We are in the earnings reporting period for Spanish banks. Significant improvement is expected for the fourth quarter of 2022, which will help close sound annual accounts for what is the third most important banking sector in the European Union by asset volume, behind only Germany and France.
It is appropriate to assess the desirability of growing profits in an environment marked by high uncertainty, macroeconomic complexity, and difficulties arising from inflation for various groups.
Banks, like any other company, must be profitable to be sustainable. The sector has had to manage an anomalous situation of low and even negative interest rates over the last decade, which has affected its profitability and has made financial intermediation extraordinarily difficult. According to the EBA, the average return on equity of the Spanish banking sector over the last ten years has been 6.6%, taking into account the international business of banks, and 3.9% if only business in Spain is considered. These levels mean that in recent years profitability has been below the cost of capital, that is, below the return required by investors. With the latest available data from the third quarter of 2022, the profitability of Spanish banks has improved somewhat to reach levels of 10.5% on a consolidated basis and 9.5% in Spain.
The return to solid profit levels is good news and an important normalization of the sector’s situation, as it contributes to having stronger banks. A strong and competitive banking sector is essential for the progress of society and for the economy to function, since only in this way can it provide financing to the real economy. Likewise, the banking sector’s ability to generate results on a recurring basis is its best contribution to financial stability.
A review of how banks allocate these profits can help reinforce the importance of profitability and understand why the resources generated by banks are desirable for the Spanish economy.
First, a substantial portion of profits is allocated to strengthening the banks’ own capital, which is essential for expanding the lending activity of institutions. Indeed, strict and demanding capital regulations require that, for every 100 euros of risk assets such as loans granted to customers, banks must immobilize more than 12 euros in the highest quality capital on their balance sheet to cover the unexpected loss that some of their loans may incur. The main source for organically generating this capital is through the undistributed profits of institutions.
Second, we always refer to profits obtained after making provisions, that is, the resources that banks must have to cover the expected losses of the risks assumed. Given the risk of an adverse macroeconomic scenario, supervisory authorities are insisting on the need to adopt a prudent approach to provisions.
Third, the existence of profit-generating banks enables meeting the financing needs of households and businesses. Banks do not produce consumer or industrial goods. But thanks to the financing they provide, they enable companies to produce them and households to consume them, from housing to goods and services. In other words, banking profitability enables banks to finance the day-to-day activities of citizens and businesses, as well as structural challenges such as the green transition, the necessary innovation to increase the potential growth of the Spanish economy, or the digital transition that companies must undertake to achieve efficiency gains and adapt to new trends imposed by consumers and competition. Bank financing to SMEs is particularly relevant, as there is no clear alternative for them. From January to November 2022, new operations to companies worth 25% of Spanish GDP were granted, of which 157 billion euros (48% of the total) went to SMEs.
Fourth, a portion of profits can be allocated to compensating shareholders through dividend payments. A solid and recurring dividend is essential, not only for the banking sector but for any other sector, because it facilitates access to capital markets and enables a stable investor base. The trend in the European banking sector is a distribution policy of between 40% and 50% of after-tax profits. The increase in the profitability of Spanish banks is therefore positive for strengthening the investor base, which already includes nearly six million retail shareholders. Especially at a time when, due to the normalization of the European Central Bank’s monetary policy, the cost of capital is also rising and because profitability of banks is a structural priority for the supervisor.
Fifth, another portion of the resources generated by banks is allocated to tax payments. The sector has a corporate tax rate of 30%, which is higher than that of other sectors. International comparison shows that the Spanish banking sector, not counting the recent temporary bank levy, is among the countries that pay the most taxes along with France, far ahead of German, Dutch, and Italian banks.
Finally, thanks to the strength of balance sheets and profits, banks are able to reinforce their commitment to society with initiatives as relevant as those dedicated to improving personalized care for the elderly, strengthening financial inclusion in rural Spain, or more recently, relief measures for mortgage debtors in difficulty.
In short, the strength of the Spanish banking sector constitutes a competitiveness factor for the economy as a whole. Banks will continue to be part of the solution to the complex economic context and will continue to exercise their social function, which is none other than to support clients so they can financially carry out their personal or business projects. To successfully fulfill this purpose, profitability is their first and main line of defense.
María Abascal, Director General of the Spanish Banking Association
