10.05.2022
The Spanish banking industry and the economic challenges ahead*
17th Banking Industry Meeting - IESE
Pablo Hernández de Cos
Governor
*iEnglish translation from the original in Spanish
Introduction
Good morning.
I wish to begin by thanking the IESE for the invitation to this meeting, which gives me the
opportunity to address the main challenges for, and developments in, the Spanish banking
industry.
The Russian invasion of Ukraine is a new shock for the world economy, just two years after
the pandemic triggered a shock to economic activity unprecedented in recent history.
The long-term consequences of the war in Ukraine are difficult to predict, but they will
foreseeably be severe, not only from a geopolitical standpoint but also from an economic
one. In the short and medium term, the Russian invasion and the western world's response,
imposing unprecedented sanctions, have significantly stepped up the uncertainty. This has
had adverse consequences for economic activity and has given rise to further inflationary
pressure.
All this, in a setting in which the Spanish economy was gradually recovering from the
economic effects of the health crisis. Yet this recovery was still incomplete and uneven
across economic sectors, and it continued to be affected by the course of the pandemic
and by the sharp increase in inflation which began in the second half of 2021.
When this new shock emerged, the Spanish banking sector's resilience remained generally
high and it had returned to pre-pandemic profitability levels. But the war introduces new
risks for financial stability. Although Spanish banks have very little direct financial exposure
to Russia and Ukraine, the indirect effects of the war may be significant. Particularly through
its impact on households and firms, especially those experiencing a slower or tardier
recovery from the pandemic and whose solvency may now have worsened.
I will now outline how the Spanish banking industry stood previous to the Russian invasion,
before moving on to analyse the economic and financial risks that the new tense geopolitical
environment poses.
Recent banking industry resilience
Turning to the situation of the Spanish banking industry previous to the start of the war in
Ukraine, most noteworthy, first, was the gradual normalisation of bank lending, following
the strong growth observed in 2020, underpinned by public policies. Specifically, bank
lending to the resident private sector fell slightly in 2021. By sector, the deceleration in
lending to non-financial corporations (NFCs) and sole proprietors, essentially explained by
demand factors, offset the more expansionary behaviour of lending to households, in
particular loans for house purchase.1
If we analyse how lending has evolved compared with income, in the business sector the
recovery of turnover and the subdued growth of debt in 2021 appear to have led to an
improvement in firms' financial situation, although on average it is still more vulnerable
than before the pandemic.
Thus, firms' average debt and debt burden ratios began to fall in 2021 and the percentage
of highly-indebted firms2 decreased across the board, down to almost pre-pandemic levels
in the sectors moderately affected and largely unaffected, but still 7 percentage points (pp)
higher than in 2019 in those that were severely affected.
In the case of households, favourable labour market and income developments are also
contributing to the recovery in their economic and financial situation. In 2021,
households' gross disposable income (GDI) grew by 2.2%, although it remained 2.8% down
on 2019. From the onset of the health crisis to end-2021, households' aggregate net wealth
rose by 9.8%, assisted by the increase in value of their financial assets and, above all, their
real estate assets and by their relatively stable debt levels.
All told, there was a broad-based decline in the bank debt-to-total asset ratio, particularly
in the lower net wealth deciles.3 In the top net wealth decile, debt continues to far exceed
the value of assets (by around 50%), thus signalling the financial vulnerability of this
segment.
In the public sector, the government debt-to-GDP ratio fell by 1.6 pp in 2021, but it remains
very high and approximately 20 pp of GDP above the pre-pandemic level. Likewise the
budget deficit which, despite falling by 3.4 pp in 2021, still amounted to 6.9% of GDP.
These high government debt and budget deficit levels suggest that the Spanish economy
is vulnerable to a possible deterioration of financing conditions. They also limit the fiscal
space available to respond to new risks, should they materialise, and to mitigate their
effects. The possible impact of these considerations on sovereign funding costs would also
have consequences for the funding costs of other sectors, including the banking sector.
Second, as regards the impact of these developments on bank balance sheet credit quality,
non-performing lending to the resident private sector fell by 5.4% in 2021, to
€49.3 billion, a larger drop than in 2020 but well below those recorded in the pre-pandemic
years. This downward pattern confirms the differential performance of non-performing
loans (NPLs) in this crisis. The economic policy measures implemented have proven
crucial in maintaining households' and firms' ability to pay and their net lending. Thus, the
NPL ratio for credit to the resident private sector stood at 4.2% at end-2021, down 0.2 pp
year-on-year.
