Spain: Deposit Guarantee Fund Asset Management

Two early attempts by the Spanish government to address the banking crisis that emerged in 1977—the initial establishment of the Deposit Guarantee Fund merely as a deposit insurance provider and the establishment of the Banking Corporation in 1978 to take control of troubled banks—addressed liquidity problems but could not solve underlying solvency issues. Spain therefore decided to significantly expand the legal authority of the Fund to include the ability to purchase assets, inject capital, and provide guarantees to acquiring banks, so that these tools could be used in tandem to rehabilitate failed banks.

After the Bank of Spain identified a significant capital shortage in a bank, the Fund would take over ownership of the distressed banks. The Fund would assess the bank’s financial situation, replace management, and determine a financial assistance package to return the bank to viability and reprivatize the bank. One significant component of the Fund’s ability to resell the banks was the purchase of assets, which would make the bank more attractive in a bidding procedure among solvent banks (De Juan 2019).

In March 1980, the passage of Royal Decree-Law 4/1980 established the Deposit Guarantee Fund for Banking Institutions as a public body governed by the rules of private law and significantly expanded its authority (Spain 1980). The enhanced Fund combined the deposit guarantee scheme with the management function performed up until this point by the Banking Corporation, but now with increased legal powers. The Fund became known as the “Bank Hospital” (De Juan 2019).

Special authority was granted to the Fund when it was reconstituted in 1980, after it became clear that the Banking Corporation’s powers, specifically its inability to recapitalize banks, were “inadequate … for dealing with impending crises” (Sheng 1991). The Fund was granted authority to recapitalize distressed banks, take over bank ownership, extend credit to banks at any rate or in any form, acquire assets at book value, provide guarantees to an acquiring institution, and absorb losses to restore banks to solvency (De Juan 2019). The Fund remained responsible for the administration of the deposit insurance scheme (Sheng 1991).

In 1980, the Fund’s mandate expanded beyond its initial objective to protect depositors and prevent bank runs. The Fund was mandated “to carry out all the operations deemed necessary to reinforce the solvency and operation of the banks, in [defense] of the interest of the depositors and of the Fund itself” (Sheng 1996; Spain 1980).

After the Fund became the primary owner of a distressed bank, it developed a financial assistance package, which could include the purchase of assets and long-term lending. The financial assistance package was an important factor for the eventual sale of a bank, as the Fund could carve out bad assets that a buyer would be unwilling to take on (Klingebiel 2000). After reaching a sales agreement, the Fund would purchase the nonperforming assets at book value and then manage and liquidate the assets (De Juan 2019). The Fund was required to resell the bank within one year, and it had the objective to maximize recovery value on the problem assets it acquired (Klingebiel 2000).

The stated purpose of the Fund as it was reconstituted in 1980 was “to guarantee the deposits held in banking institutions in the way and to the extent that the government establishes, and also to carry out any such actions as it considers necessary to reinforce the solvency and proper functioning of the banks, in the [defense] of their interests of their depositors and of the Fund itself” (Spain 1980).

The Deposit Guarantee Fund issued annual reports detailing its operations (Deposit Guarantee Fund 1981; 1987). The Fund also had an Administration and Control department responsible for financial recordkeeping and preparing the annual budget and financial plan (Sheng 1996). Furthermore, the governance structure of the Fund and its relationship to the Bank of Spain “fostered a public perception of fairness” (Sheng 1996).

The Fund was publicly owned and “operated as an independent public agency under private law” (Klingebiel 2000).

The Board of Directors consisted of eight members—four bankers from industry and four Directors from the Bank of Spain. The Deputy Governor of the Bank of Spain served as chair and cast the decisive vote in the case of a tie. The four bankers served in their individual capacities and not as representatives of their banks. They were nominated by the Bank of Spain and appointed by the Ministry of Economy (De Juan 2019).

The operations of the Fund were closely coordinated with the Bank of Spain, especially in the initial and final stages of a bank intervention.

