06.07.2021
The Spanish banking sector: over one year of fallout from the
pandemic
16 IESE Banking - Banking: helping to boost the economy
Pablo Hernández de Cos
Governor
Good morning,
I should like to thank the IESE Business School for the invitation to this event, which gives
me the opportunity to discuss the main developments in the banking sector since the onset
of the pandemic. The proper identification of risk developments in the sector is crucial, both
to inform the authorities' and banks' response in this new economic recovery phase and to
draw lessons with a view to tackling the medium and long-term challenges.
A good point of departure for this analysis might be to identify why it has been oft-repeated
during this crisis that, thus far, the banking sector "has been part of the solution, not part of
the problem".
Besides the fact that this crisis has been entirely exogenous in origin and bears no relation
to the sector itself, there are two aspects that, in my view, have been crucial.
First, the international financial reform implemented over the past decade has given rise to
a healthier, more capitalised banking sector that is more resilient to different shocks. In
Spain, this reform also came in tandem with a programme of very profound restructuring in
the sector.
Second, the banking sector's resilience during the crisis has benefited crucially from the
decisive economic policy response (monetary, fiscal and prudential), which has substantially
alleviated the impact of the crisis on the financial position of households and non-financial
corporations, thus lessening the effect on financial institutions' balance sheet quality. The
decisions taken by macro- and microprudential authorities have also allowed the banks'
capital positions to improve during the crisis, and have authorised the use of buffers to help
smooth the provision of financing to other economic agents, as a complement to the fiscal
and monetary measures.
Although banking was among the hardest-hit sectors - in terms of stock market valuations
- during the initial stages of the crisis, its share price valuations have recovered significantly
on international financial markets after the development of vaccines was announced in
November 2020. This reflects the fact that, thus far, the crisis has largely been prevented
from developing a relevant financial component.
Some examples will suffice to illustrate the banking sector's resilience during the crisis and
the role played by economic policies in maintaining it.
The resilience and role of the banking sector during the crisis
First, let us look at the indicator reflecting credit developments. For the first time since the
global financial crisis, the volume of bank lending to the resident private sector in Spain
increased in 2020 (by 3.5%). Total new lending to the resident private sector in 2020 was
up 5.6% on 2019, although there were contrasting performances for non-financial
corporations and sole proprietors (rising 6.6%) and households (down 5.6%).1
These developments were heavily influenced by the credit support programmes,
particularly the ICO guarantee programme. Indeed, the volume of credit drawn in
transactions linked to the ICO guarantee facilities represented 18% of total new lending
granted by deposit institutions in Spain in 2020 and 34% of new lending extended to
nonfinancial corporations and sole proprietors.
Also notable is the role played by the macro- and microprudential measures. On the
evidence available, the authorities' recommendation to limit dividend distribution appears
to have had a positive impact on credit (see Martínez-Miera and Vegas (2021) for an analysis
of Spain and Hardy (2021) for an international comparison). Similarly, there is also
preliminary evidence that those banks which started out with stronger solvency positions
have been able to increase credit to a greater degree during the crisis.
And, of course, the European Central Bank's forceful monetary policy response has been
essential in guaranteeing favourable financial conditions for all economic agents during the
pandemic.
Second, the adverse effects of the pandemic on economic activity have not, to date,
translated into a higher volume of non-performing loans (NPLs). NPLs to the resident private
sector continued to decrease, albeit to a lesser extent than in previous years. In 2020,
the stock of NPLs fell by 3.8% year-on-year (down 4% in March 2021), compared with steep
declines in 2019 (-19.1%) and 2018 (-29.1%). The NPL ratio also continued to decrease,
again more moderately than in recent years, to stand at 4.4% in December 2020 (the same
rate as in March 2021), down 0.4 percentage points (pp) on the previous year.
The public support measures for firms and households would largely explain the lower
sensitivity of NPL rates to changes in activity during this crisis. These measures appear
capable of absorbing a significant share of the potential impact of the crisis on banks'
solvency, thus limiting solvency risks.2
Third, the impact of the pandemic has also squeezed the Spanish banking sector's
profitability. In 2020, the consolidated net profit of Spanish deposit institutions as a whole
was negative (around -€8 billion). This translated into a return on assets (ROA) of -0.21%
and a return on equity (ROE) of -3.1%. However, this adverse result was influenced by the
negative extraordinary adjustments made during the year at some of the system's main
institutions.3 Excluding these adjustments, the sector's profitability would be positive,
albeit considerably down on the previous year, with ROA standing at 0.3% and ROE at
4.3%.
