The economic context has turned around with the war in Ukraine. There were uncertainties due to the pandemic and the risk of new waves of infections. Despite this, the economic recovery was taking shape and the financial situation of families and companies was taking a breather. But the war and the energy crisis aggravated by the Russian invasion hinder recovery. “The combination in the short term of higher inflation, which erodes the real income of households and companies, and an increase in interest rates, could reduce the payment capacity of these agents,” warns the Bank of Spain in its latest Financial Stability Report (IEF). Hence, the supervisor demands prudence from banks and that they do not release the provisions made by the pandemic.
This loss of payment capacity is especially influenced by the uncertainty generated by the Russian offensive. This will cause, in addition to the rise in inflation and the acceleration in the increase in interest rates, a reaction in monetary policy. On the possible growth of defaults, the expiration of the grace periods of the ICO loans still in force, which will expire at the end of summer, will also play a relevant role. Therefore, as Ángel Estrada, General Director of Financial Stability, Regulation and Resolution of the Bank of Spain, stated at a press conference, all these milestones “are going to have a significant effect, in one way or another”.
In credit portfolios, according to the report, there are still latent deteriorations that could materialize in the coming quarters. The supervisor figures that there is an increase in loans that are one step away from being considered delinquent: some 94,000 million euros, 8% of the total debt of households and companies. These are in what the Bank of Spain calls special surveillance. This includes those who have not yet defaulted, but a greater risk of becoming delinquent has already been appreciated. Specifically, they have risen 14.3% during the last quarter of 2021, while delinquencies have decreased.
In addition, the text recalls other challenges that the sector faces: “Recent developments confirm the need to address the structural challenges that already existed in the banking sector and in other segments of the financial system. In particular, the growing competition from technology companies and the rise of crypto assets, the increase in cyber risks, now aggravated by geopolitical tension, and the potential negative effects associated with climate risks.
In this report, the Bank of Spain has also included a stress test for the financial sector with an adverse scenario and a severe one to verify whether the Spanish banking system would withstand the ravages that could result from the war. An exam that the sector passes as a whole, although with heterogeneous results. In other words, not all entities would go through it with the same ease to absorb the impact, although the supervisor does not detail which entities are the ones that would suffer the most.
The possible increase in defaults will not be homogeneous in the productive fabric either: the sectors that will suffer the most will be those that have not yet recovered from the coronavirus crisis. In other words, they continued with fragile accounts and now, with a new increase in costs, their situation may become unsustainable. “We focus our attention on the sectors that were very affected and that are now also affected by the energy crisis: transport, hotels, construction and agriculture, among others. The most vulnerable households, with lower incomes, will also suffer, because the effort they make to buy these essential products will be greater”, explained Estrada.
He knows in depth all the sides of the coin.
Before the war there were already doubts about rising inflation, but with the war the risks are multiplied: in geopolitical matters, with the aforementioned inflation that threatens to be more persistent and, furthermore, with the evolution of the coronavirus. The supervisor warned in the autumn of the threat of an upward spiral in prices, although since then the situation has worsened. And it is already discounted that there will be less global economic growth, as collected by all international organizations. Likewise, “investors’ risk aversion has risen, with the consequent rise in premiums associated with risky assets,” the report states. That is, there is the possibility of additional adverse corrections in the prices of some assets.
“The main risk is geopolitical, associated with the invasion of Ukraine,” said the director general of Financial Stability, Regulation and Resolution of the supervisor. And from there the rest of the threats derive: “We do not have large direct exposures, but the implications for financial stability are due to indirect effects: both Russia and Ukraine are producers of relevant raw materials that are becoming more expensive with the war. This raises inflation, which was already high, and there is also less growth in income because they are imported raw materials that have to be paid for”, Estrada reported.
To this must be added the greater uncertainty and the effect that economic sanctions have on Russia: “They are necessary, but they have global effects,” he warned the media. In other words, it is a double-edged sword with which Europe also suffers. The other big cloud that the Bank of Spain has been focusing on for weeks are the feared second-round effects on inflation. That is to say, that there are increases in wages linked to the CPI, which would make the upward spiral even more persistent, as the general director of Financial Stability, Regulation and Resolution of the supervisor has recalled.
In addition, although restrictions linked to the pandemic have been relaxed in recent weeks, it is a continuing problem. In fact, Estrada recalls what is the most relevant risk today: “China, with its zero covid policy, maintains strong restrictions and can cause bottlenecks to become more pronounced.” There is also the risk of new variants, but in this case the supervisor considers that the Spanish economy is better equipped than it was months ago: “The experience accumulated in previous waves would point to a greater capacity of the economy to resist adverse epidemic developments.”
Loss of confidence
The doubts that hang over the global economy are a setback for world trade and for the confidence of households and companies: “They can postpone their consumption and investment decisions, which would contribute to the weakening of economic growth,” says the report.
On the part of the public accounts, the war in Ukraine is going to put even more pressure on a debt and a deficit that are already at the limit. “It may mean greater pressure on public spending, in the short term, to offset the temporary increase in energy and food prices and to reduce external energy dependence,” says the Bank of Spain. To which he adds that the high levels of deficit and public debt make the country’s economy more vulnerable to the deterioration of financing conditions.
The governor of the supervisor, Pablo Hernández de Cos, has demanded in recent weeks that a fiscal consolidation plan be designed to redirect the situation. And the report insists on this issue: “It is necessary to design a medium-term fiscal consolidation program that allows containing and reducing the vulnerabilities associated with high public debt, for its application once the recovery is solid.”