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IMF Says Spain Banks Must Bolster Capital as Risks Stay High

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July 15 (Bloomberg) -- Spain should make banks bolster their capital without cutting lending by issuing stock, curbing cash dividends and paying senior staff more with shares, the International Monetary Fund said.

“Risks remain that banks may face pressure to support capital ratios by further accelerating credit contraction,” the IMF said in its third progress report on reforms of the Spanish banking industry published today. “Supervisory actions to strengthen solvency and reduce risks should prioritize measures that increase nominal capital over ones that reduce lending.”

Spain sought a bailout for its banking system last year on concern that losses at former savings banks such as the Bankia group would contaminate public finances at a time when the government was seeking to trim its budget deficit. While industry reform as part of the 41.3 billion-euro ($53.8 billion) bailout process remains on track, “risks to the economy and hence to the financial sector remain elevated,” the IMF said.

Regulators should allow Spanish banks to convert their deferred tax assets, or DTAs, into transferable tax claims as a means to bolster capital, the IMF said. The amount of such conversions should be conditional on lenders forgoing dividends, issuing more stock and boosting their coverage of soured assets, said the IMF.

Regulatory Pressure

Spanish banks, which have accumulated 51 billion euros in DTAs during the country’s financial crisis, are suffering as a result of new capital regulations known as Basel III, which will deduct most of them from Tier 1 capital over time.

“Risks to capital persist,” the IMF said. “To dispel uncertainty regarding the degree to which Spanish banks will be able to use their DTAs and improve the quality of their capital, a mechanism could be created to allow banks to convert DTAs into transferable tax claims.”

Spain needs to ensure as much as possible that the need for more robust capital doesn’t restrict the ability of banks to lend as Spain’s economic slump stretches into its sixth year, the IMF said.

Spain should “focus supervisory actions to bolster solvency and reduce risks on measures that, while boosting banks’ capital situation, do not exacerbate already-tight credit conditions,” it said. “For banks with market access, new equity issuance is the fastest path toward capital-building and should be strongly encouraged.”

Conservative Assumptions

The Bank of Spain wrote to banks in June recommending they limit dividend payments and saying cash payouts should not exceed 25 percent of profit.

The Bank of Spain must “strongly implement” a review of banks’ classification of their refinanced loans to ensure they are being covered properly, the IMF said. Lenders in Spain have restructured or refinanced 208.2 billion euros of loans, the Bank of Spain said in May.

The IMF also called on Spain’s bad bank, known as Sareb, to use more conservative assumptions for house prices in its business plan “as these are still falling sharply and further correction is likely.” Sareb should analyze how its balance sheet would evolve under different scenarios and review its business plan and develop contingency strategies accordingly,” the IMF said.

The IMF is publishing quarterly reports to monitor Spain’s banking reform program.

To contact the reporter on this story: Charles Penty in Madrid at cpenty@bloomberg.net

To contact the editor responsible for this story: Frank Connelly at fconnelly@bloomberg.net

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