1.1. Executive summary*

At December 2018, Santander was the largest banking group in the Eurozone by market capitalisation (EUR 64,508 million) and the 16th in the world.

The Group engages in all types of activities, operations and services that are typical of the banking business in general. Its business model is focused on commercial banking products and services with the aim of meeting the needs of its 144 million customers, including private banking customers, SMEs, businesses and corporates.

Santander’s strategy remained focus on customer loyalty. The number of loyal customers (19.9 million) rose by 2.6 million in the year (+15%), with individuals as well as companies rising. The number of digital customers (32.0 million) rose by 6.6 million in 2018 (+26%), underscoring the strength of our multichannel strategy.

 

The Group operates through a global network of 13,217 branches, the largest excluding Chinese banks and Sberbank Group, as well as digital channels, in order to provide top-quality service and flexibility. Santander is among the top three banks in customer satisfaction in seven of our main countries.

Santander has EUR 1,459,271 million assets and manages EUR 980,562 million of total customer funds across all its customer segments. It has more than four million shareholders and over 200,000 employees. Retail Banking accounts for 87% of the Group’s total income.

The Group is highly diversified and operates mainly in 10 core units, where it maintains significant market shares.

In terms of solvency, Santander is bolstering its capital ratios and improving credit quality, while remaining one of the most profitable banks.

 

1.2. Santander Group Pillar 3 report overview

 

1.2.1. Background information on Santander Group

Banco Santander, S.A. is a private-law company, subject to the rules and regulations applicable to banks operating in Spain. In addition to its own activities, Banco Santander is the parent of a group of subsidiaries engaged in a variety of activities, which together make up Santander Group. The CRR and CRD IV and their transposition in Spain through Bank of Spain Circular 2/2016, on supervision and solvency, apply on a consolidated level across the entire Santander Group.

Santander Group does not make use of the exemption contemplated in article 49 of the CRR, therefore the disclosure of table INS1 (Non-deducted participations in insurance undertakings) does not apply.

As of 31 December 2018, under Article 7 and 9 of the CRR, the subsidiaries Santander Leasing S.A. EFC and Santander Factoring y Confirming S.A. EFC are exempt from the minimum capital requirements, the limit on large exposures and the internal corporate governance obligations. No use of the exemptions under the applicable regulations has been made for any other Santander Group subsidiaries.

Santander Group is one of the banks that have not required state aid in any of the countries in which it operates.

For all those aspects for which disclosure is required under Part Eight of the CRR and which are not applicable to Santander Group, see Appendix II – CRR Mapping – , where they are reported as “N/A” (not applicable).

As of 31 December 2018, none of the financial institutions included in Santander Group consolidated had less than the minimum capital required under applicable regulation.

1.2.2. Governance: approval and publication

Pursuant to the official disclosure policy, Santander Group publishes its annual Pillar 3 disclosures report following board approval. Prior to the board of directors’ approval on 26 February 2019, the report was reviewed by the risk supervision, regulation and compliance committee at a meeting held on 25 February, and also by the capital committee at a meeting held on 8 February 2019.

Additionally, on 21 February 2019, the report was reviewed by the audit committee.

 

Furthermore, a set of quarterly information has been published since March 2015 in compliance with the EBA’s: Guidelines on materiality, proprietary and confidentiality and on disclosure frequency, pursuant to article 432, sections 1 and 2 and article 433 of Regulation (EU) 575/2013.

No exceptions have been made to the publication of information considered proprietary or confidential.

Appendix II contains a list showing the location of the information disclosed in accordance with the relevant articles of Part Eight of the Regulation.

The information contained in this report has been subject to review by the external auditor (PwC), who did not find any issue with regard to the reasonableness of the disclosures and compliance with the reporting requirements established in the CRD IV and the CRR.

Governing bodies’ certification

The board of directors of Santander Group certifies that the publication of the Pillar 3 disclosures report is compliant with the guidelines of Part Eight of Regulation (EU) 575/2013 and consistent with the “Pillar 3 Disclosures Policy” adopted by the board of directors.

The Pillar 3 Disclosures Report relies on a range of processes relating to the internal control framework, with duties and responsibilities having been defined for review and certification of the information set out in the report at several levels of the organisation.

In addition, the external auditors carry out an ex ante review, and the work plans for recurring reviews by internal audit also cover this report.

The Pillar 3 disclosures report is available in the Shareholders and Investors section of the Santander Group website (www. santander.com), under “Financial and Economic Information”.

 

Disclosures of Santander Group subsidiaries

In addition to the information contained in this report, Santander Group subsidiaries that are considered to have significant importance for their local market, pursuant to article 13 of the CRR (Application of disclosure requirements on a consolidated basis), publish information at individual level on their websites in relation to: own funds, capital requirements, capital buffers, credit risk adjustments, remuneration policy and the application of credit risk mitigation techniques.

1.2.3. Transparency enhancements

In recent years, Santander Group has taken note of the recommendation issued by different international bodies with the aim of improving the transparency of the information published each year in the Pillar 3 disclosures report.

In December 2016, the European Banking Association (EBA) published its final guidelines on disclosure requirements under Part Eight of the Capital Requirements Regulation. These guidelines provide guidance to financial institutions on how to comply with applicable regulations.

Further, in March 2017 and December 2018 the Basel Committee published the second and third phase of its Revised Pillar 3 Disclosure Requirements.

Santander Group has now incorporated all of this year’s applicable enhancements. Appendix II provides a list showing the location of the information required under the different articles of Part Eight of the CRR, while the Santander Group website includes a file containing all of the tables shown in this document in editable format to facilitate their treatment.

A detail of the applicable enhancements can be found in the Appendix I.

1.2.4. Disclosure criteria used in this report

This report has been prepared in accordance with the applicable European Capital Requirements Regulation (CRR).

Below are the details of the type of information that best reflects the discrepancies between the regulatory information shown in this report, and the information shown in the Annual Report and the accounting information:

 

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The measures of credit risk exposure used for calculating regulatory capital requirements include:

 

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not only current exposures, but also potential future risk exposures arising from future commitments (contingent liabilities and commitments) or changes in market risk factors (derivative instruments)

 

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the mitigating factors of these exposures (netting agreements and collateral agreements for derivative exposures, and collateral and personal guarantees for on-balance-sheet exposures).

 

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Criteria used when classifying defaulted exposures in portfolios subject to advanced approaches for calculation of regulatory capital are more conservative than those used for preparing the disaggregated information provided in the Annual Report.

 

1.3. Scope of consolidation

Santander Group companies included in the scope of consolidation for the purposes of calculating the capital adequacy ratio under the CRR are the same as those included in the scope of consolidation for accounting purposes under Bank of Spain Circular 2/2018.

1.3.1. Differences between the consolidation method for accounting purposes and the consolidation method for regulatory capital calculation purposes

In application of Part I (General Provisions) of the CRR, certain Santander Group companies are consolidated using a different method to that used for accounting consolidation.

The companies for which a different consolidation method is used, based on the regulations applied are listed in Appendix V of the 2018 Pillar 3 Appendix document available on the Santander Group website. To this day, both the participations in significant financial institutions and insurance companies are exempt from deductions under CRR’s article 48.

 

For the purposes of calculating the capital adequacy ratio based on the nature of their business activities, Santander Group units included in the prudential scope of consolidation are consolidated using the full consolidation method, with the exception of jointly controlled entities, which uses proportionate consolidation. All companies that cannot be consolidated based on their business activities are accounted for using the equity method and so are treated as equity exposures.

