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Economic, financial and regulatory environment

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THE YEAR 2017 WAS MARKED BY A RECOVERY IN BANKING ACTIVITY IN A CONTEXT OF REGULATORY PRESSURE AND LOW PROFITABILITY.

LAST YEAR WAS THE BEST YEAR FOR THE WORLD ECONOMY SINCE 2011. GLOBAL GROWTH WAS STRONG, CLOSE TO 3.5%. 

The strength of the European countries was especially significant because the improvement during 2017 was both quantitative and qualitative, with the growth being more balanced across countries (France and Italy, which had been lagging behind, performed significantly better) and across the components of demand (the acceleration of consumption reduced dependence on the foreign sector).

The emerging economies improved too, mainly thanks to the strength of China (6.9%) and the recovery of Brazil and Russia (which exited recession).

Overall, for the first time in more than six years, all the main economies grew above their potential, reducing idle capacity and boosting global inflation, thus warding off the risk of deflation. Specifically, prices in the euro area rose 1.5% in 2017, compared to 0.2% in 2016.

The robust macroeconomic conditions were an important factor in bringing stability to the financial markets, in contrast to the occasional spikes in risk, both political (uncertainty created by the Trump administration, Brexit, political uncertainty in Catalonia and difficulties in forming a government in Germany) and geopolitical (North Korea, Islamist attacks, tensions between Iran and Saudi Arabia).

In this scenario the central banks slowly gained confidence in the sustainability of the global expansion and took steps to gradually withdraw monetary stimulus measures. The United States Federal Reserve raised its interest rate three times, to a range of 1.25%-1.50%, and started to reduce its balance sheet in October.

In April the European Central Bank (ECB) slowed the monthly pace of asset purchases from 80,000 to 60,000 million and announced a further decrease, to 30,000 million euros, from January this year, although it extended its programme until September.

This synchronised action by the main central banks generated some upward pressure on yields, although persistently low inflation (especially in the euro area), geopolitical uncertainty and doubts as to whether the United States would be able to implement its tax reforms limited the scope for upward movement.

The 10-year Spanish bond performed well, despite the political uncertainty in Catalonia, and the risk premium held steady between 100 and 130 basis points, falling to 70-80 basis points at the start of 2018.

SURGE IN THE SPANISH ECONOMY

After four years of expansion, the GDP exceeded the levels it had reached before the crisis broke in 2008.

The buoyancy of economic activity translated into strong job creation, with 490,000 more people in work, in terms EAPS, for a total labour force approaching 19 million, the best year-end figure since 2008. This had the effect of reducing the unemployment rate to 16.5% of the labour force, its lowest level in nine years. However, the aftermath of the crisis is still apparent in employment levels, as 1.75 million jobs have still not been recovered.

THE SPANISH ECONOMY MAINTAINED A VERY DYNAMIC PACE THROUGHOUT 2017, WITH GDP GROWTH OF

3.1% 

The inertia of the Spanish economy continued to benefit from favourable financing conditions, the strength of the tourism industry (which continued to set new records) and in particular, the favourable performance of its trading partners.

Unlike on previous occasions, the growth is proving compatible with the correction of imbalances (such as the external deficit and private debt) which in the past have tended to cut such expansions short and is sustained by all the components of demand, both consumption, investment and exports.

Household spending continued along the path of gentle moderation begun in mid-2015, as certain factors that stimulated spending (tax cuts, low inflation) were dampened, while others persisted (positive labour market performance, fall in interest rates). Companies, for their part, took advantage of their high financing capacity to continue to increase and improve the stock of productive capital and reduce their indebtedness.

Construction, which the previous year was held back by the slowdown in public investment, achieved faster rates of growth, mainly thanks to the residential segment. The housing market performed strongly, driven by prices and real estate development, albeit with notable differences between regions.

External demand once again contributed positively to GDP growth, thanks not only to strong exports (partly due to the locomotive effect of the European economies) but also to the constant efforts to improve the competitiveness of the productive sectors, not only through price and cost reduction but also through innovation and internationalisation.

