Circular 5/2021 of the Bank of Spain modifying Circular 2/2016 on macroprudential supervision and solvency

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Circular 5/2021, of December 22, of the Bank of Spain, amending Circular 2/2016, of February 2, to credit institutions, on supervision and solvency, which completes the adaptation of the Spanish legal system to Directive 2013/36/EU and Regulation (EU) No 575/2013. (BOE of December 23, 2021). [ 1 ]

[1]

Includes error correction published in the BOE of December 30, 2021.

One of the main lessons learned from the financial crisis that the global economy experienced more than a decade ago is that banking regulation and supervision must adopt a macroprudential perspective to complement the traditional microprudential approach. Indeed, to safeguard the financial stability of a country, it is not enough to guarantee the safety and solidity of each financial entity individually, but it is also necessary for the financial system as a whole to be stable and resilient. In this way, the fundamental objective of macroprudential policy is to protect the economy from systemic risk, understood as defined in the single additional provision of Royal Decree-Law 22/2018, of December 14, establishing macroprudential tools.

Systemic risk has a multidimensional character, so it is impossible to reduce it to a single objective that allows addressing each of its dimensions in the most efficient way possible. Furthermore, its dynamic nature means it can experience significant variations throughout financial cycles. Therefore, it is essential to have a broad and sufficiently varied set of macroprudential tools that allow, on the one hand, to address each of these dimensions in the most efficient way possible and, on the other, to adapt macroprudential policy to the temporal oscillations of systemic risk.

Given these considerations, and taking into account the assessment of various international bodies, such as the International Monetary Fund (IMF) or the European Systemic Risk Board (ESRB), Royal Decree-Law 22/2018 introduced additional macroprudential tools into our legal system to address possible vulnerabilities for the financial system, so that the three financial supervisory authorities – the Bank of Spain, the National Securities Market Commission, and the General Directorate of Insurance and Pension Funds – could have the necessary instruments to contribute to mitigating eventual disturbances with potential systemic impact. For its part, Royal Decree 102/2019, of March 1, creating the Macroprudential Authority Council of Financial Stability, established its legal regime and developed certain aspects related to macroprudential tools, completing the institutional framework of macroprudential supervision.

Article two of Royal Decree-Law 22/2018 introduced a series of modifications in Law 10/2014, of June 26, on the regulation, supervision, and solvency of credit institutions, to include the new macroprudential tools in the legal system of this subsector of financial entities. For its part, Article 15.1 of Royal Decree 102/2019 provides that the Bank of Spain may adopt the following macroprudential tools:

a) Capital buffer requirements, as provided for in Articles 43 to 49 of Law 10/2014.

b) The establishment of limits on sectoral concentration, in accordance with Article 69 ter of Law 10/2014.

c) The setting of conditions on the granting of loans and other operations, by virtue of Article 69 quater of Law 10/2014.

Likewise, paragraph 2 of the final third provision of Royal Decree 102/2019 empowers the Bank of Spain to issue, by circular, and in accordance with Article 3 of Law 13/1994, of June 1, on the Autonomy of the Bank of Spain, any provisions necessary for the development, execution, and compliance with the macroprudential tools provided for in letters b) and c) of its Article 15.1, as well as those provided for in letter a) when only required with respect to exposures to a specific sector or category and with respect to what is provided in Articles 43 to 49 of Law 10/2014. To this end, the enabling norm states that the circular will detail the regulation of its content and the procedure for communication to the public and interested parties, among other aspects. These three macroprudential tools complement those already established in the aforementioned Law 10/2014, whose fundamental objective was to transpose into our legal system the regulatory changes on credit institutions introduced in the European Union (EU) through Directive 2013/36/EU, of June 26.