The basis of the information used for accounting purposes differs from that used for the calculation of regulatory capital requirements. The measures of risk exposure may differ depending on the purpose for which they are calculated, such as financial reporting, regulatory capital reporting or management information. The exposure data included in the quantitative disclosures in this document are used for calculating regulatory capital.

The following table shows the relationship between the various categories of the financial statements and the risk categories in accordance with prudential requirements.

 

Shown below are the main differences between the carrying amounts appearing on the financial statements and the exposures for prudential purposes:

 

The reconciliation of public and non-public balance sheets is shown in Appendix VI on the Santander Group website.

 

1.3.2 Substantial amendments due to a change in perimeter and corporate transactions

A breakdown is provided below of the main purchases and sales of stakes in other companies, and other major corporate transactions by Santander Group last year:

i. Sale of the 49% stake in WiZink

On 6 November 2018, once the pertinent regulatory permits had been secured, the transactions arising from the agreement between the companies managed by Värde Partners, Inc. (“Varde”) and WiZink Bank, S.A. (“WiZink”) disclosed by the Group on 26 March 2018 were carried out, by virtue of which:

i. Banco Santander sold Varde its 49% stake in WiZink for EUR 1,043 million, with no material impact on the Group’s profit or loss; and

ii. Banco Santander and Santander Totta acquired the debit and credit card business sold through Banco Popular in Spain and Portugal that WiZink had acquired in 2014 and 2016. The Group paid a total of EUR 681 million in the transaction, receiving net assets of EUR 306 million (mostly loans and receivables worth EUR 315 million). The business combination produced EUR 375 million of goodwill, which will be managed by the businesses in Spain.

With these transactions Santander Group is resuming Banco Popular’s debit and credit card business, which improves the marketing strategy and facilitates the integration of Banco Popular.

 

ii. Acquisition of the retail banking and private banking business of Deutsche Bank Polska, S.A.

On 14 December 2017, the Group announced that its subsidiary, Santander Bank Polska, S.A. (Formerly Bank Zachodni WBK S.A.), and Banco Santander, S.A., had reached an agreement with Deutsche Bank, A.G. to acquire (through a carve out) the retail and private banking business of Deutsche Bank Polska, S.A., excluding its foreign currency mortgage portfolio and CIB (Corporate & Investment Banking) business, and including asset management company DB Securities, S.A. (Poland).

In November 2018, after the pertinent regulatory authorisations were secured and approval was given at the respective annual general meetings of Santander Bank Polska, S.A. and Deutsche Bank Polska, S.A, the acquisition was completed, with EUR 298 million paid in cash and newly-issued Santander Bank Polska, S.A. shares subscribed in full by Deutsche Bank, A.G. As consideration, it received net assets worth EUR 365 million, mainly customer loans and deposits, and loans and deposits from credit institutions, worth EUR 4,304 million and EUR 4,025 million, respectively, with negative valuation adjustments of EUR 82 million (mainly under “Loans”).

A gain of EUR 67 million was recognised on the difference between the fair value of the net assets acquired and the value of the transaction, recorded under “negative goodwill recognised in results” in the Group’s consolidated income statement.

iii. Sale agreement of Banco Popular’s real estate business

In relation to Banco Popular’s real estate business, on 8 August 2017, Banco Santander announced the transaction with the Blackstone Fund entailing the acquisition by the fund of a 51% stake and, accordingly, control over the real estate business, which comprises the portfolio of repossessed properties, real estate asset holding companies, non-performing loans relating to the real estate sector and other assets related to this activity of Banco Popular and its subsidiaries (including deferred tax assets) registered on certain specified dates (31 March 2017 or 30 April 2017).

The agreements were entered into following receipt of the European Commission’s unconditional authorisation of the acquisition of Banco Popular by Banco Santander for the purposes of competition law.

The transaction was completed on 22 March 2018, after the required regulatory authorisations were secured. The transaction involved the creation of several companies, with Project Quasar Investments 2017, S.L. as parent, in which Banco Popular holds a 49% stake and Blackstone the remaining 51%, and to which Banco Popular and certain subsidiaries transferred the business composed of the aforementioned assets and the stake in Aliseda Servicios de Gestión Inmobiliaria, S.L. The price attributed to the assets contributed was approximately EUR 10,000 million, with the vehicle funding approximately 70% with bank borrowings. Following the contribution by shareholders of the required liquidity to the vehicle so its business could operate, the 49% stake was recognised in the Group’s balance sheet at an amount of EUR 1,701 million, under “Investments in joint ventures and associates - associates”. The transaction did not have a material impact on the Group’s income statement.

iv. Merger by absorption by Banco Santander of Banco Popular, S.A.U.

On 23 April 2018, the boards of directors of Banco Santander and Banco Popular Español approved and subscribed the planned merger by absorption of Banco Popular, S.A.U. by Banco Santander.

On 28 September 2018, the deed of the merger by absorption of Banco Popular Español, S.A.U. by Banco Santander, S.A. was placed on file with the Mercantile Register Office of Cantabria. As a result of the merger, Banco Santander acquired, by universal succession, all the rights and obligations of Banco Popular, including those acquired by Banco Pastor and Popular Banca Privada through their merger with Banco Popular, which was also approved by their respective boards on 23 April 2018. This transaction did not have a significant impact on the Group’s income statement.

v. Agreement with Aegon Group as business partner in several insurance lines

On 3 July 2018, the Group announced that it had reached an agreement with the Aegon Group whereby the latter will be the insurance partner in Spain in life-risk and certain lines of general insurance. The agreement and scope under which it will be implemented are subject to several conditions and to the process of termination of the alliance between Banco Popular and its current partner. Therefore, it is not possible to determine when the transactions will be closed. They are not inspected to have a significant impact on the Group’s income statement.

1.4. Regulatory framework

On 26 June 2013 the Basel III legal framework was incorporated in the European legal order via Directive 2013/36 (CRD IV), which repeals Directives 2006/48 and 2006/49, and Regulation 575/2013 on prudential requirements for credit institutions and investment firms (the CRR).

CRD IV was introduced into Spanish law through Law 10/2014 on the regulation, supervision and solvency of credit institutions, and its subsequent regulatory implementation via Royal Decree 84/2015 and Circular 2/2016 of the Bank of Spain, which completes its adaptation to Spanish law.

The CRR, which is immediately applicable in all European countries, provides for a phased-in period that will allow institutions to adapt gradually to the new requirements in the European Union. The phased-in arrangements have been introduced into Spanish law through Bank of Spain Circular 2/2014 affecting both the new deductions from capital and the instruments and elements of capital that cease to be eligible as capital under the new regulation. In March 2016, the ECB published Regulation 2016/445/ EU, adjusting certain timelines established in Bank of Spain Circular 2/2014, especially the calendar for (Deferred Tax Assets) DTAs. The capital buffers provided for CRD IV will also be phased-in gradually, starting in 2016 and reaching full implementation in 2019.

The review of the capital regulatory framework in force (CRR/CRD IV) by the European governance bodies is nearing completion. The new framework (CRR II/CRD V), which is expected to be approved in early 2019, will include different Basel standards, such as the Fundamental Review of the Trading Book for market risk, the Net Stable Funding Ratio for liquidity risk, or the SA-CCR for calculation

 

of the EAD by counterparty credit risk or interest rate risk in the banking book (IRRBB). Amendments will also be made relating to the treatment of central counterparties, the MDA, Pillar 2, the leverage ratio and Pillar 3 among others.

