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SPAIN Memorandum of Understanding on Financial-Sector Policy Conditionality

This Memorandum of Understanding on financial-sector policy conditionality (MoU), details the policy conditions as embedded in Council Decision […] of 20 July 2012 on specific measures to reinforce financial stability in Spain.

Monday 16 July 2012, by Carlos San Juan

1. On 25 June 2012, the Spanish Government requested external financial assistance in the context of the ongoing restructuring and recapitalisation of the Spanish banking sector. The assistance is sought under the terms of the Financial Assistance for the Recapitalisation of Financial Institutions by the EFSF. II. Recent economic and financial developments and outlook

2. The global financial and economic crisis exposed weaknesses in the growth pattern of the Spanish economy

3. The unwinding of economic imbalances is weighing on the growth outlook.

4. The challenges that face segments of the banking sector continue to negatively affect the economy as the credit flow remains constrained.

5. With the exception of a few large and internationally diversified credit institutions, Spanish banks have lost access to wholesale funding markets on affordable terms.

III. Key objectives

IV. Restoring and strengthening the soundness of the spanish banks: Bank-specific conditionality

- Diagnostics
- Recapitalisation, restructuring and/or resolution
- Burden sharing
- Segregation of impaired assets: Asset Management Company

V. Ensuring a sound framework for the banking sector: Horizontal Conditionality

VI. Public finances, macroeconomic imbalances and financial sector reform

VII. Programme Modalities

VIII. Programme monitoring

Annex 1: Data requirements

V. Ensuring a sound framework for the banking sector:

Horizontal Conditionality

23. A strengthening of the regulatory framework is critical to enhance the resilience of the Spanish banking sector. Spanish authorities will take additional measures in the following areas. · Spanish credit institutions will be required, as of 31 December 2012, to meet until at least end-2014 a Common Equity Tier (CET) 1 ratio of at least 9%. The definition of capital used to calculate this solvency ratio will be based on that (eligible capital) established in the ongoing EBA recapitalisation exercise. · From 1 January 2013, Spanish credit institutions will be required to apply the definition of capital established in the Capital Requirements Regulation (CRR), observing the gradual phase-in period foreseen in the future CRR, to calculate their minimum capital requirements established in the EU legislation. However, the additional capital needed to meet the 9% capital ratio will be calculated based on the capital definition established in the ongoing EBA recapitalisation exercise. In any case, Spanish credit institutions will not be allowed to reduce their capital base with respect to December 2012 figures, without previous approval from the Banco de España. · The current framework for loan-loss provisioning will be re-assessed. On the back of the experiences of the financial crisis, the Spanish authorities will make proposals to revamp the permanent framework for loan loss provisioning, taking into account the temporary measures introduced during the past months, as well as the EU accounting framework. Furthermore, the authorities will explore the possibility to revise the calibration of dynamic provisions on the basis of the experience gathered during the current financial crisis. To this end, the authorities will submit by mid-December 2012, a policy document for consultation to the European Commission, ECB, EBA and IMF on the amendment of the provisioning framework if and once Royal Decree Laws 2/2012 and 18/ 2012 cease to apply. · The regulatory framework on credit concentration and related party transactions will be reviewed. This review, to be carried out by the Spanish authorities by mid-January 2013, will in particular assess whether a strengthening of the regulatory framework is warranted. · The liquidity situation of Spanish banks will continue being closely monitored. For the purpose of monitoring their liquidity position, credit institutions in receipt of State aid or for which capital shortfalls will be revealed in the Stress Test will, as of 1 December 2012, provide standardised quarterly balance sheet forecasts (funding plans) to the Banco de España and the ECB. The Banco de España will provide regular information on the liquidity situation of these banks to the European Commission, the ECB and the IMF, as specified in Annex 1. · The governance structure of former savings banks and of commercial banks controlled by them will be strengthened. The Spanish authorities will prepare by end-November 2012 legislation clarifying the role of savings banks in their capacity as shareholders of credit institutions with a view to eventually reducing their stakes to noncontrolling levels. Furthermore, authorities will propose measures to strengthen fit and proper rules for the governing bodies of savings banks and to introduce incompatibility requirements regarding the governing bodies of the former savings banks and the commercial banks controlled by them. Moreover, authorities will provide by end- November 2012 a roadmap for the eventual listing of banks included in the Stress Test, which have benefited from State aid as part of the restructuring process. · Enhanced transparency is a key pre-requisite for fostering confidence in the Spanish banking system. Several important measures have already been taken to increase the quality and quantity of information provided by credit institutions to the general public, notably concerning real estate and construction sector exposures. The authorities released for public consultation a regulatory proposal aimed at enhancing and harmonising disclosure requirements for all credit institutions on key areas of their portfolios such as restructured and refinanced loans, sectoral concentration. This regulatory proposal will be finalised in consultation with the European Commission, the ECB, the EBA and the IMF and become effective by end of September 2012. 