Miguel Fernández Ordóñez: Presentation of the 2010 Annual Report
Testimony of Mr Miguel Fernández Ordóñez, Governor of the Bank of Spain, to the
Parliamentary Committee on Economic and Financial Affairs, on the occasion of the
presentation of the 2010 Annual Report, Madrid, 21 June 2011.
* * *
Ladies and gentlemen,
I appear before you today on the occasion of the presentation of the 2010 Annual Report. As
was the case last year when I gave testimony, the circumstances surrounding us remain
complicated. It would not be overstating the case to say we are at a crucial crossroads for
the future of the economic and monetary union and for the anchoring of the recovery in
Spain.
The crisis that broke in the summer of 2007 has gone through various phases and is bringing
major consequences to bear. A year back, before this Committee, I spoke of the events that
had shaken the euro area in the spring of 2010, with the emergence of the sovereign debt
crisis, the response of the authorities with the approval of the financial assistance
programme for Greece, and the first steps towards the reform of the euro area governance
mechanisms. The effects of the crisis on the Spanish economy were very serious, but
economic policy responded with an ambitious fiscal adjustment plan, fresh impetus to the
financial restructuring process and the launch of structural reforms in various fields. Set
against the serious circumstances then facing Spain, it may be said that the right approach
was chosen, and the initiatives adopted helped mitigate the risks that had materialised.
Despite this favourable change of course, the situation twelve months on remains complex,
both from the European perspective and from the domestic standpoint of the Spanish
economy.
The European sovereign debt crisis is the most serious episode to impact the euro area
since the single currency was founded. Its very nature and the difficulties in tackling it have,
moreover, highlighted the shortcomings of the institutional framework of the euro. These
include most notably the insufficient degree of fiscal discipline imposed by the Stability and
Growth Pact, the absence of mechanisms to check the build-up of macroeconomic
imbalances and the lack of tools with which to manage crisis situations such as those
witnessed.
Yet we must also acknowledge that there has been significant progress in recent months in
these three areas. There have been various legislative initiatives to reinforce the Stability and
Growth Pact, to establish arrangements for the prevention and correction of macroeconomic
(other than fiscal) imbalances and, finally, to address crisis situations with the so-called
European Stability Mechanism.
But beyond the necessary reform of the economic governance of the euro, the difficult
position of the Irish, Portuguese and, above all, Greek economies must be redressed.
Tensions are at a peak and the outcome of the situation may have very important
consequences for the euro area as a whole.
It is often acknowledged that European construction has been forged through the
overcoming of recurrent episodes of crisis, from which the project has always emerged
strengthened. Let us hope this is true this time and that the European authorities' decisions
will rise to the challenge.
The Spanish economy was particularly affected by the sovereign debt crisis when the Greek
and Irish economies had to resort to adjustment programmes. Conversely, when the same
happened with Portugal in April this year, the impact was less, despite our closer economic,
trade and financial ties with this country. This was due to the set of measures that had been
adopted previously to speed the approval of some reforms and thus tackle confidence
problems. In any event, the Spanish economy remains under the scrutiny of the markets,
which continue to demand an unjustifiably high level of sovereign risk premia. In past weeks
we have witnessed the effect caused by the recent discussions in Europe on the potential
participation of the private sector in the bail-out of the Greek economy, while doubts
resurfaced over the seriousness of Spain's commitment to pushing through outstanding
reforms.
The spread of the sovereign debt crisis to Spain was ultimately due to the presence in our
country of certain factors of vulnerability as a result of the imbalances that had built up during
the previous upturn. And these were compounded by the factors that had emerged during
the crisis, such as the high unemployment rate and the burgeoning budget deficit.
The main imbalances accumulated in the phase of strong growth were attributable to a sharp
expansion in demand that gave rise to a substantial increase in private-sector debt, excesses
in the real estate sector, and price and cost increases that tended to crowd out domestic
output in favour of imports, systematically raising the external deficit.
The unfolding of the economic crisis further complicated the situation. Firstly, because it gave
rise to severe job destruction, as a result of shortcomings in the workings of the labour
market. At 21%, the unemployment level has not only highlighted the need to reform the
institutional framework of this market; the figure also raises doubts about the Spanish
economy's capacity to restore its potential growth and ensure the sustainability of its public
finances.