However, despite this good NPL performance, there are latent credit portfolio
impairments.
Stage 2 loans4 continued to rise at high rates at end-2021 (14% year-on-year), although
notably below the growth rates of previous quarters. At December 2021, Stage 2 loans
accounted for 8% of all loans, up 2.2 pp on pre-pandemic levels.
Forborne loans5 also rose by 14% (compared with the decline of 9% in 2020), owing to
strong growth among NFCs and sole proprietors. At end-2021 they accounted for 5% of
total outstanding loans, the same percentage as prior to the pandemic.
The economic sectors most severely affected by the pandemic show the greatest
signs of deterioration. Here, the combined share of NPLs and Stage 2 loans stood at
almost 24% at December 2021, compared with 17.7% in the moderately affected sectors
and 15.5% in those least affected.
The credit quality of loans backed by the State through the Official Credit Institute
(ICO) deteriorated somewhat in 2021, although at a slower pace than in the previous
half-year. At December 2021, 20.2% of ICO-backed loans were classified as Stage 2
exposures (up 3.9 pp on June 2021), and 3.5% as NPLs (up 1.4 pp on June 2021). It must
be noted, however, that 30% of these loans continue to benefit from grace periods, which
will come to an end in summer 2022.6
In the present setting, these credit exposures with some sign of impairment may, in turn, be
more vulnerable to the materialisation of risk. Accordingly, careful monitoring is
needed, together with early and correct recognition of potential losses.
Third, profitability improved substantially7 in 2021. Specifically, return on assets (ROA)
stood at 0.67% (compared with -0.21% in 2020 and with 0.51% in 2019).
Extraordinary items, which were negative in 2020 and positive in 2021,8 had the most
impact on profitability. Excluding extraordinaries, ROA stood at 0.57%, an increase of
37 basis points (bp) on 2020 and down just slightly compared with 2019 (0.63%).
The main driver of the improvement in ordinary profit was the reduction in impairment
losses, which fell by 43.5% compared with 2020 to €14.3 billion, a somewhat lower level
than in the two years prior to the pandemic.
The recovery in profit in 2021 was widespread across the main countries where Spanish
banks pursue significant international business. Profitability also improved at the
European level, following the notable decline in the previous year, returning to close to
prepandemic levels. As in Spain, the main driver of this improvement was the significant fall in
impairment provisioning.
The breakdown shows that gross income rose by close to 3% in 2021, driven by the timid
recovery in net interest income9 and, above all, by a 10.4% increase in net fees and
commissions, which more than offset the drop in gains on financial assets and liabilities. In
any event, net interest income remained lower than in 2019.10 Fee and commission income
has increased in recent years,11 mainly on account of payment services, although it is still
low compared with Spanish banks' main European peers.
Profitability remained positive in 2022 Q1. Thus, ordinary profit at the six listed banks rose
by more than 30%12 year-on-year, with increases of 9%-10% both in net interest income
and fee and commission income. Meanwhile, impairment losses fell by 9% compared with
March 2021. It must be noted, however, that the full economic impact of the war in Ukraine
did not materialise in the first quarter of the year.
8
In 2021 extraordinary gains were recognised as a result of two mergers (€4.2 billion in total), the spin-off of an insurance
company (€0.9 billion) and restructuring costs at the two big banks (-€1.2 billion). In 2020, extraordinary items included
the negative adjustments to goodwill of the two banks with the largest international presence (-€12.2 billion), the
adjustment for deferred tax assets (-€2.5 billion), restructuring costs at one bank (-€1.2 billion) and capital gains on the
sale of business lines (€0.6 billion).
9
However, as the year-on-year increase in net interest income (1.4%) in 2021 was lower than the increase in average
total assets (3.8%), its contribution to the change in ROA in 2021 was negative.
10
This decline is explained by the larger drop in interest income than in interest expenses. The fall in consolidated net
interest income over the last two years, concentrated in 2020, is due to a narrower interest rate spread (price effect) and
a drop in the volume of assets combined with an increase in the volume of funding (volume effect). The latter represents
an important difference compared with business in Spain, where the volume effect partially offset the likewise negative
price effect.
11
Since 2015, net fee and commission income as a percentage of total assets has increased from 0.41% to 0.45%.
12
By contrast, net profit at the six listed banks fell by 29% in 2022 Q1 compared with a year earlier, but this was due to
the almost €4.3 billion recorded in extraordinary gains in March 2021 as a result of the merger at CaixaBank.
