The GOVERNANCE blog

Governance: An international journal of policy, administration and institutions

The Spanish paradox: Lessons from the Spanish financial system’s resilience in the global economic crisis

Sebastian RoyoBy Jane Whitehead.  As the European Commission (EC) approves the Spanish government’s proposals to restructure four struggling banks, with the aid of a €40 billion loan from the eurozone’s emergency bailout fund, it might seem counter-intuitive to look to the Spanish financial sector for examples of good practice.

In fact, Spain’s largest financial institutions showed striking resilience in the initial phase of the crisis, from 2008-2010, argues Sebastian Royo, Professor in the Department of Government and Associate Dean of the College of Arts and Sciences at Suffolk University.  Royo’s article “How did the Spanish financial system survive the first stage of the global crisis?” has just been published by Governance.  Royo also analyzes the country’s rapid reversal of fortune after 2010, when worsening economic conditions, the implosion of the real estate bubble and weaknesses in the regulatory framework brought Spain’s financial institutions to the brink of collapse.

Royo makes a case for the particularity of the Spanish experience. Discussion of the economic crisis has tended to blur distinctions among countries, he said in an interview. “Spain has been lumped together with Ireland, with Portugal, with Greece, and the reality is that the situation in each country has been very different,” Royo argues. For example, in 2007, before the crisis, at 36.3 per cent of GDP, Spain had one of the lowest rates of public debt in the western world. “So the notion that the country was irresponsible and that public debt had got out of control is simply not true,” he said.

Spain’s banks were also relatively strong at the outset of the crisis, said Royo. A well-coordinated regulatory framework limited the acquisition of repackaged US subprime mortgages and other toxic assets. The Bank of Spain required institutions to make provision against possible future losses, in the form of a reserve deducted from capital in good times and released in times of downturn, which left Spanish banks with larger capital buffers than those in most other countries.

Royo draws a clear line between Spain’s so-called “Big Three” banks, Banco Santander, BBVA and La Caixa – and the regionally-based Cajas de Ahorro (savings and loans institutions), often run by politicians with little financial experience. These have been hard hit by bad mortgages and reckless loans to construction companies, driven by a culture of what Royo calls “quick enrichment” on the part of their managers. On the other hand, the “Big Three” have been relatively little exposed to toxic assets in the real estate sector, and BBVA and Santander have diversified internationally, and have indeed acted as rescuers in foreign markets, with Santander investing in the US, UK, Germany and Brazil. Their international ventures have supplied greater resources, funding and capital, while limiting their vulnerability to Spain’s weak economy.

“Probably the most important lesson is that Spain once again ignored the impact of a real estate bubble on the financial sector,” said Royo. Excessive lending to property developers, failure to contain the real estate bubble, over-concentration in property loans, and failure to manage risk meant that in the end, for all its initial advantages, the Spanish banking sector could not escape the effects of the global crisis. As the four nationalized banks affected by the EC-approved deal announce plans to lay off thousands of employees, close branches, and cut their loans and investments, Royo’s prescription is straightforward. “I want to stress the importance of going back to basics,” he said. “The management of risk is the most crucial obligation for any financial institution.”

FREE ACCESS to Royo’s article in Governance.

Written by Governance

November 28, 2012 at 8:21 pm

Posted in Profiles

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