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Banco de Portugal creates the Financial Stability Department

On 1 July 2013 the Board of Directors of Banco de Portugal created the Financial Stability Department. With this decision, Banco de Portugal strengthens its action in the field of banking regulation and supervision, thus contributing to the stability, efficiency and resilience of the financial system.

Up to now, the financial stability functions assigned to Banco de Portugal have been mainly carried out by two departments: the Economics and Research Department and the Banking Prudential Supervision Department.

The creation of this new department also reflects the need to adapt the Bank’s organisational structure to the setting-up of the Banking Union and, in particular, of the Single Supervisory Mechanism.

The main functions of the Financial Stability Department are to:

  • identify, monitor and assess risks to financial stability;
  • contribute to the definition and implementation of macroprudencial policy, including the presentation of proposals for measures and instruments to prevent and mitigate systemic risks;
  • carry out activities linked to the resolution function;
  • develop the prudential legal framework;
  • monitor and support the Bank’s participation in European macroprudential supervisory and policy structures (Governing Council and General Council of the European Central Bank, Supervisory Board of the Single Supervisory Mechanism, European Banking Authority), as well as in other international fora;
  • monitor and support the Bank’s participation in national supervisory and financial stability structures: National Council of Financial Supervisors and National Financial Stability Committee.

The Financial Stability Department will be chaired by Adelaide Cavaleiro, formerly the Deputy Head of the Banking Prudential Supervision Department of Banco de Portugal.

Lisbon, 9 July 2013

Background information

Safeguarding financial stability

Safeguarding the stability of the Portuguese financial system is one of the basic missions of Banco de Portugal. To fulfil this mission, Banco de Portugal is entrusted with a number of tasks and powers: it is a lender of last resort (in the framework of the European System of Central Banks), acts as a regulatory and supervisory authority, oversees the payment system, and implements deterrents and penalties.

Banco de Portugal has developed a strategy to ensure the robustness of institutions, preserve the integrity of the financial system and safeguard confidence in the banking system. This strategy has four major goals: to strengthen bank solvency; protect the banking system’s liquidity; increase the effectiveness of the financial system and, in particular, banking system surveillance; and improve the regulatory framework.

Banco de Portugal has released Financial Stability Reports and studies on this matter, some of which were also published in leading international journals. In 2012, Financial Stability Reports (released in March and November) included articles produced by in-house staff on household indebtedness and default; developments in access to credit by non-financial corporations; systemic risk models; systemic liquidity risk models; and a scoring model for Portuguese firms.

Macrosupervision of the financial system

Banco de Portugal monitors cyclical and structural developments in the financial sector, to identify and assess vulnerabilities and systemic risk sources that may jeopardise financial stability.

The global financial crisis has stressed the need for regular assessments of the financial system and better monitoring and analysis methodologies. Moreover, it has highlighted the importance of developing macroprudential instruments to prevent or mitigate systemic risks. Changes in the EU financial architecture and governance have helped strengthen the Bank’s role in this domain, a trend that will continue with the Banking Union.

Banco de Portugal’s action in terms of financial stability includes the monitoring of the banking system, the regular release of analyses on financial stability and the development of macroprudential instruments.

In the framework of the Economic and Financial Assistance Programme (EFAP), Banco de Portugal monitors the national financial system, particularly as regards the banking sector, namely through the quarterly review of the funding and capital plans of the eight largest groups. These plans, which are a key component of prudential supervision, are a crucial tool to assess the adjustment of the banking sector and the economy in general, given that they include detailed information on banking groups’ balance sheet and profit and loss account projections over the medium to long-term horizon. In 2012 the consistency between aggregated individuals plans and the macroeconomic scenario underlying the Programme was reviewed, namely as regards funding to the economy.

The Bank also carries out quarterly stress tests on major banks, on the basis of a common macroeconomic scenario. Stress tests performed in 2012 confirmed the institution’s resilience, even when faced with particularly adverse macroeconomic scenarios.

At the same time, Banco de Portugal develops systemic risk assessment instruments. More specifically, in 2012 Banco de Portugal:

  • (i) built indicators on contagion risks among sectors and institutions;
  • (ii) improved and developed new stress test methodologies;
  • (iii) intensified the modelling of the interaction between the financial sector and real economy; and
  • (iv) widened the scope of the study on the financial situation of households and firms, building on the microeconomic databases available. The combination of micro and macro information is key for studies on macroprudential policy, given that the impact of the materialisation of risks on the various economic agents varies.

Banking Union / Single Supervisory Mechanism

The financial and monetary integration that followed the creation of the single market and the single currency was not accompanied by a full integration of banking system supervision nor of the mechanisms that form the “safety net” built to withstand the impact of any banking system failure (deposit guarantee schemes, recapitalisation and resolution mechanisms), which continued to be mainly domestically based.

In this context, and taking into account the heightened financial market tensions and increasing difficulties in the transmission mechanism of the Eurosystem conventional monetary policy, the scene was set for the establishment of integrated supervision in the euro area – the Single Supervisory Mechanism –, as a first step towards a Banking Union and the materialisation of a true Economic and Monetary Union.

The Banking Union should rely – in the long term – on three complementary pillars. The Single Supervisory Mechanism is the first pillar. The ECB will be entrusted with the prudential supervision of euro area credit institutions, performing these tasks under a Single Supervisory Mechanism comprising the ECB and the relevant national authorities, with a view to “contributing to the safety and soundness of credit institutions and the stability of the financial system within the EU and each Member State, with full regard and duty of care for the unity and integrity of the internal market”. According to the Regulation, credit institutions established in other Member States may also be overseen by the ECB, in the scope of reinforced cooperation mechanisms that may be established with the relevant authorities.

The second pillar is a European Single Resolution Mechanism for banks, allowing the resolution of institutions without affecting systemic stability and the financial situation of the countries where they operate. The third pillar will be a common system of deposit protection, which will help reduce the likelihood of potential deposit runs, which, in a contagion situation, would rapidly constrain banking system liquidity.

These three pillars are based on the assumption that a single prudential rulebook will be maintained, which may be made more flexible for macroprudential policy purposes.

Resolution function

A solid resolution regime makes it possible to reduce distortions in the financial system associated with the implicit support given by the State to financial institutions (moral hazard), due to its systemic importance and contagion risks. In this context, special mention should be made to the new preventive, corrective and resolution regime and changes to the deposit guarantee scheme, which has been in force since early 2012.

As a resolution authority, Banco de Portugal is entrusted with developing the legal framework governing the resolution of banks, assessing the systemic impact of the resolution or winding-up of institutions, establishing resolution plans and strategies for each group/institution, and adopting corrective and resolution measures where necessary.

At European level, the proposal for a EU Directive on bank recovery and resolution is being discussed by the European Parliament and the Council.