## Executive Summary (content unit: _cr06212) ## Source details **Canonical URL:** [Executive Summary (content unit: _cr06212)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06212.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06212.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06212.pdf.json) --- ### Key findings on the financial sector and macroeconomy - Overall verdict: Spain’s financial sector is "vibrant, resilient, highly competitive, and well-supervised and regulated." - Strengths: - high degree of financial intermediation; low intermediation margins; well-capitalized and professionally managed financial institutions; prudential framework "at the cutting edge of innovation." - payment and securities’ settlement systems are robust and well-integrated internationally. - Growth and external position: - "Real GDP growth has averaged 3.6 percent a year since 1996." - Foreign saving, at 7.4 percent of GDP in 2005, filled the gap between domestic savings and investment. - Net foreign direct investment was negative in 2005. - External current account deficit widened, reflecting a persistent inflation differential with the euro area. - Housing and household balance sheets: - "House prices rose by 104 percent in real terms between end-1997 and end-2005." - Overvaluation estimates: "on the order of 25 to 35 percent, relative to end-2005 levels." - 12-month house price increase decelerated from 18.5 percent at end-2003 to 12 percent at end-2006Q1. - Household debt rose from "45 percent of disposable income in 1993 to 112 percent of disposable income in 2005." - Average LTV ratio of outstanding loan portfolio was 65 percent at end-2004. - Debt-to-income ratio rose from 77 percent in 2001 to 112 percent in 2005. - Over 95 percent of outstanding mortgage loans are at floating rates. - Average duration of outstanding mortgage loans is 25 years; some products up to 50 years; new products include interest-only mortgages and long grace periods. - Credit and external financing: - Private sector lending has grown faster than deposits, driven by housing loans in a low real interest rate environment ("short-term rates are negative in real terms"). - Portfolio flows were primary external financing source in 2005: €40 billion (4.5 percent of GDP). - Cross-border funding: net debt of credit institutions with the rest of the world was €214 billion at end-2005. - Market structure: - Five largest credit institutions account for just under half of system assets. - Deposits accounted for three-quarters of credit institutions’ total liabilities at end-2005: 55 percent resident deposits and 20 percent non-resident deposits. - At end-2004, of the €122.5 billion of outstanding securitized bonds, 62 percent were held by foreigners, 34 percent by domestic financial institutions, and 4 percent by the nonfinancial resident sector. - Industrial participations: - At end-2004, participations by a group of 19 credit institutions totaled more than €48 billion, equivalent to about half of those institutions’ regulatory capital. - More than 80 percent of participations are in listed companies concentrated in utilities, energy, and telecommunications. ### Risks, stress tests, and vulnerabilities - Stress test conclusions: - "Stress tests showed credit institutions and insurers to be highly resilient" to shocks (rising interest rates, fall in house prices, drop in equity prices, sharp depreciation of the U.S. dollar). - Results suggest credit institutions would be able to absorb losses associated with large adverse shocks without systemic distress. - Supporting factors: strong capitalization, sizeable loan-loss provisions under Spain’s provisioning framework, sound risk management, extended period of strong growth. - Stress-test specifics and outcomes: - Most severe scenario (sustained deterioration in credit quality during a three-year window) resulted in average losses equivalent to 13 percent of Basel regulatory capital. - Illustrative 1992-93 downturn exercise produced average losses of 16 percent of regulatory capital. - For the 12 most affected institutions (about 12 percent of system assets), Basel CAR fell to between 4 and 8 percent. - Core stress-test shocks calibrated on historical Spanish experience and aligned with other Euro area FSAPs. - Scenario estimates (select): - Drop in house prices in Spain estimated to produce average losses equivalent to 11 percent of CAR with a maximum of 27.4 percent. - A 30-percent decline of equity prices would generate losses equivalent to 8.6 percent of regulatory capital (14.3 percent for sampled savings banks). - A 30-percent decline in equity prices: six banks and four savings banks (37 percent of assets in sampled institutions) would incur a net loss after unrealized gains, with average impact of 5.4 percent of regulatory capital (13.3 percent in the worst case). - Oil price increase to US$80 per barrel; depreciation of the U.S. dollar by 30 percent; crisis in Latin America included in scenarios (losses for Latin America crisis: less than 1 percent of regulatory capital). - Liquidity resilience: - An exercise indicated all maturing liabilities within a month plus 20 percent of demand deposits can be covered by projected sources of funds and available fixed income securities. - BE-designed exercise: contingency plans allow coping with withdrawal of 39 percent of maturing time deposits and 10 percent of demand deposits within a month without cutting normal operations. - Macro scenario risk: - Slowdown in domestic housing demand would reduce output and consumption, raise unemployment ("construction itself accounts for 14 percent of employment"), weaken household debt-servicing capacity, and could dampen market appetite for credit institution debt. - Double-digit credit growth over the last five years, led by housing-related credit, is "cause for concern." - Policy implication: - Moderation of credit expansion and mitigation of credit risk depend in part on "rising interest rates"; "tighter prudential rules alone are unlikely to be sufficient." - A gradual increase in euro-area interest rates—if decided by the ECB—would "help in dampening both house price increases and credit demand in Spain." - Staff supports BE concerns on non-traditional mortgage products; "Additional prudential measures with respect to these mortgages are recommended." ### Supervisory and regulatory observations - Supervisory strengths: - High degree of observance of principles dealing with effective supervision by BE, CNMV, and DGSFP. - BE has developed an effective risk-based supervisory prudential framework, including dynamic loan-loss provisioning system introduced in 1999/2000. - Recommended institutional reforms: - "Further strengthening the independence of the three financial sector regulators by delegating the authority to issue norms and sanction violations from the Ministry of Economy and the Council of Ministers to the respective agencies." - "Create an institutional mechanism for regular and continuous high-level coordination among the Bank of Spain, the National Securities Commission (CNMV), and the Insurance and Pensions supervisor." - "Ongoing reforms of the Statutes of the Autonomous Communities should clearly maintain the State-level supervisors’ sole responsibility and powers regarding prudential supervision and regulation." - "Separate insurance supervision from the Ministry of Economy to achieve greater operational, institutional, and budgetary independence." (Box 1: MT) - "Appoint members of the CNMV’s board to longer, non-renewable terms." (Box 1: MT) - "Introduce regulations to prevent a credit institution representative serving on the board of a nonfinancial company from taking part in the institution’s decisions regarding that company." (Box 1: MT) - Legal framework recommendations: - Transfer most regulatory powers currently under the ME to the BE to enable the BE to promulgate prudential rules and consider granting BE license revocation authority. ### Issues and recommendations related to savings banks and industrial participations - Savings banks governance and structure: - Savings banks increased share of customer deposits from one-third in 1980 to more than one-half in 2005. - Operate with no share capital; allocate about thirty percent of nonretained profits to social and welfare projects; more reliant on retained earnings for Tier 1 capital. - Cannot be bought by banks but can sell branches or assets, merge subject to Autonomous Communities’ approval, and buy other financial institutions including banks. - Recommendations for savings banks: - Ensure 2002–2003 governance initiatives are fully implemented and strengthen if needed. (MT) - Promote new means to raise high-quality (Tier 1) capital, such as issuing cuotas participativas to the market. (MT) - Allow savings banks to merge freely within and across Autonomous Communities provided BE rules favorably on the merged institution. (MT) - Reduce over time the public sector representation ceiling on savings banks’ boards—currently at 50 percent. (MT) - Industrial participations: - Concern about large equity investments in nonfinancial companies; recommendation to adopt conservative Basel II approaches and consider limiting controlling equity positions and conflicts of interest. ### Main FSAP recommendations (selected, from Box 1) - Macro-relevant (ST): - "Tighten provisioning or capital requirements for non-traditional housing and construction loans." ST - "Implement additional regulatory measures aimed at reducing the risks of nonfinancial equity investments (industrial participations) of credit institutions, such as the most conservative approaches considered in Basel II for such participations." ST - Financial sector supervision (ST/MT): - Strengthen independence of supervisors by delegating norm-making and sanctioning authority from ME and Council of Ministers to respective agencies. ST - Create permanent coordination mechanism among BE, CNMV, and DGSFP. ST - Separate insurance supervision from ME. MT - Appoint CNMV board members to longer, non-renewable terms. MT - Introduce regulations to prevent conflict of interest for credit institution representatives serving on nonfinancial company boards. MT - Savings banks (MT): - Monitor governance reform effects; allow mergers; promote cuotas participativas; reduce public sector board representation ceiling (50 percent currently). *Source: Executive Summary of IMF Financial Sector Assessment (content unit: _cr06212 - Executive Summary).* --- ### 6. The erosion of competitiveness poses a risk of slower growth in the years ahead ### Short-term outlook and external sector - Short-term growth prospects remain strong, but "the external sector drag is around 2 percentage points." - Total investment rose from 21 percent of GDP in 1996 to 29.7 percent of GDP in 2005. - Domestic saving was equivalent to 22.3 percent of GDP in 2005, resulting in an external current account deficit of 7.4 percent of GDP. - Net portfolio flows were the primary external financing source in 2005: €40 billion (4.5 percent of GDP). ### Investment composition and credit distribution - Construction is the most rapidly growing component of investment; consumption also grew rapidly. - Credit concentration (2000–2005) shows a strong share of credit to Construction and Real Estate and to Households. - Credit to housing and construction represented about half of private credit portfolios for banks and two-thirds for savings banks at end-June 2005. - As of end-June 2005, credit institutions had securitized around 20 percent of their mortgage assets; thus most (80 percent) of the credit risk remains with the originating institution. ### Housing, mortgage credit, and household balance sheets - Mortgage and household credit indicators: - Average LTV ratio of outstanding loan portfolio: 65 percent at end-2004. - Debt-to-income (DTI) ratio: 77 percent in 2001; 112 percent in 2005. - Over 95 percent of outstanding mortgage loans at floating rates. - Average mortgage duration: 25 years; maturities offered up to 50 years. - New mortgage products include interest-only mortgages and long grace periods for principal. - Policy and mortgage market reform: - Staff recommends tightening provisioning or capital requirements for non-traditional housing loans. - Authorities preparing draft mortgage reform: streamline commissions for early amortization; reduction and streamlining of fees when modifying mortgage contracts; enhanced information requirements; lowering legal costs for refinancing; enhancing repayment capacity of issuers of mortgage-backed securities; reinforcing independence of appraisal companies. ### Financial system strengths and structure (selected figures) - At end-2005, average cost-to-income ratio was below 57 percent (compared with 60 percent in the U.S. and >63 percent in major EU countries). - Domestic credit increased from 57 percent of assets in 2000 to about two-thirds of assets in 2005. - Savings banks increased their share of customer deposits from one-third in 1980 to more than one-half in 2005. ### International integration and cross-border exposures - Net debt of credit institutions with the rest of the world: €214 billion at end-2005. - Cross-border inflows in 2005 were almost equally divided between portfolio flows (€15.5 billion) and foreign deposits plus interbank loans (€12 billion). - Exposure to loss of assets abroad declined to close to 5 percent of capital at end-March 2005, compared with 11.2 percent in December 2003. ### Nonfinancial equity investments (industrial participations) — risks and recommendations - Value of participations (end-2004) by 19 credit institutions: more than €48 billion (about half of those institutions’ regulatory capital). - Concentration in utilities, energy, and telecommunications. - Staff favors conservative Basel II treatment and consideration of limits on controlling equity positions and conflict-of-interest regulations (e.g., prevent credit institution representative serving on board of nonfinancial company from taking part in institution’s decisions regarding that company). *Source: IMF staff report chapter titled "6. The erosion of competitiveness poses a risk of slower growth in the years ahead."* --- ### 32. Overall, the system was found to be resilient and well-prepared to absorb the losses associated with large adverse shocks ### System resilience and stress testing (high-level) - Overall finding: the system was found to be resilient and well-prepared to absorb losses from large adverse single-factor and multiple shocks. - Factors underpinning resilience: - strong asset quality and capitalization of systemically important credit institutions; - comfortable loan-loss cushion from rigorous provisioning system; - sound risk management practices; - extended period of strong growth. - Specific buffers: - low loan-to-value ratio for housing loans; - large unrealized capital gains in equity participations. - Stress-test outcomes: - Most severe three-year sustained credit-quality deterioration produced average losses equal to 13 percent of Basel regulatory capital. - 1992-93 downturn illustrative exercise produced average losses of 16 percent of regulatory capital. - For 12 most affected institutions (about 12 percent of system assets), Basel CAR fell to between 4 and 8 percent. - Liquidity risk: judged small; large credit institutions have well-diversified funding sources. - Savings banks: generally more sensitive to adverse shocks due to larger industrial participations, larger exposures to mortgage loans and developers, and slightly lower loan quality. ### Insurance and private pension funds (selected figures) - Insurance market: - Spanish insurance market is the tenth largest in the world and the sixth largest in Europe by net premium income. - Assets managed by insurance sector: €192 billion at end-2005; 61 percent corresponded to life insurers. - Assets covering technical provisions some 15 percent above statutory level; solvency margin surplus of 158 percent. - Stress tests indicate insurers resilient to a wide range of shocks. - Private pension funds: - Portfolios increased from €13 billion in 1995 to €73 billion at end-2005 (8.1 percent of 2005 GDP). - Number of participants rose from 1.8 million to 9.3 million between 1995 and 2005. - Pension funds relatively risk-averse and not systemic. ### Capital markets (selected figures) - Collective investment institutions managed assets: €323 billion at end-2005. - In past five years, 12 to 14 percent of household savings placed in investment funds. - Trading infrastructure includes four stock exchanges (Madrid, Barcelona, Bilbao, Valencia), AIAF Mercado de Renta Fija, Mercado de Deuda Pública en Anotaciones, MTS, SENAF, and MEFF. *Source: _cr06212 - 32. Overall, the system was found to be resilient and well-prepared to absorb the (excerpts).* --- ### 59. Recent regulatory initiatives, accounting standards, and Basel II implementation ### Accounting and Basel II preparedness - IFRS came into effect in Spain in June 2005 following EC adoption. - Implementation of Basel II is expected by 2007. - Larger Spanish credit institutions and the BE appear well prepared for Basel II credit and market risk framework; significant data collection and model development for advanced IRB approach underway. - Models in many cases suggest excesses of current capital due to lower portfolio risk measures. - BE is taking a conservative and measured approach to implementation to minimize undue reduction of capital or provisioning. ### Transparency and AML/CFT - Transparency assessment: high degree of observance with recommended improvements. - BE action plan (first phase): improve consistency between Spanish and English web pages; add institutional information (internal code of conduct, CVs of Governing Council members); reorganize banking supervision website. - AML/CFT: - FATF assessment conducted in September 2005; draft mutual evaluation report to be considered by FATF Plenary in June 2006; once adopted, a ROSC will be forwarded to the Fund. ### Pyramid scheme scandal (nonfinancial sector) - Two firms solicited small savers to purchase collectible stamps, promising guaranteed returns; media reports estimate more than 300,000 affected small investors and amounts involved about €4–5 billion (0.4–0.5 percent of GDP). - Activities subject to consumer protection and collective investments in tangible assets legislation; investigations include alleged money laundering. - Authorities intend to review operations and regulation of such firms, which fall outside financial sector regulators’ scope. ### Basel Core Principles assessment (selected) - Bank supervision effectively carried out by BE with high degree of compliance. - Recommendations include transferring most regulatory powers from ME to BE, considering granting BE license revocation authority, and strengthening conflict-of-interest rules where bank directors also serve in industrial companies connected to banks. - Supervisory tools rely heavily on moral suasion; a recommendation to issue guidelines on best banking practices to make supervisory expectations more explicit. *Source: IMF staff report excerpt (sections 59–71) and related annex material.