Banking: From Confusion To Perplexity. A Question Of Transparency

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Aristóbulo de Juan | The Spanish system lends itself to great confusion. It is therefore difficult to diagnose. This situation has been dragging on since the recent real estate bubble and the poor handling of the ensuing crisis. Perhaps as a consequence of the doctrine of deregulation. But this situation continues to be favoured by the existence of an ineffective regulatory framework, based on the elusive principle that it is not the actions of the present that should count, but the forecasts of the future. The short-term economic and political costs of turbulence were thus avoided by giving priority to maintaining a semblance of stability, without taking into account that problems that are not addressed when they arise tend to grow faster than possible improvements in the context.

This policy is embodied in two main pillars: theoretical capital requirements and tolerant transparency rules and practices. In effect, the current regulatory capital concept collapses the concept of equity, the basic indicator for measuring insolvency, and considers capital as a non-content component such as goodwill and deferred tax credits. Moreover, the regulations continue to base the valuation of assets on legal default and not on the debtor’s ability to pay, which is no longer checked by supervisors. All in all, the information provided by institutions in terms of capital and results may be debatable or highly questionable.

But perhaps the most worrying consequence of this framework is that a large part of the bad assets may not be provisioned and may remain on banks’ balance sheets or be shifted to investee special purpose vehicles. As a result, in addition to the possible losses that they entail, they give rise to new current losses. Because they do not generate income but their financing does entail costs.

As a result, the accounts of some banks show an NPL ratio of 4% or 5%, which does not reflect the real quality of the assets, thus leading to highly insufficient provisions. They also show excellent capital ratios, which are misleading. The best analyst could be wrong, because if he analysed bad information he came to superficial or wrong conclusions. As the computer scientists say “garbage in, garbage out”. We have the recent example of the fictitious accounts declared by the failed savings banks. And, of course, the drama of Banco Popular, whose resolution revealed a loss greater than its capital, when just a month earlier its own accounts showed a highly positive net worth.

Then, in 2020, the pandemic broke out and, faced with the crisis it produced, a series of measures were approved that prevented the emergence of new problems and even pre-existing ones. Think of the legal postponement of legal delinquency, the tolerance in the coverage of losses and the State facilities (ICO, SEPE), which reach sums of less than 120,000 million and allow companies in difficulties to survive. Some analysts do not rule out the possibility that part of this aid has been earmarked for companies that have been able to repay their debts to the banks. In this case, the banks would also be helped, with the public purse assuming the risk. These measures may have been unavoidable but they contribute to the opacity of the system. In any case, these are temporary measures.

It is worth recalling here that, since 2010, the European Central Bank, like other central banks, has been injecting massive amounts of liquidity into the markets. This “whatever it costs” policy probably saved systemic problems initially, but has been perpetuated to date, which may have relaxed the banker’s sense of risk and prevented existing problems from surfacing. Again the danger of opacity.

Against this backdrop, the banks are beginning to publish their 2021 year-end accounts, and they report some unique facts, which I will summarise here. In addition to the optimism already described in the valuation of assets and the insufficiency of provisions, many banks are deciding to reverse part of these provisions, thereby artificially boosting their results. On the other hand, banks that have acquired other institutions use negative goodwill to kill off previous provisions and thus improve their results with an accounting entry. Recall that this goodwill is only an accounting entry for the difference between the acquisition price and the book value of the acquired entity.

The aforementioned reversal of provisions and negative goodwill have led more than a few banks to declare spectacular results that are striking. In some cases they are more than double those declared as a result of their own business.

It is also the case that the profits thus achieved have been able to feed the distribution of dividends. In any case, institutions have decided on a dividend distribution of around 50% of profits, without it being clear whether this is pre-tax or post-tax profit.

On the other hand, the rules allow negative goodwill to also feed into regulatory capital, which can thus remain at artificially satisfactory levels.

In terms of dividends, “scrip dividends”, or the payment of part of the dividend in treasury shares, is also becoming widespread. If these were shares that the bank already held in treasury, it would be a good measure to clean up its capital. But what we are seeing today is that it involves paying with newly acquired own shares and in volumes of up to 10% of equity capital, which would allow the bank to distribute higher dividends, but with the same outflow of liquidity as if it were paying in cash, and causing an artificial rise in the share price that alters the market game.

Regardless of the uniqueness of the practices described here, one wonders whether they can be understood in the economic context of our country. Because we are still recovering from the severe slump caused by the pandemic and many companies and sectors are facing serious problems that may have been covered up by the “life-saving” measures and the huge abundance of liquidity, problems that may emerge when these measures expire and liquidity on the markets is significantly reduced.

This is without taking into account the strong international problems, such as higher energy prices, disruptions in supply chains and a sudden rise in inflation. And, of course, the tense geopolitical context.

This whole picture coexists with numerous clean audit reports. I don’t know how supervisors see it. But I, for lack of more information, have moved from confusion to bewilderment.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.