Young job seeker is interviewed at a job fair in Barcelona. Spain's youth unemployment remains among the highest in the European Union. (Photo: Gustau Nacarino/Reuters/Newscom)

Young job seeker is interviewed at a job fair in Barcelona. Spain's youth unemployment remains among the highest in the European Union. (Photo: Gustau Nacarino/Reuters/Newscom)

IMF Survey : Spain Moving Ahead with Financial Sector Reforms

February 20, 2014

  • Sector shows major improvements over course of reform program
  • Equity prices strengthen, risk premiums fall
  • Continued efforts needed to enhance banks’ ability to lend

A new report released by the IMF says Spain’s efforts to reform its financial sector have substantially reduced the likelihood of threats spreading from banks to the rest of the economy.

Plaza De La Cibeles, Madrid, Spain. Over the last 18 months, banks increased their provisions for losses on loans by some 80 percent (Photo: Andrea Comas/REUTERS/Newscom)

Plaza De La Cibeles, Madrid, Spain. Over the last 18 months, banks increased their provisions for losses on loans by some 80 percent (Photo: Andrea Comas/REUTERS/Newscom)

Spain’s Financial Sector

In July 2012, Spain began a major program of financial sector reform. Financial assistance was initially provided by the European Financial Stability Facility to support restructuring and recapitalization of Spanish banks and other financial institutions. Later, responsibility for providing financial support shifted to the European Stability Mechanism.

The IMF monitored the progress of Spain’s 18-month financial sector reform program via quarterly reports. This is the fifth and final report.

The 2012 assessment of Spain’s financial system set the stage for the reform program. That assessment concluded that while there was a core of strong banks that are well managed and appeared resilient to further shocks, vulnerabilities remained and a comprehensive strategy was necessary to address them.

Speaking to IMF Survey, Ceyla Pazarbasioglu, who led the Financial Sector Assessment Program (FSAP), and Kevin Fletcher, who headed the IMF team that prepared the latest monitoring report, discussed some of the conclusions of the report, including the most pressing issues facing Spain’s financial sector and the policy actions needed to further strengthen it.

IMF Survey: Can you give the big picture of Spain’s financial sector program and the role the IMF had in it?

Pazarbasioglu: Back in October 2011, we went to Spain to conduct the FSAP. At that time, the situation was deteriorating fast. A domestic real estate boom-bust exposed substantial weaknesses in the savings bank sector, shortcomings in the policy and regulatory framework, and an over-reliance on wholesale funding. The country was witnessing a financial sector crisis unprecedented in its modern history.

The authorities had been taking steps to respond. They took the politically very difficult step of starting to reform the savings banks, raised minimum capital requirements, and required substantial provisioning for real estate-related assets. But the challenge was enormous and markets were rapidly losing confidence. In addition to the global financial crisis and the domestic real estate crisis, the country was also hit with the European sovereign debt crisis. We advised them as part of our FSAP to implement a comprehensive strategy—undertaking a thorough, independent valuation of banks; establishing a credible backstop; restructuring weak banks; and dealing with legacy assets—as well as an effective communication strategy to preserve financial stability and to lay the groundwork for recovery.

All of these measures were made part of their program supported by the European Stability Mechanism. We did not participate in the funding of the program but monitored the reform as requested by the European partners. And today we are publishing the fifth and final monitoring report.

IMF Survey: Have policies adopted at the European level played a role in helping to address weaknesses in Spain’s financial sector?  Going forward, what are the key issues?

Pazarbasioglu: It is remarkable how much financial market conditions improved during the program. As we note in the report, risk premiums on external borrowing by Spain’s banks and sovereign are down more than 75 percent and equity prices up more than 50 percent during the program period. We have seen similar trends in other stressed euro area financial markets.

These are the results of the package of crisis-fighting measures adopted in Europe during the last 18 months, including coordinated and prompt action to finance Spain’s financial-sector program. The ECB’s Outright Monetary Transactions framework has removed dangerous tail risks related to euro area breakup. Progress on banking union has demonstrated the commitment to improving the European Monetary Union architecture, but more needs to be done to ensure an effective framework of supervision, resolution, and safety nets.

Going forward, the Comprehensive Assessment conducted by the Single Supervisory Mechanism—if executed in a credible and robust manner—holds the key to resolving uncertainty about balance sheets, reducing funding costs, stimulating credit supply, and establishing the ECB’s credibility as supervisor.

IMF Survey: What are the main conclusions of the final monitoring report? Is Spain well prepared now for the challenges facing its financial sector?

Fletcher: In the report, we conclude that the authorities steadfastly implemented their program of financial sector reform, and these actions substantially strengthened Spain’s financial system and reduced threats emanating from it to the rest of the economy.

For example, between March 2012 and September 2013, banks increased their provisions for losses on loans by some 80 percent. Yet the ratio of banks’ capital (CT1) to their risk-weighted assets nonetheless rose by about 1½ percentage points. This is an enormous effort in terms of recognizing losses, cleaning up balance sheets, and bolstering buffers against adverse shocks. These efforts have in turn boosted confidence in the system, helping to reduce Spain’s external borrowing costs and create a foundation for sustainable recovery.

That said, Spain’s economy and financial system still face important challenges, and it will be essential to maintain the reform momentum in a variety of areas. In the financial sector, this includes continuing efforts to further enhance banks’ ability to lend and support economic recovery and job creation, including by further bolstering banks’ capital by maintaining limits on dividend pay-outs and by encouraging banks to issue more equity.

Such efforts will also help support banks’ balance sheets ahead of the Single Supervisory Mechanism’s comprehensive assessment, for which there are still some uncertainties regarding its methodology and stringency.

IMF Survey: This type of monitoring role was a first for the IMF. What are the key lessons from the experience?

Fletcher: Probably the key lesson is that the Fund needs to be flexible in how it provides its services to member countries. In this case, the Fund tailored its role to fit the requirements of Spain’s specific situation, with a good outcome. Other situations may require different modalities. The key is to be flexible so that we can contribute in the best way possible.