In this respect, the rapid fiscal deterioration has been one of the factors that has increased
our country's exposure to the euro area debt crisis. Our starting point was a healthy one, with
a budget surplus in 2007 and a low public debt ratio. But the deterioration was so sharp that,
in the space of scarcely two years, the deficit climbed above 11% of GDP and debt moved
into a delicate dynamic just as the financial markets began to worry about the expansionary
deviation of public finances in other countries. In this climate of nervousness, the high levels
of private-sector debt, the need for balance-sheet write-downs in the financial sector and the
difficulty the economy faced in growing at a sufficiently high level all weighed on the
perception of the sustainability of our public finances.
Moreover, the banking system, which had negotiated the first wave of the international
financial crisis without excessive difficulties, came up against bigger problems when the main
elements of the underlying macroeconomic crisis began to be felt at banks. Combining with
this was the tightening of financing conditions for credit institutions raising funds abroad, as a
result of the prevailing instability on financial markets.
Faced with all these circumstances, it was vital to firmly show that matters could be turned
around and that Spain was not bound to follow the path of instability of other countries. To do
this, the change in economic policy stance last spring was essential, since it demonstrated a
willingness to react to and redress the imbalances.
Given the source of the tensions, the priority was to right the trajectory of public finances. To
this end, an ambitious fiscal consolidation plan was approved in May last year. It brought
forward the bulk of the adjustment to be made to the years 2010 and 2011. In parallel, there
was a patent and pressing need to tackle the labour market shortcomings that were
hampering the absorption of unemployment and the adjustment of the economy. Hence a
labour market reform was launched. Finally, in the financial field, the restructuring initiated a
year earlier was accelerated to overhaul the savings bank sector.
Thanks to these measures, the recovery of the Spanish economy remained on track,
although it continued at a slow pace, due to the very need to undertake unavoidable
adjustments. In this respect, the weight of real estate activity in output continued to decline
and the external deficit was also further corrected. There was no significant progress in
inflation, but this was due to the influence of temporary factors, such as the rise in VAT in
July last year and the hike in oil and other commodities prices. Once these effects have
worked through, inflation should fall again in the coming months, although for this to happen
it will be vital no second-round effects should come about, as these would harm the
economy's competitiveness.
Write-downs of the balance sheets of non-financial corporations and households have
continued, with a slight decline in the outstanding balance of credit extended to these agents.
In the case of non-financial corporations, behaviour has differed across the productive
sectors, with modest increases in financing to companies other than those in real estate
development and construction. In the case of households, deleveraging will no doubt be
slower, insofar as the bulk of household debts are in mortgage loans extended over long
terms, whereby repayment will be gradual.
Adjustment of the imbalances in the economy is vital in order to soundly underpin medium
and long-term growth, although in the short run, balance-sheet write-downs in the general
government sector, at credit institutions and in households and firms may check any take-off
in spending. Fortunately, the sluggishness of domestic demand is being offset by the
buoyancy of external demand. The thrust of exports has been substantial and should
continue to be so, whereby attaining further gains in competitiveness will be vital. This is the
key variable for making the adjustment of the imbalances compatible with the firming of a
more dynamic recovery.
If this combination of adjustment and growth were to successfully take root, the Spanish
economy could see private-sector deleveraging, the stabilising of public finances and the
restructuring of the banking system lead to an increase in confidence, softer financial
conditions and, in sum, an improved economic outlook that would boost investment and
employment.
The role of economic policy remains pivotal for steering the adjustment process. In the case
of fiscal policy, the measures adopted last spring marked the starting point. But substantial
challenges lie ahead and determination will be required to define and specify the measures
that allow public finances to resume a stable path. In the short run, the deficit target for 2011
is ambitious, as it entails a reduction of more than 3 pp of GDP to 6%. But, at the same time,
compliance is crucial in view of the financial markets' extreme sensitivity to the course of
public finances. A great effort is needed but, as we have so much at stake, it is vital to
prevent deviations from these targets from arising and, should they do so, the necessary
measures must immediately be implemented to correct them, as the government has
undertaken to do.
