On January 28, Elena Salgado, Spain’s minister of economics and finance, presented the government’s plan for strengthening the financial sector. Salgado, who also serves as Spain’s second vice-president, explained that the most important goals of this plan are to restore the confidence of the markets in the strength of the Spanish economy, and the credibility of its financial institutions. Hopefully, she said, the plan will make it easier for these institutions to be financed, guaranteeing the channeling of credit into the real economy and, with that, boosting growth and employment. Last year, Spain’s economy shrank by 0.1%, according to the Bank of Spain. At the end of the year, the unemployment rate was 20.3%.

In Spain, savings banks are non-profit institutions with a strongly regional footing. One goal of the government’s plan is to maintain these institutions’ social initiatives, or the part of their profits that they invest in local projects. Following the mergers and consolidations of 2010, and the restructuring process of last year, there are currently 36 savings banks. These institutions, a unique characteristic of the Spanish financial system, were especially hard hit by the real estate crisis of 2008.

In an effort to “clear away any doubts harbored by investors,” noted Salgado, the plan immediately established “a minimum basic capital requirement” for financial institutions “that advances the capital requirements established in the Basle III” agreement. This “core capital” requirement will be 8% of the assets weighted by risk. But it can be higher for those institutions where private sector investors do not a have a meaningful presence, and which depend on financial markets for a majority of their capital — which is to say, for the savings banks. Two days later, Salgado declared on the TVE public network that the government will request that savings banks have core capital of between 9% and 10%.

“This is not the time to put so much emphasis on the solvency of the savings banks and their level of capitalization,” notes Manuel Romera, professor of financial management at IE Business School. “You have to focus more on measuring their liquidity, their levels of capital risk, their credit risks, the risks of the market…. This is the time to worry more about their assets and less about their liabilities.” In any case, he believes that the basic 8% core capital requirement means “doubling the most demanding expectations” and is “a bit excessive.”

Oriol Amat Salas, professor of finance and accounting at Pompeu Fabra University, believes that the required 8% is “sufficient, so long as the institutions properly account for their exposure to risks in the real sector and in their financial investments.”

“Generally speaking, it is a good thing that [the government] ask these credit institutions for some guarantees for dealing with hard times,” says Mauro Guillén, director of the Lauder Institute at Wharton. “You have to avoid situations of exposure to risk, because the savings of citizens are involved.” At the same time, he considers it important to realize that the government’s plan also means moving ahead with the core capital goals of Basle III, which also brought changes with respect to measuring the assets that are held. He notes, for example, that in accordance with Basel III, when institutions own shares of other companies, those shares don’t count in measuring their core capital, but rather penalize them. “The government has to clarify some of the criteria for measuring the capital requirements, such as whether or not they will take into account the industrial portfolios of the financial institutions, as established in Basle III,” he says.

According to the plan, in order to guarantee that institutions reach this ratio of solvency through their recapitalization, and that the normal credit flows of the economy take place, the core capital requirement must be fulfilled based on the companies’ assets, weighted by risk on their balance sheets, as of December 31, 2010. Those institutions will have until fall of this year to acquire the capital they need to arrive at the required level.

In September, the Bank of Spain will determine which institutions are maintaining their capitalization needs. To guarantee complete compliance with new requirements for all institutions, the government will authorize FROB, the Fund for Orderly Banking Restructuring, to finance temporary assistance by acquiring ordinary shares under market conditions for those institutions that do not meet their own required needs for financing, and also for those that apply for it. In such cases, the government will remain an investor for a temporary period of no longer than five years. In order to facilitate FROB’s departure from these institutions, these institutions will have to restructure their governance bodies.

FROB, a fund created in June 2009 with government capital, aims to manage the restructuring processes of credit institutions and contribute to reinvigorating those institutions’ own resources. The government did not specify exactly how much capital would be required to help the financial system comply with the new rules. However, it did note that the total amount will not exceed 20 billion euros. “This doesn’t mean that FROB must contribute 20 billion, because all or part of this quantity can be obtained in private markets,” noted Salgado.

Assessing the Plan

Romera believes that the government has accurately calculated the capital needs of the Spanish financial system. “This is the figure on which we can act in coming months,” he notes. “It is an accurate amount because the executive branch has used it as a foundation for its forecasts.”

“The government’s contribution is not very high; if only that were the case. In fact, the executive branch estimated that FROB’s resources were only about 80 billion to 90 billion euros,” notes Amat. Despite his doubts about Salgado’s estimates, Salas believes that, “Generally speaking, the established plan is enough to produce the needed restructuring of the system.” All the more so, he says, “if, in addition, it is accompanied by correct accounting of the damage that was produced by investments made in the real estate sector.”