Fourth, the cost-to-income ratio13 worsened slightly in 2021, affected by the
extraordinary restructuring costs recorded at several significant banks, although it remains
lower (better) than that of the European peers.
In recent years the Spanish banking industry's operating capacity has converged
towards average European values, against a backdrop of branch closures and staff
reductions in the main European countries. Thus, at December 2020, the number of
branches per 100,000 inhabitants in Spain was 47, a figure similar to that of the French
banking system and close to that of the Italian one,14 although Spain's population density is
lower. Between 2008 and 2020 the number of branches was cut by more than 50%, while
staff reductions, albeit lower, were also significant (close to 40%). In both cases, these are
the second highest cuts among the main European countries.15 Branch closures have been
comparatively higher in urban areas with higher population growth.16
13
The cost-to-income ratio is defined as the ratio of operating expenses to gross income, such that higher (lower) values
denote lower (higher) efficiency.
14
In 2008, there were 100 branches per 100,000 inhabitants in Spain, compared with around 60 in France and Italy (data
as at December 2020, which are the latest data available with comparable ECB information for the different European
countries).
15
Second only to the Netherlands.
16
In Spain branch closures have affected municipalities of all sizes, albeit with slightly more cuts in larger ones (around
56% since 2008 for municipalities with more than 50,000 inhabitants) and fewer in smaller ones (around 40% for those
with fewer than 5,000 inhabitants). The smaller municipalities are the only ones where the population declined in this
period, in keeping with the demographic decline in Spain's rural areas in recent decades.
Fifth, as regards the cost of bank funding, in the money markets secured interest rates
stand at historically low levels. But wholesale market funding costs have risen, on
expectations of a less accommodative monetary policy and the uncertainty prompted by
the crisis in Ukraine. Indeed, expectations of interest rate rises have fed through to
wholesale market interest rates on long-term bank debt (a measure of funding costs) more
robustly than to the Overnight Index Swap (OIS) rate.17 Thus, banks' credit risk spread has
widened.
There were mixed developments in the cost of new issuances in 2021 across instrument
types and issuers. Banks stepped up their debt issuance to comply with prudential and
resolution requirements, with issuances of Tier 2 instruments and contingent convertible
bonds (CoCos). More banks made such issuances in 2021, giving rise to greater cost
dispersion.18 There was also a significant increase in unsecured debt issuances, in this case
at a slightly higher cost than in 2020. Meanwhile, deposits at Spanish banks continued to
grow in 2021, albeit at slower rates than in the previous year.19
Overall, the average cost of liabilities20 has fallen in the last two years, down to 0.5% at
end-2021, below its pre-pandemic level (slightly over 1%).
After falling in 2020, the cost of capital rose in the first ten months of 2021,21 but then fell
back again, to 8.1% at December 2021. This is below the sector ROE (10.5%), even
without taking into account extraordinary items (9%).22
Sixth, in terms of solvency, the common equity tier 1 ratio (CET1) held relatively stable
in 2021, after increasing in 2020.23
The CET1 ratios of the main European countries' banks also held relatively stable, meaning
that in terms of its CET1 ratio the Spanish banking industry remains in last place. This
difference owes largely to Spanish banks' higher asset density, influenced by structural
factors such as the more widespread use of the standardised approach to calculate asset
risk weightings. Indeed, at December 2021, the leverage ratio of Spain's significant banks
(5.7%) was only slightly below the European average (6%).
The increase in the ratio between 2019 and 2020 was broad-based across banks. The
distribution of the CET1 ratio in 2021 reflected convergence towards the central values of
the distribution. Thus, solvency levels have increased at banks whose levels were lower and
have decreased at banks whose levels were higher.
To sum up, the Spanish banking industry has proved resilient to the economic crisis
triggered by the pandemic, maintaining the supply of credit to the private sector and a
correct solvency level. It has also been able to swiftly recover its profitability.
Yet given the high level of uncertainty and the scale of the potential risks on the
horizon, close monitoring of risk and prudent behaviour by banks remains particularly
necessary. I will now move on to discuss the risks that lie ahead.
Impact of the potential materialisation of the risks identified following Russia's
invasion of Ukraine
Russia's invasion of Ukraine has triggered geopolitical tensions of uncertain severity and
duration. The two main channels through which the conflict may have a significant economic
impact are: first, the surge in energy and other commodity prices, with its accelerator effect
on inflation and penalising effect on economic activity; and second, the negative impact of
the war on world trade, business and household confidence, and financial uncertainty.