The most significant change is the implementation of the TLAC Term Sheet, established internationally by the Financial Stability Board (FSB) within the European capital framework, known as the Minimum Requirement of Eligible Liabilities (MREL), whereby systemically important banks will have to comply with MREL requirements under Pillar 1. Changes also include the amendment of the Resolution Directive (BRRD), which will be replaced by BRRD II establishing MREL requirements under Pillar 2 for all resolution entities, both systemic and otherwise, whereby the resolution authority will decide the requirements on a case-by-case basis.

In 2018, the SRB set target MREL requirements based on the 2017 policy. These targets are set for each resolution group, both Multiple Point of Entry (MPE) strategies, as is the case for Banco Santander, and Single Point of Entry (SPE) strategies.

In January 2019, the SRB published the 2018 MREL policy. Among its key points we would highlight the hybrid approach under which eligible liabilities issued are only computed at the level of the point of entry, along with the Resolution Group’s own funds. The policy also establishes that individual requirements will be set for relevant entities of each Resolution Group and there will be guidance on internal MREL so as to align the policy with the regulatory changes to be introduced in the BRRD.

1.4.1. Regulatory changes in 2018

In 2018, significant progress was made on the capital review and crisis management process, while issues such as sustainability and digital transformation started to take on a leading role in the regulatory agenda.

International framework

In 2018, the Basel Committee continued to work on the following issues, among others:

 

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Market risk. In March, the consultation on the Review of Minimum Capital Requirements for Market Risk was launched, to be completed in June 2018, to conclude the review of the market risk standard.

 

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Simple, transparent and comparable short-term securitisations. In May, the Basel Committee published: i) Criteria for identifying simple, transparent and comparable short-term securitisations, together with IOSCO; and ii) Capital treatment for simple, transparent and comparable short-term securitisations.

 

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Global systemically important banks (G-SIBs). In July, the Basel Committee published a document entitled Global Systemically Important Banks: revised assessment methodology and the higher loss absorbency requirement, which includes the first review of the framework for global systemically important banks. This revised methodology is expected to be implemented by the national jurisdictions by 2021, when it will be revised again.

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Pillar III disclosure requirements. The Basel Committee published the Third Review of its Pillar III Disclosure Requirements in December 2018.

 

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Sovereign debt. In March 2018, the consultation on the discussion paper published in 2017 reviewing the treatment of sovereign debt was completed. The main options raised in the paper involved additional disclosure requirements (Pillar 3) and capital surcharges (Pillar 1 and Pillar 2) for sovereign debt exposures except for exposures to central banks denominated in domestic currency (of the central bank) and for exposures to central banks in countries where monetary policy is centred on the exchange rate.

With respect to crisis management, in 2018, the Financial Stability Board (FSB) continued to address the definition and design of elements in the crisis management process to ensure its effectiveness and practical application. Two main sets of guidelines were released during the year:

 

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Funding strategy for the implementation of a resolution plan. These guidelines covered, among others: the need for entities to have sufficient capacity to estimate and control their funding requirements in the event of resolution; the need to have sufficient assets and private funding channels in the event of resolution; and the need to have temporary access to industry funds, in addition to funding from central banks.

 

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Bail-in implementation procedures. The aim of the guidelines is to facilitate the implementation of a resolution strategy based on the absorption of losses by creditors. The guidelines include the obligation of the institution to disclose any instruments that may be the object of a bail-in and the need for securities regulations to contain the option of cancelling the securities, informing creditors and issuing new securities after the resolution.

Further, in the summer of 2018, the FSB asked for feedback following the implementation of the Total Loss Absorbing Capacity (TLAC) process in the different jurisdictions. The objective is to assess the degree of consistency in its implementation in relation to the content and dates established in the TLAC term sheet published in 2015. The feedback collected and the FSB’s own analysis will be included in the report published by the FSB in the summer of 2019. No changes are expected with regard to the definition of the TLAC, but as a result of this report, the FSB could issue guidelines to facilitate the implementation of the standard.

In November 2018, the Financial Stability Board (FSB) updated the list of G-SIBs for 2020. Santander remains within the least systemic group of banks and is subject to the minimum additional capital surcharge for banks of systemic importance (1%).

In the digital arena, the fintech phenomenon and the need to review the regulatory and supervisory framework are increasingly pressing points on the agendas of international authorities. In 2018, these authorities published several papers on this subject.

In February, the Basel Committee (BCBS) published a report on sound practices and implications of fintech developments for banks and bank supervisors. The report looks at the challenges involved in adopting financial technologies and the appearance of new business models for banks. Among other considerations, the BCBS proposes the supervisory framework to be developed ensuring appropriate supervision without hampering innovation.

 

Along these lines, in October, the International Monetary Fund (IMF) and the World Bank (WB) presented their Bali fintech agenda. This agenda includes a set of 12 policy elements aimed at helping member countries to harness the benefits and opportunities of financial technology to develop solutions to improve financial services, mitigate risk and achieve stable and inclusive growth.

Among other points, the agenda recommends modernising legal frameworks to enable innovation, in addition to increased monitoring of new market participants, products and activities by the authorities. The IMF and WB suggest reviewing the competition policy framework for fintech to take account of the new business models.

The document also suggests that the determination of what constitutes a systemically important entity may need to be expanded to include non-bank financial institutions and entities providing critical fintech infrastructure, and exploring the implications of this in areas such as security networks, including deposit insurance or issues relating to crisis management and the resolution of problems affecting these entities.

European regulation

In 2018, work continued at European level on the review of the capital framework and the resolution framework (review of CRR/ CRD/BRRD). In December 2018, agreement was achieved in several key areas:

 

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The option not to deduct software from capital resources in certain circumstances, to be determined by the EBA.

 

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The SME supporting factor will be expanded, and an infrastructure supporting factor introduced.

 

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The subordination requirement is established at a minimum of 8% of total liabilities and equity. The entity may reduce this level with a limit; but the fully subordinated requirement may also be demanded.

 

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The M-MDA concept is created, whereby for nine months the resolution authority may decide, at its discretion, although in consultation with the competent authority, whether to apply the restriction in the event of non-compliance with MREL. This decision is reviewed on a monthly basis.

 

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The moratorium tool may not be used before an institution is classified as Failing or Likely to Fail, and for a maximum duration of two days.

The implementation process of the definitive Basel III framework, approved by the Group of Governors and Heads of Supervision of the Central Banks (GHOS) on 7 December, in the European Union has commenced.

The objective of this text seeks to review the frameworks for calculating capital requirements in relation to credit, market and operational risk, and is intended to ensure that they are more simple, readily comparable and risk-sensitive, while also reducing any variability in risk-weighted assets that is not justified with regard to the different risk profiles.

Therefore, to progress with the draft regulation to be implemented by Basel in Europe, the European Commission launched a Consultation on the finalisation of Basel III to be completed in April 2018. A request was also submitted to the EBA for a quantitative and qualitative assessment of the implementation of the Basel III framework, which involved a complete analysis of the potential impact of the different elements in the reform of the banking sector and the general economy of the European Union.

Meanwhile, the European Commission has yet to determine the equivalence of the jurisdictions of third countries, based on EBA questionnaires. The work was put on hold in 2016 but resumed in late 2017, with Argentina being one of the jurisdictions to undergo an assessment. For the qualification of CCPs, the Commission once again extended the phased-in period until 15 June 2019.

