The Portuguese financial system is facing several serious challenges, arising from the international financial instability, particularly marked in Europe during 2010, and worsened, in the Portuguese case, by the need of adjustment of structural imbalances, which are becoming more severe. The strong deterioration of the prospects of international financial markets players on the sustainability of the public finances situation in Portugal has been reflected in a strong increase in the risk premium on sovereign debt, which has had negative repercussions on the Portuguese banking system’s access and funding costs in the international wholesale debt markets. This increase in risk premium occurred against a background of a significant differentiation in sovereign risk assessment in the euro area. The imbalances of the Portuguese economy are not only associated with a worsening fiscal situation but also with a persistent and significant deterioration of the economy’s external position, against a background of high levels of private and public indebtedness and low economic growth over the course of the last decade.

As the Portuguese economy’s external indebtedness has been almost fully intermediated by the public sector and the banking system, these sectors’ difficulties in access to financing in the international debt markets force the intensification and acceleration of the adjustment between the Portuguese economy’s savings and investment, involving all institutional sectors. In addition, the Portuguese economy’s necessary deleveraging process will imply changes in the size and composition of the balance sheet of the Portuguese banking system, in a context of more difficult financing conditions in the international wholesale markets. The Portuguese economy’s prospects over the next few years will tend to condition the evolution of the banks’ profitability (making it more difficult for them to reinforce their capital base), and will also imply an expectable intensification of the materialisation of credit and market risk. In addition, the unsustainability of the permanent large scale use of Eurosystem financing will require a redefinition of Portuguese banks’ financing strategy, particularly in a framework of persisting major restrictions on access to financing in the wholesale debt markets. This being the case, the adoption of strategies for taking resources from customers is essential in order to mitigate the liquidity risk of the Portuguese banking system.

During the course of 2010, loans granted by Portuguese banks to non-financial corporations and households decelerated only gradually and the indebtedness of the public sector continued to increase. This evolution was, to a large extent, sustained by the unconventional monetary policy measures implemented by the European Central Bank during the international financial crisis. These measures were essential to avoid significant falls in private and public sector financing flows. Furthermore, 2010 continued to be marked by a significant materialisation of credit risk. The increase in default ratios was more expressive in loans to non-financial corporations and loans to households for consumption and other purposes, with a relative stabilisation of this indicator in loans to households for house purchase. Notwithstanding the global worsening of default indicators, reference should be made to some slowdown in the materialisation of credit risk.

In the first half of 2010, the profitability of the Portuguese banks decreased in year-on-year terms but recorded a slightly positive evolution vis-à-vis the end of the preceding year. This slight increase was essentially the result of the positive effects associated with other provisions and impairment losses (not related to credit to customers), in addition to the containment of operating costs. The results generated by the international activity continue to make an increasingly more expressive contribution to the profitability of the Portuguese banks, representing around one third of the results generated in the first half of 2010. In the third quarter of 2010, the profitability indicators of the six major Portuguese banking groups remained relatively stable, when compared to the previous quarter. In turn, own funds adequacy ratios were significantly above the recent minimums observed at the end of 2008. In the first half of 2010 there was a slight deterioration of the overall own funds adequacy ratio vis-à-vis the end of the previous year and, in contrast, an increase of the original own funds (Tier I) ratio. In the third quarter of 2010, the regulatory capital ratios of the six major Portuguese banking groups remained broadly in line with what was seen during the first half of the year.

Notwithstanding the highly adverse setting in which Portuguese banks have been operating since the start of the international financial crisis, they have displayed a remarkable capacity to resist and adapt themselves, being able to continue to ensure the financing of the economy. Against this background, the difficulties faced by Portuguese banks in accessing the international wholesale debt markets essentially reflect the increase in the sovereign risk premium, in a context of greater risk differentiation in the euro area, as well as the Portuguese economy’s structural imbalances, but not any intrinsic profitability or solvency problems of the Portuguese financial system. However, given the prospects for the Portuguese economy, the reinforcement of the booking of impairments for credit losses and of banking system capital are considered to be indispensable for ensuring the continuity of their capacity to resist adverse shocks.

Reference should be made to the fact that the need for the adjustment of the Portuguese banking system will be reinforced, over the medium and long term, by the implementation of new regulatory requirements on capital and liquidity ratios under Basel lII. Although these adjustments, when considered globally, could have negative impacts on banking system profitability, they will help to reinforce the stability of the financial system, ensuring the necessary conditions for improving the capacity to resist future shocks. Convergence to the new regulatory requirements on an international level will also imply significant adjustment endeavours by Portuguese banks which, as a whole, will have to reinforce their regulatory capital base, increase the proportion of liquid assets in their balance sheets and endeavour to secure more stable financing sources.

Lisbon, 30 November 2010.