To see this task through, all levels of government must be involved. This begins with the
regional governments, who must firmly redress their budgetary positions, in which connection
the strict arrangements for the authorisation of indebtedness may prove helpful. Another
confidence-building factor would be greater transparency of regional government budgetary
information. True, significant headway has recently been made in this area. But, to dispel
doubts about the state of regional finances, it would be very important to see the regular
publication of figures for the regional governments as a whole and for each particular region,
with the same periodicity, degree of detail, lag and accessibility as State figures.
The heavy deterioration in the general government deficit in this crisis advises, moreover,
adopting measures to achieve a more balanced budgetary performance both in upturns and
in recessions. Here, the government announcement to include in the Budgetary Stability Law
a rule whereby general government spending may not exceed the medium-term growth rate
of the Spanish economy is most positive. This rule would be immediately applicable to
central and to local government, but its adoption by the regional governments would also be
pursued.
Fiscal sustainability also needs the economy to swiftly restore its dynamism and to achieve a
high potential rate, since this is a fundamental means of financing the public spending
increases to which population ageing is inevitably going to lead. The proposed pension
system reform submitted by the government in January this year is also a key step towards
curbing these costs. The financial markets have understood that this reform strengthens
fiscal sustainability, so it would be advisable to set this proposal down in the form of
legislation as soon as possible. Further, the sustainability to which the reform refers should
be specified, so that a procedure is in place to ensure at all times that pensions growth is on
a sustainable path.
On the financial front, further headway in restructuring the banking sector has been made in
2010 and in 2011 to date. The most significant regulatory step here was the creation, in
2009, of the Fund for the Orderly Restructuring of the Banking Sector (FROB). The FROB
has proven most useful in paving the way for merger and integration processes in the
savings bank sector, which was highly fragmented. As a result, the number of institutions in
the sector has fallen relatively quickly from 45 to 18. In those operations that received funds
from the FROB, the institutions concerned submitted restructuring plans that envisage
reductions in the number of offices and in other operating expenses.
Other major steps in banking system restructuring have been the reform of the legal regime
governing savings banks, approved last summer. And more recently, in February this year,
Royal Decree-Law 2/2011 was enacted. This raised the minimum required level of top-quality
capital for all credit institutions. It encourages tapping the markets for funds, either through
market launches or through the entry of new investors, although the FROB is authorised to
inject the capital needed in those cases in which banks cannot meet the new requirements
through resort to the markets. This recapitalisation strategy encouraging the entry of private
investors into savings banks requires time and effort by all concerned. But it offers clear
advantages in the medium and long term as regards the cost to taxpayers and, above all, the
soundness and durability of new projects, compared with the nationalisations used in other
countries, where problems differed and it was not necessary to pursue beforehand a strategy
based on the rationalisation of the weakest institutions to attain gains in efficiency, size and
governance.
Recapitalisation is moving ahead under the terms and timeframe envisaged in Royal
DecreeLaw 2/2011. On 11 March, the Banco de España published the capital needed by all
institutions to comply with this legislation. Most commercial banks and half of the Spanish
savings banks met the requirements laid down. Following the collapse of one of the
integration projects, 13 institutions - commercial banks and savings banks - needed to
increase their capital. On 14 April, the Banco de España approved the strategies and
timeframes submitted by these 13 institutions. Two of them were the subsidiaries of foreign
banks that are being recapitalised by their parents. A further two Spanish banks opted to
reinforce their capital by tapping the market. Of the remaining institutions, namely nine
savings banks or groups of savings banks. four opted as a primary alternative to increase
their capital resorting to the markets, and, as a second option, resorting to the FROB.
Another savings bank decided to participate in an integration process with a better
capitalised institution. Finally, the remaining four savings banks that had to increase their
capital to meet the new requirements chose the FROB as their primary option.
The institutions opting to tap the markets, whether through IPOs or through private investors
taking a stake in their capital, are currently immersed in the process associated with this
strategy. In the case of savings banks that have resorted to the FROB to recapitalise, the
business and recapitalisation plans are being analysed, and the valuation of these
institutions by independent experts is under way. Accordingly, the entire process is moving
ahead as scheduled in the legislation, which stipulates that the new requirements shall be
met by 30 September this year, although institutions opting for private investment may apply
for a three-month extension, extendible to six months in the case of market listings.