With respect to supervision, the supervisory activity conducted by the Single Supervisory Mechanism (SSM) within the framework of the Supervisory Review and Evaluation Process (SREP) is notable. In this area, Banco Santander’s Joint Supervisory Team from the European Central Bank worked tirelessly in 2018, holding over 100 meetings with the bank, most of which were related to its inspection and monitoring activities.

Along with a busy supervisory agenda, in 2018 the SSM continued to make great strides towards the harmonisation of supervisory policies across countries, and improving the transparency of their expectations.

Europe also continues to make progress in the implementation of the crisis management framework. The Single Resolution Mechanism (SRM), the second pillar of the Banking Union after the Single Supervisory Mechanism, has been operational since 1 January 2016. In January 2018, the definitive system under which banks contribute to the administrative expenditure of the SRB came into effect, replacing the transitory system of November 2014. The Single Resolution Board, together with the national resolution authorities, have defined the framework for establishing MREL (minimum requirement of eligible liabilities) and continue to work towards ensuring the effectiveness of the resolution framework.

Turning to the Single Resolution Fund managed by the Single Resolution Board, the period of gradual mutualisation will allow for a transition from the national resolution funds, in place in several euro area countries until 2016, to the Single Resolution Fund, which will be fully implemented by 2024. The funding target of the Single Resolution Fund is 1% of covered deposits in 2024. The first year was calculated at 60% nationally (BRRD perimeter) and 40% across the euro area (SRM perimeter). In 2017, these percentages were inverted, with 40% of funding in the BRRD perimeter and 60% within the SRM perimeter. In 2018, 33% was in the BRRD perimeter and 67% in the SRM perimeter. Funding under the SRM perimeter will be steadily raised to reach 100% in 2024.

In 2018, debate continued over the creation of a backstop for the Single Resolution Fund, after an agreement was reached on the design and allocation for funds for the European Stability Mechanism (ESM), which will act as the backstop. However, the issue of the provision of liquidity on resolution remains unresolved.

 

Negotiations on Pillar 3 of the banking union, the European Deposit Insurance Scheme (EDIS), for which the European Commission already submitted a proposal in 2015, are advancing slowly. A route map is being prepared to commence policy negotiations. For this purpose, a high-level work group will be set up, which will publish a report in June 2019.

Further, in March 2018, the Commission published a raft of measures to address the high rates of non-performing loans (NPLs). These included a draft regulation governing minimum cover for losses deriving from NPL exposures, which is expected to be approved in early 2019.

In May 2018, the Commission published its legislative proposal for a framework to create Sovereign Bond-Backed Securities (SBBS). No progress is expected to be made in 2019.

In the digital area, in March 2018, the Commission presented its Fintech action plan: for a more competitive and innovative European financial sector. The plan encompasses 23 initiatives through which the Commission aims to enable the financial sector to benefit from advances in new technologies (such as artificial intelligence, blockchain or the cloud), while at the same time ensuring that innovation is safer for customers. These initiatives, which the Commission has already started to develop, include:

 

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Enabling innovative business models to scale-up across the EU through clear and consistent licensing requirements (e.g. the Commission has presented a proposal to establish a European passporting regime for crowdfunding service providers for companies).

 

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Increasing competition and cooperation between market players through common standards and interoperable solutions (e.g. encouraging the development of APIs compatible with PSD2 and GDPR).

 

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Facilitating the emergence of innovative business models across the EU through innovation facilitators such as sandboxes, and increasing cooperation between the authorities and the industry (e.g. creation of EBA Fintech Knowledge Hub for the purpose of exchanging knowledge and experiences with financial institutions, new entrants and technology providers).

 

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Reviewing the suitability of the rules and ensuring technology neutrality (e.g. setting up an expert group to assess whether there are regulatory obstacles to financial innovation).

 

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Removing obstacles to cloud services (e.g. setting up work groups to develop safety certification systems for providers, and facilitate data portability between providers).

 

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Enabling the development of blockchain applications (e.g. creation of the Blockchain Observatory and Forum and two special expert groups to define the policy, legal and regulatory terms required for the roll-out of applications, and assess and promote the most promising cases).

 

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Enhancing the security and integrity of the financial sector (e.g. assess barriers limiting information sharing on cyber threats in the financial markets).

The European Commission has also progressed in the implementation of its strategy to create a Digital Single Market, focusing on three main issues:

 

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Building a European data economy.

 

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Online platforms and how to ensure these continue contributing to the economy and to society as a whole.

 

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Strengthening cyber security.

In regard to building a data economy, the Commission has been working on several initiatives to protect privacy and create trust in the digital economy: the GDPR came into force in May 2018, establishing a common European framework for personal data protection. In 2018, the free flow of non-personal data regulation was approved, which will come into force in May 2019. The draft ePrivacy regulation, which is still at the discussion phase, has yet to be approved.

Further, to address the challenges raised by the use of artificial intelligence and big data, the Commission is working on defining a suitable legal framework for data analysis and automatic decision-making. With this aim, in 2018 it set up an expert group on artificial intelligence to draw up some ethical guidelines to govern the use of this technology and recommendations on how to enable policies for the development of this technology.

In the area of platforms, in April the Commission submitted a draft regulation for online brokerage services to ensure fairness and transparency for business users. The EC also set up a group of experts for the observatory on the online platform economy to monitor the legislative proposal.

In the area of cyber security, in 2018 the Commission worked on three main aspects: 1) strengthening the role of ENISA as a permanent European cyber security agency, while also making it a key body for pan-European cyber security certification, 2) strengthening cooperation between member states to protect against potential large-scale cyber-attacks, 3) promoting the concerted implementation of the NIS directive in the different member states.

In the last few years, and particularly from 2015 following the signing of the Paris Agreement on climate change and sustainable financing, there has been a re-directing of environmental policies at international and European level. Specifically, key regulatory proposals have been made given the major role that financial institutions can play in the transition to a sustainable economy.

Therefore, in 2018, the European Commission implemented the legislative package known as “EU action plan on sustainable finance” which sets out the route map for reaching the EU’s targets for 2030, including a 40% reduction in greenhouse gas emissions. Highlights of the action plan, which is currently being debated by the European parliament and the council, include:

 

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Establishing a common language for sustainable finance, i.e. a unified classification system (‘taxonomy’) within the EU that defines what can be considered sustainable, and signals the areas where sustainable investment may have the greatest impact.

 

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Establishing EU labels for green financial products based on the EU classification system: this will help investors to easily identify products that comply with green or low-carbon criteria.

 

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Clarifying asset managers’ and institutional investors’ duties to consider sustainability in the investment process and strengthen disclosure requirements.

 

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Introducing sustainability in prudential requirements: banks and insurance companies are a major source of external financing for the European economy. The Commission will assess the viability of recalibrating the capital requirements for banks (green supporting factor) for sustainable investors, when this is justified from the standpoint of risk.

 

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Increasing the transparency of corporate reports.

It should also be noted that at December 2018, as part of the European agreement to review the CRD and CRR, certain key factors exist relating to sustainable finance: the possibility of including environmental, social and corporate governance risks (ESG) in the SREP; greater transparency for companies with regard to ESG risk and the mandate enabling the EBA to carry out an analysis to assess the viability of recalibrating the capital requirements for banks (green/brown factor).

Santander Group voices the concerns and thoughts of its corporate offices and local teams on matters relating to the financial sector where these affect its business. The corporate and local public policy function, in coordination with the business units and support divisions concerned in each case, identifies the regulatory alerts and establishes the Santander Group’s stance.

