Good morning, everyone. Before beginning, allow me to thank the organizers for their kind invitation to participate in this event.
This is my first conference following the passing of our advisor, Federico Prades, who shared no fewer than twenty-four years of his professional life with the AEB. I bring this up not only because of his undeniable merits and dedication to this organization but because my speech will address the situation of Spanish banking from the perspective of its recent evolution. To begin, I must say—and let us not deceive ourselves—that what happens to the sector will depend largely on what happens to the Spanish economy. That is, the positive evolution of the Spanish economy is a necessary, but not sufficient, condition for the sector’s success. And it is here where Federico’s judgment is missed.
If we look at the recent evolution of the sector, we could summarize it as follows: improvement in all relevant magnitudes, with great heterogeneity among entities—which undoubtedly favors innovation and encourages competitiveness—and the persistence of challenges facing the sector, derived from more structural factors such as regulation or the low interest rate environment.
My intervention will be structured around three axes. In the first, I would like to speak briefly about the fundamental elements of banking activity; subsequently, I will analyze the economic environment and the situation of banks in the current economic context; and finally, I would like to share with you some reflections on the challenges that, from my point of view, the Spanish banking system will have to face to continue successfully leading an increasingly regulated industry.
Without further ado, allow me to remind you that the primary activity of banks is none other than maturity transformation—that is, capturing resources in the short term to lend them in the long term. To the extent that short-term interest rates are usually lower than long-term rates, this process of maturity transformation allows banks to obtain a profit or an intermediation margin. Another fundamental characteristic of banks is the capturing of specific liabilities, or third-party resources: their customers’ deposits. In this sense, it is never too much to remember that banks manage other people’s money—that of their depositors—and therefore must ensure the return of the money they have lent to their asset clients to thus guarantee the stability of the deposits of their liability clients.
Furthermore, banks provide their customers with various services, many of them payment services. I am referring to credit and debit cards, ATMs that allow for convenient and fast cash withdrawals, etc. But also to other services such as securities custody or those that allow for long-term savings to be made profitable, such as pension funds, etc. To provide these services, banks must have infrastructures such as, for example, ATMs, and specialized personnel to advise customers, which represents an additional investment that must be recovered.
It is interesting to reflect for a moment on this issue: fees for services rendered. Historically, banks did not pass fees on to customers, and the cost of services, along with the commercial profit, was subsumed into the margins; this resulted in higher interest rates for loans and lower financial remuneration for deposits. Customers might think they were better treated then. But that was not the case. It was a mere financial illusion. Firstly, subsuming costs into margins meant subsidizing customers who demanded the most services and penalizing those who needed the fewest. Secondly, the lack of transparency regarding those fees implicit in the rates did not allow for price comparison and therefore went against the interests of banking customers. It also went against the most competitive and efficient entities. Accepting that in the banking industry, as in any other industry, it is difficult for the consumer to pay for services received—especially when they have received them apparently for free for many years—accepting this, I say, the current fee scheme, where the consumer knows what they are paying and why they are paying it, is undoubtedly much better than the old system of implicit fees, cross-subsidies, lack of transparency and, therefore, absence of competition.
But let us return to banking activity. Another secondary activity of banks is market intermediation, which is reflected in the heading called ROF (net trading income). In an environment of falling interest rates, this activity allows for increased profits and has contributed significantly to bank results in recent years, thereby offsetting the negative impact of low interest rates. Looking ahead, a leading role for these operations in banking results is not to be expected, for two reasons. Firstly, because the process of falling rates has come to an end. And secondly, but more importantly, because the tightening of regulation will greatly complicate this type of activity, so a smaller scale in this activity can be expected in the future.
Another relevant element of the nature of banking is that these are companies with private shareholders. And these shareholders demand a return consistent with the investment made and the risks assumed. Far from that static and simplistic vision in which shareholders never change, the reality of shareholders in modern listed companies is very different. A shareholder in Europe holds shares for less than a year on average (calculate the division between stock market trading in a year and market capitalization, and if it is greater than one, it means that shares rotate more than once per year). This means that if the ROE or profitability of the banking entity is below the cost of capital or the return required by shareholders, they will withdraw their capital and banks will have no choice but to reduce their balance sheets over time. A weakened balance sheet would end up slowing down credit to the real economy, with negative consequences for both financial stability and economic growth.
What is the banking business environment today? Three elements characterize it: an economy in recovery after a crisis that can only be described as brutal; an environment of low interest rates as a result of ultra-expansive monetary policies; and a sector that is gradually recovering from the impact of the crisis on its balance sheets, but which must face increasingly demanding regulation and supervision. Let us look at these matters in detail.
The Bank of Spain’s quarterly report confirms that the economic recovery process took hold in the third quarter, in which GDP continued to grow above three percent at an annualized rate. Considering the complex international environment, I honestly believe—and I wish Federico Prades were here to confirm it—that it is a positive result and that it would be extraordinary to manage to consolidate it. To do so, it is essential to create an environment of stability and competitiveness that continues to attract the interest of foreign investors. In any case, this improvement in growth, driven not only by consumption but also by investment and exports, helps to bolster the demand for solvent credit, relieves pressure on customers experiencing difficulties—and therefore improves the non-performing loan ratio—and increases the value of foreclosed assets.
