Miguel Fernández Ordóñez: Economic developments and the financial
sector - a Spanish perspective
Speech by Mr Miguel Fernández Ordóñez, Governor of the Bank of Spain, at the 2008
International Monetary Conference - Central Bankers Panel, Barcelona, 3 June 2008.
* * *
Ladies and Gentlemen,
I would like to thank the International Monetary Conference for inviting me to participate in
today's Panel. We meet at a moment when we are confronted with particularly difficult
challenges, in the wake of substantial economic shocks.
I would like to take advantage of the opportunity to comment on these challenges from the
Spanish perspective. I will first focus on economic developments, and then turn to the
financial sector.
The Spanish economy began to show some signs of a slowdown in early-2007, after more
than a decade of robust expansion.
The slowdown preceded the recent financial turmoil. The deceleration in domestic demand
arose as a result of the gradual tightening of monetary policy since 2005, and of a
moderation in house prices. The residential investment sector has suffered a particularly
intense slowdown, entering into a period of adjustment after a protracted boom. The
containment of domestic demand has been more pronounced since mid-2007, when the
turmoil emerged.
The slowdown has eroded consumer and business confidence. It is already having an impact
on the spending decisions of households and firms. We are seeing signs that credit
conditions are tightening, as a consequence of the reappraisal of risks and changes in
macroeconomic and sectoral expectations.
In this context, we expect internal demand to continue weakening over 2008. Indeed, the
most recent economic projections released by the Bank of Spain show reduced GDP growth
in 2008 and 2009.
At the same time as we face a slowdown in growth, we are seeing sharp increases in
headline inflation. These have been driven by large energy and food price rises at the global
level.
The price boom has affected Spain to a larger extent than some other countries, partly due to
the higher relative weight of these items in household expenditure. And the Spanish
economy may be more vulnerable than other countries to second-round effects due to the
widespread existence of indexation mechanisms.
I would like to make a few comments about what economic agents should and should not do
to face these challenges.
On inflation, the key issue is how firms and workers respond to the recent shocks. I would
like to make two points:
• First, firms should not view the shocks as permanent. In other words, they should
not consolidate price-rises over the longer term.
• Second, workers should understand that inflation cannot be offset by demanding
wage increases that are not justified by productivity developments. This would just
keep inflation persistently high, as the 1970s experience painfully showed.
From the perspective of GDP growth, if we are to see a quick return to our potential, we need
flexibility in supply and demand responses. We need to see increased dynamism, particularly
in those sectors which are not as directly affected by the current slowdown.
Other measures are also necessary, such as liberalisation and deregulation policies, to
improve competitiveness. Policies aimed at improving the human capital of our workers and
increasing labour mobility should also be encouraged.
Finally, a comment on fiscal policy. The current fiscal situation in Spain is sound, having
ending 2007 with a budget surplus and reduced public debt. Indeed, let me recall that our
public debt to GDP ratio, at 35%, is the lowest among the big EU countries. It is important to
maintain this stance in the face of the current slowdown. Expansionary demand policies
could prove counterproductive. We should avoid a deterioration of the budgetary situation
beyond that implied by automatic stabilisers.
Let me turn now to the financial sector. So far, the impact of the recent turbulence on
financial stability in Spain has been limited. This is largely thanks to the actions of the banks
themselves, who have not entered into the kinds of business that have been most directly
affected. Spanish banks have demonstrated that you do not need to turn to the
originate-todistribute model to become an efficient and profitable banking business. Plain vanilla,
traditional business can be compatible with high returns on equity and efficiency. It also has
the added value of implying greater stability. But I think that the Bank of Spain's approach to
supervision has also had a positive effect. Let me emphasise two key characteristics in this
respect.
•
The first characteristic, which has set us apart from other supervisors, has been our
strong role in accounting rule-making for the banking sector in Spain. This has
meant that the accounting rules for the banking sector take into account supervisory
sensitivities, whilst being also consistent with IFRS. One example of this is the
socalled "dynamic provision", which we introduced in 2000. This allowed Spanish
banks to build up a significant provisioning buffer in a transparent manner, to be
used in bad times, when problem loans increase. In 2005, the Bank of Spain
reformed the dynamic provision when adopting International Financial Reporting
Standards. Despite the reform, banks kept the strong provisioning level set by the
former rules, and today they face the current situation with a sound buffer of loan
loss provisions (1.3% of total assets at the end of 2007, and this despite bad loans
being at historically low levels).
•
The second characteristic that has proved useful is the Bank of Spain's prudent
approach to bank regulation. One example has been our stance on off-balance
sheet investment vehicles. We have not prohibited the development of investment
vehicles, but we told banks that if they set up Special Investment Vehicles, these
should be consolidated with the group, and therefore be subject to capital
requirements and provisions. Under these conditions, no such vehicles were set up.
As a consequence, the Spanish banking system has not been so seriously hit by the
de-leveraging process as other systems that have a freer attitude towards these
vehicles.
Furthermore, securitisation in Spain has mainly been used as a financing tool, to raise
resources on the wholesale financing markets in order to meet the demand for loans from
households and businesses. Since the element of credit risk transfer was limited, Spanish
banks have had little incentive to issue overly complex financial instruments. Furthermore,
we have always required capital to be held against liquidity enhancements to securitizations,
which we consider may have significant credit risk.
Let me take this opportunity to make a brief observation on the securitisation sector, which
some have described as being in "dire straits". I am sure that this sector will ultimately
recover. But to do so, it must distinguish between traditional products that are sound,
transparent, standard and easy-to-value, and "multi-layer" securitisations and complex
structured products which are difficult to understand and assess. The good news is that the
market is starting to differentiate between products. An example of this is the recent
placement of several Spanish banks' issues of simple covered bonds.
In short, our recent experience shows that to be successful supervisors we need to combine
an open attitude to financial innovation whilst keeping at the same time some good old
fashioned supervisory suspicion towards it, especially when it entails overwhelming
complexity or elements of regulatory arbitrage.
The Spanish banking system has faced the recent turmoil from a well-capitalized, profitable
and efficient position. However, there is no room for complacency. In today's global financial
system, the Spanish banking system is not immune to problems if serious global
macroeconomic imbalances materialise or if the current situation persists. Banks' managers
and directors alone are responsible for running institutions and for their results. But central
banks and bank supervisors must rise to the challenge and collaborate closely with each
other so as to help return stability to the global financial system.