The main courses of action taken along these lines are as follows:

 

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Santander Group has been a keen participant in the main banking associations worldwide and in Europe, and in the main markets in which it operates. Among other assistance, it contributes inputs to the replies drawn up in connection with ongoing regulatory consultations.

 

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Santander Group has maintained proactive, constructive dialogue with policy-makers through the existing channels (hearings) and sends individual replies to official consultations on issues considered relevant to the Santander Group.

 

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In particular, Santander Group has worked to consolidate and make known the sturdiness of its organisational model through subsidiaries that are fully independent when it comes to capital and liquidity. It also has the benefits of geographic diversification and recognition of the issuance of capital instruments from third countries and equivalence of the jurisdictions of third countries where the bank operates. In addition, one of the bank’s main objectives is for subsidiaries to adopt return- and advanced-capital-based management systems via internal models, given the improvements in comprehensive risk management and adequacy in the calculation of capital these provide.

 

•

Santander also maintains that the regulatory framework should enable banks to play an active role in the new digital economy, and implement their transformation so that they can continue to respond to changing consumer needs.

 

Table 3. Main capital figures and capital adequacy ratios

 

EUR million

 

		Fully loaded								Phased-in
		Dec-2018				Dec-2017				Dec-2018				Dec-2017
Common Equity (CET1)			66,904				65,563				67,962				74,173
Tier 1			75,838				73,293				77,716				77,283
Total capital			87,506				87,588				88,725				90,706
Risk weighted assets			592,319				605,064				592,319				605,064
CET1 Ratio			11.30	%			10.84	%			11.47	%			12.26	%
Tier 1 Ratio			12.80	%			12.11	%			13.12	%			12.77	%
Total capital ratio			14.77	%			14.48	%			14.98	%			14.99	%
Leverage Ratio			5.10	%			5.02	%			5.22	%			5.28	%

 

 

2018 CET1 Fully Loaded evolution

 

%

 

Regulatory Capital vs Regulatory requirement

 

 

 

1.	Global systemically important Banks buffer

2.	Conservation capital buffer

3.	Countercyclical capital buffer

 

Capital management and control at Santander Group is a fully transversal process that seeks to guarantee the bank’s capital adequacy, while complying with regulatory requirements and maximising profitability. It is determined by the strategic objectives and by risk appetite set by the board of directors. To achieve this, the following policies have been established to shape the approach that the Group applies to capital management:

•

Establish adequate capital planning, so as to meet current needs and provide the necessary resources to meet the needs of the business plans, regulatory requirements and the associated risks in the short and medium term, while maintaining the risk profile approved by the board.

 

•

Ensure that the Group and its companies maintain sufficient capital to cover requirements during stress scenarios due to the increase in risks as the macroeconomic climate deteriorates.

 

•

Optimise capital use through appropriate allocation of capital among the businesses, based on the relative return on regulatory and economic capital and taking the risk appetite, growth and strategic objectives into account.

Santander Group maintains a very comfortable capital adequacy position, well above the levels required by applicable regulations and by the European Central Bank.

Santander Group’s solvency ratios at 31 December 2018 are as shown in table 3. Phased-in ratios are calculated applying the transitory schedules for implementation of Basel III, whereas fully loaded ratios are calculated without applying any schedules, hence, using the final regulation.

IFRS 9 became effective on 1 January 2018, implying changes in accounting that affect capital ratios. Santander decided to applying the transitional arrangements, implying a 5-year transitional period.

Had it not applied the IFRS 9 transitional arrangements, the total impact on the fully loaded CET 1 ratio at December would be -27 bps. For further details, see Appendix XII.

 

Capital and solvency ratios

 

 

 

 

In fully-loaded terms CET1 in December stood at 11.30%, increasing by 46 bps during the year and reaching the goal at year-end which was announced at the beginning of the year. The fully-loaded capital ratio was 14.77%, up by 29 bps during the year.

2018 CET1 Fully Loaded evolution

 

 

The increase of 46 bps in the year is mainly due to profit generation and risk assets management, which put the ordinary generation for the year at 64 bps, together with 21 bps from the perimeter (mainly Blackstones and Wizink), partially offset by -25 bps from regulatory impacts/one-offs (mainly minorities of SC USA and restructuring costs), and another 14 bps from various causes, including the valuation of available for sale portfolios.

From a qualitative point of view, Santander Group has solid ratios that are suited to its business model, the structure of its balance sheet and its risk profile. Santander Group exceeds the 2019 minimum regulatory capital requirements for the total ratio by 179 basis points, taking into account the surpluses and shortfalls of AT1 and T2.

 

 

•

Autonomy. The Group’s corporate structure is based on a legally independent subsidiary model, each responsible for its own capital and liquidity. This provides advantages when raising funds and limits the risk of contagion, thus reducing systemic risk. Under this structure, subsidiaries are subject to two tiers of supervision and internal control: local and global. Each unit must raise and manage its own financial resources accordingly in order to maintain the required levels of capital at all times. Local units must have the necessary capital to carry on their activity autonomously and meet local regulatory requirements and the expectations of their local market.

•

Solvency. The Group and its subsidiaries must ensure at all times that the structure and level of their capital is suitable in view of the risks to which they are exposed. Capital must be allocated accordingly so as to ensure the effective management of the risks assumed within the subsidiaries and it must be assigned proportionately among all those risks.

•

Efficiency. The Group and its subsidiaries must roll out mechanisms to actively seek and promote an efficient use of capital and to ensure that the value created by an investment exceeds at least the cost of the capital invested. Capital is a scarce commodity that must be used as efficiently as possible, given the high cost of generating capital, whether organically or through the markets. Subsidiaries must have on- going monitoring mechanisms in place to optimise their capital consumption.

 

2.1.1. Capital function

The core principles provide the basic guidelines for the Group entities in managing, monitoring and controlling capital.

2.1.1.1. Organisation

The organisational structure has been defined with a view to achieving compliance with the principles of capital management while ensuring that the relationship between each subsidiary and the corporation in this function facilitates the subsidiary’s financial autonomy, subject to strict monitoring coordinated at Group level.

Santander Group’s risk management and control model is based on three lines of defence. The first line comprises the business functions or activities that assume or generate exposure to risk. Risks undertaken or generated within the first line of defence must be compatible with the risk appetite and limits in place. To carry out its function, the first line of defence must have the resources to identify, measure, address and report the risks assumed. The second line of defence comprises the function of controlling and supervising risk, along with the compliance function. This second line of defence is charged with effective control of risks and ensures that they are managed in accordance with the risk appetite defined.

Internal audit is the third line of defence and the last layer of control, and regularly assesses policies, methods and procedures to ensure they are suitable, and also checks they are operational.

The risk control function, the compliance function and the internal audit function are sufficiently separate and independent from each other and also regarding the other functions they control and supervise when carrying out their tasks. They likewise have access to the board of directors and/or to its committees at the highest level.

2.1.1.2. Capital governance

To ensure the capital function operates properly when it comes to both decision-making and supervision and control, Santander Group has developed a structure of responsive and efficient governance bodies so as to ensure the involvement of all the areas concerned and the necessary involvement of senior management. Because of the Group’s hallmark subsidiary-based structure, the governance structure of the capital function must be adapted to preserve the subsidiaries’ capital autonomy, while allowing centralised monitoring and coordinated management at Group level. There are also various committees that have responsibilities at regional level and also for coordination at Group level. The local committees must report to the corporate committees as and when required on any relevant aspects of their activity that may affect capital so as to ensure proper coordination between the subsidiaries and the corporate centre.

