After 4 years, we are entering in a new recession. Started as a financial crisis in the USA subprime mortgage market, turned into a first economical recession in 2009, into a fiscal crisis because the increasing deficits and public debts, into a banking sector fall because the interaction between public debt and financial system, into a political crisis because has revealed the European governance weakness and all the political leaders are being wiped out by elections, and, finally, it’s turning into a social crisis: 200 million people around the world currently unemployed are calling for action to avoid the ‘lost decade’, specially for youth.
This crisis has all the elements to be a perfect storm: deep, globalized, complex. Indeed, we are in a vicious circle: weakness of economic growth, sovereign debt crisis and fragility of financial systems are feeding off each other.
In the short term, the most important challenges are to solve the sovereign debt and banking crisis and to restart growth. Crisis has been quite severe so far. But things are likely to get much worse. The latest forecasts of international institutes are quite depressive: recession again, poor economic activity, high unemployment with all its negative and social consequences.
Headlines of latest international reports say it clearly:
World Bank 2012: Uncertainties and Vulnerabilities
WEO (IMF): Global Recovery Stalls, Downside Risks Intensify
GFSR (IMF) Deeply into the Danger Zone
In fact, dark times are waiting for us. Bad time for poetry.
Spanish economy 1994-2007
In Spain, before the crisis broke, between 1994 and 2007, the Spanish economy experienced a strong economic expansion. We have lived a kind of miracle: fourteen years of growth and jobs. And this expansion was accompanied by high levels of investment (mainly residential), budgetary equilibrium (surplus in years 2005-06-07) and low levels of public debt (36% of GDP in 2007). Apparently, Spain was a model student in the EU.
However, during this period, the economy also accumulated great imbalances, especially the following two: housing (building and prices), and a very large current account deficit.
While public finances were under control, we allowed the rising external private debt until extremely high levels. In other words, we were living beyond our means with boom in real estate and in consumption, funded by foreign investors, until the bubble burst.
Economic and financial situation
At present, paradoxically, Spanish financial situation is not too bad, comparatively. Even though deficit in 2011 will be higher than expected, Spain has a lower debt to GDP ratio than not only Greece and Italy, but also France, Germany and the UK.
But Spanish economy has a very painful wound in its heart: the jobless rate has reached 22%, especially youth unemployment, almost 50%. The highest rate in EZ. Something extremely painful and absolutely unacceptable. This is the main problem with Spanish economy.
Not only we have this sad record in the euro zone but also during the ‘great recession’ Spain has suffered the highest employment losses in the OECD countries (from 8% to 22%) A lot of this jobs lost have come from building sector after the bubble burst.
However, unemployment is not only a heritage from the building sector crash. Spanish labour market is very disfunctional and is divided between insiders and outsiders, in other words, between old and younger people, with different labour conditions.
… true, but it’s not all the truth
Low level of public debt is true, but is not all the truth. Under the water of public finances, there are a lot of private debts.
Leveraged by external investors (that’s what the current account deficit means), Spain is the third country more endebted in the world, acording to the slide.
As foreign investment dried, when capital markets closed, Spain, like other southern countries (PIIGS), has started to suffer intensely, not only public sector, but private companies, families and financial institutions.
Someone could ask ¿where have all the flowers gone? ¿where are all these amounts of debts? Answering this question is not very easy. Obviously, Spain has made a quantum leap and now is a modern economy. But, also, there have been quite a few excesses: unsold houses, airports without flights, highways with no cars,….
Latest issues
And now, the present situation is determined by sovereign debt strains and contagion effects. Greece is out of market, Portugal is suffering a hard increase of its risk premia. Italy, Spain, Belgium, and even France, are under the markets turbulences.
The problem is: sovereign debt is inextricably linked with banking crisis. In fact, they are two sides of the same coin. Gobernments and private banks agravate each other’s financial stress.
The last issue has been the rating downgrade of nine euro countries by Standard & Poor’s. (NYT 16.01.12) France and Austria lost their AAA ratings, and Italy and Spain had their ratings cut by two notches. Germany, Finland, Luxembourg and the Netherlands all retained their AAA status, while the ratings of Portugal and Cyprus were cut to junk
But, like Murphy’s law says, things can get much worse . We are entering in a new recession and, as a consequence, the unemployment rate will go on growing this year. Experts are waiting to reach a rate near 25% jobless. Definitely, growth and jobs have to wait.
