8  BIS Review 67/2007  One positive aspect is that institutions are raising finance especially by resorting to medium-term resources, which are more stable than those that might be obtained on the interbank market. Insofar as the secondary markets are sufficiently liquid, subordinated debt or preference share issues can contribute to greater market discipline. Moreover, asset securitisations allow a portion of risks to be transferred towards other investors, thereby contributing to better risk management. Despite the challenges ahead for Spanish institutions, their resilience was heightened in 2006. Profits – the first line of defence against potential problems – not only increased notably but were also sound. This was reflected in the main income statement margins which, combined with moderate growth in operating expenses, contributed to the favourable dynamics of earnings last year. The return on equity increased once again, maintaining, as earlier indicated, a wide spread over long-term government bond yields. The solvency of Spanish institutions held stable in 2006, with the attendant ratio comfortably above regulatory requirements. This came about, moreover, in a setting in which the sharp growth of activity exerted upward pressure on capital requirements. Earnings in 2006 and solvency levels thus attested to the sound position of Spanish institutions. And this was further corroborated by the available market indicators, by the stress tests conducted during the IMF Financial Sector Assessment Programme (FSAP) and, subsequently, by the loss distribution method, which shows that, even in a highly unfavourable scenario, any losses generated would be amply covered by the capital in the system.

But the slowdown was still modest, it affected only house purchase loans and it did not suffice to curb the rising trend of the sector’s debt/income ratio. The associated interest burden also increased, further boosted by the rise in interest rates. Thus, although there has been some headway in Spanish households adapting their spending and saving patterns to the progressive withdrawal of the monetary stimulus, this is still limited. In the corporate realm, however, the presence of other factors meant that the increase in interest rates scarcely affected corporate investment and debt. As earlier stated, investment in capital goods  BIS Review 67/2007  5  became the most dynamic expenditure component in 2006, owing principally to two factors: the pressure exerted by demand on the degree of capacity utilisation, which drew close to its historical high; and the sound results posted by most companies along with their favourable outlook. The buoyancy of investment was duly reflected in the sector’s debt ratios. These increased once again, fuelled by bank lending growth rates of around 30%. Significantly, however, a very sizeable portion of funds raised was earmarked for financing Spanish institutions’ participation in various mergers and acquisitions. These M&A operations showed renewed vigour in 2006 not only in Spain but also worldwide. As in the case of households, the simultaneous increase in liabilities and in the related borrowing costs translated into an increase in the interest burden borne by corporations.