THE BANKING SYSTEM REFORM pdf

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28014 MADRID

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MINISTERIO
DE ECONOMÍA
Y HACIENDA

25 – X - 2010

THE BANKING SYSTEM REFORM

1. Introduction


Saving Banks (Cajas de Ahorros) play an essential role in the Spanish financial system and
social network. From an economic point of view, they have been, throughout their history, a
significant driving force for growth, savings, allocation of resources and financial inclusion.
They have also grown to be an essential element for the credit access of households and
firms. Another crucial aspect that explains the importance of saving banks for the Spanish
society is their effect on the general interest through the compliance with their social duties.
Indeed, the allocation of surpluses to the provisions of goods and services in the territories in
which they are present is a very valuable complement of our welfare state.

In general terms, saving banks as the rest of the Spanish banking sector, faced the first
phases of the financial crisis, originated in August 2007, with outstanding resilience due to
their so called “traditional” banking model based mainly on retail banking, the high quality of
the Bank of Spain prudential supervision and a privileged position in terms of efficiency,
profitability, and level of provisions and capital.

Nevertheless, the persistence of the financial crisis together with the serious economic
downturn have resulted in an intensively adverse environment for the Spanish financial sector
and hence in lower levels of banking activity, difficulties for obtaining financing from
international markets as well as an increase in the levels of delays in payments.

Spanish entities have reacted to such conditions reducing operative costs, intensifying efforts
to gain new deposits and reinforcing the quality of own funds. However, regarding saving
banks, the financial crisis highlighted two main flaws. On the one hand, there is an excess of
capacity and on the other hand there is a need for greater flexibility both in access to capital
resources and in the adjustment processes.

In such a context, Spanish saving banks have undertaken a restructuring process that already
affects more than three quarters of the sector and that will result in a substantial reduction of
the number of entities and hence in an increase of the efficiency and soundness of the saving
banks sector.

This has been a significant first step. Nonetheless, the current reform of the international
financial system will result in new challenges in terms of higher capital requirements both in
quantity and in quality. Spanish credit entities must be prepared to face the new requirements
from a reinforced position to avoid losing competitiveness in the international arena. It is
therefore a must that the regulation on saving banks is reformed in order to facilitate their
access to external capital in the best possible conditions.

Consequently, there is an urgent need to reform the saving banks model in order to guarantee

their continuity and their contribution to the Spanish financial system.

In such a context, the Spanish government has undertaken a wide-reaching reform of the
saving banks in Spain through the approval of a Royal-Decree Law (Real Decreto Ley) for the
reform of the legal framework of the Saving Banks. It is probably the most ambitious reform
ever done in this sector. Indeed, the changes introduced guarantee the capacity of saving




25 – X - 2010



MINISTERIO
DE ECONOMÍA
Y HACIENDA



ALCALÁ, 9
28014 MADRID

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banks to keep working efficiently in our financial system, of which they account for close to
50%, while being able to adapt to the current challenges, with a high skilled management and
strengthening their balance sheets with high quality capital. This reform is already operational.
Specifically, the main objective of the reform is to strengthen saving banks so as to adapt them
to the needs and challenges of the current financial situation by tackling their main structural
weaknesses. This is done through two main channels: the reduction of the political influence at

the same time as the governance structure is professionalized and, secondly, the
enhancement of their capacity to raise external capital.


2. Strengthening the selection of management on the basis of professional
criteria
One of the main objectives of the reform is to make corporate governance more professional
and transparent in line with the principles underlying corporate governance of banks.

Indeed, the growing complexity of financial activity has also reached saving banks, traditionally
focused on a retail-oriented business model. This requires management teams to be selected
among the best professionals of each area and the main members of the governing bodies to
have exclusive dedication to their obligations within the saving bank, aligning their personal
objectives with the long-term interests of the saving bank and its social purpose.
Such measures include:

a) The ceilings on the voting shares for public entities within saving banks have been reduced
from 50 percent to 40 percent. In cases where a saving bank has issued preferred stock
with political rights, such ceiling would be reduced proportionately to take into account the
political rights of the holders of such instruments. A fit and proper exam has been
introduce for the representatives of regional governments so that they have to comply with
requirements regarding good repute and sufficient experience to perform their duties. The
Decree-Law therefore reduces the weight of the political influence in the governing bodies
of the saving banks and guarantees that political representatives are also qualified to
execute the responsibilities of their job.

b) Along the same lines, the reform prohibits elected officials to be members of governing
bodies. This ensures, not only a reduction of the political influence within the executive
decisions of the entity, but also the exclusive dedication from the main members of the
governing bodies to their duties within the saving bank.

c) Dispositions on conflicts of interest have been included to rule out any possibility of
misalignments of the personal interests of categories of staff that can potentially have a
material impact on the soundness of the entity and on the long-term interests of the saving
bank.
d) New requirements on knowledge and expertise are included regarding control functions,
directors and managers.
e) Criteria on reputation and experience have been further strengthened through the
establishment of a new Appointment and Remuneration Committee which is constituted in









25 – X - 2010



MINISTERIO
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Y HACIENDA



ALCALÁ, 9
28014 MADRID

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a way that enables it to exercise competent and independent judgment on appointments
and therefore on the suitability of managers to perform their duties.
f) To further guarantee the management of savings banks from an exclusively professional
and efficient perspective, former administrative limitations to mergers within savings banks
have considerably been reduced so that any refusal to authorize the merger should be
justified on the basis of objective criteria.
g) Finally, in order to give transparency and increase market discipline on saving banks’
corporate governance, they will publish annually a report on corporate governance.
3.
Strengthening the ability of savings banks to raise external top quality capital

The reform also
amends another of the main flaws that the current crisis has highlighted
regarding saving banks, their inability to issue capital. Indeed, the former regime has proven
incapable of providing the saving banks with an efficient capitalisation instrument to meet the
strong growth that the sector has experienced over the last decade or the recapitalisation
needs originated in the current crisis.

