33. Capital base and capital management
- Capital base
Bank of Spain Circular 3/2008, of 22 May 2008, and its subsequent amendments (the most recent by Bank of Spain Circulars 4/2001, of 30 November 2011, and 9/2010 of 22 December 2010), on the calculation and control of minimum capital base requirements, regulate the minimum capital base requirements for Spanish credit institutions –both as individual entities and as consolidated groups– and how to calculate them, as well as the various internal capital adequacy assessment processes they should have in place and the information they should disclose to the market.
The minimum capital base requirements established by Circular 3/2008 are calculated according to the Group’s exposure to credit and dilution risk, counterparty and liquidity risk relating to the trading portfolio, exchange rate risk and operational risk. In addition, the Group must fulfill the risk concentration limits established in said Circular and the internal Corporate Governance obligations.
Circular 3/2008 implements Spanish regulations on capital base and consolidated supervision of financial institutions, as well as adapting Spanish law to the relevant European Union Capital Requirements Directives, in compliance with the accords by the Committee on Banking Supervision of the Bank for International Settlements in Basel.
Specifically, within the framework of the new accords reached by this Committee, and its implementation by the European Commission, the transfer process to the Spanish solvency regulations under CRD2 (Directives 2009/111, 2009/27 and 2009/83) and CRD3 (Directive 2010/76) was completed. Thus, modifications affecting the definition of eligible capital, transactions related to securitizations, the monitoring of remuneration policies, management of liquidity risks and the requirements for financial instruments held for trading were incorporated into the Spanish regulatory framework.
The BBVA Group is adapting the ongoing regulatory changes and, in addition, is preparing for the significant modifications that will take place in the regulatory framework for solvency of financial entities in 2013, as regards the capital framework for banks (known as “Basel III”) and insurance entities (“Solvency II”):
As of December 31, 2011, 2010 and 2009, the Group's capital exceeded the minimum capital base level required by Bank of Spain regulations in force on each date as shown below:
| Capital Base | Millions of Euros | ||
|---|---|---|---|
| 2011 (*) | 2010 | 2009 | |
| Basic equity | 35,491 | 34,343 | 27,114 |
| Common Stock | 2,403 | 2,201 | 1,837 |
| Parent company reserves | 33,656 | 28,738 | 20,892 |
| Reserves in consolidated companies | 1,552 | 1,720 | 1,600 |
| Non-controlling interests | 1,662 | 1,325 | 1,245 |
| Other equity instruments | 5,189 | 7,164 | 7,130 |
| Deductions (Goodwill and others) | (10,839) | (10,331) | (8,177) |
| Attributed net income (less dividends) | 1,868 | 3,526 | 2,587 |
| Additional equity | 5,944 | 7,472 | 12,116 |
| Other deductions | (5,303) | (4,477) | (2,133) |
| Additional equity due to mixed group (**) | 1,070 | 1,291 | 1,305 |
| Total Equity | 37,202 | 38,629 | 38,402 |
| Minimum equity required | 26,462 | 25,066 | 23,282 |
The main changes in 2011 in the amounts of capital resources shown in the above table have been:
- The capital increases under the “Dividend Option” program mentioned in Notes 4 and 27.
- The goodwill recognized for the acquisition of Garanti mentioned in Note 20.1, which increases the deduction in Capital Base.
- The impairment of goodwill of the CGU of the United States mentioned in Note 20.1, which reduces the deduction in Capital Base.
- The operation involving the repurchase of preferred securities and subsequent issue of convertible bonds, mentioned in Note 23.4.
- However, the conversion of the Convertible Bonds mentioned in Notes 23.4 and 27 has had no impact on the total calculation of the Group’s capital base, given that said bonds were already considered eligible for the purposes of the Group’s basic funds from the date on which they were subscribed and paid since they were obligatorily convertible upon maturity.
In addition to that established in Circular 3/2008, Spanish financial groups and entities must comply with the capital requirements set forth by Royal Decree-Law 2/2011 of 18 February 2011 reinforcing the Spanish financial system. This standard was issued for the purpose of reinforcing the solvency of the Spanish financial entities. It thus established a new minimum requirement in terms of core capital on risk-weighted assets which is more restrictive than the one set out in the aforementioned Circular, and that must be greater than 8% or 10%, as appropriate. This new ratio, which had a temporary purpose, had to be satisfied prior to March 10, 2011, without the BBVA Group having to take any extraordinary actions to adapt to it.