As stated in the preamble of Royal Decree-Law 22/2018, on certain occasions, exposures to specific sectors have concentrated the majority of systemic risks. This was the case of the Spanish real estate sector in the past financial crisis, but there are other examples on an international scale. In such a situation, activating aggregate macroprudential tools could have counterproductive effects. Specifically, if credit growth is excessive in a single sector, an increase in capital requirements for all exposures could lead entities to further increase their exposure to that sector, since that tool does not allow altering the relative cost in terms of regulatory capital of granting credit to the sector to reflect the higher systemic risk it entails. On the contrary, aggregate macroprudential tools would increase the cost in terms of regulatory capital of credit for all branches homogeneously. In contrast, if the measure affects a specific sector or a defined group of sectors, it increases the relative cost of credit to those sectors, altering the relative profitability of different portfolios against the sector or sectors generating systemic risk. In any case, the application of a sectoral tool must be accompanied by strict monitoring of its potential spillover effects on the rest of the sectors to avoid the problem of excessive credit growth shifting between sectors. Furthermore, the considered sectors must have a systemic dimension to prevent the tool from having a microprudential character. To this end, this circular allows the Bank of Spain to set the countercyclical buffer on entities' exposures to a specific sector, in addition to total exposures.

Another macroprudential tool would be the establishment of limits on the sectoral concentration of entities' exposures. Like the countercyclical capital buffer, when established on a specific sector, it revolves around the total volume of exposures of a sector. This concentration is defined in terms of the ratio of sectoral exposure to Common Equity Tier 1 (CET1) capital, so it does not constitute an absolute quantitative limit on exposure. It is also a sectoral tool, so it seems logical to expect it to have the same effects noted for the countercyclical capital buffer when established on one or more sectors, and the need to carefully analyze potential spillover effects on other sectors must be emphasized. In this case as well, the sectors must have a systemic dimension and be coherent, as far as possible, with those contemplated in the countercyclical capital buffer. The fundamental difference of this tool with respect to the countercyclical capital buffer established on one or more sectors lies in the fact that its activation would more effectively curb the growth of sectoral concentration, while the countercyclical capital buffer would only disincentivize it, by making the increase in credit exposure to the sector or sectors on which it was activated more expensive in terms of capital.

The capacity to set conditions on the granting of loans and other operations has the potential to directly affect credit; specifically, the flow of new credit. This instrument would set limits on the conditions for granting new credits, so it would be susceptible to application when, for example, a level of overvaluation of housing prices is observed that could cause future corrections to reduce the value of collateral below the committed loan, when a borrower does not have a sufficiently sound financial situation, or when it is appreciated that the loan granting indicators of a significant percentage of the credit portfolio reach worrying levels from the point of view of the solvency of an entity or a group of entities.

Available empirical evidence shows that loans granted with stricter criteria in terms of their leverage, the effort made for their repayment, or their maturity (that is, with shorter maturity terms) subsequently exhibit significantly lower delinquency rates. In fact, those loans in which several of these stricter criteria are satisfied simultaneously usually experience significantly lower probabilities of default than those loans in which only one of them is satisfied. In this sense, credit standards are key to guaranteeing the safety and solidity of banks, as well as reducing systemic risk. Therefore, the evaluation of banks' loan granting policies is crucial to reducing the impact of disturbances in the future.

The characteristics of loans susceptible to being affected by this tool can be varied. The decision to set conditions on certain characteristics and not others will therefore depend on the specific situation to be confronted, that is, the nature of the systemic risk, to decide which is most effective for its mitigation. However, it must be taken into account that setting conditions on one characteristic can lead to excesses in others, so it may be necessary to act on several characteristics simultaneously. Furthermore, spillover effects may also occur to other credit portfolios not affected by the introduced limits (for example, from mortgage-guaranteed operations to those without such guarantee), which could also lead to extending measures to those areas. The regulation of this instrument must also contemplate the possibility that conditions be modulated based on the characteristics of the borrower and the lender to thus guarantee its effectiveness.

In the exercise of the conferred empowerment, this circular regulates the establishment of the countercyclical capital buffer on one or more sectors, the limits on exposures to specific sectors, and the possibility of setting limits and conditions on the granting of loans and other operations by entities for operations with the private sector in Spain.

In line with what is established in Article 15.2.d) of Royal Decree 102/2019, the regulation of the countercyclical buffer is based on international best practices regarding the objectives, instruments, and indicators of a macroprudential nature. Specifically, this circular incorporates into the framework of the countercyclical buffer most of the guiding principles of the Basel Committee on Banking Supervision (BCBS) published in November 2019.

