Fernando Restoy: Challenges for the Spanish banking sector
Closing address by Mr Fernando Restoy, Deputy Governor of the Bank of Spain, at the
XXI Meeting of the Financial Sector, organised by ABC, Deloitte and Sociedad de Tasación,
Madrid, 1 April 2014.
* * *
Good morning.
Thank you, Paco, for your kind words. It's a great pleasure for me to be with you this year for
the closure of the 21st edition of the Financial Sector Meeting organised by ABC, Deloitte
and Sociedad de Tasación, in which the Banco de España has traditionally taken part. The
conference has had a very full day, in which the country's main financial institutions have had
their say. Allow me to bring some thoughts to the discussion on the main challenges for the
banking sector ahead of the changes in the regulatory and supervisory framework and, most
particularly, ahead of the banking union.
1. Introduction
Looking back, I believe such significant structural transformations as those currently
sweeping the banking industry are almost unprecedented.
At present, the banking sector must face a host of highly relevant changes on various fronts.
Changes in prudential regulations, arising from the adoption of the new Basel III
requirements, whose implementation has yet to be completed; possible rule changes that
restrict banks' business model (the so-called structural measures); far-reaching changes in
the regulations governing the resolution of weak institutions and changes also in supervisory
practices, with the foreseeable increase in capital requirements derived from stress tests, the
development and deepening of Pillar 2, and the inclusion of macroprudential considerations,
among other factors.
In Europe, in particular, the reforms take on a special dimension following the start-up of a
new unified regime for the prevention, management and coverage of banking crises.
Following the approval last year of the Regulation setting up the single supervisory
mechanism, preparations for which are - as I shall later mention - well under way, the
political agreement reached last week on the single resolution mechanism allows us to
envisage the start-up of an effective banking union in Europe.
It is difficult to overstate the importance of the steps taken here, in light both of their scope
and their speed. The combination of unified supervision, with the adoption of common rules
of conduct for vulnerable institutions, the creation of the European resolution agency, with
significant executive capacity, and the establishment of pan-European bank
riskmutualisation mechanisms all mark a huge step forward for the monetary union and, by
extension, for European integration.
Admittedly, the political agreement on the single resolution mechanism has some limitations,
insofar as it does not entail per se the full lifting of national borders in respect of the
management and resolution of banking crises. Unquestionably, though, the agreement
marks decisive progress towards cross-country uniformity in the treatment of different bank
liabilities in the event of viability problems and, in turn, it minimises the vulnerability of
national public finances to bank crises, by ensuring that investors, and not taxpayers, will
bear the brunt of the costs of these crises. In doing so, it does in fact successfully defuse
many of the factors that have destabilised the monetary union over the past four years.
At the same time, the creation of a single resolution mechanism is a vital complement to the
single supervisory mechanism. It resolves the problems of legitimacy and compatibility of
incentives that would have been generated by the relinquishing of sovereignty over the
surveillance of the banking sector and crisis-prevention without concurrently having a
common mechanism for managing and covering the ensuing consequences.
Accordingly, the political agreements reached are added motivation for all those involved -
the ECB, national supervisory authorities and banks themselves - in the intense preparations
for the single supervisory mechanism.
At the moment, a good deal of effort is being focused on the comprehensive exercise to
assess the solvency of European banks which, as reflected in the Community Regulation
creating the single supervisory mechanism, must be conducted before the mechanism
commences operating next November.
Allow me now to turn to the design and implications of this analytical exercise.
2. The comprehensive assessment of European banks
The comprehensive assessment being conducted by the ECB chiefly comprises two
fundamental elements: the analysis of asset quality and the stress tests.
The asset quality analysis involves evaluating, taking balance sheets as at 31 December
2013 as a reference, how rigorously financial statements reflect the value of banks' different
assets. This requires reviewing aspects such as the accounting classification of assets, the
principles used to recognise their impairment, the sufficiency of the provisions set aside, how
collateral is considered and, in the case of assets recorded at fair value, the suitability of the
methodology used to determine their value.
Having completed the selection of the asset portfolios for review, actual analysis has now
begun in what is called phase 2 of the exercise, whose methodology was made public on
11 March.
The process will not only require banks and supervisory authorities to assign sizeable
resources; it will also involve the leading European audit and asset valuation firms. The ECB
estimates that, not counting supervisory staff and bank employees themselves, more than
1,000 people will work on the exercise. Remember that the portfolios selected for the review
amount to 58% of the risk-weighted assets of the 128 institutions, i.e. some €3.72 trillion,
which will involve reviewing in detail an average of 1,250 credit records per bank. In Spain,
we calculate that the review will affect assets valued at €663 billion, and will require the
analysis of more than 21,000 loan records.