As of December 31, 2011, the Group’s capital exceeded the minimum capital base level required by Royal Decree-Law 2/2011, together with the last issue of mandatory convertible bonds into shares (at the discretion of the issuer on any date of the payment of the remuneration), that comply with the eligibility requirements of the European Banking Authority (EBA), totaled approximately €5,700 million.
- Stress test and new recommendations on minimum capital levels
In the first half of 2011, 91 of the main European financial institutions underwent stress tests coordinated by the European Banking Authority (EBA) in cooperation with the European Central Bank (ECB), the European Commission and the European Systemic Risk Board (ESRB).
The results of these stress tests, released on July 15, 2011, showed that the BBVA Group was one of the European institutions that best maintained its solvency levels, even in the most adverse scenario anticipated at the time, which incorporated the impact of a possible sovereign risk crisis and a substantial reduction in the valuation of the real estate assets.
On October 26, 2011, the EBA, in cooperation with the competent national authorities, announced the conducting of a study on the capital levels of 71 financial institutions throughout Europe based on data available as of September 30, 2011.
As a result of this study and in order to restore market confidence in the European financial system, the EBA issued the recommendation of reaching, as of June 30, 2012, a new minimum capital level in the ratio known as Core Tier 1 (“CT1”), on an exceptional and temporary basis, in order to address, among other issues, the current situati0n of the sovereign risk crisis in Europe. This new recommended level is temporary in nature; as such, the EBA has announced its intention to lift it once confidence in the European financial markets is restored.
Based on the information released on December 8, 2011, the BBVA Group would need to increase its capital base by €6,329 million in order to reach this minimum level set for the CT1 ratio as of June 30, 2012. Of this amount, €2,313 million correspond to the temporary increase in the capital base for exposure to the aforementioned sovereign risk.
On January 20, 2012, the BBVA Group submitted to the Bank of Spain a specific action plan following the recommendations of the EBA that will enable it to reach the minimum level set for the CT1 ratio at the end of June 2012. This plan is being examined by the Bank of Spain jointly with the EBA.
The measures already taken under this plan include the issue of convertible subordinated debentures completed on December 30, 2011 (see Note 23.4). This action, together with organic generation of capital and other additional measures envisaged in the plan will enable the BBVA Group to comply with the recommendations issued by the EBA without having to apply for government aid. As of December 31, 2011, 84% of the recommended capital base increase had been reached.
- Capital management
Capital management in the BBVA Group has a twofold aim:
- Maintain a level of capitalization according to the business objectives in all countries in which it operates and, simultaneously,
- Maximize the return on shareholders’ funds through the efficient allocation of capital to the different units, a good management of the balance sheet and appropriate use of the various instruments forming the basis of the Group's equity: shares, preferred securities and subordinate debt.
This capital management is carried out in accordance with the criteria of the Bank of Spain Circular 3/2008 and subsequent amendments both in terms of determining the capital base and the solvency ratios.
This regulation allows each entity to apply its own internal ratings based (IRB) approach to risk and capital management. The BBVA Group carries out an integrated management of these risks in accordance with its internal policies (see Note 7) and its internal capital estimation model has received the Bank of Spain's approval for certain portfolios.
Capital is allocated to each business area of the BBVA Group (see Note 6) according to economic risk capital (ERC) criteria, which are based on the concept of unexpected loss with a specific confidence level, as a function of a solvency target determined by the Group, at two levels:
- Core capital, which determines the allocated capital and is used as a reference to calculate the return on equity (ROE) generated by each business; and
- Total capital, which determines the additional allocation in terms of subordinate debt and preferred securities.
Due to its sensitivity to risk, CaR is an element linked to management policies of the BBVA Group businesses themselves. It standardizes capital allocation between them in accordance with the risks incurred and makes it easier to compare profitability. The calculation of the CaR combines credit risk, market risk, structural risk associated with the balance sheet, equity positions, operational risk, fixed assets risks and technical risks in the case of insurance companies. Internal models were used that have been defined following the guidelines and requirements established under the Basel II Capital Accord, with economic criteria prevailing over regulatory ones.