The decline in the sector's return on ordinary activities essentially owed to the reduction in
net interest income and fees and, particularly, the increased provisioning in anticipation of
credit impairments. Meantime, the appreciation of the euro against other currencies,
particularly those of some emerging countries, has lessened the contribution made to
results by business abroad, whose figures, measured excluding the exchange rate effect,
have been more stable.
In the year as a whole, losses due to provisions for impairment losses on financial assets
amounted to €8.7 billion, up on the 2019 figure. In any event, the bulk of this increase was
recorded in the first half of the year,4 and slowed significantly from June.
The sector's results were positive in 2021 Q1, albeit largely conditioned by the positive
extraordinary results arising from a merger.5 These extraordinary elements aside, the
increase in profit in the first quarter was essentially explained by a significant reduction in
provisioning, which stood at pre-pandemic levels.
Fourth, the unfavourable profitability performance in 2020 did not translate into a
worsening of the sector's solvency. Quite the contrary: capital ratios increased. The
reasons for this are: i) the aforementioned negative extraordinary factors on profitability
affected balance sheet items that have no bearing on prudential solvency (for instance,
goodwill); and ii) the authorities implemented various measures to shore up institutions'
CET1 ratio, most notably the European Union's regulatory reform ("quick fix") and, again,
the public guarantee programme and the recommendation against paying dividends.
Despite their heterogeneous initial solvency positions, banks performed favourably across
the board in 2020. Moreover, as at December 2020, accounting capital and reserves
constituted the main components of Spanish banks' prudential capital, while deductions for
goodwill lost relevance as compared with previous years owing to a significant share of this
having been amortised.
More recently, in 2021 Q1, Spanish banks' solvency ratios held stable relative to December
2020.
Short and medium-term risks
In my view, this positive sector performance must not obscure some of the short, medium
and long-term risks that still exist.
The latest macroeconomic projections point to robust growth in the coming quarters once
the vaccination programme has gathered pace and restrictions on movement have been
progressively lifted. However, significant uncertainties remain as to the course of the
pandemic itself, private consumption, tourism flows, the economic impact of the NGEU
funds and the damage to the productive system caused by the pandemic.
Against this background, there is still the risk of credit quality impairment being more
pronounced in the future than has been observed to date, especially in the sectors hardest
hit by the pandemic, and particularly once the support measures are gradually withdrawn.
In fact, some signs of credit quality impairment were already observed in 2020.
Specifically, Stage 2 loans6 increased substantially in 2020 (24.3%), and their growth has
quickened in 2021 to date (37.5% in March). Meanwhile, although forborne loans continued
to fall year-on-year, these declines have been far more moderate since the onset of the
pandemic (-2.3% in March 2021, compared with -19.6% in March 2020). Lastly, NPLs
increased in the consumer portfolio in 2020, growing by 23% (but slowing to 15.9% in
March 2021).
Deeper analysis of the growth of NPLs and Stage 2 loans in the business lending segment
reveals that the sharpest increases occurred in sectors severely affected by the pandemic.
Thus, while total NPLs extended to business activities presented a year-on-year decline of
-1.8% in December 2020 (-1.5% in March 2021), the hospitality and transportation sectors
posted increases of 5.8% and 19.2% (rising to 14% and 44% in March 2021), respectively.
In December 2020, these two sectors represented around 15% of Spanish banks' loans to
non-financial business activity, while the group of severely affected sectors accounted for
20% and the moderately affected sectors a further 30%.
Specific credit risk analysis of the firms and households that have benefited from ICO
guarantees or from moratoria can help predict potential future impairments when the
measures are progressively withdrawn. For instance, analysis of the relative position of firms
that obtained ICO-backed loans reveals that these presented an, ex ante, higher risk profile.7
As regards the classification of loans whose moratoria were no longer in force at end-2020
(either through expiry or cancellation), around 20% were in Stage 2 and 8% were classified
as non-performing.8 We should bear in mind that at end-2020 ICO loans represented around
19% of total lending to businesses, and loans with moratoria accounted for 5.3% of loans
to households. Approximately 80% of the outstanding moratoria as at December 2020
expired in June 2021, and virtually all of the rest are expected to do so before end-2021.
Likewise, as I have mentioned on numerous occasions since the onset of the pandemic, the
financial vulnerability of some business segments has increased, especially in the
activities hit hardest by the crisis and in smaller firms. In the case of households, the increase
in the saving rate and the reduction in debt at aggregate level mask the existence of
segments that have seen their financial fragility increase. These vulnerabilities could also
lead to future rises in default rates.
A second significant aspect is the heterogeneity in the impact of the crisis on the
banking sector, stemming from the different starting positions in terms of solvency and
balance sheet quality, but also from a heterogeneous exposure to the countries, sectors
and firms most affected by the crisis.
