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Weak demand might slow up the recovery in credit
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The banking system needs 15.15 billion euros to comply with the new capital requirements.
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In March, attention regarding Spain's financial system was focused primarily on the publication of its recapitalization requirements, estimated by the Bank of Spain. According to this institution, the financial system needs 15.15 billion euros to meet the new capital requirements demanded in the Financial Sector Reinforcement Plan. This figure accounts for 1.4% of Spanish gross domestic product (GDP) and is lower than the estimates by leading international analysts. The greater basic capital required for savings banks compared with banks, 10% and 8% of risk-weighted assets respectively, means that the former have a greater need to recapitalize.
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However, the amount published by Spain's banking regulator will be lower as several savings banks that do not meet the minimum capital ratio demanded by the Bank of Spain have announced their intention to go public. In this case their capital requirements will be lowered by two percentage points to 8%, the same level as the one required for banks. In any case, covering the additional capital required by the system is guaranteed, either through private investors or through contributions from the Fund for Orderly Bank Restructuring (FROB in Spanish). This recapitalization will undoubtedly strengthen the solvency of Spain's financial institutions. They will therefore find it easier to pass the new stress tests that will be carried out on banks in the spring. In short, this is a step forward in restoring confidence in the Spanish financial system.
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The strength of the financial sector will open up wholesale financing markets to banks.
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What effect will bank recapitalization have on credit trends? On the one hand, the European Central Bank (ECB) believes that adopting this plan might hinder the recovery in credit for households and firms. However, a more solid financial system is expected to encourage wholesale financing markets to open up to banks. As a consequence, Spanish banks' dependency on ECB financing will lessen, continuing the trend that started last August. All this will help to channel credit towards the private sector.
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The recovery in industrial activity and services is reflected in an increase in their financing.
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There are, however, other factors that might slow up the recovery in credit in 2011. In spite of fewer doubts regarding the financial system's real estate risk, this system performing less well than expected might prevent the wholesale markets from opening up so readily. It will therefore be important to keep a close eye on trends in real estate doubtful debt over the next few months. As we expected, this ratio rose again in December 2010, boosted by the large amount of doubtful assets related to real estate development and construction. The continuation of this trend raised the banking system's doubtful debt rate to 6.06% in January this year.
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But the factors that will hinder credit growth can be mainly found on the side of demand. Of note is the weak recovery in the Spanish economy expected for 2011. Albeit to a lesser extent, the ECB raising interest rates will also have a slight impact on credit demand. In this last case, our forecasts predict two hikes in the reference interest rate, in May and October, placing it at 1.5%. Given such expectations, the interest rate for new credit granted rose by 26 basis points in January. For its part, the interbank market interest rate (Euríbor) has accelerated its growth since the start of year, a trend that is expected to slow up over the next few months. Demand for mortgages to buy housing won't be very dynamic either this year. This is due to the mortgage burden of households because of the rise in interest rates and especially the withdrawal of tax deductions. However, the fall in house prices will keep this effort at stable levels.
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Given this scenario, the reduction in private sector financing in January comes as no surprise. But this fall will not become generalized throughout the year. A breakdown of financing by sector shows that industrial activity and principally that of the services sector grew in 2010, a trend that might remain for the whole year. On the other hand, general government debt continued to grow in the first month of the year.
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However, weak demand might reduce the outstanding credit balance in 2011.
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In short, a good result for the Spanish financial system in the stress tests is expected to dissipate doubts regarding the sector, opening up wholesale financing markets to banks. However, the economic situation augers weak credit demand which might lead to a reduction in the outstanding credit balance in 2011.
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Fall in deposits and the return on liabilities in January.
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The balance of bank liabilities compared with households and firms fell by 1.9% month-on-month in January. This decrease took place within a context of falling interest rates, down for the second month in a row. The performance of returns on deposits is expected to affect the change in the future balance of bank liabilities. However, there are several factors that will push interest rates in opposite directions over the coming months.
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Will the fall in interest rates on bank liabilities continue?
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On the one hand, the gradual opening up of financing markets to Spanish banks should reduce the need to attract customer deposits. This will reduce competition between institutions and thereby the interest rates for new deposit operations. This is probably the main reason for the fall in returns on bank deposits in January.
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However, this effect might be weakened by the action taken by the main European monetary authority over the next few months. The possibility of the ECB toughening up the conditions for accessing liquidity auctions and the probable rises in the official interest rate will push up deposit returns. This second effect is expected to become more significant over the next few months, leading to a new period of rises in rates for liabilities during the second half of the year.
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In the medium term, interest rates are expected to rise again.
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However, the trend in bank deposits may be affected by the upswing in mutual funds. In fact, February's figures show that net subscriptions for mutual funds increased, this being the first rise since November 2009. The gradual reduction in risk aversion in the markets expected for this year might keep this trend going during 2011.
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