The responsibilities of the Board of Directors of the Fund included:

1. Informing and advising the Bank of Spain on the Fund’s operations;
2. Preparing and approving the Fund’s financial statements, and requesting advances from the Bank of Spain to the Fund when necessary;
3. Notifying the Bank of Spain which banks experienced financial difficulties that could require Fund intervention;
4. Determining the form of payment of annual premiums contributed by the banks;
5. Stipulating the requirements for admitting new banks to the Fund, and informing of any changes in membership;
6. Requesting external audits of member banks and determining the frequency and extent of these audits, and if necessary requesting external audits of associated companies;
7. Suspending payment of deposit guarantees to any depositor directly associated with the financial troubles of a bank;
8. Authorizing asset purchases from banks in crisis, explicitly limiting further involvement of the Fund, and without precluding requests to the bank management to take further remedial actions (Sheng 1996).

The Fund was comprised of three departments: Legal, Administration and Control, and Asset Management. The Legal Department could start legal or criminal action against former administrators of banks the Fund intervened on or temporarily controlled. It also served as legal counsel for the other departments (Sheng 1996).

The Department of Administration and Control oversaw internal matters of the Fund and of the banks controlled by the Fund. It was responsible for the recovery of claims, maintaining timely records, and servicing obligations of fixed assets (e.g. property taxes). The Department coordinated the sale of assets and bank reprivatizations with the other Departments. It prepared the Fund’s annual budget and financial plan, and requested advances from the Bank of Spain to the Fund when necessary (Sheng 1996).

The Asset Management Department administered the sale of assets owned by the Fund that were not directly related to banking. It assessed their financial viability, minimized any additional financial commitments, and attempted to sell the best assets as fast as possible. The Department appraised, or subcontracted appraisal of, the fixed assets of the Fund. It also focused on improving the least attractive assets while it searched for buyers (Sheng 1996).

The legislation that established the Fund did not set a size limit on the Fund’s asset purchases. In total, it acquired 270 billion pesetas in loans at face value, 31 billion pesetas in real estate, and 72 billion in equity in banks (Klingebiel 2000).

The Fund met its annual costs with the help of equal contributions from the Bank of Spain and the banking industry. Also, by law, the Bank of Spain could make long-term loans to the Fund at the rediscount rate, with no limit (De Juan 2019). Ultimately, the Bank of Spain provided substantial loans to the Fund, which the Fund expected to pay back over time through asset sales and the continuing contributions from the banks and the Bank of Spain.

The industry’s and the Bank of Spain’s annual contributions each equaled between 0.1% and 0.3% of all bank deposits of member banks (De Juan 2019). Initially, annual contributions were set at 0.1% (Spain 1980). Contributions from the banks totaled 0.12% of liabilities per year (10% of annual profits). By the end of 1984, these contributions reached only $0.5 billion, significantly less than the total losses absorbed. Therefore, the Bank of Spain had to lend $2.9 billion to the Fund through long-term loans at a 7.25% annual interest rate (Sheng 1996).

The Fund’s estimates suggested it would be able to repay the Bank of Spain’s loans completely by the end of the 1990s, based on its reserves (Sheng 1996). However, it is not clear from public sources whether the Bank of Spain or Spanish taxpayers ultimately bore losses on these loans to the Fund. The Fund’s debt was 506 billion pesetas at the end of 1986 and 349 billion pesetas at the end of 1989 (Deposit Guarantee Fund 1987; El Pais 1990).

Typically, the Bank of Spain would provide initial liquidity support to struggling banks and in doing so determine the viability of the recipients. In some cases, the Bank of Spain determined that a bank would be viable if remedial actions were taken, and agreed to a plan of action. In other cases, the central bank identified and assessed the extent of insolvency and demanded recapitalization by existing shareholders with the threat that the Fund would take control unless such recapitalization occurred. The Bank of Spain allowed Fund appraisers to be involved in the assessments so the Fund could be better prepared to tackle specific problems, even before acquiring full control of the bank (Sheng 1996).

Insolvent banks were pressured to recapitalize or give control to the Fund. Banks whose shareholders were unwilling to recapitalize them could stop receiving liquidity support from the Bank of Spain and even lose their license to operate. The General Corporate Law was amended to reduce the quorum of shareholders necessary to approve recapitalizations. This allowed the Fund to expedite the process of interventions in insolvent banks (Sheng 1996).

