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Table of Contents1.Introduction32.Causes of Spanish banking Crisis42.1Deregulation destroyed Spanish Banks42.2High proportions of doubtful loans on the balance sheet42.3Weakness in risk management62.4Pressure from the property bubble63Consequences of Spanish banking crisis63.1Banks failed and the bailout package63.2Decline in competitiveness83.3Social consequences and deepening recession84Worldwide implications and Lessons from Spains banking crisis94.1Worldwide implications of Spanish banking crisis94.2Lessons from Spains crisis105Conclusion11References12


1. IntroductionSpain is coping with the worst crisis in the last fifty years. What this country has to suffer from now is the impact of the international financial crisis, however, the root cause of the problem is Spains banking system. Before the crisis, Spanish banks had stable developments and safe operations. The Spanish banking system was considered one of the strongest in the world, as the reputation of its banks had been built up during the history (Btiz-Lazo, 2004). Spain also had a tangible banking-supervising structure. Bank of Spain was seen as a typical one of this structure as the international standards of solvency was always applied before the country was required to implement them (Buck, 2013). However, with the explosion of the crisis: The whole banking system staggers. In the middle of 2012, Fitch cut the credit rating of nearly 20 Spanish banks (including 2 biggest banks: Santander and BBVA) by three notches to BBB after many banks in this country had been slashed before (Sills, 2012). This essay is to elaborate on the Causes and Consequences of the Spanish banking crisis and indicate some lessons to avoid similar issues. Two core sectors: Risk management in the banking system and the real estate sector will be analyzed deeply as they mainly contributed to the explosion of the crisis. Some issues that are affected by the crisis such as the bailout of banks and debt growth will be pointed out as well.

2. Causes of Spanish banking Crisis2.1 Deregulation destroyed Spanish BanksSince 1988, the removal of branching barriers in Spain has led to a significant nationwide expansion of Spanish savings banks, also known as Cajas, in terms of branches and total assets. The main target of deregulating the banking system in Spain is to motivate competition among banks in order to raise allocative efficiency and economic growth. However, this expansion has created a good condition for these banks to stimulate their growth aggressively by lending more and higher risk taking.Apart from Traditional banks, Saving Banks play the major role as it accounts for than 48% of deposits and 46% of the loans in the whole industry. Before the crisis, a big number of the Savings Bank harbored financial imbalances, mainly due to the high risk concentration in construction activities and property development. As the domino effect, when the real estate market sunk into the crisis, it led to harsh impacts on the banking system. 2.2 High proportions of doubtful loans on the balance sheetThe Spanish banking system made great losses due to the burst of the housing bubble and the heavy proportion of real-estate loans in their balance sheet.Figure 1: Spains Non performing loans Ratio

Source: (Michael, 2013)Figure 1 shows the vast increase in the Spains Non performing loans Ratio from 1978 to 2012. The non-performing loans (NPLs) among banks in Spain rose dramatically from 2008 to 2012 and peaked at over 11% in May 2012. After that, the trend seemed to decrease due to the transfer of bad assets into national bad bank SAREB. Most of NPLs in the banking system are mortgage loans.Figure 2: Spains Non performing loans: Construction and real estate services

Source: (EURO-BANKS.COM, 2012)Figure 2 shows the proportions of NPLs in construction and real estate services of Spanish banks increased very fast from 2008 to 2012 and peaked at over 30% and 28%, respectively in November 2012. However, Spains NPLs are not only high in the construction and real estate sector but other sectors also show negative trends. Figure 3: Spains non performing loans: increasing across the board

