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The credit squeeze deepens in the second half of the year
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The financial sector faces 2012 in a healthier state and with more capital.
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During this year that is now coming to an end, Spain's financial sector has extensively transformed itself. As a result, the banking system is facing 2012 in a healthier state and with a higher level of capital. This achievement should have dismissed investors' doubts regarding the sector's solvency and should have made it easier to access wholesale funding. However, the worsening of tensions in debt markets over the last few months has prevented this from happening. This fact, within a context of weaker economic recovery and private sector deleveraging, has furthered the credit squeeze during the second half of the year.
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In fact, the standstill in the outstanding balance of credit to other resident sectors in September, a month that typically sees large increases, speeded up the year-on-year drop in credit by 9 tenths of a percentage point, to 2.6%. As can be seen in the graph below, this is the biggest drop since the start of the last economic recession. This credit squeeze is partly due to demand for mortgages being brought forward by households in 2010, resulting from the end of tax incentives to purchase housing.
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In September, credit to other resident sectors falls by 2.6% year-on-year.
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The bank loan survey published by the Bank of Spain highlights the different factors underlying the credit squeeze in the third quarter of the year. According to the responses from the ten institutions that take part in the survey, both supply and, principally, demand factors were involved. In the first case, the greater difficulty in accessing wholesale funding and deteriorating prospects of economic growth meant that the criteria applied to grant loans became slightly tougher in the third quarter. But the main reason came from the side of demand. The fall in credit applications between July and September was very big, particularly in the case of households.
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We expect credit squeezes in 2011 and 2012.
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As a consequence, private sector financing decreased by 54.77 billion euros in the first nine months of the year, consolidating the deleveraging started in 2010. This trend contrasts with the performance of public sector debt, which grew by 63.7 billion euros over the same period.
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Looking to the future, we expect the underlying factors applying downward pressure to credit will continue for the remainder of the year and this will bring the year-on-year drop in credit to almost 4.0% by December 2011. If the economic pulse remains weak and problems in the economic and financial arena do not improve next year, credit will continue to fall significantly.
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Within this context of a drop in credit and the slight deterioration in the labour market, many are now looking to the trend in the doubtful debt ratio. This remained practically stable in September at 7.16%. However, our forecasts point to further rises over the coming months due to the deterioration in the real estate portfolio.
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The main risks to banks' solvency are their high exposure to the real estate sector and to public debt.
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In fact, Spanish banks' high and problematic exposure to the real estate sector represents the main risk they must face. According to the Bank of Spain's Financial Stability Report, in June 2011 doubtful, foreclosed and standard assets under supervision related to property development totalled 176 billion euros. Certainly a high figure, but it's important to bear in mind that provision coverage (specific and general) accounts for 33% of these assets. This ratio would be enough to cover any hypothetical losses resulting from the standard scenario of July's stress tests, although not a more adverse scenario.
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Along the same lines is the exposure of Spain's banks to peripheral sovereign debt (Italian, Greek, Portuguese and Irish) that, at December 2010, was equivalent to 0.4% of all assets. Unlike what has happened in other banking systems, this figure does not seem to entail any significant risk to the strength of Spain's financial system. Only a reduction in the value associated with Spain's public debt, accounting for 6.9% of banking assets, would actually affect their solvency.
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With regard to liquidity tensions, the closure of wholesale funding markets might make it difficult to renew the more than 120 billion euros of bank debt that matures in 2012. In this respect, the one-year liquidity auction of the European Central Bank (ECB) to be held this December will help to ease this risk.
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In short, Spain's banking sector is saying goodbye to 2011 in a stronger state. Nevertheless, market tensions and less economic activity are the main risks that could affect the sector in the coming year. All this within a situation of private sector deleveraging that will continue to restrict credit.
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Deposits fall in September
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Deposits of firms and households fall by 1.1% year-on-year in September.
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Within this context of tension in wholesale funding markets, deposit institutions are modifying their liability structure. This has led to greater appeal for private deposits, increasing the fixed-term deposits attracted. However, the data available up to September show a 1.1% reduction in the deposits of Spanish households and firms compared with the same month a year ago. An analysis of the different bank liabilities show that this drop has occurred in both short-term instruments (including sight and savings deposits) as well as long-term. The reasons for this fall are mostly due to bank deposits being replaced with another kind of financial instrument offering a higher yield.
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July's decree law curbs rising interest rates.
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In fact, the higher risk premium associated with Spain's public debt has pushed up yield on issues carried out over the last few months. This has diverted funds from households and firms towards these instruments and has turned the Spanish public sector into a tough competitor for banks.
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Given this situation and the need to secure funding, Spain's banks are being forced to increase the yield offered by their products. An increase that, in the case of deposits, is limited by the decree law that, since July, has regulated the interest rates that can be offered by financial institutions. This can be seen in the trend in interest rates of banks' new liabilities operations. In September, this stood at 1.7%, one tenth of a percentage point above the figure recorded the previous month.
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Moreover, the cut in the ECB reference rate has reduced the margin to increase the yield on liabilities over the coming months. As a consequence, banks themselves are designing new products that do not come under this directive, allowing them to secure resources from firms and households, as is the case of commercial paper.
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The higher yield on Spain's public debt represents tough competition for banks.
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For their part, mutual funds are maintaining the trend started in April 2011, with net new withdrawals totalling 891 million euros.
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