Financial Stability Report – May 2014
Banco de Portugal discloses the Financial Stability Report today.
This Report includes a Chapter on the identification of risks to stability and, where relevant, the instruments that are deemed more effective to mitigate them. This Chapter was first included in the Financial Stability Report in November 2013, in line with the assignment given to Banco de Portugal on the macro-prudential oversight of the financial system and to preserve the financial stability of Portuguese economy.
This report includes an analysis covering the banking sector, the insurance sector, pension funds and mutual funds. It includes also an analysis on the non-financial sectors.
Financial system stability
1. After three years since the beginning of the Economic and Financial Assistance Programme (EFAP), important progress was made in some fields: the economy started to show net lending abroad, public accounts were the object of a significant structural adjustment, and there was some evolution concerning structural reforms. In the context of the orderly deleveraging of their balance sheets, banks have ensured an appropriate flow of financing to the economy, in particular to the goods and services tradable sectors, while increasing its solvency and liquidity.
2. However, progress made in the Portuguese economy is still insufficient. This calls for continuance of the reforms started during the applicable EFAP period, with a view to ensuring the required sustained improvement of the economy and living standards of the Portuguese population. Indeed, some of the structural vulnerabilities that the international financial crisis has very clearly exposed still persist. These vulnerabilities arise in particular from the high indebtedness levels of the private and public sectors, translated into the financial sector leverage and, in general, into the external debt stock, and from the weak pace of actual and potential economic growth.
3. The adoption of credible policies, aiming at increased competitiveness and external balance and based on public fiscal discipline, on a robust financial sector, and on the deepening of structural reforms, is critical to sustainable economic growth and to promote favourable access conditions to international markets. Indeed, this is the only way to favour, for a considerable time, external credibility acquired in the context of implementation of the EFAP. It must always be borne in mind that a positive balance in external accounts – i.e., net lending abroad – will make it possible to reduce Portuguese economy’s external indebtedness. Within an international framework characterised by financial market fragmentation in the euro area and high uncertainty levels related to the sovereign debt crisis, the EFAP made it possible for the Portuguese economy to take advantage of stable external financing, at a relatively low cost. With the conclusion of the EFAP, the conditions associated with such financing (amounts, maturities and rates) will be especially conditional on the authorities’ policies and the behaviour of resident economic agents.
4. The financial sector will continue to face important challenges. In particular, the banking sector´s regulatory and competitive framework is undergoing profound changes. Despite the positive contribution to financial stability of the projected regulatory changes, the simultaneous adoption of a wide and complex set of new rules will involve operational risks and induce behaviour adjustments, that may trigger some disturbance in the short run. In the medium term, within the framework of the banking union, the banking business model will certainly be different from the current one. Competition for the best customers will increase, favouring the most efficient institutions. The others will tend to be restricted to poorer quality exposures, which will adversely affect their profitability and growth potential.
5. The recovery of banking sector profitability, particularly affected over the past three years, require continued effort by the institutions to reduce operational costs and to increase own funds. This is especially pressing in a context where the banking system must reduce its high dependence on financing from the Eurosystem and needs to return to bond and capital markets.
This Financial Stability Report includes three articles, two of which are the responsibility of the authors, economists in Banco de Portugal:
- “Strategy and instruments of macro-prudential policy”;
- “A resolution mechanism for the banking union: rationale and set-up”, by João Freitas;
- “Cash-holding decisions of Portuguese non-financial corporations: an analysis of financing restrictions”, by Luísa Farinha and Pedro Prego.
Lisbon, 15 May 2014