 

Regulatory capital

 

•

Capital requirements: The minimum amount of capital the supervisory authority requires the entity to hold to safeguard its solvency, based on the amount of risk assumed, in terms of credit, market and operational risk.

 

•

Eligible capital: The capital the regulator considers eligible to meet capital requirements. The main components of eligible capital are accounting capital and reserves.

Economic capital

 

•

Internal capital requirements: The minimum amount of capital that the Group needs with a specified level of probability to absorb unexpected losses deriving from its current exposure to all risks taken on by the entity (including risks additional to those contemplated under the regulatory capital requirements).

 

•

Available capital: The amount of capital the Group itself considers eligible, on management criteria, to meet capital needs.

Cost of Capital

The minimum return required by investors (shareholders) as compensation for the opportunity cost incurred and the risk assumed on investing their capital in the entity. This cost of capital represents a “cut-off rate” or “minimum return” to be achieved and allows comparisons to be made between the different business units and their efficiency to be assessed.

Leverage ratio

Regulatory measure that monitors the financial solidity and strength of the Entity by linking size and capital. This ratio is calculated dividing the Tier 1 by the leverage exposure, which takes into account the balance sheet exposure and adjustments due to derivatives, secured financing transactions (SFTs) and off-balance sheet items.

 

Return on risk-adjusted capital (RoRAC)

The return (understood as net profit after tax) on internally required economic capital, Therefore, the higher the economic capital, the lower the RoRAC. For this reason, the Bank must demand a higher return from transactions or business units that consume more capital.

RoRAC takes the investment risk into account and so provides a risk-adjusted measure of return.

The use of RoRAC allows the Bank to better manage its activities, assess the real risk-adjusted return of businesses and be more efficient in decision-making relating to investments.

Return on Risk Weighted Asset (RoRWA)

Defined as the return (understood as net profit after tax) on a business’ risk-weighted assets.

The use of RoRWA allows the Bank to set up strategies to allocate regulatory capital and ensure the maximum return is obtained.

Value creation

Any profit generated above and beyond the cost of economic capital.

The Bank will create value when the risk-adjusted return, measured by RoRAC, is higher than its cost of capital. Otherwise value will be destroyed. It measures the risk-adjusted return in absolute terms (monetary units), supplementing the RoRAC result.

Expected loss

Average NPL losses expected by the entity over the course of an economic cycle. From the point of view of expected loss, defaults are considered a “cost” that could be eliminated or reduced through appropriate selection of borrowers.

 

The Group’s capital function is performed at two levels:

 

•

Regulatory capital: regulatory capital management is based on an analysis of the capital base, the capital adequacy ratios as defined by applicable regulations and the scenarios used in capital planning. The aim is for the capital structure to be as efficient as possible, in terms of both cost and compliance with regulatory requirements. Active capital management includes strategies for capital allocation and for efficient usage of business units, securitisation, asset sales and issuances of capital instruments (hybrid capital instruments and subordinated debt).

 

•

Economic capital: the economic capital model ensures that sufficient capital is available and allocated accordingly to cover all the risks to which the Group is exposed as a result of its business activity and according to its risk appetite. It also aims to optimise value creation at the Group and across all its business units.

By effectively measuring the capital needed for a given business activity, together with the return on that business, the Group is able to optimise value creation by selecting those business activities that offer the best return on capital. This capital allocation process is carried out under different economic scenarios and with the level of capital adequacy determined by Santander Group in each case. The scenarios include those that are expected to occur and those that are far less likely though still plausible.

2.1.3. Capital management priorities

The Group’s most notable capital management activities are:

 

•

Establishing solvency objectives and the capital contributions aligned with the minimum regulatory requirements and internal policies, in order to guarantee a solid level of capital, coherent with the Group’s risk profile, and an efficient use of capital to maximise shareholder value.

 

•

Developing a capital plan to meet the objectives coherent with the strategic plan. Capital planning is an essential part of executing the three-year strategic plan.

 

•

Assessing capital adequacy in order to ensure that the capital plan is coherent with the Group’s risk profile and with its risk appetite framework also in stress scenarios.

 

•

Developing the annual capital budget as part of the Group’s budgetary process.

 

•

Monitoring and controlling budget execution and drawing up action plans to correct any deviation from the budget.

 

•

Calculating capital metrics.

•

Drawing up internal capital reports, as well as reports for the supervisory authorities and for the market.

Details of the most significant actions undertaken in 2018 are set out below:

Issues of financial instruments with the legal status of capital

In March 2018, Banco Santander S.A. made one issue of contingent convertible bonds (CoCos) for EUR 1,500 million in a bid to strengthen its AT1 capital.

In February, Banco Santander, S.A. carried out an issuance of subordinated debt for EUR 1,250 million, and in April, Bank Polska S.A. for EUR 229 million. These placements are intended to enhance the total capital ratio, as it qualifies as Tier 2 capital.

Dividend policy*

The board of directors’ intention is to distribute EUR 0.23 charged to 2018’s earnings in four dividends, three of them in cash and one a scrip dividend (Santander Dividendo Elección).

For further details, see the Corporate Governance Chapter (section 3.3: Dividend policy) on the 2018 Annual Report.

 

In December 2015, the European Central Bank issued a recommendation on dividend allocation policies applicable to all euro area credit entities as of 2016. The recommendation calls for conservative dividend policies and prudent assumptions and has been fully observed by Banco Santander S.A.

Lastly, in some regions, restrictions on the payment of dividends have been implemented, such as in Poland, where the national authority (KNF) has imposed stricter minimum restrictions on the payment of dividends, with additional limits for entities with large mortgage exposures in foreign currency, or in Argentina, where BCRA notice “A”6464 was issued in 2018, amending the rules on distributing profits and coupons on perpetual instruments, making them more restrictive.

 

2.1.4. Capital targets

Santander Group works towards a fully loaded CET1 ratio from 11% to 12% in the medium term.

Fully loaded CET1 Capital evolution

 

 

Note 1: Pro-forma including January 2015 capital increase

The continuous improvement seen in the capital ratios is a product of the profitable growth strategy pursued by Santander Group and a culture of active capital management across all levels of the organisation.

Highlights:

 

•

The reinforcement of teams dedicated to capital management and greater coordination with the Corporate Centre and local teams.

 

•

All countries and business units have drawn up individual capital plans focused on achieving a business that maximises the return on capital.

 

•

Greater weighting of capital as part of incentive schemes. Certain aspects relating to capital management and returns are now taken into account when setting the variable remuneration payable to members of the senior management.

 

•

The relevant metrics include the Group’s fully-loaded CET1, the capital contribution of the different countries and the return on risk-weighted assets (RoRWA).

 

•

The qualitative aspects considered include the proper management of regulatory changes affecting capital, effective management of capital relating to business decisions, sustainable capital generation and effective capital allocation.

In tandem, the Group continues to develop a programme to ensure the ongoing improvement of infrastructure, processes and methodologies supporting all aspects relating to capital. The aim here is to ensure more active management of capital, enable the Group to respond rapidly to the already numerous and still growing number of regulatory requirements and carry out all associated activities more efficiently.