The Fund gained control of a bank at a shareholders meeting, which had to be convened within seven days of the Bank of Spain requesting it. The Bank of Spain would inform shareholders of the scope of the problems the institution faced, such as the extent of losses and the effect of write-offs on bank capital and reserves. If the bank had no capital and its shareholders were unwilling to recapitalize it, they had to “volunteer” to sell capital to the Fund for a symbolic price of one peseta per share. This price could be more if the bank’s capital was not fully depleted or if shareholders were “innocent” and deserved protections (Malo de Molina and Martín-Aceña 2011; Sheng 1996). A process called the “accordion operation” consisted of first, an erosion or dilution of shares held by former shareholders, followed by recapitalization provided by the Fund, with the fund taking majority ownership (De Juan 2019). It served two purposes: to amortize potential bank losses and to penalize shareholders by significantly diluting or writing off their participation (De Juan 2019). In some instances, the Fund gained control only after applying the accordion operation to the holding company (Sheng 1996).

The government directly nationalized the politically sensitive Rumasa group, rather than use the Fund. The group included 20 of the 52 banks affected by the crisis (Klingebiel 2000).

The Fund purchased problem assets that were considered undesirable to potential acquirers, as its goal was to ultimately reprivatize the intervened bank (Sheng 1996). It could acquire any type of asset, including loans, shares, real estate, or other asset types (De Juan 2019). The Fund did not acquire performing loans, as those were part of the acquisition and reprivatization (Klingebiel 2000).

The Fund, together with the Bank of Spain, arranged a prospectus for the sale of a troubled bank with a set deadline for bids. The prospectus would be sent to selected domestic and foreign banks and included the maximum value of and specific conditions under which bad assets could be carved out by the Fund. This turned out to be the key issue in recurrent negotiations between the Fund and potential buyers.

The offer also outlined the specifics on the support provided by the Fund and the Bank of Spain (e.g. subsidized interest rates, regulatory forbearance, guarantees against “hidden liabilities,” etc.). Potential buyers could make counterproposals, which the Fund Board of Directors would review. Buyers were required to renounce any future claims or legal actions against the Fund that would result from differences between expected and realized asset returns. Lastly, the Board would communicate to the Ministry of Finance the offer chosen. Then, the Ministry had fifteen days to exercise its option to purchase the shares when the national interest was a concern. This two-stage mechanism provided checks and balances to the restructuring efforts (Sheng 1996).

The Fund purchased the non-performing assets of the insolvent banks at book value—that is, at the nominal value of loans less provisions—because Spanish authorities deemed it impossible to determine a market price. In doing so, the Fund absorbed any related losses. As those losses were typically greater than a bank’s equity, this policy was the main restructuring measure that the Fund adopted. According to the former head of the Fund, “the share capital increases carried out were intended for recapitalization and were insufficient for this purpose” (De Juan 2019). Overall, real estate and other asset purchases accounted for about 80% of Fund transactions and bank equity purchases accounted for 20%. The 24 restructured banks had initial capital of 56 billion pesetas; they wrote off 40 billion pesetas on bad loans and received 71 billion in capital from the government (see Appendix C). In comparison, the Fund spent more than 300 billion pesetas to acquire non-performing assets and real estate in order to facilitate transactions with acquiring banks.

In terms of asset management, the main goal of the Fund was to dispose of the assets purchased as fast as possible while maximizing their recovery value (Klingebiel 2000). By law, the Fund had to release control of the banks in which it intervened within a year, but the assets acquired could be sold beyond that timeframe (Sheng 1996). 

The Fund sold assets including (a) stock holdings of the Fund in firms or holding companies or liquidations; (b) real estate; (c) securities; and (d) loans. As for the loans that the Fund could not sell to the new investors of a bank, sale of mortgage loans and real estate were the most successful (Klingebiel 2000).

At the time of this writing, there was public data available on the amount the Fund recovered on the disposal of assets. By the end of 1986 the Fund had accumulated losses of 90 billion pesetas (Deposit Guarantee Fund 1987).

The Fund did not have a defined sunset date. It was legally required to offer the intervened banks for sale within a year, but the asset management activities did not have a defined timeframe. The Fund continued to manage assets as of 2000 (Klingebiel 2000).