Since 2012 the economy has been generating financing capacity, currently equivalent to 2% of GDP, which is making it possible to finance investment while continuing to reduce private sector leverage. In fact, household and corporate debt reached 159.9%, the lowest figure in 12 years.

Inflation started the year at a four-year high (3%) but then began to gradually decline, ending the year at 1.1%, compared to 1.6% in 2016. The annual average was 2.0% (-0.2% the previous year).

For 2018 we anticipate a moderate slowing of the rate of growth, although the powerful expansionary inertia and the positive external context will favour average GDP growth in the region of 3%.

BANKING BUSINESS AND REGULATION

In the banking arena, the year was marked by an increase in banks’ financial strength and a recovery of activity, in financial and regulatory conditions that put great pressure on profitability.

Over the year, Spanish banks strengthened their balance sheets and further improved their ability to absorb shocks. The solvency indicators rose and the non-performing loans ratio was reduced by more than one percentage point, to below 8%. The resolution of Banco Popular, which was absorbed by Santander in June, did not give rise to any problems for system stability.

The activity of Spanish banks was supported by the buoyancy of the economy and the favourable financing conditions. New lending to households and companies gathered pace, reaching a cumulative total of more than 400,000 million euros (excluding renegotiated loans), up 11% on the previous year.

The progress was spread across all sectors, including SMEs, the self-employed, consumer finance and housing. However, it was not sufficient to prevent the volume of lending to companies and households as a whole from falling year-on-year, albeit more slowly, as a result of the gradual deleveraging of certain segments of the private sector.

The stability of deposits proved compatible with an increase in the net assets of mutual funds, largely due to higher net subscriptions. The loan-to-deposit ratio of companies and households continued to decrease and by year-end was 50% below the high reached at the start of the crisis.

Profitability remained subject to the strong pressure of continuing very low interest rates.

The net interest margin narrowed again last year, although lower net interest income was offset by an increase in net fee and commission income and a further reduction in operating expenses, giving Spanish banks one of the best efficiency ratios in the euro area.

PROFITABILITY REMAINED SUBJECT TO THE STRONG PRESSURE OF CONTINUING VERY LOW INTEREST RATES

Measured in terms of capital, financial system profitability remained below the cost of capital, as in most European countries. To achieve this, banks continued to make strategic adjustments through cost cutting, mergers and advances in digital transformation.

As regards supervision, 2017 was the second year of application of the Supervisory Review and Evaluation Process (SREP) by the ECB. Through the SREP, the supervisor sets minimum capital requirements for significant institutions and issues Pillar 2 Guidance (P2G), a new confidential and non-binding requirement.

The ECB, one of whose top priorities is to reduce non-performing loans, issued guidance to banks on how to manage their high volumes of non-performing loans and properly clean up their balance sheets.

The EU’s Economic and Financial Affairs Council (Ecofin) proposed an action plan that includes additional measures to reduce the stock of non-performing loans, which must be adopted during the first quarter of 2018.

In Spain, the Government passed a decree law on urgent financial measures, which included two substantial changes: a reform of the legal regime governing cooperatives and the creation of a new category of loss-absorbing liabilities, “non-preferred senior debt”, which will facilitate compliance with the MREL and the TLAC.

INCESSANT REGULATORY REFORM

In 2017 the regulatory reforms continued. At the global level, implementation of the TLAC buffer (loss absorption requirement for global systemically important banks) went ahead, prompting a significant increase in new issue volume.

In Europe, further progress was made towards Banking Union, with the agreement to review the crisis resolution and solvency frameworks, in line with the reform proposed by the Commission in November 2016.

Measures include the introduction of the TLAC in Europe and its alignment with the MREL (minimum required eligible liabilities for European systemically important banks, at an individual level) and the creation of a new category of loss-absorbing liabilities (non-preferred senior debt).

The Single Resolution Board published its policy on the MREL, the highlights being that the targets will be set and notified to banks in the first quarter of 2018, will not be public and will be reviewed annually, and that the Board will set bank-specific transition periods of no more than four years.

In addition, transitional provisions were introduced to mitigate the impact on own funds of the new IFRS 9 accounting standard, which is intended to improve the coverage of financial instruments.

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