Few narratives are more rousing than a classic underdog story. A protagonist that confounds expectations by overcoming seemingly insurmountable obstacles never ceases to amaze us. The Spanish banking industry has become an archetype of just this sort of success story. Since the financial crisis, there has been a remarkable revitalisation of Spain’s banks, culminating in the emergence of Banco Santander as the Eurozone’s largest bank by market capitalisation. This unexpected twist is an example of what happens when a national government works with EU institutions to craft effective policies in an effort to shore up its banking sector.
The History of the Spanish Banking Crisis
Spain’s modern banking crisis has its roots in 2007 when housing prices began to fall. In the two decades leading up to the Great Recession, Spanish housing prices rose by approximately 200%. In order to finance this expansion, real estate developers took out significant loans from Spain’s savings banks, known as “cajas” in Spanish. Once the housing bubble popped, these debtors were unable to pay back their loans and several cajas became insolvent.
In August 2012, these damaging non-performing loans (NPLs) made to the corporate and household sector reach 16.8% and 3.8% respectively, a historic high for Spanish banks. Consequently, the Spanish government negotiated a €100 billion reform package with the European Stability Mechanism (ESM), an EU funding programme, to help recapitalise and consolidate the country’s banking industry.
Spain’s Executive Resolution Authority (FROB) worked in tandem with the ESM to help contain the banking crisis. Established in 2009, the FROB supervised the mergers of 25 troubled cajas into 7 new financial entities, which received financial assistance through the ESM package. The FROB also enabled the sale of troubled banks by providing them with much needed liquidity, guaranteeing their assets, and offering buyers protection against potential liabilities.
The Implementation of Bad Banks
In order to get the bad debt off bank’s balance sheets, the FROB invested €2.1 billion into SAREB, a Spanish acronym that translates into Company for the Management of Assets proceeding from Restructuring of the Banking System. SAREB is a public-private initiative known as a “bad bank”, which enabled ailing Spanish banks to separate their good assets from the NPLs, placing the latter under the management of SAREB. This initiative made it possible for banks to attract investors and raise capital through the sale of bonds, keeping them afloat and functioning.
SAREB absorbed more than €106 billion worth of troubled assets at a 52% discount, giving Spain’s banks some much needed breathing room. The special value of a “bad bank” is that its structure allows for specialised management of bad debts. Functioning similarly to an asset management firm, SAREB repaid between 20-22% of deleveraged and senior debt while also earning €17 billion in revenue.
While this was a great start to tackling the country’s debt issues, one of the key challenges going forward will be to ensure SAREB’s positive cash flow. SAREB still needs to dispose of €40 billion worth of assets. It is expected that this sale will generate around €52 billion, of which nearly €42 billion will be used to repay senior bond holders. If SAREB is unable to repay this debt, the government guarantee will kick in, an outcome which policy makers are keen to avoid.
Another residual concern relates to the profitability of the Spanish banking sector. Currently, profitability is below the cost of capital faced by Spanish banks. This can be attributed to several factors including low interest rates, reduced banking activity, legal costs, and those NPLs that remain on banks’ balance sheets. Improving the profitability of Spanish banks will be essential if the sector is to be financially viable in the medium to long term.
Placing these reservations aside, there are good reasons to remain optimistic about the ongoing recovery of Spain’s banking sector. Last June, regulators successfully intervened to facilitate the sale of Banco Popular to Santander. This timely action contained any potential contagion and avoided a state bailout. Preparations are also underway for the merger of Bankia, which was partially nationalised in 2012, with Banco Mare Nostrum. Bankia has stated that this merger will save €155 million and open up new business opportunities for the bank. Importantly, the merger also means that tax payers will be reimbursed for the bank’s bailout.
The Spanish Banking Sector Revitalised
Key indicators also suggest that the industry is once again on stable footing. According to a November 2017 report published by Spain’s central bank, the Spanish banking industry currently exceeds the minimum amount of capital required by regulators. Also, as of March 2017, the NPL ratio for Spanish household debt was comparable to the European average, while the NPL rate for loans to non-financial corporations was only slightly above the European average.
Spain’s banking sector has come back from the brink of collapse to become a model for how to manage a banking crisis. The strategic intervention of the government through FROB and SAREB meant that core banks were not substantially affected and that vulnerable financial institutions were recapitalised and restructured. This successful revitalisation process has been coined the “Spanish way” to solving similar economic issues in Europe. In fact, SAREB is currently being considered as a blueprint for future EU initiatives. The surprising revival of Spain’s banking sector is added proof that observers shouldn’t underestimate the resiliency of Southern Europe.