The establishment of the countercyclical capital buffer on one or more sectors is a technical improvement of this tool, as it allows its application both on the set of exposures and on some sectors, or even on both simultaneously.

For the activation and determination of the countercyclical buffer on specific sectors, a broad set of variables with the capacity to act as early warning indicators of sectoral imbalances in Spain, correlated with increases in systemic risk in the financial system, is identified. Based on empirical literature and BCBS guidelines in the context of the countercyclical buffer, the following categories of indicators are considered, in particular: i) sectoral credit volume indicators – measures of credit growth, intensity, and gaps –; ii) asset price indicators – evolution and specialized imbalance measures for each sector –; and iii) sectoral macrofinancial imbalance indicators – indebtedness, net wealth, financing capacity or need, savings rate, and consumption and investment gaps, among others –.

With regard to sectoral limits on the concentration of exposures, it seems necessary to establish continuity with the countercyclical capital buffer on one or more sectors. Therefore, the only difference between these measures, in terms of the sectoral segmentation of the credit portfolio, is that two additional sectors are added that cover exposures to the financial sector. Furthermore, just as in the microprudential supervisory perspective, concentration is defined in terms of the weight that that exposure has on own funds; in this case, on the entity's CET1. In this way, an absolute limit on exposures is not established, but rather this depends on the entities' resources to cover potential losses. In this sense, another difference of these measures with the countercyclical capital buffer is that the exposures to which they refer are not risk-weighted. These limits may be required for a specific sector, or for several of them jointly, and may be in force alongside other macroprudential tools.

Since, at the time of their introduction, there may be entities that are above the sectoral concentration limits, a time period for adjustment will be specified to facilitate rapid convergence towards them. To determine the concentration limits, the Bank of Spain will take into account, among other criteria, the evolution of aggregate exposure in each sector, its historical weight in the total exposure portfolio and its recent evolution, its relevance in GDP and sectoral value added, and, of course, its weight in aggregate CET1.

Regarding the setting of limits and conditions on the granting of loans and other operations, this circular establishes different conditions susceptible to being activated. Thus, in accordance with the preamble of Royal Decree-Law 22/2018, the Bank of Spain may set limits on the maximum indebtedness a borrower can obtain, given the collateral provided (loan to value), the part of disposable income that can be allocated to debt repayment (debt service to income), the level that debt represents in income (debt to income), and the maturity term of the operation, among other measures. These limits may be activated individually or jointly, and other macroprudential instruments may be in force simultaneously. Likewise, these limits may be different for specific groups, both for natural persons and legal entities. This may occur, either because such distinctions benefit financial stability, or because the application of different limits for specific groups facilitates the application of measures and does not harm their effectiveness in reducing systemic risk. In the same way, the measures may consider a certain percentage of credits that remain excluded from the limits.

To determine the need for activation of these tools, the Bank of Spain will analyze, among other criteria, the recent evolution of credit and real activity, the characteristics of loan granting, and multiple indicators of the degree of solvency, incomes, and indebtedness of natural and legal persons.

The circular consists of a single provision, a final provision, and an annex. The single provision introduces into Circular 2/2016 the new macroprudential framework described above.

This circular responds to the principles of necessity, effectiveness, proportionality, legal certainty, transparency, and efficiency, as required by Article 129 of Law 39/2015, of October 1, on the Common Administrative Procedure of Public Administrations.

With regard to the principles of necessity and effectiveness, this circular is the necessary instrument for the development of the regime applicable to the new macroprudential tools available to the Bank of Spain, in accordance with Royal Decree-Law 22/2018 and Royal Decree 102/2019, whose final objective is to identify, prevent, and mitigate the development of systemic risk and ensure a sustainable contribution of the financial system to economic growth.

As for the principles of proportionality, legal certainty, and efficiency, this circular establishes the minimum essential regulation for the fulfillment of its purposes and is coherent with the rest of the legal system, both national and international, and the only administrative burdens it imposes refer to the requirement that entities report the necessary information so that they can be implemented. Finally, with regard to the principle of transparency, the circular has been submitted to the pertinent public hearing and information process.