* --- ### 72. Definition of banking activities, prudential regulation, and supervision practices ### Licensing, prudential regulations, and ongoing supervision - Definition and use of the name "bank" are clearly established in law and licensing requirements are complied with. - Prudential regulations considered adequate; BE legally empowered to enforce them with a prudential framework stricter in capital composition. - Spain applies strong loan classification and provisioning rules supported by off-site credit risk follow-up and significant on-site presence. - Supervisory approach: intense ongoing monitoring complemented by regular on-site inspections; BE’s off-site supervision guides on-site work. ### Remedial measures and cross-border banking - Law of Discipline and Intervention assigns sanction authority by severity: BE imposes sanctions for light/serious infractions; ME imposes sanctions for very serious infractions on BE proposal. - Assessors advised considering delegating further sanction power to BE to bolster enforcement. - BE has adequate systems to collect information from home-country supervisors and parent bank organizations for cross-border supervision. ### Selected recommended actions (preserved wording where numeric/term specific) - Introduce changes to transfer most regulatory powers currently under the ME to the BE to enable promulgation of prudential rules. - Consider granting the BE licensing revocation authority in appropriate circumstances. - Issue guidelines on best banking practices, particularly those fostering effective risk management. - Fully implement the June 15, 2005 BE/SEPBLAC collaboration agreement (Money Laundering). - Consider seeking direct BE authority to remove external auditors where unfit. - Consider delegating from the ME to the BE further sanctioning authority for gravest infractions, particularly those calling for suspension of bank officers. *Source: IMF staff assessment content (sections 72 and related).* --- ### Insurance supervision: assessments, findings, and recommended action plan (selected) ### Institutional and market context (selected figures) - Net premium income in 2004: €45.5 billion. - Market rankings: - Tenth largest in the world overall; sixth largest in Europe overall. - Non-life: eighth globally, fifth in Europe. - Life: sixteenth internationally, eighth in Europe. - Penetration index: 5.77 percent of GDP. - Density: €1,080 per capita. - Market entities end-2004: total 330; 227 insurance companies (81 percent of premiums); 44 mutual societies (18.5 percent); 59 social mutual societies (0.2 percent). - Assets covering technical provisions exceeded statutory level by 15 percent; solvency margin surplus 158 percent. ### Main supervisory findings and vulnerabilities - DGSFP (insurance supervisor) is part of the ME and lacks legal powers to issue binding secondary regulation; DGSFP not independent. - Institutional arrangement limits ability to allocate resources timely and attract/retain skilled staff. - Regulatory gaps identified: - No general law-level corporate governance requirements applicable to all insurers. - No explicit regulatory requirements on risk assessment and management, internal control frameworks, or fit-and-proper requirements for actuaries and investment staff. - Limited group-wide supervision of financial conglomerates from insurance standpoint. - No regular market-wide analysis required of insurers; supervisory authority does not demand market-wide systematic reporting. - Insurance agents and brokers are not required by regulation to adopt AML/CFT measures. ### Recommended Action Plan (selected ICP recommendations) - Principle 3: Implement institutional arrangement for insurance supervision that strengthens independence, allows DGSFP to issue binding secondary regulation, and provides a budgetary scheme to attract skilled personnel. (selected items) - Principle 6 & 7: Include suitability requirements for actuaries in licensing and fit-and-proper schemes; require timely notification to supervisor of circumstances affecting key functionaries. - Principle 9 & 10: Establish general corporate governance and internal control requirements, including internal audit, risk management, outsourced function assessment, and board responsibilities. - Principle 11 & 17: Implement regular market analysis and strengthen group-wide supervision coordination with BE and CNMV; allocate resources to enable effective group-wide supervision. - Principle 18, 21, 22: Require explicit risk-assessment and management frameworks; require board-approved strategic investment policies; require expertise and oversight for derivatives use and related audit procedures. - Principle 28: Provide necessary resources for effective AML/CFT supervision and draft AML/CFT legislation for insurance agents and brokers. ### Authorities’ response (selected initiatives and clarifications) - DGSFP provided clarifications and indicated draft amendments: - Draft amendment to ROSSP to establish internal control procedures documentation, board responsibility, proportionality, independent expert supervision, contingency plans, and annual board report on internal control effectiveness. - Forthcoming rules to specify investment policy responsibilities, allowable derivatives categories, maximum positions, authorized counterparties, and periodic documentation. - Legislative amendment to require propriety for insurance actuaries; companies remain accountable for appointed actuaries. - AML/CFT clarifications: Article 2.1 of Royal Decree No. 925/1995 assigns accountability of insurers for agents; forthcoming amendment to maintain company accountability and require brokers to be bound by AML/CFT obligations. *Source: IMF staff report content on IAIS assessment and authorities’ response.* --- ### CNMV governance, securities market supervision, and securities settlement systems (selected) ### CNMV governance and powers - CNMV governed by seven-member board chaired by full-time president; president and vice president appointed by government in consultation with ME and experts. - Board includes the general director of the treasury and the deputy governor of the BE as ex-officio members. - Executive Committee prepares agenda and exercises delegated powers. - Consultative committee chaired by vice-president (non-voting), composed of 17 members representing markets, issuers, investors and three Autonomous Communities; must be consulted on circulars, sanctions for very serious infringements, licensing/delicensing, mergers/takeovers, and branch authorizations for non-EU states. - CNMV sanctioning powers restricted: can sanction light or serious breaches; for very serious infringements CNMV proposes sanctions to the ME; potential criminal acts referred to Public Prosecutor. - Licensing of ESIs and withdrawal of licenses: remit of ME upon CNMV proposal; ME retains licensing and delicensing powers over insurance companies (on DGSFP proposal) and credit institutions (on BE proposal). - Recommendations: - Appoint CNMV board members to longer, non-renewable terms. - Vest CNMV with power to design and adopt secondary legislation, capacity to grant/withdraw licenses, and power to sanction on administrative grounds any infractions. ### Iberclear and securities settlement systems (selected statistics and recommendations) - Iberclear operates two platforms: SCLV (securities other than public debt; model 2 DVP) and CADE (public and private debt; model 1 DVP). - More than 99 percent of securities dematerialized in Iberclear. - Total value of trades settled in Iberclear systems in 2004: €82,798 billion - €1,505 billion in equities - €81,293 billion in debt - System uptime: 99+ percent; backup facility is 20 km from main site and fold-over takes two hours. - Investment compensation scheme covers up to €20,000 per depositor. - Key recommended actions: - Prohibit debit balances in participant securities accounts in SCLV (to eliminate temporary short positions). - Test backup facility with members more frequently and evaluate independence of critical services between main and backup sites. - Implement international communication standards for all participant communications (already >75 percent implemented). - Improve participant consultation processes and transparency on CNMV/BE oversight roles; consider publishing Memorandum of Understanding text. *Source: IMF assessment of CNMV and CPSS/IOSCO assessment of Iberclear and securities settlement systems.* --- ### Payment systems (SLBE) assessment and CPSS recommendations (selected) ### SLBE characteristics and governance - SLBE is the single systemically important payment system (RTGS), owned/operated/controlled by the BE and connected to TARGET. - Law 41/1999 (Settlement Finality Law) provides legal framework ensuring irrevocability and finality of payment orders. - Participants: 184 direct participants (33 branches of foreign institutions) and 36 indirect participants. - SLBE features: queuing mechanisms, intraday credit, bilateral and multilateral algorithms, liquidity reservation facility. ### Findings and recommended actions - Legal framework sound and enforceable; circulars regulate SLBE but should be consolidated for readability and transparency. - Contingency and operational recommendations: - SLBE Manual should give clearer guidance on participant behavior in emergencies. - Require participants to have clear internal policies and procedures and conduct operating audits. - Conduct periodic IT infrastructure reviews of participants. - Evaluate distance and independence between main site and backup facility to ensure continuity (backup currently 20 km). - Monitor use of liquidity reservation facility to avoid discrimination and ensure central bank debiting capability. - Periodically publish oversight statistics and reports. - CPSS core principles were rated as observed; recommended actions are relatively minor enhancements. *Source: IMF assessment of SLBE and CPSS Core Principles observance.* --- ### Transparency, accountability, and public reporting (selected recommendations) ### Public reporting and transparency - Financial agencies should issue periodic public reports on major sector developments; BE should issue a periodic report on payment systems and include payment system oversight activities in the Management Report. - BE to make Code of Conduct publicly available; public disclosure of staff standards of conduct recommended. - BE actions: maintain comprehensive public information programs; improve English website consistency; make supervisory information more accessible. ### Deposit Insurance Funds (FGDs) - Three FGDs operate under same rules; each fund covers up to €20,000 per depositor (EU minimum). - Recommended to develop formal policy on public communications by senior FGD officials, publish internal governance procedures, and state policy regarding appearances before designated public authorities. *Source: IMF assessments on transparency (Banking Supervision, CNMV, Deposit Insurance, Payment Systems).* --- ### 6.3 Loan-loss provisioning, stress tests, and systemic resilience (selected technical details) ### Spanish dynamic provisioning (technical) - Spanish provisioning recognizes two types of loan-loss provisions: generic (g) and specific (s). - Generic provisions accumulate in generic fund G, required to remain within limits: - 0.33αL ≤ G ≤ 1.25αL. - In a given quarter, total required provisions, p, are the sum of generic and specific provisions: - p = g + s = L α β = ∆ + + - (vectors of parameters α, β, γ set by BE; banks may use own estimates subject to approval.) - Novelty: second term (βL) captures latent risk and fluctuates with business cycle; during upturn latent risk > specific provisions increasing generic fund; generic provision treated as cost when positive and as revenue when negative (subject to positive balance). - New regulation changes parameters (stricter) and lowers limits to generic fund; on impact expected to release provisions system-wide due to cap reduction and large accumulated provisions. ### Stress-testing framework and outcomes (select) - Scenario analysis adverse cases: - (a) oil to US$80 per barrel; - (b) two-year cumulative drop in real house prices in Spain and the UK by 21 and 28 percent, respectively; - (c) 30-percent depreciation of the U.S. dollar against other currencies; - (d) crisis in Latin America (political crisis transmitted via capital market turmoil). - Core bottom-up stress tests covered seven largest financial groups (37 institutions, ~two-thirds of system assets). - Equity-price shock (30-percent decline): sampled results noted above (8.6 percent of regulatory capital system-wide; 14.3 percent for sampled savings banks). - Credit risk sensitivity: PDs for mortgage and commercial loans increased by 200 and 100 percent respectively from end-2004 levels — systemically important institutions would remain above 8 percent Basel CAR. - More severe sustained deterioration over three years (PDs at 1992-2004 averages + 2 SDs, stressed LGDs) average losses = 13 percent of Basel capital; sample CAR from 12.7 percent at end-2004 to 11.0 percent. - Liquidity exercises indicate ability to cover maturing liabilities within a month plus 20 percent of demand deposits and contingency for large deposit withdrawals as noted earlier. *Source: IMF staff report excerpts on provisioning and stress tests.* --- ### 233. Insurance sector stress tests — coverage and results ### Coverage and methodology - Stress tests conducted by 27 insurers covering 50 percent of non-life market and 62 percent of life market. - Framework followed approach similar to CEIOPS Preparatory Field Study for Solvency II. - Fair-value revaluation prior to stress tests increased net assets by 82 percent industry-wide (individual changes ranged from 360-percent increase to 8-percent increase); real estate revaluation had largest impact. ### Selected stress-test outcomes (presented in percent of insurer's capital; positive number indicates reduction in capital) - Market and cross-sector shocks: - A fall in real estate prices of 17 percent would reduce insurers’ capital by 5.6 percent (sector-wide). - Life insurers: downward parallel shift of yield curve by 200 basis points would reduce capital by 25 percent. - Non-life insurers: upward parallel shift of 200 basis points would reduce capital by 10 percent. - Insurance-specific risk factors: - Underwriting risk (15-percent shock to mortality or survival rates) would produce the largest impact: decrease of 4 percent sector-wide. - Life insurers: 15-percent increase in mortality rates reduces capital by 18 percent. - Non-life insurers: 10-percent increase in average claim for "mass events" reduces capital by 7.3 percent. - Mixed insurers: increased average claim for peak events reduces capital by 1.3 percent. *Source: IMF staff report content on insurance stress tests and results.* --- *Source: Executive Summary and chapters of IMF Financial Sector Assessment (content unit: _cr06212).* ### Executive Summary ...................................................................................................... ### EXECUTIVE SUMMARY ### Key findings on the financial sector and macroeconomy - Overall verdict: Spain’s financial sector is "vibrant, resilient, highly competitive, and well-supervised and regulated." - Strengths: a high degree of financial intermediation; low intermediation margins; well-capitalized and professionally managed financial institutions; a prudential framework "at the cutting edge of innovation." - Acceleration since euro area entry: expansion of Spain’s financial system accelerated since joining the euro area, in the context of a long period of strong economic growth and rising employment. - Real GDP growth: "Real GDP growth has averaged 3.6 percent a year since 1996," sustained by domestic demand, particularly consumption and construction. - External position: - Foreign saving: "Foreign saving, at 7.4 percent of GDP in 2005," filled the gap between domestic savings and investment. - Net foreign direct investment: "Net foreign direct investment, however, was negative in 2005." - Current account: widening external current account deficit reflecting a persistent inflation differential with the euro area. - House prices and housing boom: - "House prices rose by 104 percent in real terms between end-1997 and end-2005." - Overvaluation estimates: "private and official analysts now estimate overvaluation on the order of 25 to 35 percent, relative to end-2005 levels." - Some deceleration sign: "the 12-month increase in house prices decelerated from 18.5 percent at end-2003 to 12 percent at end-2006Q1." - Credit and balance-sheet trends: - Private sector lending has grown faster than deposits, driven especially by housing loans in a low interest rate environment ("short-term rates are negative in real terms"). - Portfolio flows as external financing: "Portfolio flows were the primary external financing source in 2005, amounting to €40 billion (4.5 percent of GDP)." - Household debt: rose from "45 percent of disposable income in 1993 to 112 percent of disposable income in 2005," above the euro-area average but below Germany, the United Kingdom, and the United States. - Household assets: households maintain strong net wealth positions, but "a large share of their assets is in real estate." - Mortgage credit: "almost exclusively at variable rates" and has grown rapidly; credit to real estate developers and construction companies has also grown rapidly. - Cross-border funding: credit institutions have relied heavily on cross-border capital flows and issued significant fixed-income instruments to attract funds. - Equity holdings: some larger credit institutions hold relatively large equity investments in nonfinancial companies ("industrial participations"). ### Risks, stress tests, and vulnerabilities - Stress test results: "Stress tests showed credit institutions and insurers to be highly resilient to a variety of shocks, including rising interest rates, a fall in house prices, a drop in equity prices, and a sharp depreciation of the U.S. dollar against other currencies." - Conclusion from stress tests: results "suggest that credit institutions would be able to absorb the losses associated with large adverse shocks without systemic distress." - Factors supporting resilience: strong capitalization of systemically important institutions; sizeable loan-loss provisions as required under Spain’s provisioning framework; sound risk management practices; extended period of strong growth. - Macro scenario risks: - A slowdown of domestic demand for housing would affect output and consumption, raise unemployment ("construction itself accounts for 14 percent of employment"), weaken household debt-servicing capacity, and could dampen market appetite for credit institution debt. - The double-digit growth of credit over the last five years, led by housing-related credit, is "cause for concern." - Monetary policy implication: moderation of credit expansion and mitigation of credit risk depend in part on "rising interest rates," since "tighter prudential rules