As a major European economy Spain’s banking sector has relatively fared well in the international financial crisis. Both Banco Bilbao Vizcaya Argentaria (BBVA) and Banco Santander (BS), amongst the largest banks in the world, have done relatively well compared to their peers. With very few banks needing capital infusion and government hand holding,Spanish banks have done quite well in past years fueled by a real estate boom. Of course as the real estate declines over the past two years and the economy is in recession, many banks do have heavy exposures to the real estate sector and are saddled with a rising rate of bad loans. The government is stepping up with a fund of up to €90 billion (US$125.46 billion) to help banks restructure and cope with the effects of recession.
However the relatively better performance of Spanish banks is still commendable and can be attributed to below key factors:
In many countries across the world, banks are required to increase reserves as losses increase and allowed to decrease reserves as profits rise. This setup increases bank lending during economic boom periods and decreases lending activity during downturns, a cyclical tendency.
Banco de Espana sets reserves based on an weighted average of a banks’ assets, with the weights determined by past default frequencies for different asset classes. The hypothesis is that historical default frequencies will accurately reflect reserves going forward. This presumes that the historical record provides a good indication for distinguishing between cyclical and more permanent components of loan performance.
We already see many countries starting to look at dynamic provisioning as a best practice. Of course the issue with dynamic provisioning and its compatibility with IFRS needs to be handled. Here again Bank of Spain has led the way to find common ground in terms of accounting standards.
So hats off to Spain for showing the way for prudent banking via solid commonsense risk management!
Sources & Acknowledgements: BBVA Economic Research Working Paper, Feb 2009 – "Dynamic Provisioning and other tools"; Banco De Espana; Financial Times; Financial Week.
Sai Sireesh is Director of Risk Management & Compliance Strategy & Solutions, Worldwide Financial Services for the Microsoft Corporation. Mr. Sireesh has over 18 years of global experience across Risk and Compliance Consulting, Financial sector Strategy and blueprints execution. He has worked in North America, Australia, Singapore, Malaysia, Philippines, Thailand, Indonesia and India, is a regular contributor to the Journal of Regulation & Risk, and has authored several global research studies and articles.