Consequently, in the exercise of the powers conferred, the Board of Directors of the Bank of Spain, upon proposal of the Executive Committee and in accordance with the Council of State, has approved this circular, which contains the following norms:

Single Provision. Amendment of Circular 2/2016, of February 2, of the Bank of Spain, to credit institutions, on supervision and solvency, which completes the adaptation of the Spanish legal system to Directive 2013/36/EU and Regulation (EU) No 575/2013.

The following modifications are introduced in Circular 2/2016 [ 2 ] :

a) In norm 2, a new paragraph 11 is introduced, with the following wording:

«11. Chapters 10 and 11 of this circular, on limits to sectoral concentration and on other macroprudential tools, respectively, shall apply to credit institutions authorized in Spain and to branches in Spain of credit institutions with headquarters in Member States and non-EU countries.»

b) Norm 3 is modified, which shall have the following wording:

«Norm 3. Branches in Spain of credit institutions with headquarters in European Union Member States.

The requirements established in this circular shall not be generally applicable to branches in Spain of credit institutions with headquarters in EU Member States; this exclusion shall not reach what is provided for in Chapters 10 and 11 of this circular. This is without prejudice to their obligation to send to the competent authority data on the Spanish real estate market referred to in Article 430 bis of Regulation (EU) No 575/2013, and in accordance with statement C 15.00 established in Annex VI of Implementing Regulation (EU) No 2021/451, of December 17, 2020, establishing implementing technical standards for the application of Regulation (EU) No 575/2013 of the European Parliament and of the Council in relation to the reporting of information for supervisory purposes by entities, and repealing Implementing Regulation (EU) No 680/2014.

However, for reasons of financial stability, the competent authority may require these branches to provide additional information on their activities.»

c) Norm 8 is modified, which shall have the following wording:

«Norm 8. Countercyclical capital buffer specific to each entity.

1. In accordance with Article 45.1 of Law 10/2014, credit institutions shall maintain a countercyclical capital buffer consisting of Common Equity Tier 1 capital calculated specifically for each entity or group. Such buffer shall be determined on all exposures of the entity or group or exposures to a specific sector.

2. The countercyclical capital buffer requirement calculated specifically for each entity or group shall be determined on the total amount of risk exposure calculated in accordance with Article 92.3 of Regulation (EU) No 575/2013, with the clarifications provided in this norm and in norms 9 to 12 bis of this circular, multiplied by the percentage referred to in paragraphs 3 and 4 of this norm, according to the following formula:

Where:

– CCAi: Denotes the percentage of the countercyclical capital buffer set for the total amount of risk exposure for country i.

– RFPi relevant: Denotes the total amount of their own funds requirements for credit risk, determined in accordance with Part Three, Titles II and IV, of Regulation (EU) No 575/2013 and corresponding to the relevant credit exposures, in accordance with paragraph 5 of this norm, for country i.

– RFPTotal relevant: Denotes the total amount of their own funds requirements for credit risk, determined in accordance with Part Three, Titles II and IV, of Regulation (EU) No 575/2013 and corresponding to all their relevant credit exposures, in accordance with paragraph 5 of this norm.

– APRTotal: Denotes the total amount of risk exposure, in accordance with Article 92.3 of Regulation (EU) No 575/2013.

– CCASi,j: Denotes the percentage of the countercyclical capital buffer set for the amount of risk exposure of sector j of country i.

– RFPi,j relevant: Denotes the total amount of their own funds requirements for credit risk, determined in accordance with Part Three, Titles II and IV, of Regulation (EU) No 575/2013 and corresponding to the relevant credit exposures, in accordance with paragraph 5 of this norm, for sector j of country i.

The percentages of the countercyclical buffer applicable on the total amount of risk exposure and on the amounts of risk exposure to one or more sectors may have equal or different values, it being possible that some of them are zero, and others, positive, and those with positive values are not necessarily equal. Therefore, it cannot be understood that, if the percentage applicable to the risk exposure to one or more sectors were different from zero, and the one applicable to the total risk exposure were zero (or no percentage had been determined), this implies that the countercyclical buffer percentage applicable to the total amount of risk exposure of the entity or group has been set for the first time, or increased.

The Bank of Spain may set the percentages referred to in the previous paragraph simultaneously or at different times. To do so, it will take into account, among other criteria, the existence of transmission risks of imbalances to other sectors or categories that were