alone are unlikely to be sufficient." - A gradual increase in euro-area interest rates—if decided by the ECB—would "help in dampening both house price increases and credit demand in Spain." - Non-traditional mortgage products: staff supports concerns in the Bank of Spain’s (BE) 2005 Financial Stability Report about non-traditional mortgage products; "Additional prudential measures with respect to these mortgages are recommended." ### Supervisory and regulatory observations - Supervisory strengths: overall strengths of financial system supervision are recognized, but several recommendations are made for all three supervisors. - Independence and coordination: - Recommendation: "Further strengthening the independence of the three financial sector regulators by delegating the authority to issue norms and sanction violations from the Ministry of Economy and the Council of Ministers to the respective agencies." - Recommendation: "Create an institutional mechanism for regular and continuous high-level coordination among the Bank of Spain, the National Securities Commission (CNMV), and the Insurance and Pensions supervisor." - Recommendation: "Ongoing reforms of the Statutes of the regional governments (Autonomous Communities) should clearly maintain the State-level supervisors’ sole responsibility and powers regarding prudential supervision and regulation." - Insurance supervision: recommendation to "Separate insurance supervision from the Ministry of Economy to achieve greater operational, institutional, and budgetary independence." (Box 1 lists this as MT.) - CNMV governance: recommendation to "Appoint members of the CNMV’s board to longer, non-renewable terms." (Box 1 lists this as MT.) - Conflict of interest rule: "Introduce regulations to prevent a credit institution representative serving on the board of a nonfinancial company from taking part in the institution’s decisions regarding that company." (Box 1 lists this as MT.) ### Issues and recommendations related to savings banks and industrial participations - Savings banks governance concerns: structural features (similar to foundations; no private owners) make strong governance particularly important despite strong performance and growing market share. - Recommendations for savings banks: - "Ensuring that initiatives to improve corporate governance of all credit institutions are fully implemented, strengthening them if needed." - "Promoting new means to raise high-quality (Tier 1) capital, such as issuing cuotas participativas to the market." (Footnote: Marketable capital shares without voting rights.) - "Allowing savings banks to merge freely within and across Autonomous Communities." - "Reducing over time the public sector representation ceiling on savings bank boards, currently at 50 percent." - Industrial participations: - Concern: "Some of the larger credit institutions have relatively large equity investments in nonfinancial companies (these holdings are called 'industrial participations' in Spain)." - Recommendation: "To mitigate the risks inherent in equity investments, and considering the substantial changes that are taking place within the regulatory framework (capital adequacy and accounting rules) the BE should implement additional regulatory measures to reduce the incentive for industrial participations, such as adopting the most conservative approaches under Basel II." ### Main FSAP recommendations (summary from Box 1) A. Macro-relevant Recommendations - "To discourage excessive risk-taking, the Bank of Spain should tighten provisioning or capital requirements for non-traditional housing and construction loans." ST - "Implement additional regulatory measures aimed at reducing the risks of nonfinancial equity investments (industrial participations) of credit institutions, such as the most conservative approaches considered in Basel II for such participations." ST B. Financial Sector Supervision - "Strengthen the independence of financial sector supervisors by delegating more broadly the authority to issue norms and sanction violations from the Ministry of Economy and the Council of Ministers to the respective agencies." ST 1/ - "Create an institutional mechanism for permanent and continuous coordination among the Bank of Spain, the securities market supervisor (CNMV), and the insurance supervisor." ST - "Ongoing reforms of the Statutes of the Autonomous Communities should clearly maintain the State-level supervisors’ sole responsibility and powers regarding prudential supervision and regulation." ST - "Separate insurance supervision from the Ministry of Economy to achieve greater operational, institutional, and budgetary independence." MT - "Appoint members of the CNMV’s board to longer, non-renewable terms." MT - "Introduce regulations to prevent a credit institution representative serving on the board of a nonfinancial company from taking part in the institution’s decisions regarding that company." MT C. Issues Related to Savings Banks - "Monitor the results of the 2002 and 2003 regulations on the governance of savings banks, particularly as regards outside influence on the decisions of savings banks, strengthening them if required." MT 2/ - "Allow savings banks to merge freely within and across Autonomous Communities provided the Bank of Spain has ruled favorably on the suitability of the merged institution." MT - "Promote new means to raise high-quality capital from private sources, such as the issue of cuotas participativas." MT - "Reduce over time the public sector representation ceiling on savings bank boards—currently at 50 percent." MT (Notes from Box 1: "ST (short term), or within 12 months." "MT (medium term), or 1–3 years.") *Source: Executive Summary of IMF Financial Sector Assessment (content unit: _cr06212 - Executive Summary).* ### 6. The erosion of competitiveness poses a risk of slower growth in the years ahead. ### 6. The erosion of competitiveness poses a risk of slower growth in the years ahead. ### Short-term outlook and external sector - Short-term growth prospects remain strong, but "the external sector drag is around 2 percentage points." - Total investment rose from 21 percent of GDP in 1996 to 29.7 percent of GDP in 2005. - Domestic saving was equivalent to 22.3 percent of GDP in 2005, resulting in an external current account deficit of 7.4 percent of GDP. - Net portfolio flows were the primary external financing source in 2005, amounting to €40 billion (4.5 percent of GDP). ### Investment composition and credit distribution - Construction has been the most rapidly growing component of investment; consumption has also grown rapidly. - Figure data (2000–2005) indicates a strong share of credit to Construction and Real Estate and Households (see source figures). ### Housing, mortgage credit, and household balance sheets - Mortgage loans have been growing rapidly for several years, accompanying a housing boom driven by declining interest rates, rising employment, immigration, increased number of incomes per household, and a decline in average household size. - Average LTV ratio of outstanding loan portfolio was 65 percent at end-2004. - Debt-to-income (DTI) ratio rose from 77 percent of disposable income in 2001 to 112 percent in 2005. - Credit to housing and construction represented about half of private credit portfolios for banks and two-thirds for savings banks at end-June 2005. - As of end-June 2005, credit institutions had securitized around 20 percent of their mortgage assets; thus most (80 percent) of the credit risk remains with the originating institution. - Over 95 percent of outstanding mortgage loans are at floating rates. - Average duration of outstanding mortgage loans is 25 years. - Maturities of mortgage products offered have increased markedly from a maximum of 10 years in 1985 to up to 50 years in a few cases by the time of the report. - Recent new products include interest-only mortgages and long grace periods for payment of principal. ### Macro-financial risks and policy recommendations on housing lending - Rapid growth of credit to housing and construction feeds the house price boom and overall household debt, increasing credit institutions’ vulnerability to a sharp downturn in the housing market. - Potential second-round effects of a housing downturn: weaker output and consumption, increased unemployment, weakened household debt-servicing capacity, and reduced market appetite for credit institutions’ debt. - Staff recommends tightening provisioning or capital requirements for non-traditional housing loans to discourage excessive risk-taking. - The Bank of Spain (BE) is encouraged to complement moral suasion by further tightening provisioning or capital requirements on housing and construction loans, especially non-traditional mortgages. - Authorities are preparing a draft reform of the mortgage market, including: streamlining commissions for early amortization; reduction and streamlining of legally established fees when modifying a mortgage contract; enhanced information requirements from credit institutions to their clients; lowering legal costs involved in mortgage refinancing; enhancing repayment capacity of issuers of mortgage-backed securities; reinforcing the independence of appraisal companies. ### Financial system strengths and structure - FSAP findings: financial sector is vibrant, resilient, highly competitive, and well-supervised and regulated. - Strengths: high degree of financial intermediation; efficient allocation of savings; wide access to financial services; low intermediation margins; well-capitalized and professionally managed financial institutions; prudential supervisory framework noted for innovation (e.g., dynamic loan-loss provisioning system in 1999). - Payment and securities’ settlement systems are robust and well-integrated internationally. - At end-2005, the average cost-to-income ratio was below 57 percent, compared with 60 percent in the U.S. and an average of more than 63 percent in major EU countries. - Five largest credit institutions account for just under half of system assets. - Deposits accounted for three-quarters of credit institutions’ total liabilities at end-2005: 55 percent of liabilities in resident deposits and 20 percent in non-resident deposits. - Domestic credit increased from 57 percent of assets in 2000 to about two-thirds of assets in 2005. ### Savings banks vs. commercial banks - Savings banks increased their share of customer deposits from one-third in 1980 to more than one-half in 2005. - Savings banks’ share in total credit to the private sector has been increasing and is concentrated in lending to individuals and to small- and medium-size enterprises. - Savings banks operate with no share capital and allocate nonretained profits to social and welfare projects (about thirty percent of profits in recent years). - Savings banks are more reliant than commercial banks on retained earnings to meet Tier 1 capital needs; they cannot be bought by banks but can sell branches or other assets, merge subject to Autonomous Communities’ approval, and buy other financial institutions including banks. - Larger banks expanding overseas; larger savings banks increasing industrial participations; all credit institutions have been aggressively expanding mortgage portfolios. ### International integration and cross-border exposures - Net debt of credit institutions with the rest of the world was €214 billion at end-2005. - Cross-border inflows in 2005 were almost equally divided between portfolio flows (€15.5 billion) and foreign deposits plus interbank loans (€12 billion). - Spanish banks expanded assets abroad in two stages: initially large acquisitions in emerging economies (especially Latin America), later increased presence in other European countries, notably the United Kingdom (increase in U.K. share mainly reflects the acquisition of Abbey Bank by the Santander group in 2004). - Exposure to loss of assets abroad declined to close to 5 percent of capital at end-March 2005, compared with 11.2 percent in December 2003. - At end-2004, of the €122.5 billion of outstanding securitized bonds, 62 percent were held by foreigners, 34 percent by domestic financial institutions, and 4 percent by the nonfinancial resident sector. ### Nonfinancial equity investments (industrial participations) - At end-2004, the value of participations in listed and nonlisted companies by a group of 19 credit institutions (holding approximately 80 percent of CI assets) totaled more than €48 billion, equivalent to about half of those credit institutions’ regulatory capital. - More than 80 percent of participations are in listed companies, concentrated in utilities, energy, and telecommunications. - Risks: returns on equity are relatively risky and volatile; declines in equity prices would reverse recent gains; concentration in a few sectors or companies adds volatility; major participations can create conflicts of interest and informational asymmetries and could lead to suboptimal lending. - BE has required credit institutions to enhance monitoring of these investments. - Staff favors adopting the most conservative approaches to the treatment of industrial participations under Basel II. - Consideration should be given to limiting the possibility of credit institutions holding controlling equity positions in nonfinancial companies and introducing regulations to prevent a credit institution representative serving on the board of a nonfinancial company from taking part in the institution’s decisions vis-à-vis that company. ### Vulnerabilities, prudential indicators, and stress tests - Capital adequacy ratio (CAR) for credit institutions fell slightly from 12.3 percent at end-2004 to 12.2 percent at end-2005. - Nonperforming loans (NPLs) were 0.6 percent of total gross credit. - NPLs by loan category: 0.2 percent for mortgage loans; around 2 percent for consumer loans. - Earnings are at a comfortable level for both banks and savings banks. - Core stress tests examined shocks to market risks, interest rate risk, credit risk, and liquidity risk, and adverse macroeconomic scenarios: a drop in house prices in Spain and the UK; an increase in oil prices; a depreciation of the U.S. dollar against other currencies; and a crisis in Latin America simulated by turmoil in capital markets in the region. - Stress tests were carried out jointly by the FSAP team, the BE, and the group of systemically important credit institutions, covering the seven largest financial groups (about two-thirds of system assets) and credit institutions as a group. - Stress-test shocks were calibrated on historical experience in Spain and were in line with those applied in FSAPs for other Euro area countries. *Source: IMF staff report chapter titled "6. The erosion of competitiveness poses a risk of slower growth in the years ahead."* ### 32. Overall, the system was found to be resilient and well-prepared to absorb the ### _cr06212 - 32. Overall, the system was found to be resilient and well-prepared to absorb the ### System resilience and stress testing - Overall finding: the system was found to be resilient and well-prepared to absorb the losses associated with large adverse single-factor shocks, as well as multiple shocks resulting from the adverse macroeconomic scenarios. - Factors underpinning resilience: - strong asset quality and capitalization of the systemically important credit institutions; - comfortable loan-loss cushion induced by the rigorous provisioning system; - sound risk management practices; - extended period of strong growth in Spain. - Specific buffers: - low loan-to-value ratio for housing loans; - large unrealized capital gains in equity participations. - Stress test results: - most severe scenario (sustained deterioration in credit quality during a three-year window) resulted in average losses equivalent to 13 percent of Basel regulatory capital. - illustrative exercise using 1992-93 downturn employment and growth declines produced average losses of 16 percent of regulatory capital. - for the 12 most affected institutions (holding about 12 percent of system assets), the Basel CAR fell to a range between 4 and 8 percent. - Liquidity risk: found to be small; large credit institutions have a well-diversified pool of funding sources. - Savings banks: generally showed greater sensitivity to adverse shocks due to: - larger holdings of industrial participations relative to assets and regulatory capital; - larger exposures to mortgage loans and real estate developers; - slightly lower quality of loan portfolios relative to banks. ### Insurance and private pension funds - Market size and structure: - Spanish insurance market is the tenth largest in the world and the sixth largest in Europe by net premium income. - Assets managed by the insurance sector amounted to €192 billion at end-2005, of which 61 percent corresponded to life insurers. - Solvency and stress tests: - assets covering technical provisions some 15 percent above the statutory level; - surplus of 158 percent in its solvency margin. - stress tests generally indicate the insurance system would be resilient to a wide range of shocks. - Contributing factors to resilience: - strengthening of asset‑liability management techniques; - conservative investment portfolio of the industry; - limited credit risk transfer from banking to insurance sector; - existence of a public insurance consortium (Consorcio de Compensación de Seguros) to handle extraordinary and catastrophic risk and facilitate orderly exit of weak insurers. - Supervision: - high quality of insurance supervision by the DGSFP contributed to stability and growth; - regulatory framework provides mechanisms to calculate technical provisions and capital requirements linked to the solvency margin and has been strongly enforced by the DGSFP. - Private pension funds: - value of private pension funds’ portfolios increased from €13 billion in 1995 to €73 billion at end-2005 (8.1 percent of 2005 GDP). - number of fund participants rose from 1.8 million to 9.3 million between 1995 and 2005. - growth aided by demographics (immigration, rising labor force participation and employment). - further development limited by large compulsory public pension system and life insurance sector. - pension funds follow relatively risk-averse investment strategies and do not present a systemic risk. ### Capital markets - Development and size: - well-developed and rapidly growing capital market. - collective investment institutions (CIIs) managed assets valued at €323 billion at end-2005. - in the past five years, 12 to 14 percent of household savings have been placed in investment funds. - Market structure and trading platforms: - variable‑income instruments traded in four stock exchanges: Madrid, Barcelona, Bilbao, and Valencia. - AIAF Mercado de Renta Fija: market for private fixed-income. - Government debt traded in Mercado de Deuda Pública en Anotaciones and electronic platforms MTS and SENAF. - MEFF trades futures and options on bonds, interest rates, the equity index IBEX-35, and equities. ### Financial sector supervision — overall assessment and recommendations - Overall finding: high degree of observance of