforms, including a credible public backstop and an effective communication strategy, are critical for preserving financial stability. The authorities have pursued a strategy of burden sharing between the public and private sectors. Most recently, they have switched to greater reliance on public funding in order to avoid undermining viable banks. Going forward, it will be critical to communicate clearly the timetable for the diagnostic review, a strategy for providing a credible backstop for capital shortfalls, and a plan for dealing with impaired real estate exposures.
7. The assessment of the financial oversight framework identifies strengths and weaknesses. The supervisory agencies have highly experienced and respected professional staff, who are supported by good information systems and thorough supervisory processes.
However, this assessment identified a number of shortcomings, especially a gradual approach in taking corrective action that allowed weak banks to continue to operate to the detriment of financial stability, and calls for steps in the following areas (Table 1):
Strengthening the authority and the processes, including the accountability framework, for the banking regulator to address preemptively the build-up of risks and take remedial action;
Enhancing the regulatory independence of the banking and securities regulators and addressing limitations on financial/budgetary independence for the insurance and securities regulators, while ensuring adequate accountability; and
Strengthening the regulatory framework for the insurance sector (the current solvency regime is not risk-sensitive) and the monitoring of risk build-up in the sector.
8. The conclusions above are necessarily tentative, given that the banking system strategy is still being formulated amid the wider spread of turmoil in Europe. The analysis provides a point-in-time assessment of current vulnerabilities and systemic resilience to a possible further deterioration in macroeconomic conditions. While this provides comfort regarding the direction of current policies, it is critical that the authorities continue to take decisive action to address the weaker institutions and restore market confidence in Spanish banks. Delays could exacerbate the macroeconomic downturn, erode market confidence, and damage stability more broadly.
IMF "스페인 경제 위기 넘겨 회복 조짐"
2013 Article IV Consultation with Spain- Concluding Statement of the MissionMadrid, June 18, 2013
Strong reform progress is helping stabilize the economy and external and fiscal imbalances are correcting rapidly. But unemployment remains unacceptably high and the outlook difficult. This calls for urgent action to generate growth and jobs, both by Spain and Europe.
Important reform progress is supporting the economy amid strong headwinds
1. Strong progress has been made on critical and difficult reforms since last year’s consultation. A major labor reform was instituted in July. Decisive action was taken to help clean up banks in the context of the ESM-supported financial sector program. A wide range of fiscal measures were enacted, at all levels of government, and transparency was sharply upgraded. Product and service market reform advanced. European policies were also strengthened, in particular, via the ECB’s OMT program and steps to banking union.
2. Helped by these policy actions, key imbalances are correcting rapidly and sovereign spreads have fallen sharply. Sovereign spreads have halved since last summer as financial market confidence strengthened. Wage growth has moderated and unit labor costs have decreased. This has improved competitiveness, exports have performed strongly (among the best in the euro area), and the current account has swung rapidly into surplus, thus reducing vulnerabilities. Equally remarkably, the fiscal deficit fell sharply despite the recession, with every region contributing. Private debt is also falling.
3. But strong headwinds have kept the economy in recession amid unacceptable levels of unemployment.Lower sovereign borrowing costs are not feeding through to the real economy: credit is contracting sharply and lending rates remain too high. Hampered by private sector deleveraging and fiscal consolidation, and compounded by labor market rigidities, output has contracted for seven quarters and unemployment has reached 27%.
4. While there are signs the economic contraction may end soon, the outlook remains difficult. In our baseline scenario, we expect growth to start to turn positive later this year and to gradually pick up to around one percent in the medium term, with limited gains in employment. The external sector will likely continue to be the bright spot, but probably not enough to generate sufficiently strong growth given weak domestic demand. An upside scenario similar to the government’s is certainly possible, especially in the medium term if the envisaged reforms are fully implemented by Spain and Europe. But there are also downside risks: private sector deleveraging could weigh more heavily on growth or financial market pressures intensify.
The policy imperative: generating jobs and growth
5. This outlook calls for raising the reform effort to the level of the challenge. Euro-area policies need to be much more supportive, but Spain needs to deliver on its announced program, and indeed go further in some areas. The focus should be on a pro-jobs strategy that allows the economy to grow and hire. This means building on existing progress in making prices bear more of the adjustment than quantities, helping the private sector delever, making sure banks can extend credit to healthy businesses, and minimizing the drag from the inevitable fiscal consolidation. It also means avoiding any tendency to take the prospective economic stabilization as a reason to slow the reform effort.
Making the labor market more job-friendly and inclusive
6. Labor reform needs to go further to generate jobs. Last year’s reform made substantial improvements and is gaining traction. But labor market dynamics need to improve to reduce unemployment sufficiently.
- Internal flexibility. This is improving, but more use needs to be made of the new tools for firms to adjust by modifying work arrangements rather than dismissals. This may change in the coming months, especially with the expiry of many agreements. But if it doesn’t, deeper reforms of collective bargaining may be needed (which the planned independent review could usefully inform). In the meantime, the existing tools could be sharpened, especially by simplifying opt-outs.
- Duality. Insufficient progress has been made in reducing the damaging divide between permanent and temporary contracts. The probability of finding a permanent job remains too low and that of losing a temporary job too high. This calls for aligning severance costs for permanent contracts with EU norms and increasing them more gradually with tenure. This also calls for reducing the number of contracts, widening the use of the new permanent contract, and narrowing the scope for judicial interpretation of objective dismissals.
- Enhancing employment opportunities. To help the unemployed find jobs, they need better training and placement services. For certain groups, such as the young and the low-skilled, more ambitious policies to reduce the cost (including tax cost) of employing them may be required.