Several measures are put in place to enhance the capability of saving banks to raise external
top quality capital in the form of equity, in conditions equivalent to those of commercial banks.

On the basis of this reform saving banks will have four alternatives that improve their ability to
raise capital:

a) Maintain their existing saving bank structure, with widened possibilities to issue
preferred stock (cuotas participativas) with political rights. The objective of the reform
regarding preferred stock is double: making it a more attractive instrument for investors
both national and international and guaranteeing that they are eligible instruments to be
considered as high quality own funds.

Prior to this reform, saving banks could only issue preferred stock without any political
rights and subject to limits on the amount of preferred stock that a person or group of
people could hold. This of course limited the attractiveness of the instrument and therefore
the ability to issue it in efficient, competitive conditions.

Now, saving banks will have the possibility to incorporate voting rights to the preferred
stock issued in proportion to the share that they represent on total equity. Stocks can be
issued up to a maximum of 50% of total equity of the Saving Bank.

The new regime eliminates any limitation on the total of preferred stock that an individual
or group of individuals can hold. It also strengthens the principle of liberty of issuance
removing the need for any administrative authorisation.

Finally, an in order to further increase the attractiveness of preferred stock, the decree-law
includes a disposition to recognise and give the maximum legal certainty to the
representation rights of the instrument holders in the government bodies of the saving
bank, just like in the case of a bank.








25 – X - 2010

MINISTERIO
DE ECONOMÍA
Y HACIENDA



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28014 MADRID

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b) Saving Banks can integrate part of their operating structure -at least 40%- in a
consolidated group (Sistema Institucional de Protección, SIP).

The Institutional System of Protection (ISP), established by Decree-law 6/2010 offers an
effective instrument to bring together a group of credit entities in order to pool their risk
management strategies and develop risk sharing strategies. In the special case of saving
banks, this system is organised around a central entity in the form of a commercial bank
which will pool their risk management strategies, risk sharing and will have full access to
financial markets, including raising capital. Thus, the ISP increases the ability to access
markets in order to obtain equity.

The reform strengthens the commitment on stability and permanency of the entities
forming the ISP. With than in mind, the Bank of Spain must asses the suitability of an entity
leaving the group on the basis of the soundness both of the individual entity and the
system as a whole.

To avoid the distortion of the nature of the saving banks that participate in the ISP through
the loss of control over the central entity, globally, the capital participation of all of them in

the ISP should not fall below 50 percent. It is possible though that the participation falls
below that threshold but, in that case, the Saving Banks will have to transform into a
foundation and transfer its financial activity to the commercial bank acting as the central
entity.

This system therefore tackles the problem of issuing capital while preserving the special
nature of Saving Banks.

c) Saving Banks can opt to transfer its financial activity to a bank in which they hold a
majority stake.

The decree-law establishes two new organisation models for the activities of Saving
Banks. The first new alternative envisages the indirect exercise of the Saving Bank’s
financial activity through a bank. This entails that while the Saving Bank maintains its legal
nature, the financial activity will be conducted by the bank which has the ability to access
markets in order to obtain equity.

In order to safeguard the nature of the Saving Bank, its capital participation in the bank
should not fall below 50 percent. In cases where the Saving Bank does not meet such
requirement it will have to transform into a foundation and transfer its financial activity to
the commercial bank through which it has been exercising its financial activities.
This system therefore tackles the problem of issuing capital while preserving the special
nature of Saving Banks. The Saving Bank will remain in charge of social investments.

d) Finally, as another totally new alternative, Saving Banks can renounce to their nature,
transform into a foundation and transfer their financial activity to a commercial bank in
which they will have a stake which, in this case, can be below 50%.

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4. Fiscal Treatment

In order to avoid that the choice of one of these four alternatives is based on other factors
than efficiency, the fiscal treatment of Saving Banks has also been adapted so as to
guarantee that all the types of structure are treated symmetrically. The Foundation will be
in charge of social investments.


5. Srengthening the resilience of savings banks

Finally, the decree-law takes a further step in order to strengthen the resilience of credit
entities in terms of liquidity and credit growth.

Taking into consideration international developments regarding liquidity and leverage
ratios, two new requirements have been introduced:

a) A new liquidity requirement: A key characteristic of the financial crisis was the
inaccurate and ineffective management of liquidity risk. In recognition of the need for
credit entities to improve their liquidity risk management and control their liquidity risk
exposures, the decree-law includes a new liquidity requirement in order to avoid
maturity mismatches and to guarantee a correct management of Saving Banks
liquidity.

b) Limits to Saving Banks leverage: One of the underlying features of the crisis was the
build up of excessive leverage in the banking system. During the most severe part of
the crisis, the international banking sector was forced by the market to reduce its
leverage in a manner that amplified downward pressure on asset prices, further
exacerbating the positive feedback loop between losses, declines in bank capital, and
the contraction in credit availability. Regarding Saving Banks, the decree-law
introduces a leverage ratio requirement that is intended to put a floor under the build-
up of leverage, thus helping to mitigate the risk of the destabilising deleveraging
processes.

The Bank of Spain will be empowered to further specify such measures in order to be in
line with international developments.
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