principles dealing with effective supervision by the Bank of Spain (BE), National Securities Market Commission (CNMV), and Directorate General of Insurance and Pension Funds (DGSFP). - Cross-cutting recommendations: - strengthen the independence of financial sector supervisors; currently regulators require specific delegation of authority to issue norms, and major violations must be formally sanctioned by the Ministry of Economy and Finance (ME) and the Council of Ministers. - strengthen powers of supervisors to issue norms and sanction to improve observance of international standards and align with EU initiatives. - formal independence of the DGSFP is particularly constrained because it is directly part of the ME; FSAP provided a note on alternative institutional arrangements for a more independent insurance supervisory authority. - delegate regulatory and sanctioning powers over credit institutions on prudential matters, including licensing and delicensing, from the ME and the Council of Ministers to the BE. - improve cooperation and coordination among regulatory agencies via a fully fledged cooperation arrangement providing permanent and continuous high-level coordination among heads of the three supervisors. - ensure Autonomous Communities’ reforms preserve sole State-level responsibility and powers for prudential supervision and regulation of financial institutions. ### Governance and competitiveness of savings banks — recommendations - Observations: - savings banks have faced outside attempts to influence commercial operations; structure limits capacity to raise capital. - lack the market signal provided by share price (or cuota participativa). - steps since 2002 to improve corporate governance, but too early to see full effects. - Recommended measures: - ensure regulations issued since 2002 on corporate governance are fully implemented, strengthening them if required. - promote new means to raise high-quality capital, such as issuance of cuotas participativas to the market, over time. - allow savings banks to merge freely within and across Autonomous Communities, provided the BE rules favorably on viability of the merged institution. - reduce over time the public sector representation ceiling, currently at 50 percent. ### Insurance and securities market supervision — specific recommendations - Insurance supervision: - separate the insurance supervisor from the ME to increase operational flexibility, reduce outside interference, and provide budgetary independence. - establish clear responsibilities and minimum expertise for boards of directors and senior management of insurance companies, including in the use and risks of derivatives. - Securities market supervision (CNMV): - appoint CNMV board members to longer, non-renewable terms (presently four-year terms, renewable once) to reduce vulnerability to outside influence. - the BE should routinely consult with the CNMV whenever a credit institution applying for a license intends to provide investment services to ensure consistency of requirements and oversight. ### Infrastructure — payment and securities settlement systems - Payment systems: - single large-value interbank payment system: Servicio de Liquidación del Banco de España (SLBE), connected to TARGET, owned/operated/controlled by the BE. - small-value payment system: Sistema Nacional de Compensación Electrónica (SNCE), operated by Sociedad Española de Sistemas de Pago and overseen by the BE. - CPSS Core Principles assessment: all principles observed by the SLBE. - recommended improvements: improve public accessibility to payment system information; improve readability and transparency of BE circulars; SLBE procedures manual should give clearer guidance on expected behavior of participants in emergencies; publish statistics and reports on BE oversight activities periodically. - Securities settlement (Iberclear): - national central securities depository consists of Servicio de Compensación y Liquidación de Valores (SCLV) for securities other than public debt, and Central de Anotaciones de Deuda del Estado (CADE) for public debt securities. - local securities settlement systems in Barcelona, Bilbao, and Valencia process transactions in securities listed only on corresponding stock exchanges. - CPSS/IOSCO Recommendations assessment: risks in Iberclear securities settlement system are negligible; minor improvements feasible. - issues and recommendations: - instances where SCLV will credit securities to a buyer’s account even though the seller has failed to deliver securities (authorities intend to correct this anomaly by mid-2006). - Iberclear should test contingency plans and backup facility, and participants’ backup sites, more frequently. - Iberclear’s backup facility is 20 km from the main site and appears to rely on many of the same resources, which may represent a risk. ### Dealing with problem financial institutions, liquidity support, and deposit insurance - Resolution framework: - current arrangements provide an effective framework for timely and orderly resolution of problem credit institutions. - BE relies on moral suasion and the legal sanctions’ regime to elicit prompt corrective actions. - sanctions regime classifies infractions as light, serious, and very serious; penalties range from private warnings to the revocation of banking licenses. - BE may impose sanctions for light and serious infractions and recommend penalties to the ME for very serious infractions; revocation of a license rests with the Council of Ministers. - extraordinary resolution mechanism allows the BE to appoint an interventor with veto powers or to replace management and the board in exceptionally grave cases. - Systemic liquidity and emergency liquidity support: - BE can provide emergency liquidity assistance to financial institutions, separately from the Eurosystem framework for monetary policy operations. - national central banks are responsible for financial stability, including providing emergency liquidity assistance to credit institutions in their jurisdiction; if assistance has significant euro area‑wide implications, the ECB’s Governing Council is to be consulted. - BE has deliberately kept some ambiguity about its emergency lending policies; general internal guidance exists but has not been disclosed. - Deposit insurance: - framework comprises three funds—for commercial banks, savings banks, and credit cooperatives—all operating under the same rules and procedures. - each fund covers up to €20,000 per depositor, the minimum threshold set by the EU. - an umbrella agency administers investment and use of the funds in accordance with statutory rules. - funds governed by a board of eight members selected by the ME, four representing the BE, and four of the member institutions. - Deposit Guarantee Funds (FGDs) mandate includes paying off insured deposits and contributing to recapitalization of distressed banks under exceptional circumstances—under least-cost resolution rules—and at the direction of the BE. - historical use: in the last 15 years, framework activated in cases affecting six banks and seven savings banks. - for banks: various resolution mechanisms applied. - for savings banks: support provided in form of long-term low-interest loans; no payouts to depositors were necessary. - for cooperatives: no reported cases of rescue operations by their FGD. *Source: _cr06212 - 32. Overall, the system was found to be resilient and well-prepared to absorb the* ### 59. Recent regulatory initiatives include accounting and reporting norms consistent ### _cr06212 - 59. Recent regulatory initiatives include accounting and reporting norms consistent ### Regulatory initiatives, accounting standards, and Basel II implementation - IFRS came into effect in Spain in June 2005 following the decision of the EC to adopt them. - Implementation of Basel II is expected by 2007. - Findings on Basel II preparedness: - The larger Spanish credit institutions and the BE seem well prepared for the adoption of the Basel II credit and market risk framework. - Significant work has been done to collect data and develop models necessary for adopting the advanced internal ratings-based (IRB) approach. - The Spanish Confederation of Savings Banks (CECA) is developing a common risk management tool to facilitate cost sharing among its members. - In most cases, models appear to be suggesting excesses of current capital, mainly because of lesser credit portfolio risks. - Policy challenge and supervisory stance: - Authorities face the challenge of ensuring that models are thoroughly evaluated and validated. - The BE is taking a conservative and measured approach to implementation of international standards to minimize the potential for undue reduction of capital or provisioning. ### Transparency of financial policies (assessment and actions) - Assessment outcome: - The evaluation of transparency of financial policies found a high degree of observance of the principles, but recommended a few improvements. - Recommended improvements included providing more extensive explanations on the objectives and operating procedures for banking supervision and making existing information on banking supervision more easily accessible on the BE’s website. - BE action plan (first phase) to address transparency recommendations: - Improving consistency between the Spanish and English versions of their web page. - Adding institutional information, such as the internal code of conduct for employees of the BE and the members of the Governing Council (Consejo de Gobierno) including their CVs. - Reorganizing and developing the website contents under bank supervision. ### AML/CFT assessment - An anti-money laundering and combating the financing of terrorism (AML/CFT) assessment was conducted by the Financial Action Task Force on Money Laundering (FATF) in September 2005. - A draft mutual evaluation report will be considered for adoption by the FATF Plenary in June 2006. - Once the report is adopted, FATF will forward a ROSC to the Fund which will subsequently be circulated to the Board for information. ### Other issues: pyramid scheme scandal and regulatory gaps - Incident summary: - A pyramid scheme scandal outside the financial sector was discovered in early May. - Two firms encouraged small savers to purchase collectible stamps, promising returns above traditional investments; stamps remained on deposit with the firm, which regularly paid a guaranteed minimum return apparently using funds of new investors. - Scale and financial impact: - Media reports put the number of affected small investors at more than 300,000 and the amounts involved at about €4–5 billion (0.4–0.5 percent of GDP). - Legal and regulatory considerations: - The activities of these firms are subject to consumer protection provisions included as clarified in the legislation on collective investments in tangible assets. - Ongoing investigations also concern alleged money laundering. - The authorities intend to review the operations and regulation of such firms, which fall outside the scope of financial sector regulators and supervisors. ### Summary assessment of compliance with Basel Core Principles and implications for supervisory framework - Context of assessment: - The section summarizes the assessment of the implementation by the BE of the Basel Core Principles as of November 2005; the assessment was conducted as part of IMF FSAP by a team that visited Spain during July and November 2005. - Main findings: - Bank supervision is effectively carried out by the BE and there is a high degree of compliance with the Basel Core Principles. - The BE has developed an effective risk-based supervisory prudential framework underpinned by long-standing professional credibility, recognized technical expertise and operational independence. - Enhancements in some specific areas would be advisable. - Organizational and legal observations and recommendations: - Coordination between the BE and the Autonomous Communities supervisory bodies appears to have worked smoothly overall. - Future changes in the legal regime should preserve the sole and exclusive roles of the BE in prudential oversight, avoid inconsistencies in division of responsibilities, and enhance coordination to avoid fragmentation and promote harmonization. - The BE has sufficient financial revenues to cover operating expenses and current legal protection for supervisors provides effective shielding from legal actions taken while carrying out duties in good faith. - The current legal framework establishes the ME as the principal agency charged with issuing financial regulatory rules; the ME has delegated to BE authority to issue regulations on specific areas such as accounting standards and financial statements, certain solvency standards, and financial disclosure. - Identified legal risk: the BE may be unable to respond adequately should there be conflicting interests between the institutional goals of the BE and the government, which could undermine BE’s supervisory independence. - Recommended legal and regulatory reforms: - Authorities should introduce changes to the current legal framework for banking supervision in order to transfer most regulatory powers currently under the ME to enable the BE to promulgate prudential rules. - Authorities should consider granting the BE license revocation authority in appropriate circumstances. *Source: IMF staff report excerpt (sections 59–71) and related tables and annex material.* ### 72. The definition of banking activities and the proper use of the name “bank” are clearly ### _cr06212 - 72. The definition of banking activities and the proper use of the name “bank” are clearly ### Definition, licensing, and supervisory approach - The definition of banking activities and the proper use of the name “bank” are clearly established in the law. - Licensing requirements are complied with. - The supervisory approach and regulations ensure ongoing monitoring and foster proper control of credit institutions’ (CIs’) strategies and investment decisions. - On-site examinations are designed to verify that regulatory limits are not exceeded and that the data submitted to the BE are accurate. - Given the ability of CIs headquartered in European Union members to set up branches in other European Union members, the assessors encourage the BE to maintain close relationship and coordination with other European supervisory agencies to ensure fit and proper test compliance when authorizing entry of new CIs. ### Prudential regulations and requirements (CP 6–15) - Prudential regulations and requirements are considered adequate and the BE is legally empowered to enforce them. - Capital adequacy regulations provide a comprehensive prudential framework that adheres to international standards and includes specifications that make it stricter in terms of capital composition vis-à-vis other developed countries. - Spain traditionally applies strong loan classification and provisioning rules and strong compliance procedures via: - Off-site credit risk follow up (comprehensive credit risk register system). - Significant presence in banks through on-site examinations. - In adopting international accounting standards and Basel II guidelines the BE follows a measured approach to minimize potential for undue reduction of capital and provisioning. - Assessors encouraged authorities to consider whether current conflict of interest policy guidelines adequately address potential conflicts, particularly where bank directors or officers also serve as directors in an industrial company in which the bank has ownership and to which the bank extends credit or provides other financial services. - Supervisory tools to secure CIs’ prompt corrective actions rely mostly on moral suasion. There is a need to further buttress moral suasion by making supervisory expectations on best banking practices more explicit. One alternative recommended is for the BE to issue guidelines on best banking practices, particularly those that foster effective risk management. ### Methods of ongoing supervision (CP 16–20) - The Spanish supervision system is intense in ongoing monitoring of CI policies, practices, and risk control management, reinforced with regular on-site inspection. - The BE’s off-site supervision effectively complements on-site examinations through preparation and dissemination of a comprehensive risk analysis that guides on-site work. - The BE’s on-site activities, particularly in the largest institutions, provide an effective means of validating supervisory information. ### Accounting standards (CP 21) - While the BE can use its influence and sanctioning authority to cause the removal of unfit external bank auditors, the assessors encouraged the authorities to consider seeking direct BE authority to remove external auditors. ### Remedial measures (CP 22) - The Law of Discipline and Intervention assigns sanction authority to the ME and BE based on severity of infractions: - ME imposes sanctions on the gravest offenses at the proposal of the BE. - BE imposes sanctions in less severe cases. - The framework appears to be working well, but assessors advised considering delegating further sanction power to the BE to bolster moral suasion and enhance enforcement effectiveness. ### Cross-border banking (CP 23–25) - The BE has adequate systems to collect information from home country supervisors and parent bank organizations and should continue to evaluate the effectiveness and quality of information obtained to support supervisory efforts. ### Table 5 — Selected recommended action plan items (summarized) - Legal Framework—Responsibilities and Objectives (BCP 1(1)): - Ensure any future changes preserve the sole and exclusive roles of the BE in prudential oversight of financial institutions; avoid inconsistencies in division of responsibilities; enhance coordination of supervisory bodies. - Legal Framework—Regulatory Powers (BCP 1(3)): - Introduce changes to transfer most regulatory powers currently under the ME to the BE to enable promulgation of prudential rules. - Consider granting the BE licensing revocation authority in appropriate circumstances. - Connected Lending (BCP 10): - Consider whether current conflict of interest policy guidelines adequately address potential conflicts, particularly where bank directors/officers also serve as directors in industrial companies connected to the bank. - Other Risks (BCP 13): - Issue guidelines on best banking practices, particularly those that foster effective risk management. - Money Laundering (BCP 15): - Fully implement the June 15, 2005 BE/SEPBLAC collaboration agreement. - Accounting Standards (BCP 21): - Consider seeking direct BE authority to remove external auditors where unfit. - Remedial Measures (BCP 22): - Consider delegating from the ME to the BE further sanctioning authority for the gravest infractions, particularly those calling for suspension of bank officers. ### Authorities’ response to the assessment - The Spanish authorities thanked the IMF assessment team and welcomed recognition that the Spanish supervisory system has a high degree of compliance with the Basel Core Principles and that bank supervision