Royal Decree-Law 2/2011 of 18 February for the reinforcement of the financial system

ROYAL DECREE-LAW 2/2011, OF 18 FEBRUARY, FOR THE REINFORCEMENT OF THE FINANCIAL SYSTEM.

Head of State

"BOE" No. 43, of 19 February 2011

Reference: BOE-A-2011-3254

INDEX

Preamble................................................................ 3 TITLE I. Reinforcement of the own resources of credit institutions........................ 10 Articles 1 to 3.......................................................... 10 TITLE II. Reform of the Bank Restructuring and Orderly Resolution Fund (FROB)............................ 10 Article 4. Modification of Royal Decree-Law 9/2009, of 26 June, on banking restructuring and reinforcement of the own resources of credit institutions........................ 10 Additional Provisions...................................................... 17 First Additional Provision. Exception to the obligation to formulate a public takeover offer in restructuring or integration processes.................................... 17 Second Additional Provision. Certain cases of non-subjection to temporal limitations for the activity of newly created credit institutions............................ 18 Third Additional Provision................................................. 18 Fourth Additional Provision. Certain cases of adherence to Deposit Guarantee Funds.................................... 18 Fifth Additional Provision.................................................. 18 Transitional Provisions...................................................... 18 First Transitional Provision. Strategy for compliance with capital requirements......... 18 Second Transitional Provision. Regime for preferred shares in circulation...................... 19 Third Transitional Provision. Counting as core capital certain instruments of debt mandatorily convertible........................................... 19 CONSOLIDATED LEGISLATION Page 1

Fourth Transitional Provision. Transitional regime for recapitalization operations of entities. 19 Repealing Provisions..................................................... 19 Single Repealing Provision. Regulatory repeal.................................. 19 Final Provisions......................................................... 20 First Final Provision. Modification of Royal Legislative Decree 4/2004, of 5 March, approving the consolidated text of the Corporate Income Tax Law................... 20 Second Final Provision. Extension of the regime for company administrators................. 25 Third Final Provision. Development powers................................... 25 Fourth Final Provision. Competence titles.................................... 25 Fifth Final Provision. Entry into force......................................... 25 OFFICIAL STATE GAZETTE CONSOLIDATED LEGISLATION Page 2

CONSOLIDATED TEXT Last modification: 30 November 2013 I The tensions faced by the international financial system since the beginning of the crisis have hindered the fulfillment of its essential function as a channel for credit to the economy. The increase in the cost and availability of financing has seriously affected the development of the entire real economy, limiting the possibilities of economic growth. The difficulties of the financial system in fulfilling this main function of channeling savings to the spending needs of economic agents have affected both household budgets, and, very especially, the financing of small and medium-sized enterprises, the true core element of our business fabric.

In this context, the set of credit institutions has faced, in addition to severe restrictions on access to financing, a relative deterioration of their assets, especially those related to the real estate sector, a notable increase in loans classified as doubtful, and finally, a decrease in their business, as a consequence of both the duration, intensity, and extension of the crisis, as well as the strong drop in economic activity caused by it.

The crisis has highlighted the need to guarantee by public authorities the bases for the existence of a competitive and solid financial system that facilitates intermediation between holders of financial resources and those with investment needs. A well-structured financial system constitutes the main guarantee that the productive economy of a country can have the financing it requires to develop to its full capacity, generating wealth and job creation. It can be concluded that this entire process is based on confidence, the integrity of institutions, and the proper functioning of markets.

This importance of the financial system justifies the priority and unavoidable nature of State intervention to ensure its proper functioning.