The second part of the assessment will consist of the stress test. The aim of this exercise is
to analyse the ability of banks to maintain appropriate solvency levels in two different
scenarios: a baseline or more likely scenario, and another alternative, highly adverse
scenario, with less likelihood of occurrence.
The stress test is being developed in collaboration with the European Banking Authority
(EBA). The methodology of the exercise is currently at the review stage following the
finalisation some days back of the public consultation process. The final version of the
methodology and details of the macroeconomic scenarios are expected to be published
towards the end of this month.
The implementation and quality control stages of the stress test will commence from next
month, meaning there will be some overlap with the asset review exercise. The outcome of
the comprehensive assessment will be made known in late October, and will include both the
results of the asset quality analysis and of the stress test.
As indicated on several occasions, the overall aim of the comprehensive assessment of
banks is two-pronged: on one hand, the exercise seeks to offer a high degree of
transparency concerning the situation of banks whose supervision will be conducted by the
single supervisory mechanism as from November; on the other, it intends to promote the
recapitalisation of those viable institutions that show insufficient levels of solvency. Both
avenues will help reinforce the credibility of European banks ahead of the transfer of the
supervisory function to the new authority.
I should emphasise that it would be mistaken to quantify the value of the stress test in terms
of the capital requirements it brings to light; and even more mistaken to measure its success
on the basis of the proximity of the final result to the relatively sizeable estimates in the
analyses published so far which, often, have been lacking in information and rigour.
Experience shows that, beyond the size of the capital shortfall identified, these analyses are
only credible if they manage to provide rigorous and consistent information on banks' real
situation and their ability to withstand adverse scenarios.
Accordingly, the strategy to pursue can be none other than to ensure the methodological
soundness and consistency of the exercise, and to provide the market with sufficiently
accurate information on the results obtained and the process followed.
In this respect, what should reasonably be expected from the comprehensive assessment
under way? I would essentially highlight three issues:
• First, that the exercise should be rigorous and demanding in terms of its scope.
Contributing to this is the breadth and depth of the portfolios to be analysed in the
asset quality review, the involvement of independent consultants and auditors, the
consideration for the stress test of a very harsh macroeconomic scenario, and the
setting of capital thresholds appreciably higher than the regulatory minimum set: 8%
in the baseline scenario and 5.5% in the adverse scenario.
• Second, that the exercise should be robust from the legal standpoint and reasonable
from the economic perspective. Specifically, the exercise should observe current
prudential and accounting regulations. In this connection, it uses the definitions of
regulatory capital in force at present, in keeping with the European Directive and
Regulation on capital requirements. Moreover, the macroeconomic scenarios being
designed for the stress test should include shocks to economic variables that are
mutually compatible and consistent with past experience and economic logic. That is
to say, as publicly announced by the ECB, the adverse macroeconomic scenario
ultimately adopted should be severe but plausible.
• Third, we should expect the analysis to be balanced. Namely, it should seek to
reflect and analyse the impact of all factors of vulnerability of European banks in
terms of their objective relevance, irrespective of how technically difficult their
treatment is. It should also be ensured that the macroeconomic scenarios envisaged
have a similar likelihood of occurrence in all jurisdictions and that the estimation of
capital needs acknowledges the existence of diverse national accounting
frameworks in which provisioning requirements are defined to differing degrees of
stringency.
As I said, while the challenges of this task are not minor, work is proceeding apace at the
EBA, the ECB and NCAs to ensure that the exercise meets the best quality standards.
3. How are Spanish banks facing up to these exercises?
We may well ask how Spanish banks are facing up to these exercises. As is known, the
financial sector has recently undergone intense reform involving the clean-up of balance
sheets, recapitalisation and restructuring, and the resolution of non-viable institutions under
the recently concluded financial assistance programme.
As you will recall, this process rested largely on an asset quality review exercise and a stress
test similar to those now being undertaken as part of the preparations for the single
supervisory mechanism.
There are, in any event, some notable differences that should be taken into account when
comparing both exercises. For instance, the Spanish asset review exercise involved an
exhaustive analysis of all domestic business, while its European counterpart will review a
selection of portfolios, albeit encompassing both domestic and foreign-based business.
Further, although the 2012 stress test envisaged a highly adverse macroeconomic scenario,
its focus was on the loans portfolio of institutions in Spain. Conversely, the scope of the
European exercise will be much broader, including in its adverse scenario shocks - both at
the level of the global economy and at that of each national economy - that affect all types of
exposures, including the sovereign debt portfolio.
