The core of Spain’s financial sector is well managed and appears resilient to further shocks, but important vulnerabilities remain in the system, the International Monetary Fund (IMF) said in its Financial Sector Assessment Program (FSAP) review of Spain, published today.
“The Spanish authorities have recently accelerated financial sector reforms to reduce vulnerabilities in the system. They have taken measures to address some of the most problematic banks and are currently undertaking an independent valuation of all portfolios, which is a welcome step and should help to determine further restructuring needs,” Ceyla Pazarbasioglu, Deputy Director of the IMF’s Monetary and Capital Markets Department of and head of the team that conducted the FSAP, said. “But the extent and persistence of the economic deterioration may imply further bank losses. Full implementation of reforms, as well as establishing a credible public backstop, are critical for preserving financial stability going forward.”
Risks and vulnerabilities
The Spanish financial sector has been hit by a succession of shocks. The resilience of banks to these shocks has been markedly different, largely due to their varying business models and their differences in management quality and risk management philosophies. “Our analysis of the Spanish banking sector clearly differentiates the characteristics underpinning the financial strength of different banks, which is essential in any analysis of a country’s financial sector,” said Pazarbasioglu.
The FSAP included stress tests of the banking sector, conducted to provide an assessment of vulnerabilities, including under a severe deterioration in economic conditions, and based on confidential and detailed bank-by-bank data. These stress tests are not intended to establish a definitive number for capital needs, but rather to identify critical weaknesses in some segments and particular institutions. The findings indicate that while the core of the system appears resilient, vulnerabilities remain in some segments. Under the adverse scenario, the largest banks would be sufficiently capitalized to withstand further deterioration, while several banks would need to increase capital buffers by about EUR 40 billion in aggregate to comply with the Basel III transition schedule (core tier 1 capital of 7 percent). Capital needs in these banks would be larger than this, as they would also include restructuring costs and reclassification of loans—for instance for lender forbearance— that may be identified in the recently launched independent valuations of assets. “Going forward, it will be critical to communicate clearly the strategy for providing a credible backstop for capital shortfalls—a backstop that experience shows it is better to overestimate than underestimate,” Ms. Pazarbasioglu said.
In addition, the FSAP assessed Spain’s financial sector oversight framework. It concluded that supervisory agencies have highly experienced and respected professional staff, and are supported by good information systems. However, in recent years a gradual approach to taking corrective action allowed weak banks to continue to operate to the detriment of financial stability. The processes and the accountability framework for effective enforcement and bank resolution powers therefore need to be improved.
About the FSAP
The Financial Sector Assessment Program (FSAP), established in 1999, is a comprehensive and in-depth assessment of a country’s financial sector. FSAPs are mandatory for the 25 jurisdictions with systemically important financial sectors, which include Spain, and are otherwise conducted upon request from member countries. To assess the stability of the financial sector, IMF teams examine the soundness of the banking and other financial sub-sectors; rate the quality of bank, insurance, payments, and capital market supervision against accepted international standards; and evaluate the ability of supervisors, policymakers, and financial safety nets to respond effectively to a systemic crisis. While FSAPs do not evaluate the health of individual financial institutions and cannot predict or prevent financial crises, they identify the main vulnerabilities that could trigger one.