The year 2017 confirmed the Spanish banking sector’s ability to adapt to conditions that, while reflecting the strength of the Spanish economy, are not without formidable challenges. According to information provided by the entities themselves, the attributable profit of banks belonging to the Spanish Banking Association grew by 5.1% in 2017 compared to the previous year. In line with this result, the return on equity (ROE) continued to increase, reaching close to 8%, although it remains below the cost of capital. The non-performing loan ratio of the Spanish financial system, according to data from the Bank of Spain, closed 2017 at 7.8%, representing the fourth consecutive year of decline and the lowest level in the last six years.
Consequently, Spanish deposit institutions are not only better capitalized but also demonstrate a higher degree of solvency than in the past, which facilitates the normalization of banking operations, expressed through credit flow. This process resulted in a 16% expansion rate for new credit operations for households and 8% for small and medium-sized enterprises in the past year.
The banking sector’s outlook for this year remains very positive, in line with the favorable economic context. In Spain, GDP growth is estimated to approach 3% for the fourth consecutive year, thanks to the dynamism of domestic demand, which responds strongly to intense job creation, but, above all, thanks to the notable contribution of external demand. Thus, with the impetus of economic activity and the progressive reduction of the unemployment rate, the credit profile of companies and consumers should improve. Therefore, in an environment of very low interest rates, a solid strengthening of credit to non-financial companies and households is expected in 2018.
For its part, the banking system will leverage this favorable scenario to address the challenges still facing the sector. These challenges, for banking in general, but especially for retail business, will revolve around four key areas.
Firstly, although the market assumes that the European Central Bank will begin to modify its monetary policy stance towards the end of the year, in line with the upward trend already initiated by the Federal Reserve in the United States, interest rates will remain at historical lows throughout 2018. This will limit the intermediation margin on asset operations. Furthermore, banks’ ability to continue adjusting their operating costs will become increasingly limited, as they have already reduced nearly 40% of their staff and branches since the start of the crisis. Consequently, pressure on the sector’s profitability will remain one of the system’s main challenges. Increasing credit volume thus becomes a fundamental lever for a banking model where the intermediation margin is a basic element of the income statement. However, the significant investment in technology made by financial institutions to date should provide a new boost to results due to the favorable impact it can have on efficiency, productivity, and ultimately, on operating expenses, which will necessarily have to be reduced in the coming years.
Secondly, the management of non-performing assets, primarily linked to the real estate sector, represents a formidable challenge not only due to their high volume but also their impact on the sector’s profitability. Despite the efforts made over the years to clean up the system’s balance sheets, European authorities continue to push for accelerating the sale of these assets, as some entities have already done. This introduces a new element of concern for a system that still accumulates over 100 billion euros in non-performing loans and real estate.
Thirdly, the sector faces a complex and overwhelming regulatory landscape. It is true that the degree of regulation in the sector has reached a notable maturity, and it is difficult to foresee a new surge in the coming years. However, the complexity of the framework built so far, along with the application and understanding of regulations currently being implemented in Spain, will mean that, in the coming years, management derived from the regulatory framework will generate considerable uncertainties for advancing the sector’s strategic positioning. Pending regulations in Spain, such as MiFID II, the Payment Services Market Law, or the Real Estate Credit Contracts Law, among others, will foster the emergence of a new operating environment that could be exacerbated by regulatory arbitrage stemming from shadow banking or new digital competitors.
Finally, credit growth will require significant attention to credit risk in a context where the Eurozone is entering an upward interest rate cycle, as already reflected in the long-term yield curve.
Despite these challenges, the favorable economic conditions under which the banking sector is expected to operate in the coming years, and the medium-term impact that technology and digitalization should have on the sector’s income statement, represent highly attractive factors for investors, as evidenced by the book value of many Spanish banks. This interest is also reflected in rating agencies’ assessments: Standard & Poors considers that thirteen of the fifteen Spanish banking entities it analyzes offer positive prospects, making it very likely that many of them will achieve an upgrade in 2018.
This renewed investor appetite could translate into a higher degree of capitalization, offering growth opportunities in other markets or consolidation in Spain. In any case, a new round of investments will serve to accelerate the digital transformation of the sector for the benefit of its clients.
Juan Carlos Delrieu, Director of Strategic Planning