2.1.5. Capital buffers and eligible capital requirements

Santander Group must comply, at all times, with the combined capital buffer requirement, defined as the total CET1 capital necessary to meet the following obligations:

 

•

Capital conservation buffer (CCoB): mandatory for all entities and to be phased-in from 1 January 2016. The buffer for banks in 2019 will therefore be 2.5%.

 

•

Buffers for systemically important banks: applicable from 1 January 2016. There are two types:

 

•

Systemically important institutions: for entities designated as systemically important, using a common methodology. Here, there are two different surcharges. The largest buffer rate of the two is applied:

 

i)

G-SIB buffer (Global Systemically Important Banks): common methodology whereby banks are classified into buckets based on their global systemic risk.

 

ii)

D-SIB buffer (Domestic Systemically Important Banks)

 

•

Systemic risk buffer (SRB): The competent authority may require a systemic risk buffer, where these risks are understood to be those that could trigger a disturbance in the financial system causing serious consequences for said system and the real economy. This buffer is discretionary and applies to all or some of an entity’s exposures (domestic and/or foreign risks, risks specific to certain business sectors, etc.), as decided by the authorities.

If the SRB covers all types of exposures, the greatest of the three systemic buffer rates will be applied. If the SRB only applies to a certain type of exposure, the SRB buffer will be added to the greater of the other two systemic buffers (G-SIB or D-SIB).

 

•

Countercyclical capital buffer (CCyB): the CCyB will be applied when the authorities deem that lending is growing excessively in a certain jurisdiction and it will be applied in order to constrain this excessive growth. This buffer is specifically calculated for each bank or group and consists of the weighted average of percentages of countercyclical buffers applied in regions in which the bank’s relevant exposures are located. It is also applicable from 1 January 2016.

 

The table below summarises the required regulatory rates based on the different capital buffers to be applied and Banco Santander’s position in 2019:

 

Application		Buffers (% RWAs)		2019
All entities		Conservation (CCoB)		2.5%
		G-SIB entities
Designated entities		(1%-3.5%)(1)		100% of the buffer
		D-SIB entities (2)		100% of the buffer
		Systemic risk (SRB) (3)		0%-5%
At the discretion		Countercyclical
of competent		(CCyB) (4)		0% - 2.5%
national authority
		Consolidated		CCoB + CCyB + Max (5)
		combined buffer		(G-SIB, D-SIB, SRB)

 

(1)	According to the list of Global Systemically Important Banks (G-SIBs) published by the FSB for 2019, a combined buffer of 1% is required for Santander Group.

(2)	Domestic Systemically Important Banks. The Bank of Spain requires a 1% buffer for Santander.

(3)	This requirement is 0% for Santander.

(4)	Applicable countercyclical buffer:

a)

Exposures to customers resident in Spain: 0%, according to Bank of Spain data for the first quarter of 2019

b)

Exposures to customers resident in Norway and Sweden: 2%

c)

Exposures to customers resident in the UK: 1%

d)

Exposures to customers resident in Slovakia and Iceland: 1.25%

e)

Exposures to customers resident in the Czech Republic: 1%

(5)	The greatest of the 3 buffers applies if the SRB buffer covers all exposures. Otherwise, the higher of G-SIB and D-SIB plus the SRB buffer applies.

The geographic distribution of relevant lending exposures for calculating the countercyclical capital buffer is available in Appendix XI on the Santander Group website.

 

Eligible capital requirements

The decision on capital resulting from the Supervisory Review and Evaluation Process (SREP) under the European Central Bank’s (ECB) Single Supervisory Mechanism comprises a Pillar 2 Requirement (Pillar 2R) and Pillar 2 Guidance (Pillar 2G). Pillar 2R is binding, and failure to comply may have direct consequences for banks. Pillar 2G is not directly binding, and failure to comply has no bearing on the Maximum Distributable Amount (MDA) threshold. Moreover, Pillar 2G does not automatically trigger action by the ECB. However, the ECB does expect compliance with Pillar 2G at all times. If a bank is not compliant with Pillar 2G, the ECB will give careful consideration to the reasons and circumstances and may define additional supervisory control measures.

Pursuant to notification received from the ECB, in 2019, Santander Group must report a Common Equity Tier 1 (CET1) ratio of at least 9.70% on a consolidated level. This requirement includes the Pillar 1 requirement (4.5%); the Pillar 2 requirement (1.5%); the capital conservation buffer (2.5%); the requirement deriving from its status as a global systemically important bank (1%) and the countercyclical capital buffer requirement (0.20% de CET1). Santander Group must also maintain a minimum capital ratio of 11.20% for T1 and a minimum total ratio of 13.20%.

At 31 December 2018, Banco Santander had a CET1 regulatory capital ratio of 11.47% and a total ratio of 14.98% in application of IFRS9 transitional arrangements.

Regulatory Capital vs Regulatory requirement

 

 

 

1.	Global systemically important Banks buffer

2.	Conservation capital buffer

3.	Countercyclical capital buffer

 

2.1.5.1. Global systemically important institutions

Santander Group is one of the 29 institutions designated as global systemically important institutions (G-SIIs).

The position of a global systemically important institution may pose a risk to financial stability.

The insolvency of a systemically important institution, or even just the expectation that it might become insolvent, is difficult to predict but could certainly undermine the financial system and even the real economy.

This warrants special prudential treatment, which has led to the introduction of specific capital buffer requirements for both global (G-SIIs) and domestic (D-SIIs) systemically important institutions.

This designation requires Santander Group to meet additional requirements mainly relating to the following:

•

Its capital buffer (Santander Group is included in the group of banks with the smallest capital buffer, 1%)

 

•

TLAC (Total Loss-Absorbing Capacity) requirements

 

•

The requirement to publish relevant information more often than other banks

 

•

Stricter regulatory requirements for the internal control bodies

 

•

Special supervision

 

•

Requirement to submit special reports to the supervisors.

The Basel Committee and the Financial Stability Board decide which banks qualify as global systemically important institutions, using a method based on five indicators: size, cross-jurisdiction activity, interconnectedness with other financial institutions, substitutability of financial services/infrastructure and complexity (with each category given an equal weighting of 20%). This methodology has been changed and will come into effect from January 2021. The main changes in the methodology are as follows: change in the definition of cross-jurisdiction indicators, inclusion of a trading volume indicator modifying the weighting of the remaining indicators in the substitutability category and inclusion of insurance companies in the reporting scope.

 

The information needed to evaluate the indicators is requested yearly from banks whose leverage exposure exceeds EUR 200,000 million, or from any other banks at the supervisor’s discretion (in December 2017 a total of 76 banks were considered). All these institutions are then required to publish the information before 30 April of the following year.

The information is used to draw up a global indicator. The score obtained by each bank will determine the size of the capital buffer required of it, which is based on a set of buckets defined by the regulators (CET1 surcharge ranging from 1% to 3.5%).

In November 2018, the Financial Stability Board (FSB) published the list of global systemically important institutions based on December 2017 data. This list applies to 2020. Compliance with these requirements gives Santander Group greater solidity than its domestic peers. Santander Group is currently subject to a systemic buffer surcharge of 1%, which will become fully effective in 2019.

