The Bank of Spain asks entities to prepare “in time” for the recession

The Bank of Spain has once again asked banks to make the necessary money provisions from this moment on to face the risks facing the economy and, above all, has urged them to do so “adequately and on time”, before the possible recession of the next quarters.

The General Director of Financial Stability, Regulation and Resolution, Ángel Estrada, has stressed that the message that the supervisor has been conveying in his appearances and reports in recent quarters is to ask entities to “take into account the current macroeconomic environment” and that “provide adequately, on time, that they stress their models”, as transferred in the presentation this Friday of the Financial Stability Report for autumn 2022.

The supervisor maintains its central scenario of economic growth for Spain, which contemplates a GDP increase of 4.5% for 2022, 1.4% for 2023 and 2.9% for 2024, but has warned that the possibility of A correction in economic activity has increased in recent months, in a context of persistently high inflation and the prolongation of the war in Ukraine.

This report includes an assessment of the resilience of the Spanish banking sector, which would maintain an “adequate” aggregate solvency level in the face of the materialization of macroeconomic risks, but has insisted on the sector remaining “cautious” when designing its provisioning and capital allocation plans due to the possibility that these risks materialize.

Specifically, the supervisor has evaluated the solvency of the Spanish banking system for the 2022-2024 horizon, where a base scenario has been considered, closer to the economic forecasts with an accumulated GDP growth of 9.8% for the period, and an adverse scenario of deteriorating macrofinancial conditions, including higher and persistent inflation over time, a significant tightening of financial conditions and a cumulative GDP contraction of 1.3% in the 2022-2024 horizon.

The high inflation contemplated by the Bank of Spain in this negative scenario would be transferred to the costs of households and companies and would have an impact on much stricter financial conditions, due to the tightening of monetary policy and a certain increase in risk premiums, which would reduce the agents’ levels of consumption and investment.

The supervisor has also taken into account other geographies in which Spanish banks operate, such as Mexico, Brazil or Turkey, and for the adverse scenario it includes a situation of generalized stagflation, with low economic growth and high inflation.

Thus, the conclusion of the analysis is that the aggregate solvency of the entities would remain at “adequate levels” in the face of the economic impact assumed in the adverse scenario. However, the supervisor emphasizes that this impact would be “heterogeneous” depending on the entity.

The Bank of Spain points out in its report that the generation of resources and the provisions to cover impairments would serve to sustain the profitability and solvency of both groups of banks, also highlighting the positive impact that the activity abroad of banks with a presence abroad. In the worst scenario, these positive elements would not offset the impairment losses in the country, thus reducing the solvency of the entities in both groups.

The institution maintains that the materialization of macroeconomic risks could have a significant impact in terms of capital consumption, although the sector’s loss absorption capacity is “sufficient” to maintain an adequate aggregate solvency level.

However, he asks for caution when interpreting the stress test he has carried out due to the “greater uncertainty” in the economic environment and points out that the use of scenarios with higher interest rate increases is “a break” with respect to others. tests that it has carried out in more recent years, where a contraction in demand due to the Covid-19 pandemic has been measured.

In addition, he has called for a “cautious positioning” of the sector when considering its provision and capital plans, as well as “close monitoring” of macroeconomic developments with the aim of acting quickly if the risks considered in the report materialize. analysis.

Regarding the dividend remuneration policy, Estrada pointed out that the average ‘pay-out’ ratios of Spanish banks are around the average, or even below, of the rest of the European banking systems and that from this perspective these levels “are not excessive”, although the recommendation of caution in the allocation of capital is still on the table.

On the other hand, the Bank of Spain has also studied the situation, in terms of credit risk, of the companies that have benefited from the extension of the grace periods of the Covid-19 guarantee line and concludes that these extensions offer short-term “signs of a lower ability to pay” of companies. However, this has materialized to date, above all, as a latent deterioration, in the form of a greater weight of exposures under special surveillance.

In addition, the doubtful ratio stood at 3.8% as of June 2022, falling from 4% for the first time since December 2008, while the percentage of loans under special supervision and refinanced fell in the last semester, although loans under special surveillance remained above pre-pandemic levels.