This scenario makes the case for structural reforms urgent, specially these three:
I. Fiscal adjustment
II. Labour market
III. Financial sector
The first priority is to reduce the deficit fulfilling the ongoing commitment to reach 3% GDP in 2013. But it won’t be easy. Circumstances have changed, a new recession is coming, and it’s going to be more difficult than it was thought.
The new government has launched a programme cutting expenses and increasing taxes. Furthermore, Parliament has approved a constitutional change limiting structural deficit and debt, following the agreement reached in the last European summit.
Last year several reforms have been introduced: reduction of public servants wages, no pensions rise, age of retirement extended, and so on. Nevertheless, final deficit will be higher than objective of 6% in 2011. The new government says it will be about 8%. The main deviation is located in the regional governments. As we saw before, Unemployment rate is extremely high (22.9% in comparative terms) mostly due to construction job losses.
With 5 million people unemployed, the first challenge of the Spanish economy is to reduce this rate. The coming labour market reform includes measures to increase flexibility and reduce segmentation; improve matching in the market; and enhancing human capital .
Spanish financial system
Let me tell you, in this second part, something about the process of reshaping Spanish financial system. But, before start talking about restructuring, i would like to highlight a relevant feature: financial sector is divided in banks and savings banks, more or less into halves, not only in resources recruited from household and companies but also in lending activity.
THE SAVINGS BANKS ARE FINANCIAL INSTITUTIONS CONSTITUTED LIKE PRIVATE FOUNDATIONS. THEIR BUSINESS ACTIVITY HAS TWO SIDES: FINANCIAL AND SOCIAL. The Obra Social is responsible for preventing financial exclusion and fostering economic development and social progress.
Savings banks Social works (Culture and Free Time, Social Welfare and Healthcare, Education, Historic Artistic and Natural Heritage, …) are particularly visible. If you walk on the streets of Bilbao or Bizkaia, you can see a lot of social works sponsorised by BBK. And, let me say, we are very proud of it.
BBK is a prominent case, but, fortunately, is not the only one. Through the Obra Social, Savings Banks have contributed extraordinarily to the social welfare network and financial inclusion all over Spain. Some figures out: over the past five years, the whole Social investment has reached more than 8000 million euros. During the latest 10 years, BBK has allocated 30% of its financial activity surplus back to the society, almost 1000 MM€
Good starting point
When the crisis broke, in 2007, the Spanish system had reached a very solid position in terms of financials (profitability, efficiency, solvency). Its business model is based in traditional retail banking, partly because the market share reached by Savings banks.
There are no toxic assets, no relevant exposure to sovereign debt of PIGS (southern countries of EU), in a word, there was no shadow banking system in Spain.
But, during good years, some weaknesses were accumulated by financial institutions, particularly by some savings banks. Specially, excessive credit growth related with real estate developers. But, I would like to underline that not all of the savings banks have made the same mistake. Some of them (not only BBK) are financially competitive, socially responsible and economically efficient.
At present, the diagnosis could be summarized as follows:
- Excessive exposure to real estate developers
- Overcapacity in the sector
- excesive number of relatively small institutions (45 savings banks)
- LLack of clear ownership
The main problem of Spanish financial system is its exposure to real estate risks. After bursting the bubble, there has already been a significant correction in house and land prices (and probably there will be still further corrections in the next months)
Excessive credit growth from last decade is now inside balance sheets of financial sector. Consequently, non performing loans ratio is growing rapidly, particularly in the real estate sector (almost 18%) and widespread mistrust among Spanish financial institutions
In this scenario (exposure to residential sector, overcapacity, fragmentation), in a very difficult market environment, with increasing uncertainties and risk aversion, reshaping the Spanish financial system is taking place.
The reform aims to restore the credibility of banking sector and to eliminate any doubts about its solvency cast by the prolonged effects of the crisis and the deterioration of real estate assets.
The final objective is to improve banking sector competitiveness. The main elements of the strategy are: increasing the capital requirements encouraging institutions to recapitalize in the market; FROB (public aid fund) is ready to intervene as a backstop, as a last resort.