Indeed, these factors have led us to revise down our economic forecasts for this year and
next, and to significantly raise our inflation projections for this year.
The banking industry has very limited direct exposure to Russia and Ukraine, but the
effects may be significant. The war may also have an impact on its operating risks, in light
of the potential growth of cyber attacks.
In view of these risks, our latest Financial Stability Report (FSR) includes simulations of the
impact of higher interest rates and energy costs on the economic and financial position of
Spanish businesses and households and the different tiers of general government. It also
includes stress tests in different stressed scenarios, to assess the potential impact of
largescale materialisation of some of the risks facing the Spanish banking industry.
A potential interest rate rise could increase the percentage of firms under financial
pressure. Specifically, within corporate bank financing, short-term and floating-rate loans
predominate, so changes in interest rates pass through relatively swiftly. Under a scenario
consistent with our latest projections, in which interest rates rise in line with market
expectations, firms' interest expenses as a percentage of gross operating surplus begin to
increase from 2023, standing 1 pp above their 2021 level at end-2024. Moreover, an
increase in short and long-term interest rates 100 bp higher than that envisaged under the
above-mentioned scenario adds a further 1.7 pp by 2024.24
The effects of rising energy prices25 on firms' financial vulnerability are moderate on average,
albeit very uneven across sectors.26 Thus, while the impact on firms overall stands at just
over 2 pp, among the three most affected sectors it is expected to top 5 pp.27
25
The price rises considered are those observed between our December 2021 and March 2022 projections. This is an
increase of 22% and 25% in their average level for 2022 and 2023 compared with the December projections.
26
These effects would be partially mitigated by the recent temporary measures approved to reduce the cost of oil
products.
27
Specifically, the sectors most affected include some whose profit margins are likely to be more severely hit, such as
wholesale and retail trade and repair of motor vehicles, land transport, fishing and agriculture. An above average rise in
financial vulnerability is also expected in some sectors where the impact on profit margins is comparatively smaller, such
as basic metals manufacturing, or publishing, cinema, television and radio. This is largely because some firms in these
sectors were already close to the thresholds determining vulnerable status before the shock.
For households, an interest rate rise could contribute to some deterioration in their
debt repayment capacity. But the effect of moderate rate hikes is not expected to be
very significant, partly because of the increase in recent years in the proportion of
fixedrate mortgages, which accounted for 24.9% of the outstanding amount at December 2021.
Specifically it is estimated that the proportion of households with a high net interest burden28
would rise by 1.2 pp, 2.3 pp and 3.9 pp if interbank rates were raised by 100 bp, 200 bp
and 300 bp, respectively. These effects would be most pronounced among indebted
households between the 20th and 40th percentiles of the income distribution.29
Low-income households would be most affected by rising energy prices, as energy
expenditure accounts for a larger proportion of their consumption,30 they are less likely to
be able to absorb these higher prices by reducing their saving and their net interest burden
is higher.
High debt levels also mean that public finances are more sensitive to interest rate
movements. However, the low interest rate levels of recent years have led to a continuous
decline in the interest burden as a percentage of GDP, while at the same time, longer
average debt maturities have limited the short-term impact of higher issuance costs. Under
a scenario of gradual interest rate rises consistent with the latest projections, the debt
burden is expected to stabilise as a percentage of GDP. Under that same scenario, an
additional 100 bp increase in short and long-term interest rates, with all other variables
remaining constant, will drive up interest payments by 0.4 pp of GDP by 2024.
In the Spanish banking industry stress tests, two potential stress scenarios - dubbed
adverse and severe - were simulated for the period 2022-2023. The use of this type of
extreme scenarios, which are plausible but have a relatively low probability of occurring, is
an integral characteristic of the main international stress tests and is consistent with the
goals of prudential regulation which require that banks have sufficient capital to absorb
unexpected losses.
The adverse scenario simulates a further increase in energy prices and a greater impact of
bottlenecks on global trade. This drives up inflation and, consequently, accelerates the
monetary policy response. It also entails a worsening of financial conditions.31
Under the severe scenario, the price shocks are slightly more significant than under the
adverse one, but the main difference is the inclusion of a more marked worsening of
households' and firms' confidence, which causes further falls in the main domestic demand
variables (consumption and investment).32
The adverse scenarios for the foreign economies that are important to Spanish banks are
calibrated so that their severity is consistent with the impact of the shocks on the Spanish
economy. These scenarios thus enable a rigorous analysis of the banking sector's resilience
to the risks deriving from the current geopolitical setting.