All told, Spanish banks' starting position ahead of the new exercise can generally be
confirmed as relatively favourable, if we consider the disposals of problem assets, especially
by the most vulnerable banks, the recognition of impairment of the assets most affected by
the crisis and the sizeable increase in all banks' loss-absorption capacity.
4. Beyond the analysis exercise
In any event, the exercise will, irrespective of its final result, be a good opportunity to reflect
on the relative strengths and weaknesses of the Spanish banking sector. And this can
provide a platform for banks to take strategic measures enabling them to strengthen their
competitive position in the new institutional framework.
In this connection, the regional diversification of the major banks - following a model of
stand-alone subsidiaries, in terms of both capital and liquidity - has clearly been an
advantage that has enabled them to soften the impact on their profits of adverse but not
synchronised macroeconomic developments in different economic regions.
Also worth highlighting is their proven capacity to obtain high levels of profitability in the retail
business and to maintain the value of franchises, despite the shortcomings evidenced in the
selling of loan and deposit products.
Mention may also be made of the traditional conservatism in provisioning policy, advocated
by the supervisor, which has enabled banks considerably to ease the impact of the economic
crisis on their solvency levels.
On this latter point, the necessary harmonisation of the supervisory approach within the
single supervisory mechanism may be expected in the medium term to entail some
significant changes. In particular, it would be reasonable to expect that accounting
requirements for banks tend to converge towards a common interpretation of the
international financial reporting standards applicable in the European Union by mandate of
the related Community Regulation. Consequently, the use of provisions as a supervisory
policy tool will foreseeably diminish somewhat in significance, given that the determination of
provisions will be steered to a greater extent by general accounting rules that naturally tend
to set greater store by transparency and investor safeguards than by strictly prudential
considerations.
As a result, the supervisory focus for Spanish banks will shift in the new institutional
framework from an approach under which the monitoring of accounts was foremost to one
where, while maintaining rigour in the revision of financial statements in respect of the
classification and recognition of impairment of assets, the demand for high levels of capital is
reinforced. Indeed, worldwide supervisory practice is following a clear trend, to which the
single supervisory mechanism will immediately adhere according to the supervisory manual
under preparation. This trend is, namely, towards a more intense and systematic use of the
possibility of introducing capital requirements tailored to each bank's actual risk profile (the
so-called Pillar 2).
This tendency in supervisory practice interacts with the past or envisaged regulatory changes
which quite openly pursue the progressive extension of banks' loss-absorbing capacity. Such
is the case with the introduction of macroprudential policies, the setting of supplementary
requirements on leverage ratios, the adoption of capital surcharges for systemic institutions,
the foreseeable upward revision of risk weightings for certain exposures and the introduction,
from 2016, of minimum requirements for the coverage of losses by holders of weak banks'
debt instruments as a prior condition for mobilising resolution funds.
Naturally, under the single supervisory mechanism, the harmonisation of prudential
surveillance arrangements may be expected to involve a uniform treatment of risk when it
comes to determining the capital required of all European banks. In that way, the competitive
distortions potentially generated by the different national approaches at present will be
minimised. It is also to be expected that regulatory requirements will be introduced gradually,
as is needed to avert excessive procyclical effects and significant market shocks.
Clearly, in keeping with regulatory developments and market demands, the key question for
a large number of financial institutions in Europe and the rest of the world is not so much
whether they should raise their loss-absorbing capacity, but rather what the most suitable
way and the right time to do so are.
Faced with these foreseeable changes in the regulatory and supervisory framework, and
irrespective of whether the ongoing assessment exercise is likely to be generally satisfactory,
Spanish banks must evidently seize every opportunity to strengthen their capital position as
the improvement observed in financial conditions progressively firms, be this through gains in
efficiency, retained profits or new securities issues.
5. Conclusions
To conclude, I believe the major structural changes sweeping the banking industry will have
been reiterated in this conference. We should assume that in the future the banking sector
will be better capitalised and safer. As a counterpoint, however, it will likely be smaller and,
probably, less profitable. All these changes will have appreciable consequences for banks'
business models and competitive strategies.
The concurrence of this global process and the start-up of the banking union in Europe
poses, in the short term, additional and considerable logistic and strategic challenges. Yet far
from being a disadvantage, the banking union will over the medium term improve the
European banking sector's competitive capacity. Banks will benefit not only from a genuinely
unified market but also, more directly, from the added strength this project brings to the
monetary union. And the soundness of banks and the stability of the financial system as a
whole will hinge crucially on the proper functioning of this union.
Thank you.