 

 

Global systemically important institutions

 

 

Capital buffer		Entity
5 (3.50%)		(Empty)
4 (2.50%)		JP Morgan Chase
		Citigroup
3 (2.00%)		Deutsche Bank
		HSBC
		Bank of America
		Bank of China
		Barclays
		BNP Paribas
2 (1.50%)		Goldman Sachs
		Industrial and Commercial
		Bank of China Limited
		Mitsubishi UFJ FG
		Wells Fargo
		Agricultural Bank of China
		Bank of New York Mellon
		China Construction Bank
		Credit Suisse
		Group BpsCE
		Group Crédit Agricole
		ING Bank
		Mizuho FG
1 (1.00%)		Morgan Stanley
		Royal Bank of Canada
		Santander
		Société Générale
		Standard Chartered
		State Street
		Sumitomo Mitsui FG
		UBS
		Unicredit Group

2.1.5.2. Domestic Systemically Important Institutions

When identifying Domestic Systemically Important Institutions (D-SIIs), the Bank of Spain, according to the methodology established on rule 14 of Circular 2/2016, applies a mix of guidelines based on size, importance, complexity (cross-jurisdiction activity) and the degree of interconnectedness between the institutions and the financial system. The Bank of Spain conducts a yearly review of this classification and the following institutions are included on its list for 2019:

Systemic buffer

 

Domestic Systemically Important Institutions

 

Santander Group appears on the lists of both global and domestic systemically important institutions. The Bank of Spain, based on rule 23 of Circular 2/2016, requires that the higher of the two buffers be applied. Since both buffers are the same for Banco Santander, the surcharge applicable in 2019 will be 1%.

2.2. Pillar 1 – Regulatory capital

The current regulatory framework for capital calculation is based on three pillars:

 

•

Pillar 1 sets the minimum capital requirements for credit risk, market risk and operational risk, allowing internal ratings and models to be used. The aim is to make regulatory requirements more sensitive to the risks actually incurred by financial institutions when carrying out their business activities.

 

•

Pillar 2 establishes a system of supervisory review, aimed at improving banks’ internal risk management and capital adequacy assessment in line with their risk profile.

 

•

Pillar 3 is intended to enhance market discipline by developing a set of disclosure requirements that will allow market agents to appraise key information relating to the application of Basel II, capital, risk exposures, risk assessment processes and, by extension, the bank’s capital adequacy.

2.2.1. Eligible capital

Equity at 31 December 2018 stood at EUR 107,361 million, up EUR 529 million from the year before.

 

Common equity Tier 1 capital (CET1) comprises the elements of Tier 1 capital (after applying prudential filters) and CET1 deductions after applying the threshold exemptions specified in the CRR. The regulation provides for a phased-in period that will give institutions time to adapt to the new requirements in the European Union. This phased-in applies to Santander Group under Regulation (EU) 2016/445 of the European Central Bank on the exercise of options and national discretions, published on 14 March 2016.

Without considering the phased-in schedule, CET1 is made up of:

 

•

Subscribed share capital, which stood at EUR 8,118 million at the end of December 2018.

 

•

Other tier 1 capital items: (i) paid-up share premium; (ii) effective and disclosed reserves generated against profits and those amounts that are not taken to the income statement but are recorded under “Other reserves” (any item); (iii) other retained earnings, which includes certain valuation adjustments, primarily for exchange differences and for hedges of net investments in foreign operations.

 

•

The paid-up portion of any non-controlling interests arising from the issue of ordinary shares by consolidated subsidiaries, subject to the limits set in the CRR.

 

•

Profit net of dividends, which stood at EUR 4,518 million in December 2018.

 

•

The prudential filters exclude any gain or loss on cash flow hedges. They also exclude gains or losses on liabilities and derivative liabilities measured at fair value resulting from changes in the institution’s own credit quality. In addition, prudential filters include the additional value adjustments considered according to art. 34 of the CRR.

 

•

Deductions from CET1 items include mainly treasury shares; current-year losses; goodwill and other intangible assets recognised in the balance sheet; deferred tax assets that rely on future earnings (subject to the limits set in the CRR); and the shortfall in allowances relative to expected loss on exposures using internal credit risk models and defined benefit pension fund assets shown on the balance sheet.

Tier 1 Capital comprises CET1 capital plus Additional Tier 1 capital (AT1) including preferred securities issued by Santander Group.

Tier 2 capital comprises Tier 1 capital plus Tier 2 capital (T2 and includes, inter alia, capital instruments and subordinated loans where the conditions laid down in the CRR are met.

Table 6. Regulatory capital. Changes

 

EUR million

 

Common Equity Tier 1 capital (CET1)
Starting figure (31/12/2017)			74,173
Shares issued during the year and share premium account			-10
Treasury shares and own shares financed			-42
Reserves			-826
Attributable profit net of dividends			4,518
Other retained earnings			-659
Minority interests			-1,010
Decrease/(increase) in goodwill and other intangibles			-5,815
Other deductions			-2,367
Ending figure (31/12/2018)			67,962
Additional Tier 1 (AT1)
Starting figure (31/12/2017)			3,110
Eligible instruments AT1			1,168
T1 excesses - subsidiaries			-258
Residual value of intangibles			5,707
Deductions			27
Ending figure (31/12/2018)			9,754
Tier 2 (T2)
Starting figure (31/12/2017)			13,422
Eligible instruments T2			1,406
Gen. funds and surplus loan loss prov. IRB			-3,823
T2 excesses - subsidiaries			-22
Deductions			27
Ending figure (31/12/2018)			11,009
Deductions from total capital
FINAL FIGURE FOR TOTAL CAPITAL (31/12/2018)			88,725

Eligible capital evolution

 

 

Total eligible capital decreased by EUR 1,981 million in 2018 to EUR 88,725 million.

 

In addition to movements in equity, changes in regulatory capital reflect the dividend not distributed in 2018 of EUR 1,055 million. The impact on reserves includes the impact of applying IFRS 9, which Santander Group is doing according to the progressive phase-in regime over the 5-year transitional period under Regulation (EU) 2017/2395 of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards transitional arrangements for mitigating the impact of the introduction of IFRS 9 on own funds.

Profit net of dividends amounted to EUR 4,518 million.

The movement in “Other retained earnings” reflects mainly exchange differences.

The change in minority interests, beyond accounting movements, reflects the impact of applying the transitional period provided for in Regulation (UE) No 575/2013 amounting to EUR -759 million.

Goodwill reflects the impact of exchange rate movements and corporate activity during the year. The increase in the deduction to this item was mostly due to the expiry of this period, with an impact of EUR -5,707 million.

Similarly, the change included in deductions and prudential filters was due mainly to the expiry of the period applied to the rest of the deductions, trends in the shortfall of provisions for expected loss and the change in deductions for defined benefit pension fund assets shown on the balance sheet.

Over the course of 2018, instruments eligible for inclusion as both Tier 1 and Tier 2 capital increased through new issues made by Banco Santander, S.A., of preferred securities for EUR 1,500 million applicable to Tier 1 capital and of subordinated debt for EUR 1,250 million applicable to Tier 2. Also, Santander Bank Polska, S.A. has issued subordinated debt applicable to Tier 2 capital for EUR 229 million.

Moreover, since IFRS 9 became effective, Tier 2 no longer considers the general credit risk adjustments included previously with the limits considered in prevailing regulations, with an impact on the total ratio of EUR -3,823 million.

2.2.2. Capital requirements

This section gives details of capital requirements by geography (see table 8).

Table 7 shows that capital requirements have barely changed from 2017, maintaining a Pillar I risk distribution similar to that of the prior year: credit risk 86%, market risk 4% and operational risk 10%.

Capital requirements for credit risk decreased by 2.4% compared to 2017 to EUR 40,481 million, while capital requirements for market risk increased by 3.6% and those for operational risk barely changed compared to the previous year.

RWA Evolution