13/11/2014
The good news is that the publication of the comprehensive assessment results conducted by the European Central Bank and the European Banking Authority over the last year certifies the successful completion of the restructuring process of the Spanish banking system. An ambitious and complex exercise that has lasted for a year involving more than 6,000 professionals to audit the value of assets (Asset Quality Review, AQR) and measure the resilience of balances (stress tests) of 130 European entities before hypothetical adverse scenarios up to 2016.
In the first chapter, concerning the AQR, Spanish banks registered the lowest impact of all European banks in terms of valuation adjustment needs, as the auditor considered that the portfolio value only needs to be corrected by 0.14% of the aggregate base of the substantial capital for the whole system. Procedures for the valuation, classification and provisioning of assets on the balance sheets of Spanish banks are thus validated and, more importantly for practical purposes, it is publicly certified that 'what is shown is what there really is,' central argument for the restoration of confidence in the system.
The second pillar of the test, the stress tests, simulate the hypothetical deterioration of the capital base of banks before an adverse situation defined by a cumulative contraction of GDP of almost 6 points between 2014 and 2016. In this extreme scenario, the entire banking system would record an erosion of their capital base of 1.44 points, placing Spanish banking second of the sample for highest absorption capacity of the recessive shock. For practical purposes, the result indicates that even reaching this limit no further recapitalizations would be needed and therefore the bank would hold out with the capital base it currently has.
The sum of both effects yield an aggregate deterioration of the substantive capital base of 1.6 points for the whole system until reaching 9.0%, with still enough margin above 5.5% of the regulatory capital required for that scenario, the threshold below which additional recapitalisations would be required. It is also true that this success has to be placed in the context of the smaller capital base of the Spanish system, which means that, despite the good grade of the exercises, the Spanish group finished in a not-as-prominent tenth place in the list of solvency of countries. A more modest position, but still well within the limits of regulatory compliance.
However, are these good results, by themselves, a sufficient condition to anticipate a restoration of credit supply in the medium term? The supervisor has made a declared effort in this exam to set some credible standards of review that would not impose additional restrictions to credit supply. While it is true that, in this case, consensus seems to support the employed procedures and rigour –we must remember that it is the fourth exercise following those held in 2009, 2010 and 2011,– other ingredients will be necessary before credit normalises again.
This last point is important, because we should start by understanding what we mean when we talk about the normalisation of credit supply. The great recession and the deployment of the necessary measures to overcome it in the banking sector have left a very different scenario compared to the one with which we started. In the first place, we have a new regulation, Basel II and III, which limits and conditions certain activities of banks, and sets more stringent scales for determining risk and solvency, and ultimately gears economies towards the path of deleveraging and thus to a reduction of risk and of the aggregate amount of credit in the system. This alone not only anticipates changes in the structure of supply, but also a more moderate growth of balances. And it also determines the profitability of entities which, in response, will have to apply more stringent awarding criteria if they are to have lower margins and revenue streams to absorb expected losses in the future.
Moreover, specifically in the Spanish case, the enormous consolidation effort of the sector leaves us with just fifteen banking groups compared to the nearly fifty of 2008.Evidence shows that bank concentration processes are usually solved with a decrease of credit supply and more expensive credit conditions. There are no grounds for holding that this will be solved in a different way in Spain. Indeed, it can be argued that it was precisely the excess in capability of our banking system that gave rise to an excessive and poorly calibrated credit supply in terms of risk, as it was later demonstrated. It is precisely by reducing capacity that a more selective supply could be achieved, capable of weighing necessary risks properly and of rewarding resources adequately.
On top of this we must add the burden of the financial legacy of the crisis, which has caused a default in the balance sheets of the system of 13.2% of risk-weighted assets. A huge figure which, even though it must be said that a substantial part is already provisioned, it will have to be absorbed by future benefits which, as we say, are not going to take off in the medium term. Therefore, a part of the balance sheet problem, already solved by the recapitalisation and consolidation measures, is thus allocated to the income statement, as the generation of future results must materialise to finish absorbing the losses of the past. The difficulties to generate profits will make capital supporting new credit, despite its current abundance, something scarce for the next few years and should be monitored carefully.
We frequently hear institutions emphasise their willingness to lend to solvent credit. Although it is always difficult to tell whether the credit crunch comes from the supply or demand side, the nuance here is important: when solvency is stressed, the demand problem starts to become a problem of supply. This is hardly surprising given the logic of the limiting factors to which we have referred. Be that as it may, and despite the signals sent by the banks to the markets in the last year, the fact is that even in 2014 the granting of credit to the private sector will be reduced by around 5% until reaching a figure of around 350,000 million euros compared to 900,000 in 2007, and which will grow very modestly in 2015. A brutal contraction that leads us to believe that the normalisation of credit will not be anything like it was before the crisis, either in terms of size of balance sheets, or criteria for granting new credit operations.
Normalisation will therefore be something different. Maybe we're talking about that which was already perceived at the beginning of the great recession as the final destination of economies, and what has come to be called the 'new normal,' a dull landscape featuring very moderate and prolonged growths in non-recession contexts but frequently on the verge of them. In this new normality, the credit environment would look like a containment of overgrowth, much distanced from exuberance, and a supply much restricted and conditioned by recent memory, by capability reduction and by a regulation that seeks to align itself with the macro-prudential bias in economic policies implemented in the post-crisis context.
Ultimately, the stabilisation of the banking system will move from the rationing phase to a period of credit normalisation, but such normalisation will be featured by limited volumes of supply and by strict concession terms. It is, therefore, unlikely that credit will reveal itself as a driving factor of economy or of consumer sentiment in the medium term. Perhaps the feel good factor will continue coming from household deleveraging, which have seen their financial wealth grow by 30% over the last year – mostly as a result of the amortisation of loans – rather than from houses, cars or trips funded by credit.