is effectively carried out by the BE. - On the recommendation to change the division of competences between the Ministry of Economy and Finance (ME) and the Bank of Spain (BE), and on observations regarding the role of Autonomous Communities (ACs) in supervision of the cajas, the authorities provided qualifications and comments: - On BCP 1(3): The authorities consider the current legal framework effective due to good cooperation between the ME and BE. The ME elaborates prudential rules and the BE enforces them. The ME is viewed as best suited to create the legal framework because: - There is no single financial supervisor in Spain, and the ME has a global view of banking, insurance, and securities. - The ME is responsible for negotiating EU legislation for financial services and participates in relevant EU committees. - The ME can balance efficient supervision with economic needs to avoid overregulation. - On BCP 1(3) and BCP 22 (license revocation and sanctioning authority): Under Spanish law, power to license and sanction credit institutions belongs to the public administration. The Bank of Spain does not belong to the Spanish public administration, though the legal system allows delegation of public duties to non public bodies, and the BE has powers to impose sanctions for light and serious infringements while the Ministry of Finance handles very serious infringements (with BE proposing sanctions). The authorities consider this system consistent with the Constitution and effective supervision. - On BCP 1(1): The authorities argue there is no possibility of overlapping national and regional legal frameworks; basic national regulation obliges all Cajas and entrusts ME and BE with discipline, inspection, and sanctioning on matters of competence related to monetary and financial policy, solvency and safety. - On BCP 13: Authorities contend current regulation already contains criteria defining how entities must identify, measure, monitor, and control “Other risks,” with detailed criteria in Annex IX of Circular 4/2004; Spain does not rely on “best practices” guidelines because such practices have been elevated to normative rank. The BE has nonetheless provided recommendations through publications and interventions. - On BCP 24: The BE relies on parent credit institutions providing information on subsidiaries, allowing remote inspections, without precluding direct contact and exchange of information with other supervisors. --- ### SUMMARY ASSESSMENT OF OBSERVANCE OF IAIS INSURANCE CORE PRINCIPLES #### Assessment scope and process - The assessment considered: - An extensive self-assessment prepared by the Dirección General de Seguros y Fondos de Pensiones (DGSFP) based on the IAIS Insurance Core Principles and Methodology. - Comentarios a la Autovaloración de la Dirección General de Seguros y Fondos de Pensiones sobre los “Insurance Core Principles” de la IAIS. - Ley de Ordenación y Supervisión de los Seguros Privados (LOSSP). - Reglamento de Ordenación y Supervisión de los Seguros Privados (ROSSP). - Ley de Mediación de los Seguros Privados (LMSP). - Ley de Contrato de Seguro (LCS). - Relevant secondary regulations (Real Decreto, Órdenes Ministeriales, Consultas, Criterios and Instrucciones) issued by the Consejo de Ministros, ME, and DGSFP. - The assessment process was conducted from June 22 to July 1, 2005. - The evaluation reviewed observance of the IAIS ICP and the effectiveness of the insurance supervisory agency (DGSFP), which is part of the ME. It included discussions with ME and DGSFP officers and meetings with private sector representatives. #### Institutional and macro prudential overview - Net premium income in 2004: €45.5 billion. - Market rankings: - Tenth largest in the world overall. - Sixth largest in Europe overall. - Non-life sector: eighth largest globally and fifth in Europe. - Life sector: sixteenth internationally and eighth in Europe. - Penetration and density: - Penetration index: 5.77 percent of GDP (ranked twenty-seventh globally and fourteenth in Europe). - Density: €1,080 per capita (ranked twenty-fourth internationally and fifteenth in Europe). - Market structure as of end-2004: - Total insurance entities: 330. - 227 insurance companies accounting for 81 percent of total premiums written. - 44 mutual societies accounting for 18.5 percent. - 59 social mutual societies accounting for 0.2 percent market share. - Financial strength indicators as of end-2004: - Assets covering technical provisions exceeded by 15 percent the statutory level. - Solvency margin surplus was 158 percent. #### Market characteristics and resilience - The Spanish insurance market is innovative and increasingly competitive, with important participation of banks and cajas in distribution of life products. - The sector is solvent and profitable. - The Spanish market has developed private and public infrastructure to support functioning, including the Consorcio de Compensación de Seguros for catastrophic risks and orderly exit of troubled insurers. - The sector has absorbed shocks from interest rate reductions and adverse equity markets smoothly. - Since 2000 the non-life sector has maintained clear growth; the life sector resumed growth after a slowdown in 2003. - Factors contributing to stable growth include: - Strengthening of asset-liability management techniques as part of regulatory requirements and market practices. - Limited impact of interest rate guaranteed life products. - Conservative structure of the industry investment portfolio. - Limited credit risk transfer activity from banking to insurance. - Effective compensation mechanism for catastrophic and extraordinary risks. - Future challenges: - Implementing the outcome of the EU Solvency II Project on risk management and stress testing. - Implementing new international accounting standards on insurance produced by the International Accounting Standards Board. #### Main findings on regulation and supervision - The regulatory and supervisory scheme on insurance is comprehensive and effective; the majority of principles are assessed as observed or largely observed. - Spain relies on a clear legal framework which already considers implementation of most EU Directives on insurance. - The judicial system is professional and reliable; alternative dispute resolution mechanisms like private arbitration are commonly used. - Accounting and auditing professions are well-developed and rules align with internationally accepted practices; there is an organized actuarial profession. #### Supervisory authority (DGSFP) - The insurance supervisory authority (DGSFP, part of the ME) has no legal powers to issue secondary regulation that are binding on the industry. - The DGSFP is not an independent agency and there is no regulatory governance scheme in place; for example, there are no explicit procedures regarding the appointment and dismissal of the head of the supervisory body. *Source: IMF staff report text as provided.* ### 101. The current institutional arrangement for insurance supervisions seems to create ### The current institutional arrangement for insurance supervisions seems to create ### Institutional arrangements and resource constraints - The current institutional arrangement for insurance supervisions seems to create obstacles to allocate enough resources and in a timely manner, in accordance with the risks the supervisory authority perceives. - The institutional arrangement under which insurance supervision is conducted does not provide the required resources to attract and retain highly skilled personnel and to develop all the necessary supervisory infrastructure and tools. ### Corporate governance, internal control and risk management - Finding: In general, neither general Law nor Insurance Law establishes requirements on corporate governance for insurance companies. The existing regulation is applicable only to a limited number of insurers listed in the Spanish stock exchange. - Finding: The regulatory framework does not establish specific requirements on risk assessment and management for insurers to recognize the wide range of risks that they face and to assess and manage them in an appropriate manner. - Finding: The insurance regulatory framework does not require explicitly that insurers be required to have an internal control framework that includes internal auditing, risk management systems, assessment of outsourced functions and a clear responsibility of the board of directors. - Finding: The insurance supervisory authority has a limited capacity to conduct on-site processes with respect to the existence and adequate operation of this kind of policies and systems. ### Group-wide supervision - Finding: Although the insurance supervisory authority has established formal mechanisms with the banking and securities supervisors to create a general framework for coordination and collaboration on financial conglomerates supervision, in practice these agreements are limited to exchange of information on a case-by-case basis. - Finding: There is no evidence of group-wide analysis or group-wide supervision of financial conglomerates from the insurance standpoint. ### Market analysis - Finding: The insurance supervisory authority does not conduct regular analysis of market conditions to identify main trends, scenarios and issues that could have an impact on the development and financial position and stability of the market. - Finding: The supervisory authority does not require insurers to engage in market-wide systematic reporting, or to analyze and monitor particular market-wide events of importance for the financial stability of the insurance market. ### Investments and use of derivatives - Finding: The current regulatory framework does not include the obligation for insurers to have in place an overall strategic investment policy approved and reviewed regularly by the board of directors. - Finding: The regulatory framework does not require that oversight of, and clear management accountability for, insurer’s investment policies and procedures remain ultimately with the board of directors. - Finding: There is no explicit requirement for the board of directors to satisfy itself that it has the necessary expertise to understand the issues related to the use of derivatives, and to approve and review periodically a policy on their use. - Finding: Regulation does not require explicitly that insurers have in place risk management systems and audit procedures covering the risks from derivatives. - Finding: The regulatory framework does not require explicitly that insurance companies implement audit procedures to ensure the timely identification of internal control weaknesses and operating system deficiencies on investment operations, including contingency plans. ### Licensing and suitability of persons - Finding: The regulatory framework does not include, neither for licensing nor for ongoing operation, specific fit and proper requirements for actuaries that will be in charge of the technical management of insurers, and for the staff involved with investment activities. ### Anti-money laundering, combating the financing of terrorism (AML/CFT) - Finding: The supervisory authority undertakes examinations of insurers on the compliance with the AML/CFT requirements established in the Law. - Finding: Insurance agents and brokers are not required by regulation to adopt AML/CFT measures. ### Recommended Action Plan to Improve Observance of the IAIS Insurance Core Principles (selected ICP recommendations) - Principle 3. Supervisory authority - To implement an institutional arrangement for insurance supervision that enables: - (i) strengthening of regulatory governance in terms of independence of the supervisory body (i.e., the establishment of procedures regarding the appointment and dismissal of the head of the supervisory authority and members of the governing body); - (ii) the supervisory authority to issue secondary regulation by administrative means that is binding to the insurance industry; and - (iii) a budgetary scheme that could allocate more financial resources to insurance supervision and a more flexible scheme for the allocation of resources; increase supervisory authority’s staff and attract and retain highly skilled personnel; and provide the necessary resources to enhance supervisory infrastructure and tools. - Principle 6. Licensing - To include, as part of the licensing process for insurance companies, specific suitability requirements for the actuaries that will participate in the technical management of the company. - Principle 7. Suitability of persons - To consider, as an additional element for the fit and proper scheme applicable to key functionaries, specific fit and proper requirements for actuaries. - To introduce the obligation for insurers to inform the supervisory authority, in a timely manner, of circumstances that may affect the fitness and propriety of its key functionaries. - Principle 9. Corporate governance - To establish general requirements on corporate governance applicable to insurers in which clear responsibilities for the board of directors and senior management are included. - Principle 10. Internal control - To explicitly consider in regulation the requirement for insurers to maintain a framework for internal control that includes internal auditing procedures, risk management systems, assessment of outsourced functions and clear responsibilities for the board of directors. - Principle 11. Market analysis - To implement regular analysis of the conditions of the market, not only in terms of the past developments and present situation, but also to identify trends, scenarios and issues that could have an impact on future development, financial position and/or financial stability of the market. - To include as part of the systematic financial and statistical information required of insurers for supervision purposes, the information required to conduct regular analysis of market conditions. - Principle 17. Group-wide supervision - To strengthen the coordination and collaboration framework between the insurance supervisory authority and the BE and the CNMV, in order to create and implement effective mechanisms for group-wide analysis and effective group-wide supervision of financial conglomerates. - To provide the necessary resources to the insurance supervisory authority so it can participate effectively on group-wide supervision (see recommendation on ICP 3). - Principle 18. Risk assessment and management - To include explicitly in the regulatory framework specific requirements on risk assessment and management for insurers, in order to recognize the wide range of risks that they face and to assess and manage them in a comprehensive and effective manner. - To include, as part of the supervisory process, the verification of the existence and adequate operation of policies and systems on risk assessment and management by insurers. - Principle 21. Investments - To incorporate in the insurance regulatory framework explicit requirements for insurers to have in place an overall strategic investment policy approved and reviewed regularly by the board of directors, that addresses the different aspects linked to investment risks (see recommendation on ICP 9). - To include in the regulation specific fit and proper requirements for staff involved with investment activities, in terms of appropriate levels of skills, experience and integrity. - To consider within the regulatory framework requirements for insurers to implement audit procedures to ensure the timely identification of internal control weaknesses and operating system deficiencies on investment operations that include contingency plans (see recommendation on ICP 10). - Principle 22. Derivatives and similar commitments - To consider in the regulatory framework explicit requirements on the board of directors to satisfy itself that it has the necessary expertise to understand the important issues related to the use of derivatives; to approve and review periodically a policy on their use; and to have in place risk management systems and audit procedures covering the risks from derivatives (see recommendations on ICP 9, 10, and 18). - Principle 28. Anti-money laundering, combating the financing of terrorism (AML/CFT) - To provide the necessary resources to the insurance supervisory authority so it can maintain an effective supervision on AML/CFT requirements to insurers (see recommendation on ICP 3). - To draft legislation on AML/CFT requirements for insurance agents and brokers. ### Authorities’ response and planned regulatory initiatives - General: The DGSFP appreciates the quality, precision and rigorous analysis carried out by the IMF mission and the assessor in connection with the IAIS Insurance Core Principles observance assessment. The DGSFP shares the contents of the assessment but comments on specific aspects. - Principle 18 (risk assessment and management) - The DGSFP states that the assessment does not take into consideration on-site inspections carried out, which include actions oriented to control and verify financial and non-financial risks. Inspection plans include specific references to that kind of evaluation. - The Inspection Manual, in its section on internal control and risk assessment, includes a questionnaire on risk assessment by insurers. - Clarification: Responses in the self-assessment questionnaire may have led to confusion with respect to the absence of an analysis on risk aggregation and risk interrelation. The statement that no checks are performed with respect to the effects of different risks aggregations aims to underline that, up to date, there is a lack of a system to weigh and quantify in a reliable manner the impact of diversification, aggregation and correlation of risks, in order to measure the effect of specific risks in the global risk position of an insurance entity. This does not imply that risk management systems of supervised insurers are not verified. - Principle 6. Licensing - Spanish regulations assign responsibility for the management of an insurance company to its directors. Spanish law, however, requires insurance companies to have an insurance actuary at their disposal. - Article 29.1 of the Private Insurance Organization and Supervision Regulations (ROSSP) requires that the technical provisions be certified by an insurance actuary; the insurance company must therefore choose an insurance actuary and be accountable for the appointed actuary’s actions. - Principle 7. Suitability of persons - Insurance actuaries in Spain are university graduates; their fitness is demonstrated by their possession of a bachelor’s degree (licenciatura) in actuarial and financial sciences, issued by the Ministry of Education and Science. - The company is responsible for verifying propriety; a forthcoming legislative amendment will include the requirement of propriety for insurance actuaries, although the insurance company that appointed the actuary remains accountable for noncompliance with this requirement. - Principles 9 and 10 (Corporate governance and Internal control) - A draft amendment to the ROSSP is being considered that provides for the