Source: (EURO-BANKS.COM, 2012)Figure 3 shows the increasing trends in NPLs in 3 other sectors. All of them increased dramatically since 2008 and is expected to rise in 2013. Having said that, Spanish banks harbor too much NPLs so that they had to face with serious liquidity risks when these NPLs are out of control.2.3 Weakness in risk managementBank managers were captivated by short-term benefits, therefore, they tried to grant loans, despite being aware that their customers could not repay if the real estate price does not increase in the upcoming time. During the granting process, risks were not transferred to any third parties outside the banks, therefore, when the bubble burst, banks were affected severely.The problem even got worse when Spanish banks borrowed money from international markets to offer more loans, this tactic is seen as a highly risky one. Not all banks have to face with the situation, but that method did leave the banking system massive losses. (BBC News, 2012)2.4 Pressure from the property bubbleThe real estate market is considered the source of the banking crisis in Spain. From 1985 to 2007, the value of properties in Spain increased dramatically to over 200% (Grilli, 2012). The reason for this high demand is explained by 2 factors: the larger economic enlargement (due to the real estate boom) and the low interest rate on housing loans after the Euro integration (from 9.6% in 1997 to 3.3% in 2007) (Grilli, 2012). A very sharp response on the supply was shown to meet the demand: The number of completed dwellings per year went up to half a million from 1997 to 2007. Due to this fact, housing investments also accelerated rapidly, causing an extraordinary demand for credit and created high households private debt. Since late 2007, housing prices have started to decrease slightly and sales had to suffer from a very low drop.

When the housing bubble burst, Spain has the largest reduction in the number of new constructions in the Eurozone. Investors, as a result, they had to find help from banks. Spanish banks even had to offer long-term mortgage loans to investors, up to 40 or 50 years. 3 Consequences of Spanish banking crisis3.1 Banks failed and the bailout packageIn September 2012, many banks and financial institutions in Spain had to take stress tests to see whether or not they can cope with difficulties in the crisis. Seven of them, which account for nearly 40% of the country's banking system's credit portfolio (Yahoo Finance, 2012), failed the test and they need to seek help from the government to overcome possible bankruptcy.

Figure 2: Spanish Banks failed stress tests

Source: (Yahoo Finance, 2012)A total amount of 59.3 billionwill be used by the government to prevent those banks from collapsing. 3 Spanish banks including: Bankia, Catalunya bank and Nova Galicia Banco would be reduced in scale restructured and Banco de Valencia would be sold to avoid going bankrupt (Yahoo Finance, 2012). Seeking financial assistance from the international parties.On 21st June 2012, the decision was made that 62,000 million euros would be used to rescue the Spanish banks (News Wires, 2012). The prime Minister of Spain, Mariano Rajoy initially considered the rescue fund as it is not a bailout for his country. However, in the case of Spain, it could not be able to save its banks with its existing capabilities and the costs of borrowing on the markets is too high to collect the funds. Therefore, the bailout from EC is the only choice for Spain.The Spanish government planned to inject 19 billion euros into the Bankia Bank- the fourth largest bank in Spain (Charles Penty, 2012). This is the largest rescue package in this countrys history. The Bankia Bank was affected most by the housing bubble in 2007. This bank held up to 10% of deposits in the Spanish banking system.Who provided the bailout?The money would be provided by 2 funds: the European Stability Mechanism (EMS) and the European Financial Stability Fund (EFSF) (, 2012). The money borrowed from the EMS has to be paid ahead of the countrys bond holders. This problem might make the markets less willing to lend to Spain. Spain would have to comply with the conditions of the rescue fund, in which, the country will establish a bank, which is responsible for buying back non-performing loans from other banks.

3.2 Decline in competitivenessThe crisis has affected Spains international reputation and credibility in negative ways. The country used to be seen as one of the most successful stories in the Eurozone, however, it now has to seek help from international parties. As a result of the crisis, Spains credit rating was cut from AAA before the crisis to only BBB (Moody's, 2012). As a result of the weakening of the Spanish government's creditworthiness, on 25 June, 2012, Moodys downgraded the credit rating of 28 Spanish banks (Moody's, 2012), in which, Banco Santander, one of the biggest Spanish Banks, was downgraded from A3 to Baa2. This event made the share prices of Spanish banks decreased by 4.6 % on the same day (BBC news, 2012). This means that in the future, Spain might no longer have a good position in the eyes of foreign investors and the country would not be able to govern itself as well as it used to be.3.3 Social consequences and deepening recessionThe crisis forced the country to use austerity measures, as a result, this led the country into a very serious recession due to the weak purchasing power. As we can see from the figure 4 and 5, all 5 ratios of Spain show negative signs. Its GDP growth and public deficit (general government net lending/borrowing as a % of GDP) were below zero during the 5 years, while the public debt (General government gross debt as a % of GDP) rose gradually.Figure 4: Spains economic state from 2008 to 2012

Source: (Global Finance, 2012)Moreover, the government cuts down on the scale of banks, causing wage freezes and social protests occurred in many cities of Spain, as a consequence, affecting the countrys normal operations.