In this sense, since the beginning of the crisis, two types of interventions have been occurring in the international context. On the one hand, measures aimed at, if not avoiding, at least limiting the consequences of future financial system crises on the entire economy stand out: the reinforcement of the international financial architecture; the strengthening of supervision; and the adoption of new and much more demanding capital rules for financial institutions are examples of this. On the other hand, measures to support the financial sector stand out, which States have adopted individually or jointly to restore confidence and mitigate liquidity pressures. First, the coverage of corresponding guarantee systems was expanded. Secondly, in the face of the contraction and near disappearance of wholesale financing markets, some States, in parallel with the ECB, articulated mechanisms to promote liquidity. Thirdly, to address the deterioration of banks' own resources, public capital injections into entities were carried out, with varying degrees of difficulty. Finally, in order to clarify the value of damaged bank assets and facilitate the restructuring of entities, some States approved aid to clean up their balance sheets and stress tests were conducted on a wide range of financial entities.

The Government of Spain, for its part, has been promoting a series of measures since the beginning of the crisis, which are now completed with the content of this royal decree-law, aimed at facilitating access to financing for credit institutions, safeguarding system stability, fostering their restructuring and efficiency, and ultimately ensuring the proper channeling of credit to the real economy.

These measures began with the reinforcement of the guarantee of bank deposits in line with the rest of the EU Member States, followed by support for the liquidity of credit institutions through the purchase of high-quality financial assets through the Financial Asset Acquisition Fund (FAAF) and the provision of public guarantees on their debt issuances. Subsequently, the strengthening of intervention, discipline, and resolution procedures for unviable entities occurred through Royal Decree-Law 9/2009, which created the Bank Restructuring and Orderly Resolution Fund (FROB), as a complement to actions that may be carried out by Deposit Guarantee Funds. Additionally, as a way to incentivize the necessary capacity adjustment of our financial system to the size required in the medium and long term, it was necessary to articulate temporary support for the recapitalization of solvent entities, through the acquisition of preferred shares by the FROB, conditioned on the restructuring of the requesting credit institutions. Finally, there has been a hardening of accounting standards for estimating and recognizing the impairment of doubtful credits, and especially of mortgage guarantees and properties adjudicated in lieu of payment, and, more recently, transparency has been strengthened through the establishment of an information regime on the balance sheet status of entities, detailing their exposures and provisions by loan type, as well as their business plan and solvency status.

Separate mention deserves the reform of the legal regime of savings banks approved by the Government through Royal Decree-Law 11/2010 and validated with broad consensus by the Congress of Deputies during July 2010. The depth of the reform represented a historical milestone in the regime of Savings Banks with the objective of achieving greater professionalization of their administration and management, and, above all, to equip them with the capacity to take organizational forms that would enable access to basic capital markets. The legal framework created in July is indispensable to face the current and future challenges of our financial system and, more specifically, to immediately implement the measures contained in this royal decree-law.

This set of measures has contributed to minimizing the impact of the global crisis on the Spanish financial system and, very especially, on the public treasury. At the same time, they have facilitated the most important and rapid restructuring process of the financial sector in our history. This restructuring process has been especially intense in the savings bank sector, which in less than a year went from having 45 individual entities, with an average size of 28,504 million euros, to being integrated into 17 entities or groups of entities, with an average asset volume of 75,452 million. This reduction in the number of entities has also meant the beginning of a process of reducing the number of branches and structural costs, promoting a more efficient and competitive financial system.

In addition to the implementation of measures driven by the National Government, Spanish entities underwent, in July 2010, extensive resistance tests, as they covered all our entities, and intense, that is, with very severe scenarios, especially regarding the evolution of credit to the real estate and construction sectors. The publication of these exercises, with exhaustive detail by asset type, evidenced the solidity and resilience of our financial system, showing that Spanish credit institutions, with very few exceptions (and insignificant for the system as a whole), were in a good position to face very adverse and unlikely situations.