In their reports published in January, credit agencies Fitch and Moody’s applauded the government’s plan for restructuring the financial system, as well as the requirement that institutions must have a core capital level of at least 8% of their assets, weighted by risk. Both agencies said that this plan represents a step in the right direction. According to Moody’s, “With its insistence on higher levels of capital, the government adds pressure to the current ‘owners’ of the savings banks, which are the regional governments, so that they either capture this capital or abandon their current corporate structure.”

Nevertheless, Fitch doubts that the new requirements are going to achieve the goal of restoring confidence to the market, since institutions have been given until September to determine if they are capable of raising their capital levels. Fitch believes that this is “a long period,” and it doesn’t seem to provide a “clear stimulus” for the private sector to inject funds, “especially” in those institutions where “there are doubts about the extent to which there are possible problems regarding the quality of their assets.”

Consequences for the System

“In coming months, we will see many ‘cajas’ [savings banks] begin to record losses so they can try to achieve the requirements imposed on them. Many will have to convert themselves into banks,” predicts Romera. At the same time, the savings bank system will not disappear, he says, because “many of these institutions function very well, engaging in activities that contribute a great deal to Spanish society.” Romera cites the following examples of sound management: La Caixa (Catalonia), Cajastur (Asturias), BBK, and la Kutxa (in the Basque Country).

According to Amat, “[The government] should evaluate, case by case, the condition of each institution to see if it will be possible for them to meet the capital requirements imposed on them.” However, generally speaking, he believes “they will manage to get the financing they need, although it is very likely that in some cases, the government will have to bring in capital, and it will be forced to become one of their shareholders.” In his view, “most savings banks, not all of them, are going to be converted into banks, or at least will move all of their financial activities into a bank. That will reduce the number of loan institutions, which will in a short time leave us with only about 15. Total investment in the savings banks’ social activities is going to be reduced considerably.”

Guillén believes that the government’s plan “will clarify which are the well-capitalized savings banks — and can thus continue what they have been doing until now — and which are not.” In any case, he is certain that the savings banks are going to be forced to submit themselves to the discipline of the market. “They are making a lot of bets about what is going to happen. You have to keep an open mind because there are various possible ways out. One of them is for the government to invest funds in the institutions that need it. But in the case of the savings banks, it is likely that there will be buyers from the national banks, and even that foreign capital will take over some of them,” says Guillén.

Some of these forecasts are already coming true. The first savings bank to make a move aimed at adapting to changing times was La Caixa. On January 27, it announced its transformation into a bank, converting Criteria, its holding company listed on the stock exchange, into CaixaBank, which will have 81% of its shares. The remaining 19% will belong to the 310,000 current shareholders of Criteria. La Caixa will move its banking business to CaixaBank, which will also group together its insurance business and its ownership in international banks, as well as its management of institutional investments, and investments from companies such as Telefonica (the telecom company) and Repsol (the energy firm). Meanwhile, La Caixa will still own shares of such industrial firms as Gas Natural, the energy firm; Agbar (water management), Abertis (infrastructure), and Port Aventura (theme parks), as well shareholdings in Colonial, Metrovacesa and other real estate assets.

La Caixa calculates that, using the Basel III criteria as a standard, CaixaBank will be created with core capital of 10.9%. This data assumes that Criteria will issue up to 1.5 billion euros in convertible bonds that it will place through the La Caixa network. La Caixa will continue to be a savings bank, and will own 100% of a holding company, not listed on the stock exchange, which includes its social work activities.

The other institution that revealed its cards to the market was BFA, (the Financial and Savings Bank Group), formed by a combination of savings banks led by Caja Madrid and Bancaja, and incorporating Insular de Canarias, Laietana (Catalonia), Avila, Segovia and Rioja. The goal of this transaction, according to Rodrigo Rato, president of the BFA (and former minister of the economy), is to achieve a sufficient level of basic capital — that is to say, raise it from 7.04% at the end of 2010 to at least 8% before next fall. This way, the institution expects to get the financing that the government needs from private markets, as well as employ its own resources.

“Whether or not the financial group led by Caja Madrid can manage to reach the 8% that is required will depend a lot on how the Spanish economy evolves in coming months, as well on interest rates, and the condition of important European economies such as France and Germany,” notes Romera.

As for the role that the banks will play in this process, Francisco González, president of BBVA – the second largest Spanish bank after Santander – surprised observers on February 2 with his remarks as he was releasing his institution’s annual results: “We will probably buy things in Spain,” he said. “Clearly, there are opportunities, and we will either take them or we won’t.” He insisted that in Spain, “we will do something” because “there will be a lot of institutions for sale.”

According to Guillén, BBVA "can buy but they will do so in a very isolated way to take over very specific assets in some savings banks.” Nevertheless, in his view, both big and midsize banks should bet on globalization. “The most interesting and reasonable strategy for BBVA and Santander is to grow outside the Spanish market, and gain a larger share of the international market. Midsize banks such as Popular and Sabadell may be interested in buying assets of savings banks that have problems, although it would also be more attractive for them to expand in foreign markets,” he says.