Unemployments Uncontrolled GrowthThe effect of the crisis has prompted the unemployment rate of this country to increase quickly. As can be seen from the chart, the unemployment rate of Spain increased steadily from 2008 to 2012. It is predicted that this rate will continue to increase till 2014. During only 4 years, the proportion has risen by 18% and things get worse when it comes to young people.Figure 2 : Spain Unemployment Rate

Source: (, 2013)Over a half number of young people are unemployed and his proportion is the highest rate in the Eurozone. There are many factors constituting this phenomenon:Firstly, the impact of the housing crisis has resulted in the high level of unemployed people, who work in the Spanish construction sector (including real estate).Secondly, with the trigger of the crisis, firms in Spain were forced to cut down on their costs to protect their market share and increase competitiveness. The quickest way to make adjustments is to dismiss their employees.4 Worldwide implications and Lessons from Spains banking crisisSpain, as the fourth largest economy in the Eurozone and the 10th largest economy in the world, fell into a really serious crisis and strongly affected the worldwide economy. Its problem is a big lesson for the rest of the world: A country with strong financial capabilities still cannot avoid crisis if it underestimates the importance of risk management. 4.1 Worldwide implications of Spanish banking crisis4.1 Policy implicationsThe tale of Spain has become a famous case of the world today because the survival of the Eurozone will be dependent on the recovery of the Spanish economy. It also relates to other parts of the world, where savings banks are still playing a big role in the banking system. Many nations have liberalized the regulations on components of their banks and often received negative results. Germany, for instance, removed state guarantees for its Landesbanks and savings banks in the early 2000s (Illueca, 2013). Taking advantage of lower funding costs, State- owned Landesbanks invested in very risky projects such as as tranches of securitized US subprime mortgages. Other salient examples of failure of banks due to deregulation of saving banks can be listed such as Savings bank-run in South Korea, failure of Japanese credit cooperatives in 1990s (Illueca, 2013).Overall, the study of Spanish banking crisis has 2 significant implications:Firstly, deregulation in the banking industry should take into account adequately the objectives and corporate governance (risk-taking in particular) of the banks. Secondly, liberalization, which motivates growth, can result in unexpected consequences if the former regulations were used to limit risk taking or to maintain minimum safety standards.4.2 Economic slowdown in other European countriesThe weakness of the economy in Spain directly affects other regions through trade and investment. The huge uncertainty will weaken the enterprises confidence, leading to a global economic slowdown. The problems of the banking system in the Eurozone would also improve the level of the risk premium in the interbank market, the financial system and the real economy.4.2 Lessons from Spains crisisThe failure of Spanish bank is mainly rooted from the weakness in the banking management, especially risk governance. Therefore, the most important lessons are to add more regulations to banks performance and restructure banks internal risk management using efficient methods below:a. Set up the restraint mechanism of financial riskBanks should start with the bank's property right at the reform and it is important to strengthen the constraints on the banks capital. Moreover, Spanish banks should transform the fiscal and banking functions to tighten the credit constraint on the enterprises and use finance to the bank credit constraints. Finally, through the establishment of laws and regulations on financial institutions, there are constrained in assets and liabilities management and risk responsibility. b. Strengthen the supervision of the financial industryEstablishing a supervision system of banking is necessary. First of all, it is important to improve risk management and pay more attention to compliance regulation. Secondly, the weakness of the banking system should be removed by adding more regulations such as applying the higher requirement for building up capital and provisions to increase the liquidity of banks through setting up the capital adequacy ratio, asset quality, liquidity ratio and internal control evaluation to guard against risks. At the same time, more supervision should be put on non-bank financial institutions by strengthening the external audit and strict asset-liability ratio.c. Establish an effective financial risk warning and handling mechanismIt is very necessary to establish an early warning mechanism of financial crisis, the timely discovery and treatment of the financial risk to reduce the cost of the financial crisis. On one hand it is important to build a complete, reasonable pre-warning system and according to the change of financial innovation, technological progress and other factors and timely adjustments. On the other hand, banks must form the supporting laws and regulation system of organization and system, through the financial stability report system perfect, effective and timely report the financial situation and the systematic financial risk degree, establish and improve the decision-making and implementation of the system of crisis management.5 ConclusionSpanish banking crisis is an outcome of many factors but the main cause is the poor governance in the bank industry. The effects of deregulation on the Spanish banking system have pushed Spains banks into serious situations and they had to seek assistance from the international bailout package. Having said that, deregulation is a good attention to stimulate competition between banks, however, if the risk management is not applied properly, this method might become a bomb. The world is currently facing with a very big financial crisis and mostly, it is derived from the banking crisis in big countries. Spains crisis has left bank managers many important risk-taking lessons.(2500 words)

