The return on equity of Spanish banks grew to 11.92% in the second quarter, according to the latest figures published by the Bank of Spain. This represents an increase of more than half a percentage point since the previous quarter and is consistent with the process of returning to normal European Central Bank (ECB) interest rates, after an exceptional decade in which they were zero or negative. It is worth noting that before the financial crisis, the profitability of Spanish banks was around 15%.
Profitability is synonymous with sustainability in any company, and even more so for listed companies facing market scrutiny. In European and Spanish banks, the recovery of profitability has not yet reached the cost of capital. The supervisor describes this situation—where the return required by investors exceeds that generated by the entities—as “fragile financial stability,” which may help explain why market valuations of European banks do not reflect their book value. In this scenario, Spanish banks have shown the most improvement in recent months regarding the relationship between share price and book value.
European authorities also reiterate the need for banks to preserve their strength in a context of rapid official interest rate hikes to combat inflation, and in a scenario of high geopolitical uncertainty such as the current one. This can only be achieved by improving profitability. In the case of Spanish banks, the Common Equity Tier 1 (CET1) capital ratio stood at 13.14% in the second quarter, up from 12.9% a year ago and well above official requirements.
Having a solid financial sector is fundamental to driving economic growth and competitiveness, but also to supporting companies and families in successfully overcoming the challenges they face in the future.
On one hand, capital regulation requires that for every 100 euros of new financing, banks must hold more than 12 euros of high-quality capital on their balance sheets to cover potential defaults on some of these loans. In Spain, most of the financing available to families and businesses comes from banks. Being more profitable allows them to strengthen their capital, as they are doing now, and thus maintain an adequate position to continue fulfilling their main objective of financing the economy.
With the results obtained, banks can also maintain and promote social projects and support vulnerable groups, such as the Social Housing Fund, the various support measures taken during COVID-19, and currently, helping families in need to meet mortgage payments in the face of rising official interest rates. Also noteworthy is the rapid response to the demand from elderly people to strengthen in-person service at branches and the sector’s commitment to completing financial inclusion in rural Spain.
Banks must also remunerate their shareholders, many of whom are savers who use dividends to supplement their income. Dividends are essential when valuing any company and are one of the arguments investors have for investing in its capital: they are the return on capital, or in other words, dividends are to capital what wages are to labor. They are of vital importance to companies and therefore to the economy.
We cannot overlook the fact that Spanish banks are the economic sector that contributes the most in relative terms to the welfare state through tax payments. They are at the forefront of Europe, as more than half of the results obtained by our entities are allocated to this purpose.
Everything that is positive for the economy is also positive for banks. But the inverse relationship also holds true, as having solid and profitable entities is key to driving development and prosperity.
The European Systemic Risk Board (ESRB) warns in its latest report of the risk of economic deterioration in a context of rising interest rates, which can create stress on the balance sheets of households and companies when fiscal buffers have been exhausted. The positive side is that European banks are improving profitability and maintaining a robust liquidity position, conditions that position them well to face any problems that may arise in the future.
The ability of banks to generate recurring results is their main contribution to financial stability. Profitability thus becomes the primary line of defense against existing uncertainties, allowing banks to continue contributing to solutions for the global challenges facing society.
José Luis Martínez Campuzano, spokesperson for the Spanish Banking Association