24. The supervisory framework will be strengthened. The Spanish authorities will take measures in the following areas. · A further strengthening of the operational independence of the Banco de España is warranted. The Spanish authorities will transfer by 31 December 2012 the sanctioning and licensing powers of the Ministry of Economy to the Banco de España. Furthermore, the Spanish authorities will identify by end October 2012 possibilities to further empower the Banco de España to issue binding guidelines or interpretations. · The supervisory procedures of Banco de España will be further enhanced based on a formal internal review. The Banco de España will conduct a full internal review of its supervisory and decision-making processes by end-October 2012 in order to identify shortcomings and make all the necessary improvements. In this internal review, the Banco de España will test recent improvements made to the supervisory procedures in order to ensure that the findings of on-site inspections translate effectively and without delays into remedial actions. Specifically, the authorities will analyse the need for any further improvements in the communication to the decision making bodies of vulnerabilities and risk in the banking system, in order to ensure the adoption of corrective actions. Furthermore, the authorities will ensure that macro-prudential supervision will properly feed into the micro supervision process and adequate policy responses. · The Banco de España will by end-2012 require credit institutions to review, and if necessary, prepare and implement strategies for dealing with asset impairments. The Banco de España will determine the operational capability of credit institutions to manage arrears, identify operational deficiencies and will monitor the implementation of these plans. The assessment of the adequacy of loan work-out strategies will also be based on the findings of the external auditors and consultants during the asset quality review. 25. Consumer protection and securities legislation, and compliance monitoring by the authorities, should be strengthened, in order to limit the sale by banks of subordinate debt instruments to non-qualified retail clients and to substantially improve the process for the sale of any instruments not covered by the deposit guarantee fund to retail clients. This should include increased transparency on the characteristics of these instruments and the consequent risks in order to guarantee full awareness of the retail clients. The Spanish authorities will propose specific legislation in this respect by end-February 2013. 26. The public credit register will be enhanced. The Spanish authorities will take additional measures to improve the quantity and quality of information reported to the register. The envisaged enhancements will be submitted for consultation with stakeholders by end- October 2012. Furthermore, the necessary legislative amendments will be in place by end- March 2013. Meanwhile, work on practical arrangements will continue with a view to having the envisaged enhancements operational as quickly as possible. 27. Non-bank financial intermediation should be strengthened. In light of the high dependence of the Spanish economy on bank intermediation, the Spanish authorities will prepare, by mid-November 2012, proposals for the strengthening of non-bank financial intermediation including capital market funding and venture capital. 28. Governance arrangements of the financial safety net agencies will be reviewed to avoid potential conflicts of interest. In particular, the authorities will ensure that, as of 1 January 2013 there will be no active bankers anymore in the governing bodies of the FROB. The governance arrangements of the FGD will also be reviewed, in particular with regard to potential conflicts of interest. VI. Public finances, macroeconomic imbalances and financial sector reform 29. There is a close relationship between macroeconomic imbalances, public finances and financial sector soundness. Hence, progress made with respect to the implementation of the commitments under the Excessive Deficit Procedure, and with regard to structural reforms, with a view to correcting any macroeconomic imbalances as identified within the framework of the European semester, will be regularly and closely monitored in parallel with the formal review process as envisioned in this MoU. 30. According to the revised EDP recommendation, Spain is committed to correct the present excessive deficit situation by 2014. In particular, Spain should ensure the attainment of intermediate headline deficit targets of [x]% of GDP for 2012, [x]% of GDP for 2013 and [x]% of GDP for 2014. Spanish authorities should present by end-July a multi-annual budgetary plan for 2013-14, which fully specifies the structural measures that are necessary to achieve the correction of the excessive deficit. Provisions of the Budgetary Stability Law regarding transparency and control of budget execution should be fully implemented. Spain is also requested to establish an independent fiscal institution to provide analysis, advice and monitor fiscal policy. 31. Regarding structural reforms, the Spanish authorities are committed to implement the country-specific recommendations in the context of the European Semester. These reforms aim at correcting macroeconomic imbalances, as identified in the in-depth review under the Macroeconomic Imbalance Procedure (MIP). In particular, these recommendations invite Spain to: 1) introduce a taxation system consistent with the fiscal consolidation efforts and more supportive to growth, 2) ensure less tax-induced bias towards indebtedness and homeownership, 3) implement the labour market reforms, 4) take additional measures to increase the effectiveness of active labour market policies, 5) take additional measures to open up professional services, reduce delays in obtaining business licences, and eliminate barriers to doing business, 6) complete the electricity and gas interconnections with neighbouring

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