Overall, the adverse scenario entails a negative impact of 1.8 pp on the aggregate
CET1 ratio of Spanish banks; this impact rises to 3 pp under the severe scenario.
By components, the largest adverse impact would be on credit quality, leading to greater
losses on loans to the private sector in business in Spain and a sovereign bond value
adjustment. There would also be a lower generation of funds. In turn, the lesser need for
new provisioning (owing to the greater use of existing provisions), deleveraging at banks
and more enforcement of guarantees to meet the expected credit losses associated with
ICO-backed loans, would mitigate the fall in the CET1 ratio in 2023.
Nevertheless, the impact is quite uneven across banks, owing to differences in factors
such as the composition of loans to the private sector and of the sovereign loan portfolio,
their international presence and the coverage of the ICO guarantee programme.
In particular, in the portfolios of loans to NFCs and sole proprietors, the impact varies
considerably according to firm size and economic sector.33 Loans to individuals are also
important, as in business in Spain they account for more than half of the total loan portfolio.34
The cross-bank dispersion of sovereign losses is explained by factors such as the
geographical composition of the portfolio, the maturity structure and the accounting
classification of the exposures.35
As regards net interest income, the rise in interest rates envisaged in the scenarios has a
positive impact on the net interest margin on loans to the private sector and makes
investment in debt securities more profitable, whereas the cost of deposits responds more
moderately.36 Accordingly, the cross-bank dispersion is associated with differences in the
composition of loans to the private sector, the share of debt securities as a percentage of
total assets and the weight of deposits among the sources of funding.
To sum up, the results of the stress tests show that the aggregate resilience of the
Spanish banking sector as a whole is adequate, albeit uneven across banks. Although
large-scale materialisation of the risks would entail a certain degree of capital charge, this
would not be sufficient to compromise the stability of the financial system.
35
In some emerging market economies, rising interest rates entail high discounts on holdings of their debt, although the
depreciation of their currencies against the euro limits the impact on banks' equity. Given that a significant proportion of
the sovereign portfolio is held at amortised cost (53.7% overall), considering that banks intend to hold the debt on the
balance sheet until maturity, the decrease in market value is only partially passed through to the balance sheet. This is
an important factor mitigating the impact of the crisis. Also, considering the sovereign bond holdings held at fair value,
those banks whose portfolios have shorter terms to maturity are less affected than those with longer terms to maturity.
In the case of Spanish banks, 70% of sovereign bonds held at fair value have a remaining term over one year, while just
7% have terms to maturity over ten years.
36
These positive effects predominate over the decline in the stock of performing loans that generate interest income,
prompted by higher interest rates and worsening economic activity, which lessen total credit growth and quality.
Conclusions
To recapitulate, the banking industry is facing the new shocks stemming from the invasion
of Ukraine, having posted a moderate lending performance in Spain in 2021, recovered
prepandemic profitability and maintained its solvency levels. The recovery in economic activity
in 2021 helped underpin non-financial agents' financial position, although there are still
industries and segments that are more vulnerable now than they were before the pandemic.
Yet despite this favourable performance latent credit risks persist, associated above all with
the higher proportion of Stage 2 loans, concentrated in the economic sectors most severely
affected by the health crisis.
Financial intermediaries in Spain have very low direct credit exposure to Russia. However,
the deterioration in the macroeconomic outlook and further increases in inflation will
intensify the likelihood of the materialisation, and impact on the banking sector, of the latent
risks.
In this setting, the simulation exercises performed show that, around the projection
scenarios, rising energy prices and tighter financing conditions will have an uneven impact
on the financial situation of firms and households. This impact will be contained in aggregate
terms, but will be more severe for groups that are more vulnerable on account of their
indebtedness or energy dependence. Moreover, the banking sector stress tests point to a
certain degree of capital charge under more extreme scenarios and to aggregate resilience
that remains adequate, albeit uneven across banks.
Lastly, the short and medium-term challenges must not allow us to overlook the need to
address the structural challenges that the banking sector was already facing before the
onset of the pandemic and Russia's invasion of Ukraine. In particular, the need for capacity
adjustment, as well as the growing competition from technology firms and the potential
negative effects associated with climate risks.