establishment, documentation, and maintenance, at all times, of internal control procedures adapted to the company’s organization. - The draft amendment applies the principle of proportionality, while noting that this can never lead to situations in which insured persons are unprotected. - The draft amendment provides that ultimate responsibility for establishing internal control procedures rests with the board of directors, and that management is responsible for implementing them. - Internal control will include supervision of the procedures by independent expert staff, assessment of internal and external risks, contingency plans, and an annual report by the board of directors assessing effectiveness of internal control procedures. - Principles 21 and 22 (Investments and Derivatives) - The text in preparation establishes clearly that responsibility for formulating and approving the investment policy rests with the insurance company’s board of directors, which must ensure the identification, follow-up, measurement, reporting, and management of risk. - For financial derivatives and structured products, forthcoming rules will specify usable categories, purpose, maximum positions, authorized counterparties, sharing of authorization/execution/control functions, and periodic documentation of all activities. - Principle 28 (AML/CFT) - Article 2.1 of the Regulations contained in Law No. 19/1993, of December 28, 1993, on measures to prevent money laundering, approved by Royal Decree No. 925/1995, of June 9, 1995, provides that insurance companies are accountable for the actions of individuals and legal entities acting as dealers or intermediaries for them, an obligation that also applies to insurance brokers. - A forthcoming legislative amendment will propose to maintain the aforesaid accountability of the companies for the actions of their agents, and will provide that insurance brokers remain directly bound by legal obligations with regard to specific measures to prevent money laundering, irrespective of the insurance companies for which they carry out trading activities. This provision will require the amendment of Article 2.1 of the aforesaid Law, which enumerates the parties required to comply with the provisions of that rule. ### Summary assessment of IOSCO Objectives and Principles of Securities Regulation (selected points) - Spain has modernized the legal structure for financial services through several amendments to Law 24/1988 on the Securities Market (Ley del Mercado de Valores (LMV)). - The CNMV is the main regulator of all firms and individuals related to the securities market, notwithstanding the exclusive prudential oversight of the Bank of Spain (BE) over credit institutions involved in securities dealing and the role of the Ministry of Economy in licensing. - Recommendation: The Spanish regulatory framework could be further strengthened by granting the CNMV additional oversight and sanctioning responsibilities and by reinforcing the institutional and operational independence of the CNMV. - Governance observation: The president, vice president, and non-executive members of CNMV’s Board are appointed for four-year terms, renewable once. To increase independence, appointments should be for a longer term than the present four years, and should be non-renewable; appointment of some non-executive members could draw from varied constituencies. - Operational independence observation: Important regulatory powers such as adopting new regulations in key operational areas of the securities field as well as the power to grant and withdraw licenses and to sanction very serious infractions to securities regulations remain the responsibility of the ME. Recommendation: Vest the CNMV with the power to design and adopt secondary legislation, the capacity to grant and withdraw licenses to regulated entities and products, and the power to sanction on administrative grounds any infractions of the securities law and regulations. *Source: IMF assessment and annexes as provided in the content unit.* ### 128. CNMV’s Board and Executive Committee. The CNMV is an autonomous public ### CNMV’s Board and Executive Committee ### Governance and organizational structure - The CNMV is an autonomous public authority governed by a seven-member board (Consejo) chaired by a full-time president. - The Board comprises seven members. Its president and vice president are appointed by the government, in consultation with the ME and experts in the securities field. - Three other members are appointed by the ME, and the general director of the treasury and the deputy governor of the Bank of Spain are ex-officio members. - All members are subject to conflict-of-interest rules and, with the exception of the two ex-officio members, are full-time staff who may not engage in other professional activities. - A permanent Executive Committee (Comité Ejecutivo), comprising the president, vice president and the three full-time members of the Board, prepares the board agenda and exercises delegated powers. ### Consultative committee - The CNMV has a consultative committee chaired by the vice-president as a non-voting member. - The committee is composed of 17 members representing secondary markets, issuers, investors and three Autonomous Communities. - The committee must be consulted on: - CNMV’s circulars, - the imposition of sanctions for very serious infringements, - the licensing, delicensing, mergers and takeovers of investment firms, - the authorization and revocation of authorization of branches of investment of non-EU member states. ### Scope of competence - The CNMV prudentially supervises investment services providers (ESIs), regulates public offerings and takeover bids, oversees the financial information related to securities, and supervises the marketing and distribution of financial instruments. - The CNMV is responsible for custodians of securities and of assets of collective investment schemes, for clearing and settlement systems and related custodians, without prejudice to the BE’s functions and its specific role with respect to payment systems. ### Sanctioning powers - The CNMV has somewhat restricted sanctioning powers that have to be exercised after the non-binding advice of its consultative committee. - The CNMV can only sanction light or serious breaches of relevant laws and regulations. - With regard to very serious infringements, the CNMV prepares a report on the case and proposes a sanction for the ME to impose. - Potentially criminal acts must be referred to the Public Prosecutor. - The CNMV board must inform the BE of any sanction that it intends to apply to a credit institution. ### Licensing - Licensing (and withdrawal of licenses) of ESIs is within the remit of the ME upon proposal of the CNMV. - The ME retains licensing and delicensing powers over: - (a) insurance companies upon proposal of the DGFPS, and - (b) credit institutions upon proposal of the BE. ### Coordination with the Bank of Spain - Day-to-day coordination between the BE and the CNMV is organized through inter-staff contacts, information sharing, several coordinated data bases and regular monthly meetings. - The CNMV maintains a registry of credit institutions involved in providing investment services that is publicly available on its website; information on credit institutions is updated daily from a flow of information from the BE. - The registry includes tariffs and the typical contractual documents as filed with the CNMV. ### Cross-membership arrangements and market oversight - Cross-membership fosters cooperation: the vice president of the CNMV is an ex-officio member of the board of the Bank of Spain, and reciprocally, the deputy governor of the Bank of Spain is a member of the CNMV Board. Cross-membership does not apply to the insurance supervisor. - Market operators and clearing and settlement systems are monitored through protocols regarded as founded in contract law and not in public law. - Power to impose penalties or fines, and to suspend or prohibit participation of any market participants is the responsibility of the CNMV and ME. - The law applicable to securities is largely contained in the main LMV as subsequently amended and completed by a Royal Decree transposing both the market abuse and the prospectus directives. Applicable law is also found in company law, bankruptcy law, commercial law, property law, penal law, and administrative codes. - As a member of the European Community, Spain recognizes credit institutions and investment firms that enter Spain from other European Economic Area jurisdictions by right of establishment or cross-border services. ### General preconditions for effective securities regulation - Preconditions identified include: - Existence of a legal framework supporting integrity of contract and property rights; - Legal recognition of traded instruments and trading rules; - Commercial and insolvency regimes facilitating collateral, clearing services, and enforcement of guarantees; - Sound company law protecting investors; - Laws supporting identification and protection of client assets; - Reliable and consistent accounting standards; - Confidence that rules will be consistently and equitably enforced, including in bankruptcy. - These assumptions presuppose that judicial, administrative, and regulatory authorities will reliably honor and equitably apply the rule of law. ### Recommended Action Plan to Improve Implementation of IOSCO Objectives and Principles (selected highlights) - Principle 1 (clarity of responsibilities): Enhance CNMV’s role when credit institutions intend to provide investment services; include CNMV’s assessment of program of activity of credit institutions in licensing phase. - Principle 2 (independence and accountability): Recommend appointments to CNMV’s board be for a longer term than the present four years, and be non-renewable; recommend appointment of some non-executive members drawn from varied constituencies. - Principle 2 (operational independence): Recommend vesting CNMV with power to design and adopt secondary legislation (promulgated by executive authorities); recommend capacity to grant and withdraw licenses to regulated entities and products; recommend power to sanction on administrative grounds any infractions of securities law and regulations. - Principle 3 (adequate powers and resources): Identify shortcomings in authorization of investment firms and credit institutions involved in securities dealings; limitations in adoption of secondary legislation; limitation of sanctioning powers to infracciones leves y graves excluding infracciones muy graves; recommend more flexibility in hiring specialized professionals. - Principle 8 (inspection powers): Recommend explicitly establishing in law that the CNMV may carry out inspections without prior notice. ### Authorities’ response to the assessment (summary) - Authorities broadly agree with the assessment and recognize high degree of compliance with IOSCO Objectives and Principles. - Regarding Principle 1: measures will be taken to enhance CNMV role when credit institutions intend to provide investment services. - Regarding Principle 2: authorities will lengthen the current four-year term of appointment of board members and make the term non-renewable; note that LMV requires board members to be experts in securities markets and does not preclude candidates from private sector or academia. - Authorities assert CNMV already decides on technical aspects of financial regulation, but political decisions remain with parliament and government; ME’s role is justified given its overview of three financial sectors and EU negotiation responsibilities. - Regarding sanctioning powers: under Spanish legal system, sanctioning power lies with the government; CNMV proposes sanctions for most serious infractions. - Regarding Principle 3: licensing is a public administrative power; CNMV proposes licensees to the ME. - Regarding Principle 8: authorities disagree with rating “broadly implemented” rather than “fully implemented”; Article 85 of the LMV gives CNMV sweeping inspection powers and does not impose any minimum prior notice; CNMV has carried out inspections without prior notice. --- ### Summary Assessment of Systemically Important Payment Systems (SLBE) and Recommendations for Securities Settlement Systems ### General and methodology - Assessment covered one Systemically Important Payment System (SIPS): Servicio de Liquidación del Banco de España — SLBE (a Real-Time Gross Settlement System—RTGS). - The assessment did not assess Spain’s link to TARGET. - Methodology derived from the Guidance Note for Assessing Observance of Core Principles for Systemically Important Payment Systems (CPSIPS) of the IMF and the World Bank of August 2001. - Assessment involved discussions with BE staff and meetings with commercial banks and was conducted during the FSAP mission to Spain in June-July 2005. - Assessment benefited from BE self-assessment and the assessment of the Euro Large-Value Payment System against the core principles published by the European Central Bank. ### Institutional and market structure - The SLBE is the only systemically important payment system. - The SLBE is an RTGS system owned, operated, and controlled by the BE; it is the Spanish component of TARGET and settles domestic and cross-border operations. - Law 41/1999 of November 12 (the Settlement Finality Law) provides the general legal framework, stating irrevocability and finality of payment orders, recognizing legal validity of clearing agreements, establishing procedures for insolvency and expeditious execution of collateral, and ensuring insolvency proceedings do not have retroactive effects on payment orders or collateral in the system. - The BE regulates SLBE through circulars, technical applications (aplicaciones técnicas), and communications; circulars are published in the Official Gazette (Boletín Oficial del Estado) and at BE’s website. - The SLBE is an open system with participation of credit institutions established in any European Economic Area country and investment service institutions subject to prudential supervision; treasury departments of central and regional governments and clearing houses such as the stock exchanges and IBERCLEAR also participate. - There are 184 direct participants (33 branches of foreign institutions) and 36 indirect participants in the system. - Direct participants must open a centralized RTGS account on the books of the BE for settlement and can act on their own behalf and on behalf of their customers. ### Main findings - The BE is an important player with a well-established and cooperative relationship with the financial sector; its role and responsibilities are clearly defined in law, including the oversight function. - The legal framework is sound; the Settlement Finality Law is fully enforceable and ensures irrevocability and finality even in participant insolvency. - Rules and regulations addressing SLBE are contained in a number of documents issued and modified by the BE; recommendation to consolidate payment circulars to improve readability and transparency. - The infrastructure for clearing and settlement of payments is well-developed, modern, and functional. - SLBE has systems offering protection against liquidity and credit risks: queuing mechanisms, intraday credit and bilateral and multilateral algorithms; the liquidity reservation facility was introduced to meet user needs. - Recommendation to monitor the use of the liquidity reservation facility to avoid possible discrimination against certain payments and to ensure it does not unduly prevent the central bank from debiting accounts during the day. - Contingency plans exist, but SLBE manual procedures should give clearer guidance on expected behavior of participants in emergencies (e.g., failure of a participant’s platform or SLBE platform). - Recommendation that BE require participants to have clear internal policies and procedures, carry out operating audits, and conduct periodic IT infrastructure reviews to avoid operational risks. - Recommendation to evaluate distance between the external backup center and main site to ensure sufficiency against events such as natural disasters or terrorism. - The BE complies with its oversight function and produces statistics and reports; recommendation to periodically publish and disseminate these materials. ### Recommended Action Plan to Improve Observance of the CPSS Core Principles (selected items) - Pre-settlement risk (Principles 2-5): - Revise organization of BE’s circulars to improve readability and transparency. - Ensure use of liquidity reservation facility does not unduly prevent debiting of accounts during the day. - Settlement Risk (Principles 6-10): - Revise SLBE Manual to give clearer guidance on expected behavior of participants in emergency situations. - Require participants to put in place clear internal policies and procedures and to carry out operating audits. - Conduct periodic reviews of participants’ IT infrastructure to avoid operational risks. - Evaluate distance between backup site and main site to ensure continuity against natural disasters or terrorist acts. - Periodically publish and disseminate statistics and reports on oversight activities. - Note: All CPSS principles were rated as observed. The recommended actions are relatively minor measures to enhance SLBE robustness. *Source: _cr06212 - 128. CNMV’s Board and Executive Committee. The CNMV is an autonomous public authority (excerpts).