Significantly, the recapitalisation process has been accompanied by the transformation of
most savings banks into banks, a move that has gone outside and beyond the group of
institutions that had to increase their capital to meet the new requirements.
The Banco de España considers that the capital requirements laid down by Royal
DecreeLaw 2/2011 are sufficient to ensure the soundness of the Spanish banking system, not only
under the most likely macroeconomic scenario, but also under harsher scenarios that are
most unlikely to occur. As is known, some analysts estimated that the capital needs of our
banking system may be greater in the future, under assumptions of a strong deterioration in
the Spanish economy. In this respect, the stress tests being conducted at the European level
will show to what extent banks need more capital to withstand the extreme scenarios
envisaged in these tests. If, as a result of these tests, certain Spanish banks were to
evidence additional capital needs that could not be covered by the banks themselves through
resort to the markets or to other means, the FROB would provide the funds required, as
envisaged in the Royal Decree. In any event, even under highly pessimistic scenarios about
the Spanish economy, the use of public funds to recapitalise institutions would entail only a
relatively moderate increase in the outstanding balance of Spanish public debt.
The restructuring and recapitalisation of the banking system has been accompanied by a
significant drive to write down the balance sheets of Spanish deposit institutions which, since
January 2008, have recognised and assumed asset impairment losses totalling €96 billion,
equivalent to 9% of GDP.
Lastly, I should like to stress the progress made in transparency and the significant role this
tool has played. In particular, I should remind you that the Europe-wide coordinated stress
tests conducted last year were subject in Spain to substantially higher coverage than in other
countries. Indeed, the results of all savings banks and all listed commercial banks were
published. Consequently, analysts and the public at large have all the information they need
to evaluate and assess the situation of even the smallest Spanish institutions, something
which cannot be done in other countries. Moreover, the Banco de España required all
institutions to publish in detail their exposures to the most troubled assets, along with their
volumes of wholesale funding and their liquidity situation. Lastly, another area in which the
degree of transparency in Spain is comparatively greater is that relating to provisioning since,
unlike standard practice in other countries, the methodologies for provision-measurement
and provisioning requirements are public.
Transparency is a most useful tool in financial system restructuring because it helps dispel
doubts about the soundness of the Spanish banking sector, it enables public opinion to better
understand the need to overhaul the savings banks sector, and it encourages managers and
the attendant authorities to promptly undertake the necessary restructuring process.
The Spanish economy faces considerable challenges, which I have reviewed today. But the
most pressing task undoubtedly lies in our labour market, the workings of which evidence
singular traits compared with those of other countries. In times of crisis such as the present,
these traits lead to the adjustment coming about essentially through job destruction and,
even in boom times, the unemployment rate holds at an unjustifiably high level. To reduce
such high unemployment and to rapidly generate jobs again, we must draw our institutional
and legal framework closer to the models of the other developed countries, which allow for
greater flexibility in the use of the labour factor with a greater degree of worker protection. In
fact, within the euro, the key variable for the recovery of the Spanish economy is
competitiveness. And without a far-reaching reform of these institutions, it will be very difficult
for the Spanish economy to promptly attain a reasonable rate of sustained growth.
On 10 June the government approved a Decree-Law providing for some improvement to the
regulation of collective bargaining. Foreseeably, in its passage through Parliament, greater
powers will be extended to workers and employers so that, in mutual agreement, they may
decide what they believe is most suitable to enhance the productivity and competitiveness of
their companies. The positive effects of this greater flexibility in the labour market would be
reinforced if, moreover, measures were taken to increase competition in the markets for
goods and services.
In sum, we are at a juncture where achieving the right monetary and fiscal stance and
successfully managing economic policy will be pivotal for the future of the Spanish economy.
The course the European sovereign debt crisis takes will be a determinant of paramount
importance. But whatever the scenario the role of our economic policy will remain
fundamental for overcoming the inefficiencies highlighted, for redressing the lack of
confidence hampering and raising the cost of external funding, and for keeping the Spanish
economy safe from any incident that might occur in the European arena.