Spain: Financial Sector Reform Final Progress Report (Electronic book text)

EXECUTIVE SUMMARY Spain s ESM-supported program of financial sector reform aimed to assist economic recovery by promoting financial stability. The program was adopted in mid-2012. At the time, Spain s real-estate bust and the euro-area debt crisis had combined to fuel a vicious cycle of failing banks, unsustainable fiscal deficits, rising borrowing costs, contracting output, rapid job loss, and severe financial market turmoil. The program aimed to stem the financial sector s contribution to these forces by requiring weak banks to more decisively clean their balance sheets and by reforming the sector s policy framework. These efforts aimed in turn to support economic recovery by improving banks access to market funding and by avoiding a disruptive and disorderly unwinding of a significant part of the sector. The program s strategy built on reforms that the authorities had already undertaken during the crisis (e.g., stronger provisioning requirements) and was developed in consultation with Spain s European partners, was supported by ESM financing, and was consistent with the main recommendations from IMF staff s June 2012 Financial Stability Assessment Program (FSAP) and Article IV consultation. The Spanish authorities implementation of the program has been steadfast. All of the program s specific measures are now complete. These have included the following key actions: identifying undercapitalized banks via a comprehensive asset quality review and independent stress test; requiring banks to address their capital shortfalls, including if necessary through bail-ins of junior debt and injections of public capital; reducing uncertainty regarding the strength of banks balance sheets and boosting liquidity by segregating state-aided banks most illiquid and difficult-to-value assets into a separate, newly created asset management company (SAREB); adopting plans to restructure or resolve state-aided banks within a few years, with implementation now well underway; and reforming Spain s frameworks for bank resolution, regulation, and supervision to facilitate a more orderly clean-up and better promote financial stability and protect the taxpayer. These efforts have substantially reduced threats emanating from banks to the rest of the economy, as has important policy progress at the European level. Actions under the program have significantly strengthened the system s capital, liquidity, and loan-loss provisioning. The capitalization drive has also helped to contain losses to taxpayers and bank creditors by addressing undercapitalization problems before they expanded further, as inaction would likely have produced a deepening cycle of losses on deposits, accelerating deposit outflows, and more bank failures. Financial market conditions have improved dramatically during the program, with risk premia on external borrowing by Spain s banks and sovereign down more than 75 percent and equity prices up more than 50 percent during the program period. These improvements and similar trends in other stressed euro-area financial markets reflect, among other factors, the package of key crisis-fighting measures adopted in Europe during the last 18 months (e.g., OMT) and to which Spain s financial-sector program was a contributing element. Spain s real economy is now also starting to recover, with output now growing and the unemployment rate falling."