* ### 152. The authorities thank the IMF team and the assessor for all the work undertaken and ### _cr06212 - 152. The authorities thank the IMF team and the assessor for all the work undertaken and ### B. Securities Clearance and Settlement Systems — General and Scope - Assessment conducted as part of the Financial Sector Assessment Program of observance of the CPSS/IOSCO Recommendations for Securities Settlement Systems by the securities clearance and settlement infrastructure in Spain. - CNMV prepared a thorough self-assessment of the Iberclear system used as the basis for the assessment. - Assessment scope: Iberclear (the central securities depository — CSD) for public sector and corporate debt, and equities. More than 99 percent of securities in Spain are dematerialized in Iberclear; residual securities are immobilized in this CSD. - Iberclear operates two platforms: - SCLV for securities other than public and private debt: delivery versus payment on a gross-net basis (model 2 DVP). Multilateral net positions on the cash side are settled in accounts at BE. - CADE for public and private debt securities: trade-for-trade settlement (model 1 DVP). Cash leg settled in accounts at BE. ### Institutional and market structure; usage statistics - BME is the holding company for all Spanish markets and securities settlement systems; Iberclear is a wholly owned subsidiary of BME. - All stock exchange transactions are submitted to Iberclear as “locked-in” trades and settled via Iberclear’s systems; public and private debt transactions submitted through electronic trading platforms and as OTC trades between participants. - Total value of all trades settled in Iberclear systems in 2004: €82,798 billion - €1,505 billion in equities - €81,293 billion in debt ### Regulatory structure and roles - Securities Markets Act (Ley del Mercado de Valores—LMV) establishes principles and main provisions regarding clearance and settlement systems, including creation of Iberclear. - Regulation governing Iberclear approved by the Ministry of Economy and Finance upon advice of CNMV; CNMV supervises Iberclear pursuant to Article 84 of the LMV. - BE has significant oversight role due to responsibility to prevent systemic risk and responsibility for the payment system; BE is a substantial user of Iberclear’s CADE and supervises credit institution participants in Iberclear. - CNMV and BE have cross-representation on each other’s boards; LMV directs CNMV and BE to coordinate where authorities overlap; Director General of the Treasury General Directorate sits on CNMV Board. ### Information and methodology used for the assessment - Assessment based on CNMV self-assessment using CPSS/IOSCO assessment methodology for Recommendations for Securities Settlement Systems. - Discussions held with CNMV, Iberclear, BME, Treasury, and some market participants; reviewed statutes, rules, regulations, audit reports, and business plans. - Assessment of MEFFClear (central counterparty for derivatives) postponed pending CNMV self-assessment under CPSS/IOSCO Recommendations for central counterparties. ### Main findings — Legal and operational risk, and market practices - Legal risk (Recommendation 1) - Consistent set of laws, regulations, and contracts forming legal foundation for clearance, settlement, and custody. - Customer assets protected against bankruptcy of Iberclear participants. - Dematerialization, netting, and securities lending arrangements well regulated; all laws, regulations, and contractual arrangements fully enforceable. - Transactions submitted to Iberclear deemed irrevocable and final when settled in the system; zero hour bankruptcy-cancellation cannot be raised retroactively. - Settlement agents are required to be Spanish participants; Iberclear requires legal opinions on foreign and domestic law for assets held in other CSDs. - Pre-settlement risk (Recommendations 2-5) - Matching and confirmation well established on stock exchanges, electronic markets, and OTC; more than 99 percent of trades settle on a rolling basis by T+3. - Incentives to achieve timely settlement; settlement failures closely monitored. - Active securities lending market. - Settlement risk (Recommendations 6-10) - More than 99 percent of securities dematerialized; remainder (mostly private debt) immobilized in Iberclear. - Delivery versus payment realized in both systems: SCLV (model 2 DVP) for non-debt securities; CADE (model 1 DVP) for debt. - Final settlement occurs before or at end of day in both systems; real-time finality achievable in CADE during the day. - Trades irrevocable and unconditional when reported; settlements final when securities transferred on Iberclear’s books; all trades settle in central bank money. - Iberclear’s financial resources sufficient to complete settlements in case of default by its participant with the largest settlement obligation; guarantee fund collects collateral assuming all buyers and sellers default on a single settlement day, assuming normal market conditions. - No participant has ever defaulted on the cash side. - Iberclear is never exposed to principal risk except a minor exception: SCLV may credit securities to a buyer’s account even when seller has failed to deliver, creating temporary short position in seller’s account; potential loss historically negligible due to risk controls. - Operational risk (Recommendation 11) - Iberclear systems function well (99+ percent uptime); backup site exists; fold-over to backup site takes two hours. - Contingency plans not tested with participants in the past year; recommendation to test contingency plans more frequently including participants’ backup sites. - Recommendation to evaluate whether 20 km proximity to backup site is sufficient and to assess independence of critical services (electricity, etc.) between sites. - Custody risk (Recommendation 12) - Customers legally protected against insolvency of Iberclear and its participants. - Customer securities must be segregated from participant securities on Iberclear’s books; positions reconciled daily. - In participant insolvency, a customer can request its securities be transferred to another participant. - Investment compensation scheme covers obligations to customers up to €20,000. - Entities authorized to hold securities in custody subject to supervision by CNMV or BE. - Other issues (Recommendations 13-19) - Iberclear wholly owned by BME; processes exist for users to be consulted and express views on Iberclear policies and operations. - Iberclear board represents users and must be approved by CNMV; recommendation that CNMV review participation of its representative on Iberclear board due to potential governance complications as BME demutualizes. - Access rules and termination rules disclosed and objective; membership open to non-Spanish firms but participant must have an account at BE to settle transactions. - Fees and penalties published to members. - Participant communications use proprietary formats not translatable into international formats; Iberclear in process of providing a common communication protocol employing international standards. - Supervision of Iberclear well-established and rigorous; close cooperation between CNMV and BE. - Recommendation that Memorandum of Understanding between CNMV and BE regarding coordination be made public. - Iberclear has links with foreign CSDs; Iberclear obtains legal opinions on relevant laws; in all links only free-of-payment transfers permitted and no provisional transfers allowed. ### Key statistics and operational figures (preserved exactly) - More than 99 percent (several references throughout the text). - Total value of trades settled in Iberclear systems in 2004: €82,798 billion - €1,505 billion in equities - €81,293 billion in debt - System uptime: 99+ percent - Backup site proximity: 20 km - Investment compensation scheme coverage: up to €20,000 - Implementation of international communication standards: already over 75 percent implemented (see Recommendation 16 developments). ### Table 9 — Recommended Action Plan (selected recommended actions) - Settlement risk (Recommendation 9) - Iberclear should improve risk controls by prohibiting debit balances in a participant’s securities account in the SCLV platform (to balance credits in other participants’ accounts). - Operational risk (Recommendation 11) - Iberclear should test its backup facility with its members more frequently. Its backup facility is 20 km from the main site and appears to rely on many of the same resources, which represents a risk. The actual independence of critical services, such as telecommunications facilities, should also be evaluated. - Other issues (Recommendation 15) - Iberclear should implement an effective process to obtain the views of its participants on the efficiency and costs of its services and operations, or it should regularly survey its participants on these matters. - Other issues (Recommendation 16) - Iberclear should implement international communication standards for all participant communications. - Other issues (Recommendation 18) - CNMV should review the participation of its personnel on the Iberclear Board and clarify the scope and transparency of CNMV and BE oversight roles given the dynamic environment described. ### Authorities’ response to the assessment — selected points - Authorities concur with evaluation and provide comments on recommendations. - Recommendation 9 - Rules prohibit participants from having debit balances and no participant has ever had a net overdraft. - Temporary short positions held by private customers should not be confused with prohibited debit balances on participant accounts. - Iberclear Strategic Plan includes a T+3 repurchase mechanism, anticipated for the second quarter of 2006, which will totally eliminate temporary short customer positions. - Recommendation 15 - Composition of the TAC and its regular meetings guarantee direct participants have detailed information on Iberclear activities and projects. - Iberclear is increasing dissemination activity to customers beyond existing customer care procedures (phone and mailbox on website). - Recommendation 16 - Developments since IMF FSAP mission: “Unified Matching System” (SUC)—Transfers (03/07/05) and SUC—Loans (November 21, 2005) using SWIFT with ISO standard 15022 are on stream. - SUC—Fixed Income project (structured in three stages; first published February 8, 2006) scheduled to take effect over the first semester of 2006. - Requirement for using international communication standards is already over 75 percent implemented. - Recommendation 18 - Developments: On September 22, 2005 CNMV Executive Committee approved work plan for on-site supervision mission to Iberclear, which began on October 19, 2005, with collaboration of Banco de España, to verify compliance with assigned functions including supervisory functions. ### Summary assessment of observance of the Code of Good Practices on Transparency in Monetary and Financial Policies — Banking Supervision (intro and main findings) - Assessment covers primarily the Bank of Spain (BE); other agencies (Ministry of Economy and Finance—ME—and the Autonomous Communities—ACs) examined focusing on transparency in institutional framework. - Spain follows high standards of transparency in banking supervisory policies; BE initiatives over past five years have led to observance of almost all practices of the Code of Good Practices on Transparency in Financial Policies. - Room for further refinement exists with regard to clarity of objectives and public communication (improvements at the margin). - Clarity of roles, responsibilities, and objectives - Legal and institutional framework defined in several legal texts at national and regional levels. - Law clearly articulates responsibilities of BE and ME; ACs’ role in supervision of savings banks defined under each Community’s statute. - Some scope to enhance transparency for savings bank oversight due to overlapping national and regional legal frameworks creating potential uncertainty. - Open process for formulating and reporting policies - High degree of openness in formulating and reporting banking regulation and supervision policies. - BE publicly announces and explains significant changes via Annual Report, web site, information notes, monthly publications and press releases. - Presumption in favor of public consultations for substantive technical changes; legal framework requires public debate and consultations. - Scope for strengthening transparency in relationships between BE and other financial agencies: bilateral memoranda of understanding on information sharing and consultation between BE, CNMV, and DGSFP exist but only their existence (not content) made public. - Public availability of information - BE maintains comprehensive public information program: disseminates policy decisions, provides operating-framework information and functions, publishes major speeches, data, and research, arranges seminars, maintains media contact. - BE website available in Spanish and English; English version could be updated more regularly. - General information on supervisory policies would be more accessible if posted on the banking supervision section of the website. *Source: Assessment chapter from the IMF Financial Sector Assessment Program documentation (Iberclear / Spain), as provided in the content unit.* ### 194. Transparent mechanisms for accountability and assurances of integrity of the ### _cr06212 - 194. Transparent mechanisms for accountability and assurances of integrity of the ### Banking Supervision — Main findings and accountability - Paragraph 194: Transparent mechanisms for accountability and assurances of integrity of the BE have been put in place. - Mechanisms include regular appearances before Parliament and parliamentary committees; attendance as required of cabinet meetings and meetings of the Council of Fiscal and Financial Policy of the Autonomous Communities (Consejo de Política Fiscal y Financiera de las Comunidades Autónomas); and regular reporting through the Annual Report. - Internal governance procedures necessary to ensure the integrity of operations, including internal audit arrangements, as well information about legal protections for officials and staff of financial agencies in the conduct of their official duties, are publicly disclosed through the Annual Report and the website. - The BE has a Code of Conduct, which should be made publicly available to ensure transparency. - Table 10 — Selected recommended actions (MFP Transparency Code — Banking Supervision) - V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies - 5.1.1: Disclosure of the objectives of the BE with regard to banking supervision could be more easily accessible. - 5.2: While cooperation between the BE and the ACs appears to be effective, it is advisable to minimize those circumstances where overlapping national and regional legal frameworks may create uncertainty on the respective authority of the BE and the ACs. - VI. Open Process for Formulating and Reporting of Financial Policies - 6.1: Transparency would be enhanced if legislation and regulation relating to ACs were more easily accessible. - 6.1.5: The content of MoUs should be made public, not only the year they were signed. - VII. Public Availability of Information on Financial Policies - 7.4: General information on banking supervision could be more easily accessible. The English-language website for banking supervision should be updated regularly. - VIII. Accountability and Assurance of Integrity by Financial Agencies - 8.4: Public disclosure of the Code of Conduct would strengthen transparency. - Authorities’ response (Paragraph 195) - Authorities are in broad agreement with the assessment. - Regarding cooperation with the ACs (point 5.2), authorities note that State and ACs have regulatory, supervisory and sanctioning powers within their corresponding areas, and no overlapping arises between the national and the regional legal framework. - Each AC operates under its own legal framework; laws clearly articulate the responsibilities of the BE and ME with respect to supervision of solvency, performance, and compliance with specific regulations governing credit institutions. --- ### Securities Markets Supervision — CNMV transparency assessment - Paragraph 196: Assessment covers the National Securities Market Commission (Comisión Nacional del Mercado de Valores—CNMV). - Main findings (Paragraph 197) - The transparency of the CNMV compares well with international standards. - CNMV publishes an Annual Report on the Securities Markets and a separate Annual Report on supervision activities. - There remains some scope for enhancing its public communications program. - Clarity of roles, responsibilities, and objectives (Paragraph 198) - Roles, responsibilities, and objectives of the CNMV are clearly defined in the Securities Market Law. - Law outlines modalities of accountability; procedures for appointment, terms of office, criteria for removal of governing bodies; and framework for relationship with other financial agencies. - Open process for formulating and reporting policies (Paragraph 199) - High degree of openness: CNMV announces and explains significant changes via Annual Report, website, press releases. - Annual Report on Activities discusses functions, activities, procedures, and includes an internal audit report. - For proposed substantive technical changes, there is a presumption in favor of public consultations. - Transparency could be enhanced regarding procedures for information sharing and consultation with other Spanish financial agencies: formal agreements exist but their text has not been released. - Public availability of information (Paragraph 200) - CNMV maintains an active public information program: website in Spanish and English, Annual Reports, market studies, statistics, weekly bulletin, seminars/conferences, press relations, Investor Complaints Service, investor education. - CNMV officials explain objectives and performance in speeches, but there is no presumption in favor of releasing statement texts publicly. - Accountability and assurances of integrity (Paragraph 201) - Transparent mechanisms exist: law requires CNMV to present a report to the Parliamentary Committee on Economics, Trade and Finance; CNMV President to appear before such a committee. - Internal governance procedures, internal audit arrangements, and information about legal protections for officials and staff are publicly disclosed through the annual report and the website. - Table 11 — Selected recommended actions (MFP Transparency Code — Securities Market Supervision) - VI. Open Process for Formulating and Reporting of Financial Policies - 6.1.5: Existing MoUs with other national regulators should be made public. - VII. Public Availability of Information on Financial Policies - 7.4.2: There should be a presumption in favor of releasing the text of senior officials’ statements to the public. The speeches before parliament should be posted on the website. - Authorities’ response (Paragraphs 202–203) - Authorities broadly agree and have taken measures: - (6.1.3) Documents providing interpretation of CNMV rules have been posted on the website (Criterios en el Ambito de la Autorización y Registro de los Fondos de Inversión and Criterios sobre la Aplicación de la Nueva Normativa de Mercados Primarios). - (6.3) A new section of CNMV’s website (comunicaciones) is being set up to contain speeches and statements of CNMV’s senior officials. - Authorities are considering publishing texts of existing MoUs with other national authorities (6.1.5), CNMV’s internal procedures (6.1.1), and the notes to the financial statements (8.2.1). --- ### Deposit Insurance — Transparency assessment (FGDs and AIE) - Paragraph 204: Assessment covers Spain’s three Deposit Insurance Funds (Fondos de Garantia de Depósitos—FGDs) and the FGD Management Company (AIE) established in 2000. - Main findings (Paragraph 205) - Deposit insurance policies are broadly consistent with good transparency practices. - Annual reports issued for each of the three funds and the Management Company. - Transparency would benefit from a more proactive approach to public information, notably regarding accountability and assurances of integrity. - Clarity of roles, responsibilities, and objectives (Paragraph 206) - Roles, responsibilities and objectives are clearly defined in law and described in annual reports and website. - Law outlines modalities of accountability; procedures for appointment, terms of office, criteria for removal of governing bodies; and framework for relationship between financial agencies. - Open process for formulating and reporting policies (Paragraph 207) - FGD policies, annual contributions, and bank resolution policies/procedures are publicly available