Referencesa) Pere Arqu-Castells; Elisabet Viladecans-Marsal, 2013, Banking towards development: Evidence from the Spanish banking expansion planb) SUBBAIAH SINGALA; N. R. V. V. M. K. RAJENDRA KUMAR, The Global Financial Crises with a Focus on the European Sovereign Debt Crisis, ASCI Journal of Management 42 (1): 2036c) Ana Lozano-Vivas; Michel Dietsch, How the environment determines banking efficiency: A comparison between French and Spanish industries; Journal of Banking & Finance. Btiz-Lazo, B., 2004. Strategic Alliances and Competitive Edge: Insights from Spanish and UK Banking Histories. 46(1), pp.23-56. Available at: News, 2012. Eurozone crisis explained. [Online] Available at: [Accessed 1 September 2013].BBC news, 2012. Spanish banks have credit ratings cut by Moody's. [Online] Available at: [Accessed 5 September 2103].Buck, T., 2013. Recession-hit Spain drags down top banks. [Online] Available at: [Accessed 26 April 2013].Charles Penty, E.R.-T., 2012. Bankia Seeks 19 Billion Euros From Spain for Cleanup. [Online] Available at: [Accessed 5 September 2013].EURO-BANKS.COM, 2012. Spain: non performing loans are still increasing, and not just in real estate. [Online] Available at: [Accessed 6 September 2013].Global Finance, 2012. Spain Country Report. [Online] Available at: [Accessed 3 September 2013].Grilli, M., 2012. Unwinding the Spanish house price. [Online] Available at: [Accessed 6 September 2013].Illueca, M., 2013. How deregulation destroyed Spanish banks. [Online] Available at: [Accessed 27 June 2013].Michael, 2013. Spains Real Non-Performing Loans (NPL) Approach 25% of GDP. [Online] Available at: [Accessed 3 September 2013].Moody's, 2012. Moody's downgrades Spain's government bond rating to Baa3 from A3, on review for further downgrade. [Online] Available at: [Accessed 5 September 2013].Moody's, 2012. Moody's downgrades Spanish banks. [Online] Available at: [Accessed 5 September 2013].News Wires, 2012. Spain formally asks eurozone for bank bailout. [Online] Available at: [Accessed 5 September 2013], 2012. Spanish bank bailout to start under EFSF, move to ESM: sources. [Online] Available at: [Accessed 5 September 2013].Sills, B., 2012. Spain Downgraded to BBB as Fitch Predicts Slump Through 2013. [Online] Available at: [Accessed 8 June 2012], 2013. Spain's unemployment rate. [Online] Available at: [Accessed 2 September 2013].Yahoo Finance, 2012. A glance at Spanish banks that failed stress test. [Online] Available at: [Accessed 5 September 2013].