These differences are reflected in the mixed performance of profitability at banks in 2020.
In particular, extraordinary factors aside, the impact of the crisis has widened the dispersion
range of profitability among banks.
The differences between banks appear to owe less to a differing exposure to the sectors hit
hardest by the pandemic,9 which is relatively homogeneous, than to the dispersion in terms
of exposure to SMEs. Smaller firms have been the most vulnerable to the shock and, despite
the mitigating measures put in place, are more likely to be affected by solvency problems.
Naturally, differences in credit risks across sectors of activity (besides the most directly
affected sectors) and in the geographical distribution of the exposures may also contribute
to the possible future heterogeneity of the impact of the crisis on banks. As regards the
geographical aspect, the high impact of the pandemic in 2020 H1 in some foreign countries
that are material to Spanish banks suggests that the benefits of geographical diversification
could be lesser in this crisis than during the global financial crisis. However, the contribution
of foreign business to Spanish banks' return on ordinary activities increased in 2020 as a
whole, and the growth in impairment allowances was relatively contained in various material
countries.
In any event, the potential uneven performance of the banking business in the different
geographical areas needs to be monitored. Moreover, in view of the possible materialisation
of permanent damage to some sectors of economic activity with asymmetric recovery
paths, it is important to continue monitoring changes in credit quality.
The third risk factor relates to the possibility that said increase in credit risk, together with
the observed reticence on the part of banks in using their capital buffers, could lead to a
slight credit tightening, which could weigh on real activity and on the economy's capacity
to recover.
In 2021 to date, there has been an easing in credit growth. Thus, in March 2021 new
lending fell 13% year-on-year; this decline was concentrated in credit to non-financial
corporations, whereas a more expansionary behaviour was observed in the mortgage
segment.
In any event, the fall was largely attributable to: i) the base effect stemming from the strong
increase in the first few months of the pandemic, and ii) the lengthening of the average
maturities of financing to firms that have made use of the ICO-managed public guarantee
programme.
The responses to the Eurosystem's Bank Lending Survey and the econometric analysis of
the data show that the recent reduction in the volume of lending to firms is attributable to
lower demand than in previous quarters and a slight tightening in supply. In the household
segment, credit supply conditions have remained looser since 2020 H2, and the negative
demand-side factors were concentrated in 2020 Q2, owing to the stringent mobility
restrictions.
Fourth, and from both a short and medium-term standpoint, the main challenge facing the
sector, which is common to most European banking systems, continues to be low
profitability.
Efficiency gains remain key to improving the situation. Despite the significant reduction in
recent years (branch numbers down by 51% and staff numbers down by more than 36%
since the peak levels of 2008), Spain continues to have one of the highest numbers of
branches per inhabitant among the main European countries. That said, the reduction in
recent years has drawn us closer to the levels in other countries,10 and certain demographic
factors, such as lower population density, explain, at least in part, this gap.
Moreover, in efficiency ratio terms, the Spanish banking sector is better placed than its main
European counterparts, although it is some way off from the most favourable levels
observed in recent history (43.2% in 2009, compared with 49% in 2020).
The second significant variable here is the cost of capital which, despite the improvements
in bank solvency, continues to be very high.
The initial high increase in this variable (from March 2020) and the subsequent decline back
to pre-crisis levels (from 2020 H2) have been largely explained by changes in the overall
equity risk premium. However, the greater perception of banking sector risk among
investors also led to a lower correlation with the stock exchange general index.
As the recovery progresses and economic activity returns to normal, the gap between ROE
and the cost of capital can be expected to narrow, having widened significantly in 2020 on
account of the divergent developments in the two variables. In any event, since the global
financial crisis, the sector's ROE has remained systematically below the cost of capital,
offering yet another sign of structural profitability challenges in the sector.
Lastly, this crisis is also prompting an increase in risks that were already manifest before
the crisis, such as competition from technology firms, the reliance on third-party IT services
and, of course, cyber risks.
What economic policy response is needed to address these risks?
First, the improved economic outlook, underpinned by the encouraging progress of the
health situation, has reduced the likelihood of the severest scenarios in terms of economic
growth and financial stability. Nevertheless, the recovery remains highly dependent on the
monetary and fiscal support measures. Monetary policy must continue to guarantee
favourable financial conditions for all economic agents and, for now, the fiscal measures
need to remain focused on the sectors and population groups hit hardest by the crisis. In
parallel, the structural adjustments stemming from the pandemic must be smoothed, and
efforts should concentrate on tackling our economy's structural challenges, many of which
pre-date this crisis. The timely design of a fiscal consolidation programme, to be gradually
applied when the recovery takes hold, is also key in order to foster the credibility of
economic policy.