and well explained. - System for protection of deposits disclosed in laws/regulations and on FGD’s website. - Formal procedures for information sharing and consultation with other financial agencies are available on the website. - Public availability of information (Paragraph 208) - Extensive information through website and annual reports, including financial statements, updates on bank restructuring activities, payoffs, and statistical data. - FGD website available in English and Spanish. - Office responds via e-mail, fax or telephone to public questions related to FGD mandate. - Senior officials have authority to explain policies publicly, but have not done so in practice except via the website. - Accountability and assurances of integrity (Paragraphs 209–210) - A formal policy on public communications by senior FGD officials, including appearances before parliament, would enhance transparency. - No specific rule requires appearance of FGD officials before designated public authorities to report on funds’ activities and performance. - More transparent accountability rules would be especially relevant in event of bank restructuring actions by the FGD. - Internal governance information could be enhanced: - Given reduced administrative unit size, funds do not have an internal audit. - Internal governance procedures are not made public; information on standards of conduct of personal financial affairs is not publicly disclosed by means other than legislation. - Better information important due to potential conflicts of interest of financial institutions’ representatives in FGD management committees. - Table 12 — Selected recommended actions (MFP Transparency Code — Deposit Insurance) - VII. Public Availability of Information on Financial Policies - 7.4.2: The FGD should develop a formal policy on public communications by senior FGD officials and on the release of the texts of public statements. - VIII. Accountability and Assurance of Integrity by Financial Agencies - 8.1: A stated policy regarding the appearance of FGD officials before a designated public authority (e.g., parliament or a parliamentary committee) would enhance accountability. Such an arrangement would be especially relevant in case of FGD bank restructuring actions. - 8.2.2: The FGD should publish information on its internal governance procedures. - 8.4: Information (other than legislation) on standards of conduct of personal financial affairs should be disclosed to the general public. - Authorities’ response (Paragraphs 211–213) - Authorities broadly agree but note: - On principle 7.4.2, they do not see a need to be more proactive because by law banks are obliged to provide information; cost of additional public information would be high relative to benefits, and could weaken public confidence. - On principle 8.1, the President of the FGD Management Company is the BE Deputy Governor; BE has sufficient information and four of eight Management Committee members are BE representatives, with the President having a deciding vote. - On public disclosure of internal control regulations (8.2.2), authorities view composition of governing bodies as ensuring transparency and control. --- ### Payment Systems Supervision — BE oversight transparency - Paragraph 214: Assessment relates to BE policies for payment systems oversight, including pan-European systems (TARGET, Clearnet, Euroclear) and domestic systems (SLBE for large-value payments, SNCE for low-value payments). - Main findings (Paragraph 215) - The BE adheres to almost all transparency practices with regard to payment systems oversight. - Several initiatives in the last five years to enhance transparency (e.g., occasional payment system articles in the biannual Financial Stability Review and an informative payment systems section on the website). - Some room for further refinement in public communication. - Clarity of roles, responsibilities, and objectives (Paragraph 216) - Objectives, functions, responsibilities, and authority are detailed in law. - Objective to promote smooth functioning of the payment system through efficiency and security is recognized in national and regional legislation. - Law outlines modalities of accountability; procedures for appointment, terms of office, criteria for removal, and framework for relationships between financial agencies. - Open process for formulating and reporting policies (Paragraph 217) - High degree of openness: BE announces and explains significant changes via Annual Report, website, information notes, monthly publications, press releases. - For substantive regulatory changes, presumption in favor of public consultations; legislative framework requires public debate and consultations with affected sectors. - Payment system decisions discussed with involved financial entities (about 20 member banks and the three associations) in a high level payment systems group, chaired by the BE Director General, meeting regularly (twice a year) for about three years. - Public availability of information (Paragraph 218) - BE maintains a comprehensive public information program: policy decisions, operating framework, texts of major speeches by senior officials, data, research reports, seminars, media contact. - Reporting on major payment systems developments is not on a regular basis. - Senior officials are ready to explain objectives and performance to the public, and have a presumption in favor of releasing text of their statements. - Accountability and assurances of integrity (Paragraphs 219–219 continuation and 220) - Paragraph 219: Transparent mechanisms for accountability and assurances of integrity of the BE have been put in place. - Includes regular appearances before Parliament and parliamentary committees; attendance as required of cabinet meetings and meetings of the Consejo de Política Fiscal y Financiera de las Comunidades Autónomas. - There is no periodic reporting on payment systems oversight, since the Annual Report describes operation of payment systems but not oversight activities. - Internal governance procedures, internal audit arrangements, and legal protections for officials and staff are publicly disclosed through the Annual Report and the website. - The BE has a Code of Conduct, which should be made publicly available to ensure transparency. - Table 13 — Selected recommended action (MFP Transparency Code — Payment System Supervision) - VI. Open Process for Formulating and Reporting of Financial Policies - 6.1.5: The content of the MoUs with other financial agencies should be made public. *Source: _cr06212 - 194. Transparent mechanisms for accountability and assurances of integrity of the (extracted content).* ### 6.3 Financial agencies should issue periodic public reports on how ### _cr06212 - 6.3 Financial agencies should issue periodic public reports on how ### VII. Public Availability of Information on Financial Policies - Financial agencies should issue a periodic public report on the major developments of the sector(s) of the financial system for which they carry designated responsibility. - The BE should issue a periodic report on payment systems. - Financial agencies should have a publications program, including a periodic public report on their principal activities issued at least annually. - Payment system oversight activities should be covered in a periodic report as well as be mentioned in BE’s Management Report. ### VIII. Accountability and Assurance of Integrity by Financial Agencies - Standards for the conduct of personal financial affairs of officials and staff of financial agencies and rules to prevent exploitation of conflicts of interest, including any general fiduciary obligation, should be publicly disclosed. - Public disclosure of the internal Code of Conduct would strengthen transparency. ### Authorities’ response to the assessment - The authorities are in broad agreement with the assessment. - Appropriate measures are being implemented to tackle the recommended action plan. ### Loan-loss provisioning (Spain) - Spain has been pioneering the use of dynamic provisions since 2000, with modifications after the adoption of IFRS in 2005. - Dynamic provisioning is a prudential tool to address the credit risk that builds up during credit boom periods, helping smooth loan-loss provisioning over the economic cycle and to enhance financial stability. - Dynamic provisioning recognizes that credit losses can be properly accounted and provisioned in a statistical sense as soon as the risk (or the incurred loss) appears in the balance sheet. - Under the Spanish provisioning system, banks are required to register two types of loan-loss provisions: the generic, g, and the specific, s, whose effects can be proxied by the following formulas: - g = LLs α β = ∆ + − - Ps = ∆ = γ - where L is the total value of the loan portfolio, ∆L is the change in total loans, and ∆P is the change in problem loans. - The vectors of the provisioning parameters α, β, and γ, are set by the Bank of Spain based on historical information on loan impairment and losses-given-default for specific loan categories (i.e., homogeneous groups of risks), albeit credit institutions are allowed to use their own estimates, subject to approval. - Generic provisions accumulate in a generic fund G, which is required to remain within the following limits: - 0.33αL ≤ G ≤ 1.25αL. - In a given quarter, total required provisions, p, are the sum of the generic and the specific provisions: - p = g + s = L α β = ∆ + + - The term α∆L is common in traditional provisioning rules. The novelty of Spain’s dynamic provisioning system is the addition of the second term (βL), which captures the latent risk of the loan portfolio and fluctuates with the business cycle. - During the economic upturn, the latent risk tends to exceed the specific provision(s), causing an increase in the generic fund. A positive generic provision is considered a cost for the bank, and registered against income on a quarterly basis. During an economic downturn, the generic provision is negative and is registered as bank revenue (as long as it has a positive balance). - The more recent provisioning system is similar to the system associated with the initial regulation implemented in 2000, except for changes in the provisioning parameters (which are generally stricter under the new regulation) and the limits to the generic fund (which are lower under the new regime). - The effects of the new regulation on provisioning levels of individual credit institutions will depend on the specific characteristics of their loan portfolios. On impact, however, the new regulation is expected to release provisions for the system as a whole, as a result of the combined effects of the reduction in the cap on the generic fund, and the large amount of provisions accumulated in the system. ### Stress tests for credit institutions and the insurance sector — Credit institutions - In coordination with the FSAP team, the BE and a group of systemically important credit institutions carried out several stress test exercises. - The stress tests were designed to assess the resilience of the banking system to key risk factors, and covered market risks, interest rate risk, credit risk, and liquidity risk. - Techniques used included sensitivity analysis to single and combined risk factors, and scenario analysis. - The scenario analysis considered four adverse cases: - (a) an increase in oil prices to US$80 per barrel; - (b) a two-year cumulative drop in real house prices in Spain and the United Kingdom, by 21 and 28 percent, respectively; - (c) a 30-percent depreciation of the U.S. dollar against other currencies; - (d) a crisis in Latin America, which entailed a political crisis in a key country, transmitted to other countries in the region via turmoil in capital markets and international contagion. - Cross-sector risks were assessed through parallel stress tests on a sample of insurance companies, and the results added to those of their related credit institutions. - Core stress tests (bottom-up) were conducted by a sample of systemically important credit institutions using their own internal models while applying the same methods and shocks. - The sample covered the seven largest financial groups, comprising 37 institutions and roughly two-thirds of system assets. - Complementary stress tests (top-down) were conducted by the authorities and the FSAP team for credit institutions as a group; these exercises covered credit risk, liquidity risk, and equity-price risk in the banking book, with emphasis on exposures to the domestic housing market. - Equity price risk from industrial participations held in not-for-sale portfolios: - A sample of 19 credit institutions representing roughly 80 percent of system assets indicated that a 30-percent decline of equity prices would generate losses equivalent to 8.6 percent of regulatory capital (14.3 percent for the sampled savings banks). - Six banks and four savings banks jointly accounting for 37 percent of assets in the sampled institutions would incur a net loss, even after unrealized gains, with an average impact of 5.4 percent of regulatory capital (13.3 percent in the worst case). - Credit risk: - Sensitivity analysis based on an increase of the probabilities of default (PDs) of mortgage and commercial loans by 200 and 100 percent, respectively, from their end-2004 levels indicated that all of the systemically important credit institutions would be able to absorb the losses without falling below the required minimum 8 percent Basel CAR. - A more severe scenario of sustained deterioration in credit quality during a three-year window (using PDs set to their average values during 1992-2004 plus two standard deviations, and stressed LGDs) resulted in average losses equivalent to 13 percent of Basel regulatory capital. - Such a shock would result in a decline in the average CAR of a sample of the larger CIs from 12.7 percent at end-2004 to 11.0 percent. - Four credit institutions representing 5 percent of system assets would see their CARs drop to around 7 percent. - Scenario estimates: - A drop in house prices in Spain was estimated to produce average losses equivalent to 11 percent of CAR with a maximum of 27.4 percent. - Losses associated with an oil price increase would average less than 7 percent of regulatory capital. - Losses associated with a depreciation of the U.S. dollar would be 5 percent of regulatory capital. - Losses estimated for a crisis in Latin America were less than 1 percent of regulatory capital. - Liquidity risk: - An exercise indicated that all maturing liabilities within a month plus 20 percent of demand deposits can be covered by projected sources of funds and available fixed income securities, while variable income securities provide an additional cushion. - A Bank of Spain-designed exercise indicated systemically important credit institutions have contingency liquidity plans that would allow them to cope with a withdrawal of 39 percent of their maturing time deposits and 10 percent of their demand deposits within a month, without cutting back normal operations, even if they were to lose access to the interbank market. - For some institutions, contingency plans relied heavily on issuance of covered bonds, a strategy that could entail risks should market sentiment or liquidity conditions deteriorate on a more systemic basis. - Market risks: - Market risks for the systemically important credit institutions were negligible, reflecting the small size of their trading portfolios (on average, trading portfolios amounted to about 6 percent of their assets). - Most credit institutions have hedged their interest rate and exchange rate risk. - Interest rate risk in the entire positions of systemically important credit institutions was also found to be small, reflecting the predominance of loans at floating rates. *Source: _cr06212 - 6.3 Financial agencies should issue periodic public reports on how* ### 233. Stress tests within the insurance sector, conducted by 27 insurers, covering ### Stress tests within the insurance sector (27 insurers; coverage and resilience) ### Coverage and overall conclusion - Stress tests were conducted by 27 insurers, covering 50 percent of the non-life market and 62 percent of the life market. - The system "is resilient to a wide range of shocks." - The stress-testing framework followed an approach similar to the Preparatory Field Study (PFS) proposed by the Committee of European Insurance Supervisors (CEIOPS) in preparation of “Solvency II.” ### Fair-value revaluation prior to stress tests - A fair value estimation of assets and liabilities, performed prior to the stress tests, resulted in an increase of 82 percent in net assets for the whole industry. - Individual institutions experienced net-asset changes in the range of a 360-percent increase to an 8-percent increase. - The revaluation of real estate assets had the largest impact on the increase of net assets. ### First set of stress tests — market and cross-sector shocks (comparable to shocks applied to credit institutions) - For the sector as a whole: - A fall in real estate prices of 17 percent would reduce insurers’ capital (i.e., shareholders’ equity) by 5.6 percent. - For life insurers: - A downward parallel shift of the yield curve by 200 basis points would reduce capital by 25 percent. - For non-life insurers: - A parallel shift upward of 200 basis points in the yield curve would reduce capital by 10 percent (a large share of assets is in fixed-income securities, such as treasury bonds). - For mixed insurance companies: - The real estate shock would have the greatest impact on capital. ### Second set of stress tests — insurance-specific risk factors - For the sector as a whole: - Underwriting risk (a 15-percent shock to mortality or survival rates) would produce the largest impact on capital: a decrease of 4 percent. - For life insurers: - An increase of 15 percent in the mortality rates would reduce capital by 18 percent. - For non-life insurers: - A 10-percent increase in the average claim in the case of "mass events" would reduce capital by 7.3 percent. - Note: “Mass events” refer to those risks that are high-frequency but entail small claims. - For mixed insurance companies: - An increase in the average claim for peak events would reduce capital by 1.3 percent. ### Presentation of results and units - Results are presented in percent of insurer's capital (a positive number indicates a reduction in capital). - Group definitions used in the stress-testing taxonomy: - Group 1 refers to those claims related to "mass events" (i.e., high frequency but low claims). - Group 2 (“mass events”) refers to those risks related to claims under €30,000. Group 2 corresponds to marine, aviation and transport; fire; third party motor liability; third party liability; credit; surety; and industrial multi-risks (Group 1 risks are all the nonlife risks not included under Group 2). - Group 2 (“peak events”) refers to those risks related to claims equal to or above €30,000. *Source: IMF staff report content (Spain stress tests and insurance sector results).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06212.pdf_