The bank has a low profitability problem due to the combination of many factors: the environment of very low interest rates that penalizes the margin with which it intermediates; the cost of regulatory requirements; the growing competition from shadow banking and big technology companies that threaten part of the banks’ business terrain, etc. Added to these factors, which are in a certain way structural, is the impact of the Covid-19 crisis, whose negative effects have not yet been fully manifested due to the aid granted to companies and families (ERTE, moratoriums, etc.) .
The reflection of all these factors is that the Spanish banking sector ended the 2020 financial year with a negative return on equity (ROE) of -3.9%, according to data from the European Banking Authority (EBA). This is explained both by the large Provisions made to face the potential deterioration of assets due to Covid-19, as well as for the correction of the value of the goodwill of the subsidiaries abroad of the two large Spanish banks. European banking is no stranger to this problem of low profitability, since in 2020 it was only 1.9%.
With the recovery after the control of the pandemic, things have gone for the better and in the second quarter of 2021 the ROE has risen to 11.9% (7.4% in the EU average), which is explained mainly due to lower provisions made. However, this high return should be interpreted with caution as it is partly due to excess provisions made the previous year, so the “true” return for 2021 will be lower than that figure. In any case, it is a good news that profitability recovers to ensure the viability of the banking business that requires being able to place it above what it costs to raise capital, which is the return that the investor demands.
The battery of indicators offered by the EBA allows for a diagnosis of the “health” of the banking sector Spanish in the European context. In addition to the aforementioned greater profitability, health is good in terms of efficiency, since if it costs the European bank 64 euros to obtain 100 euros of net income (efficiency ratio of 64%), it costs the Spanish bank 8.5 euro less. We have a more efficient sector than the main European sectors: 72.6% Germany, 68.6% France and 63.7% Italy.
Where we came out worse off is in terms of solvency, that is, in the amount of own resources that Spanish banks have to face their risk-weighted assets. Specifically, in the case of higher-quality capital, which is the one with the greatest potential to absorb losses, the CET1 ratio is 2.8 points lower than the European ratio (12.7% vs. 15.5%), with Spain surpassing only Greece.
One element of concern is the impact that the Covid-19 crisis is having on asset quality. For now, the delinquency rate has hardly changed (it is at 3.1%, only two tenths more than in December 2020) and is above the European average (2.3%). What has indeed suffered is the percentage of non-performing loans covered with provisions, since the coverage ratio is 40.8% (3.5 points less than the European average) and has fallen 4.1 points since December 2020 .
Certain signs of deteriorating credit quality are observed
In domestic business, credit delinquency is somewhat higher (4.43% in August), but it has not increased with the pandemic, except in some business segments. As the Bank of Spain points out in its latest Financial Stability Reportthere are certain signs of deterioration in credit quality and the growth rate of credit under special surveillance is higher in the sectors most affected by the pandemic.
The large provisions made in 2020 in anticipation of an increase in non-performing loans that has not yet materialized have an impact on the cost of risk. This increased strongly in March 2020 with the outbreak of the pandemic (from 1.1% to 1.8% of assets), remained at high levels in 2020, but already in 2021 it has returned to the level of the end of 2019 before the Covid-19 crisis. However, it is a cost much higher than that of European banks, which in June 2021 is 0.5%. The greatest impact of the crisis in Spain (one of the most affected in the EU) helps to explain this higher cost of risk.
In this x-ray of the Spanish bank in the European context, it is interesting to analyze its income structurewhere there is evidence of the weight that the traditional intermediary business has in our banking sector, characterized by a high weight in the balance of loans and deposits.
For this reason, the net interest income contributes 67.2% of its net income, well above the 55% European average. For the same reason, income from commissions weighs less, since they contribute 6.4 points less than in the EU (25.2% vs. 31.6%), being the distance even greater with Germany (36.6%) , France (35%) and Italy (39.9%).
There is room for maneuver for these fee income to gain prominence in the coming years
Consequently, there is room for maneuver for these commission income gain prominence in the coming years, especially in a scenario of very low rates that penalize the interest margin. However, Spanish banks continue to enjoy a margin in intermediation that is much higher than the European average (2% vs. 1.2%), although the gap is decreasing as the persistence of low rates puts pressure on the margin.
Although thanks to public guarantees credit to the private sector grew in Spain after the start of the pandemic (the live stock increased from February to June in domestic business), it has fallen again in July and August 2021, returning to values of March 2020. The abundance of deposits does not materialize in more loans, so the loans/deposits ratio continues to fall, to 103.2% in June 2021, a percentage lower than the 108.9% of the EU. Obviously, the lack of dynamism in credit acts against the recovery of profitability.
In short, the latest x-ray of Spanish banking invites a certain optimism in terms of profitability recoveryalthough it continues to be the main challenge in the sector that forces us to bet on efficiency gains (which requires cutting costs and diversifying income) as the main solution.
The strong provisions carried out in 2020 are expected to make it possible to deal with the increase in delinquency once it returns to normal after the end of the aid, except in some entities in the event that the support measures (such as ICO guarantees) have been effective limited. But let’s take good note of the risks pointed out by the Bank of Spain, such as the correction of the value of assets (due to rate hikes) and lower economic growth.
*** Joaquín Maudos is professor of economics at the University of Valencia, deputy director of the Ivie and collaborator with CUNEF.