In this context, in the prudential area, the recommendation by the European Systemic Risk
Board, the European Central Bank and national authorities to limit dividend distribution will
not foreseeably be extended beyond September 2021, providing there is no further
worsening in economic and financial conditions.
In any event, institutions must continue with their policy of anticipating the recognition
of credit losses, ensuring appropriate and timely recognition in keeping with supervisory
guidance. This would guarantee a reliable and prompt diagnosis of the situation at all times,
enabling institutions to continue to fulfil their role of providing financing to households and
firms. At the current juncture, authorities should continue to closely supervise the sufficiency
of the provisions made and to monitor credit quality.
Second, banks should continue to be permitted to use their capital buffers so as to
maintain the flow of credit to economic activity in this initial period of recovery. Banks should
also have sufficient time to restore any capital buffers used during this period.
Third, to address the challenge of low profitability, it is essential that banks continue to
make efficiency gains by cutting costs and making more intensive use of new
technologies.
To enhance their efficiency, banks should make optimal use of the information they hold.
This requires significant investment in digitalisation and also the incorporation of new
data processing technologies to allow them to change their business model while
controlling their risk profile. Such investment will also afford banks a greater guarantee of
success when addressing the growing competition from technology firms. Likewise, these
investments are needed to mitigate the impact and probability of cyber risks, which we have
identified as a growing threat.
Fourth, let us not forget that there are also various challenges in the regulatory and
institutional arenas, both globally and at the European level. The coming months will be key
to ensuring the full adoption of the Basel III accord in Europe. This will enable us to
remain at the forefront of the multilateral response to this crisis and to establish, within
Europe, the benefits that proper banking regulation has for economies' capacity to absorb
shocks and foster the public's well-being.
Moreover, the COVID-19 crisis has once again reminded us of the pressing need to
complete the Banking Union and strengthen the Capital Markets Union. The creation
of a common European Deposit Insurance Scheme and the adoption of appropriate
panEuropean resolution legislation for large institutions are key steps in this process, paving the
way for cross-border mergers and acquisitions and the associated potential efficiency
gains, for instance. Thus, further integration of the European financial system would open
up greater risk diversification possibilities and facilitate financing for productive activities at
a lower cost.
Lastly, in the longer term, it will also be important that the banking sector provides an
appropriate response to the risks posed by climate change. Included here are physical
risks, associated with the materialisation of an effective worsening of climate conditions
(e.g. more frequent and longer-lasting droughts, greater likelihood of fires), and transition
risks, linked to the adoption of new regulations and taxes and to the transformation of the
production process, aimed specifically at mitigating climate change.
Intervention by fiscal and environmental authorities is key to achieving an orderly and
predictable energy transition. But it is also important that the banking sector allows the
financial risks present in the different stages of this process to be duly reflected.
We financial supervisors must ensure that banks indeed correctly assess the risks, and
promote the development of appropriate reporting standards and databases to measure
them.
Conclusions
In view of the pandemic's unprecedented economic impact, the Spanish banking sector has
emerged as a mitigant of the shock and is called upon to play a key role in financing the
recovery. This has been possible for two reasons. First, the sector's healthier starting
position, following its restructuring, and the prudential regulations adopted after the global
financial crisis. Second, the essential role played by the public support measures in
mitigating the impact of the crisis on borrowers' credit quality, thus preventing a financial
crisis component that would have made it deeper and longer-lasting. That said, the crisis
has had an adverse and heterogeneous impact on the sector's profitability, although
solvency and default rates have not suffered to date thanks to the support measures
adopted.
In the future, given the uncertainties associated with the impact of the crisis on firms' and
households' credit quality and with the repercussions of gradually withdrawing the support
measures, we must be alert to indications of latent credit risk and ensure an appropriate
and timely coverage of such risk, in keeping with supervisory guidance. Ensuring suitable
risk coverage, while maintaining a flexible prudential approach, may make it easier to
prevent any undue contraction in credit that could hamper growth in the new phase of
economic recovery that we are entering.
The impact of the pandemic has exacerbated some of the pre-existing structural challenges
faced by the banking sector. These notably include the challenges associated with the cost
of capital exceeding profitability, digitalisation and climate risk management. To address
them, it is essential that banks continue to make efficiency gains, by cutting costs and
making intensive more use of new technologies.
To afford the European banking sector a greater chance of success in adapting to the
longterm challenges, it would be highly desirable for the European Union to fully adopt the Basel
III accord, complete the Banking Union and further develop the Capital Markets Union. This
would enable the European banking sector to explore the synergies and benefits of
diversification associated with potential consolidation processes at continental level.
Thank you.