On the other hand, entities have also been reacting to the difficulties presented by the current environment by adopting measures such as increasing their retail deposit base, rationalizing their structural costs, reinforcing their capital, and cleaning up their assets. Thus, the entire Spanish banking system from January 2008 to the end of 2010 recognized and assumed losses in the value of assets by an amount equivalent to 9% of GDP through the provision of specific net provisions, which naturally have dampened their results, the use of the general provision fund, and by recognition of "fair value" against reserves in the integration processes of savings banks. In addition, they have carried out a recapitalization by an amount of approximately 3% of GDP, with the solvency level of our entire system being very notable today, with a TIER 1 level of 9.6% of risk-weighted assets, according to the latest available data.

Given the current situation of our financial system, the evolution of the last months of financial tensions in the euro area environment has generated doubts about the capacity of the Spanish financial system. Constituting confidence the ultimate pillar of a financial system, this perception runs the risk of creating an undesirable dynamic insofar as these elements of uncertainty can further hinder access to financing by entities, which in turn would increase the perception of risk, hindering the flow of credit to the economy, eroding the capacity for growth, in a process of negative feedback.

It is, therefore, indispensable to prevent the development of said dynamic and immediately eliminate all uncertainty regarding our financial system and, by extension, our entire economy. To this end, it is necessary to guarantee that each of the entities composing the Spanish banking system presents levels of maximum quality capital sufficient to dispel any doubt not only about their current solvency, but also about their solidity against all types of scenarios, including those unfavorable even if they have a remote probability of materialization. In this way, confidence in the Spanish banking system will be strengthened, which will facilitate access to financing for all entities, thereby contributing to achieving the fundamental objective of any banking system, namely, the fluid channeling of savings into investment.

In this context, this royal decree-law responds to a double objective: on the one hand, to reinforce the solvency level of all credit institutions, by establishing a high level of requirement regarding maximum quality capital, in order to dispel any doubt about their solvency; and to accelerate the final phase of the restructuring processes of entities, through the indispensable framework created by Royal Decree-Law 11/2010. These objectives will guarantee the function of the financial sector to channel credit to the economy and, in the case of savings banks, it is compatible with the indispensable objective of maintaining their social work.

The measures contemplated in this Royal Decree-Law are articulated in two large blocks: the reinforcement of entity capital and the adaptation of the FROB as a public instrument to facilitate the new required capitalization.

Regarding the reinforcement of solvency, an advanced and demanding application of the new international capital standards, Basel III, is established. Thus, an immediate establishment of a minimum core capital, in relation to risk-weighted assets, is carried out, basically following the definition that Basel III establishes to be met in 2013. This minimum level of the core capital ratio is set at 8%, being 10% for those entities that have not placed securities representing their capital to third parties for at least 20%, and, furthermore, present a wholesale financing ratio greater than 20%. The aim is thus for entities to equip themselves with capital of the highest quality, sufficient to guarantee high solidity, with the highest requirement for those entities that have less agility to capture basic capital when necessary.

Additionally, the Bank of Spain may require an individual entity a higher level of core capital based on the results of stress tests that may be conducted for the system as a whole.

The elements that make up core capital are, in line with what is established in Basel III for 2013: capital, reserves, share premiums, positive valuation adjustments, minority interests; and, additionally, instruments subscribed by the FROB and, temporarily, instruments mandatorily convertible into shares before 2014 that meet certain requirements that guarantee a high capacity for loss absorption. These elements will be reduced by negative results and losses, negative valuation adjustments, and intangible assets.

These new requirements will enter into force on 10 March 2011. Furthermore, given the evidence that some entities will have difficulty reaching this new requirement immediately, the rule has designed a progressive compliance strategy.

Those entities that do not reach the required level of core capital by 10 March will have 15 business days to communicate to the Bank of Spain the strategy and schedule with which they guarantee compliance with the new 8% or 10% core capital requirements, as applicable, before 30 September 2011. This strategy, which may contemplate the capture of third-party resources and the listing of entities, must be approved by the Bank of Spain, which may also require modifications or additional measures.