Some milestones on the way towards the restrcturing:
1) In 2009 Gobernment launched FROB (public aid fund) to liquidate non viable entities and to support restructuring process of viable ones
2) In 2010: New corporate model for savings banks with 2 targets: transformation into commercial banks, and Improve governance and more professional management
3) Last year, a new law for recapitalization was published: raising solvency threshold required of institutions (core capital 8-10%) with two possibilities: private funds from market/private investors or the FROB acting as a backstop
In this process, Savings banks, as they were before, have disappeared. As a consequence of the new law, over 99% of the assets managed by savings banks have been transferred to commercial banks
We prefer to say Savings banks have changed their legal status but still they are keeping its foundations: financial competitiveness, social responsibility (profits are devoted to Obra Social works) and local roots,
BBK has been a paradigmatic model of these principles:
- one of the most creditworthy entities
- it’s social effort has been the highest in the sector, and
- our roots belong to the very heart of the Basque Country
And we want to continue in the same way.
Restructuring process: First balance
In this point, we can make a first balance of this process:
45 savings banks have been transformed into 15 commercial banks
Financial institutions have allocated 10%GDP to overall write downs in the last 3 years.
Branches and staff have been reduced about 17%
All the financial institutions have reached the required core capital through private or public capital injections
Governance and corporate model have been improved increasing transparency and market discipline
Through mergers and acquisitions, the number of savings banks has been reduced from 45 to 15. There have been several ways:
4 institutions 15% of the assets of the sector have chosen the 1st option: private capital and/or private investors. Nowadays, 3 savings bank are in the Stock Exchange market.
4 institutions (8% of the assets of the sector) have been recapitalized by FROB and will be sold in the next future. The FROB acts as a temporary backstop mechanism.
3 savings banks have been acquired by other financial groups (1 of them, Cajasur, by BBK)
Until this moment, the public injections (capital and credits) have been 17 MMM€, 1.7% GDP
Now, every financial institution, either with private or public investors, has reached the threshold required by policymakers. However, the truth is that mistrust over Spanish financial institutions still remains in the market increasing the costs of funding in the capital markets.
In order to save financial systems, Europe has adopted measures above 4.5 trillion €, 38% of European GDP as a sum of different measures of recapitalization, liquidity, guarantees and other interventions. Extraordinary and amazing figures. According to the latest European Commission report, Public Capital used in Spain have been one of the lowest in the EU (see slide) in comparative terms.
And now, after the first steps in the restructuring process, the sector is composed by 15 commercial banks, from 45 old savings banks. As a consequence, the average size of the sector has increased significantly. Simultaneously, there has been a substantial reduction of capacity, about 17% not only in branches but also in staff since 2008. This adjustment isn’t still enough and will go on further this year. Some experts say the reduction should reach at least 25-30% from its peaks.
But anything can become worse. Facing a new recession, forecasts for this year can’t be good:
- low levels of banking activity
- Pressure on funding costs will go on.
- Non performing loans will continue increasing,
- High Provisions will be necessary.
- and profits will be under a great pressure.
Obviously, this sector has also suffered from economic crisis. But, in the middle of this storm, there are also some points for hope:
ECB full allotment policy reduces the risks arising from short-term liquidity pressures. Spanish deposit institutions have enough collateral to obtain funds from the ECB
On the medium term, fixing wholesale markets will be re-opened. After ECB latest intervention, debt market keep improving
Restructuring and concentration alleviates expenses
Despite the drop in profits, banking business is viable. Although some institutions may be disappeared in the next future, as a whole, Spanish financial system is capitalized and its imbalances are now in a process of adjustment.
Final points
Let me say three final points to finish. I’m afraid this picture of Spanish economy and financial system has been so dark, almost painted in black. But this is the reality, the new normal.
In this scenario, Basque country is a little bit better than the Spanish economy average, and Kutxabank is better than the financial sector. But we are not living in an island. We have to reject auto complacency because is not a good guide. Crisis is being so hard for us and for everyone.
Even though this process of Savings banks transformation, we believe in this model. Lampedusa quoted in Il gatopardo:
“If we want everything to remain as it is, it will be necessary for everything to change.”
Thank you for your attention, thank you for your visit
ICO 26.01.12
