IMF sees weaknesses in banking system

Spain has made progress in overhauling its financial system a year after seeking a bailout from its European partners to recapitalize its banks, but the International Monetary Fund (IMF) has concluded that some weaknesses remain that have to be addressed.

In its third report in the financial sector reform, the IMF said the government needs to maximize the value of the banks that have been nationalized and improve the performance of the Sareb assets management corporation — the so-called bad bank set up to absorb the toxic assets of lenders over-exposed to the ailing real estate sector — in order to avoid conflicts of interest. It said Sareb needs to take a more realistic approach to the pricing of the assets it has absorbed, while banks as a whole should focus on strengthening their capital rather than paying dividends.

"Actions to recapitalize parts of the banking sector and the asset transfers to Sareb have provided an important boost to the system's liquidity and solvency," the report says. "Notwithstanding this progress, risks to the economy and hence to the financial system remain elevated."

The report highlights the fact that the financial sector continues to exacerbate the recession through a contraction in credit, and higher rates, and urged banks to lend more while at the same time boosting their capital.

The report points to the potential risks of banks further reducing their loan portfolio in order to meet capital adequacy ratios rather than increasing capital itself. "Supervisory actions to strengthen solvency and reduce risks should prioritize measures that increase nominal capital over ones that reduce lending," it said.

The IMF expects lenders will need to make more provisions to cover potential loan losses and should make the accurate classification of loans a priority. "In this context, the Bank of Spain's recent incentive to promote more consistent and accurate classification of refinanced loans is welcome," the report says.