Regarding interest rates, we are on the verge of an upward cycle in those economies furthest ahead in exiting the crisis. Specifically, I am referring to the United States. But the timidity with which the end of the ultra-low rate cycle is being approached reminds us that, for the eurozone, the low interest rate environment will likely continue in the coming years. Low rates undoubtedly help banking customers with debts, as it is easier for them to meet their obligations or restructure their loans. And what favors the customer favors the bank, without a doubt. Furthermore, low interest rates also lighten the cost of maintaining foreclosed assets on the balance sheet while waiting to be able to sell them.
However, such a persistent environment of low rates greatly complicates the achievement of results by banks. On the one hand, the fall in rates compresses the margins between assets and liabilities. To the extent that a significant part of liabilities—transactional deposits—have no cost for banks, the fall in rates decreases the value of that source of financing and margin generation. On the other hand, low interest rate environments are associated with flat yield curves; that is, the difference between short-term and long-term rates is reduced almost to the point of extinction. This flattening detracts from the core of the banking business which, as we have said, consists of maturity transformation—that is, lending long-term and financing in the shorter term.
Regarding regulation, suffice it to say that the review of the framework launched by the G20 and carried out by the Financial Stability Board is about to conclude. But its implementation, in areas such as bank resolution or the consistency of internal models, will still take a few years. And once its implementation is complete, we cannot rule out that the financial reform may have unintended effects on the positive diversity of banking business models currently in existence, or on a matter as primordial as liquidity in financial markets. In any case, what is relevant today is that the push toward higher levels of solvency puts pressure on profitability: if CET1 regulatory capital requirements are doubled, the ROE or return on equity, ceteris paribus, decreases by half.
In short, the business environment remains complex, but better than a year ago: uncertainties are dissipating, and what is fundamental now is to maintain that tone of improvement and clear away potential sources of insecurity.
The situation in which the Spanish banking system finds itself has been reached after an intense effort carried out by our banks in recent years on three complementary fronts: restructuring, efficiency, and solvency.
I will not dwell on the restructuring process of the financial system, which is well known to all of you and today, fortunately, practically concluded, but whose long-term consequences have yet to manifest themselves.
Instead, I would like to offer you some data that help to understand the magnitude of the effort made:
The group of Spanish entities has carried out a volume of write-downs and provisions between 2008 and 2014 of no less than 290 billion euros, a figure equivalent to 27% of national GDP. I must remind you that AEB banks have not needed public money for their recapitalization and, furthermore, have contributed a very significant part of this effort by providing about ten billion euros directly and through the Deposit Guarantee Fund.
The process of resizing the installed capacity in the sector has involved the closure of 14,000 branches (31% fewer) and a gradual and non-traumatic reduction of staff by 27%, through early retirements and incentivized departures.
This resizing has allowed efficiency ratios to remain at competitive levels, below 50%, despite the contraction of margins, comparing favorably with any banking system in our economic environment.
The effort in solvency is, if possible, even more remarkable; suffice it to point out that as of December 31, 2014, equity on the balance sheet represents 8% of total assets, an indicator of the intense capitalization process of the sector if we compare it with the 6% it presented immediately before the start of the crisis.
In terms of Basel III, and speaking only of AEB banks, the CET1 ratio as of June 2015 already stood at 12.3%. Not surprisingly, despite the increase in capital requirements established by the ECB compared to last year’s levels, listed Spanish banks more than meet the minimum solvency levels required by regulation. Therefore, the impact of an adverse scenario on the capital situation of the entities is very small.
That is to say, it is evident that the effort made in recent years in provisions, recapitalization, balance sheet cleaning, and consolidation demonstrates that Spanish banking is in good condition to accompany and support the recovery process of our economy and is, likewise, very well prepared to face the risks that may eventually arise in the future, especially those derived from a complex environment characterized by weak economic growth in Europe and the world.
Therefore, after this intense effort of restructuring and capitalization, the current situation in which Spanish banks find themselves can be described as hopeful and difficult at the same time.
Difficult, because the low interest rate scenario to which I referred weakens the margins of typical activity, and its prolongation over time diminishes the capital gains that, via ROF, have logically contributed to balancing the results in recent years.
And hopeful for two reasons. Firstly, because the return to positive rates of GDP and employment growth in the Spanish economy is already beginning to be reflected in financial activity, as demonstrated by: the progressive reduction of the non-performing loan ratio (11%); the resilience of resources captured from customers, despite the tough competition represented by investment alternatives such as funds; and, especially, the dynamism in the granting of new credit operations both to families (mortgage and consumer) and to small and medium-sized enterprises—dynamism based on economic reactivation. And secondly, because our banking system, now restructured, will once again compete and innovate with the leadership that has always characterized it in Europe.
Nevertheless, the challenge ahead for Spanish banks continues to be titanic, as have been the obstacles already overcome. The effort in the coming quarters must be focused in three directions:
Spanish banks have demonstrated their ability to overcome circumstances more adverse than the current ones, an ability based on prudent management, risk control, and the adoption of strategies that has allowed them to successfully adapt to different markets and continue on the path of efficiency and solvency to which I referred at the beginning of this presentation.
But as important as the financial variables represented by the figures cited above, the main commitment assumed by Spanish banks is to recover society’s trust in the banking system (they have always had that of their customers) and to show the fundamental role that our entities play in channeling credit toward productive activities, thereby contributing to growth, stability, and employment in our country.
From the AEB, we will not cease in our effort to try to recover the social recognition that our banks deserve. For our society and for our economy, it is of vital importance to have a solid financial system that effectively and safely fulfills the primary function assigned to it. This is how we understand it and how we want to convey it. We are sure that we will be successful in this endeavor.
Thank you very much.
José María Roldán, Chairman of the Spanish Banking Association