However, given that some issues could arise that could delay compliance, related to operations or procedures that entities might have to carry out, and which in some cases could be numerous, the Bank of Spain may authorize a postponement of up to a maximum of 3 months from the previous date and, exceptionally, in cases of stock market listings, and provided that a set of milestones have been met that generate certainty about the decision and the amount of the issuance, the execution may be extended until the first quarter of 2012.

Once the transitional period is completed and when entities have reached the new core capital requirements, and following the conceptual structure of Basel III, which establishes a capital conservation buffer, the temporary non-compliance of up to 20% of the required core capital ratio will determine the imposition by the Bank of Spain of restrictions that may affect the distribution of dividends, the provision for social welfare work, the remuneration of preferred shares, the variable remuneration of administrators and executives, and the repurchase of shares.

Foreseeing the possibility that not all entities can capture capital in the basic capital markets, the second block of this royal decree-law modifies the legal regime of the FROB in order to ensure that the proportion of support is carried out through the temporary acquisition of ordinary shares, under market conditions, of those entities that do not meet the required own resource levels and so request, either immediately or once they have gone to the market and have not captured all the necessary resources.

This measure, which logically may imply the entry of the public sector into the share capital of credit institutions, has been designed within a framework of strict compliance with applicable European Union regulations and maximum protection of public resources.

Thus, first, the acquisition price of the shares or contributions to share capital will be fixed according to the economic value of the entity, which will be determined by one or more independent experts designated by the FROB, through a procedure to be developed by the FROB, based on commonly accepted methodologies and taking into account market value.

Regarding divestment, it is worth highlighting that the presence of the FROB in the capital of entities is temporary, with a maximum holding period of five years. The disposal will be carried out through procedures that ensure competition. Nevertheless, the Bank Restructuring and Orderly Resolution Fund may, at the time of acquisition of the securities, establish the terms under which, within a maximum period of one year from the date of subscription or acquisition, it would resell said securities to the issuing entities or to third-party investors proposed by the entity benefiting from its action. This maximum period may be two years, in which case additional commitments may be required from requesting entities beyond those provided within their recapitalization plan. The conditions of such resale must ensure an efficient use of public resources and be carried out under market conditions, complying in all cases with Spanish and European Union regulations on competition and State aid.

The temporary nature of the FROB's support in the contribution of basic capital determines that the investment be made through the acquisition of ordinary shares, in order that when the time comes, the FROB can easily and under market conditions dispose of them. This requirement in turn determines that the entity benefiting from the support be a bank. It is for this reason that it is established that if the credit institution requesting financial support is a savings bank, it will have a period of three months to transfer all its financial activity either to a bank through which it will indirectly exercise its financial activity while maintaining its legal figure as a savings bank or transforming into a foundation, or to the bank that acts as the central entity of the institutional protection system of which it may form part.

In addition, the acquisition of securities by the FROB is conditioned on the elaboration by the entity of a Recapitalization Plan in which, in addition to presenting a business plan, it must assume certain commitments related, for example, to the reduction of its structural costs, the improvement of its corporate governance, or the evolution of its credit activity.

The acquisition of securities by the FROB will determine, in turn, its incorporation into the Board of Directors of the issuing entity in strict proportion to the percentage of participation of the entity.

The rule also contemplates the possibility of acquisitions by the FROB of preferred participations convertible into contributions to the share capital of credit cooperatives, under a regime that reproduces the one provided until the entry into force of this royal decree-law.

Finally, it is worth highlighting that the royal decree-law also contemplates a series of fiscal measures aimed at ensuring neutrality in the restructuring processes of the financial system.

The main fiscal issues addressed are the inclusion of credit institutions integrated into an SIP in the fiscal consolidation group of the central entity, the application of tax credits prior to the constitution of the fiscal group, the segregation of all financial business carried out by the savings banks in favor of a bank, and finally, intragroup operations when the banking entity ceases to belong to the fiscal group.

In short, these specific modifications aim to guarantee that the restructuring process of the financial sector is carried out without associated fiscal costs.