7. Faster progress in boosting competition and the business environment would complement the labor reform by reducing prices and spurring employment. The government targets an appropriate range of reforms—it now needs to deliver. Priorities include implementing a strong Market Unity law, reducing regulatory barriers that keep firms from growing, de-indexing public pricing, and finding a lasting solution to the electricity tariff deficit. The plan to open up professional services is also important and should avoid being undermined by vested interests and further delayed. To identify future priorities and build consensus, an independent “growth commission” could help.
8. A mechanism should be explored to bring forward the employment gains from structural reforms. This would augment ongoing efforts to help guide Spain’s economy to a better outcome and could comprise two elements: (1) employers committing to significant employment increases in return for unions agreeing to significant further wage moderation and (2) some fiscal incentives in the form of immediate cuts in social security contributions offset by indirect revenue increases in the medium term. A significant increase in employment and reduction in inflation will be critical so that household purchasing power in the aggregate does not suffer. The challenges for all involved are enormous, and it will be crucial to avoid that the approach is watered down or needed structural reforms delayed.
Helping the private sector delever
9. Private sector deleveraging is underway, but there is scope to smooth the adjustment process. While any change must not compromise financial stability, there is scope to continue to improve the insolvency regime:
- Corporate. The process would work better by eliminating impediments to early refinancing/restructuring of viable firms, streamlining liquidation of non-viable firms, strengthening commercial courts’ capacity, and establishing a framework to support out-of-court workouts for SMEs (e.g., mediation).
- Personal. The authorities have implemented a range of measures to address residential mortgage distress. They should consider further progress by complementing these reforms in the future by introducing (like other euro area countries) a personal insolvency regime, with strict conditions that maintains payment culture. Further information and advice for highly-indebted individuals on options to address their debt problems would also help.
10. Banks, the other side of the deleveraging coin, also need to play their part. Losses need to be promptly recognized and distressed assets sold to avoid tying up resources that could flow to more productive uses. And while it is only to be expected that aggregate credit contracts in a recession following a credit boom, a slower pace would benefit the economy as a whole.
Supporting credit while safeguarding financial stability
11. The banking system is now significantly stronger but risks remain. While the ESM-supported program1 is helping tackle legacy risk from the real estate boom-bust, the macro downsides could trigger a negative feedback loop between credit and the economy, with deteriorating loan books and pressure on profits.
12. This calls for proactive vigilance to protect the hard-won solvency of the system and to support credit. Priorities include continuing to: (1) reinforce the quality and quantity of capital, including by being very prudent on cash dividends; (2) clean up loan books and encourage prompt disposal of distressed assets, including by following up on the welcome initiative to clarify the classification of refinanced loans; and (3) remove any supply constraints, for example, by developing well-designed guarantee and risk-sharing schemes targeted at SMEs, following through on plans to enhance non-bank financing, lowering deposit rates, and clearing public sector arrears. These actions could be incentivized by swapping deferred tax assets for tax credits. Rigorous and regular forward-looking scenario exercises on bank resilience should guide supervisory action.
Minimizing the drag on growth from the inevitable fiscal consolidation
13. The required fiscal consolidation needs to be as gradual and growth-friendly as possible. Despite the substantial adjustment in 2012, the deficit is still very large and needs to be reduced further to ensure debt sustainability. But reducing it too quickly would hurt growth. The government’s new medium-term structural deficit reduction targets strike a reasonable balance between reducing the deficit and supporting growth. It will be crucial to detail how these targets will be achieved and to ensure the measures are permanent and as growth-friendly as possible. The nominal (and, if necessary, structural) targets should be flexible in the event growth falls short of the government’s projections—the more credible the consolidation plans, the more scope for flexibility on targets. Given the need to stabilize the economy and assuming the structural consolidation in train for 2013 is delivered, significant additional measures for 2013 are undesirable.
14. Encouraging progress on structural fiscal reforms needs to be followed through with ambitious legislation and rigorous implementation.
- Independent fiscal council: The proposed council has several strengths. Its independence, both real and perceived, is paramount. This would be helped by a non-renewable presidential term of five years or more.
- Sustainability factor: The committee’s proposal provides a strong framework for ensuring the sustainability of the pension system.
- Revenue and expenditure reviews: The creation of a panel of experts to advise on tax and regional financing reform should be followed through. Expenditure reviews, looking across several levels of public administration, would help find synergies, more efficient delivery of public services, and identify growth-enhancing measures.
- Multi-year budgeting: There is a need for a more medium-term basis in budgeting and to consolidate the various budget documents into one that captures the entire general government, reconciles changes to the prior-year budgets, and shows clearly the impact of policy changes.
- Regional fiscal discipline: Last year’s strong regional performance should be cemented by further improving the implementation of the Organic Budget Law.
Europe should do more
15. Last, but certainly not least: more should be done at the European level to ease Spain’s adjustment. Recent euro-area actions have reduced tail-risks and financial market stress. Nevertheless, these initiatives have not been sufficient to reverse financial fragmentation, fix the broken transmission mechanism, and deliver higher growth and employment, neither for the euro-area nor Spain. Of particular importance to Spain would be moving faster to full banking union, which would help break the sovereign/bank loop by allowing Spanish firms to compete for funds on their own merits rather than on their country of residence. Further ECB measures to reduce the much higher borrowing costs facing Spain’s private sector would also be important. Spain and the euro-area should keep the option of an OMT-eligible program open to help cement market confidence and lower yields.