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Financial Stability Report – November 2011

  1. There has been a substantial increase in the materialisation of risks to financial stability over the course of the last six months, both worldwide and in Portugal. This evolution reflects the deterioration of the macroeconomic and financial environment, in a context of widespread tensions in euro area sovereign debt markets. The deterioration of the macroeconomic and financial conditions further intensifies the challenges facing the Portuguese economy, as well as the Portuguese financial system. Indeed, the adjustment of economic imbalances will have to be implemented in a much more adverse environment, particularly as regards the foreseeable evolution of external demand. This implies a greater materialisation of credit and market risk and a deterioration of the Portuguese banking system’s profitability. There is, however, under the Economic and Financial Assistance Programme, a diversity of instruments which mitigate the impact of these shocks on the Portuguese financial system, notably in terms of eventual additional capital requirements. The deleveraging of the Portuguese financial system is also being permanently monitored by Banco de Portugal to ensure an orderly and gradual process which does not compromise the financing of the Portuguese economy.
      
  2. The loans to customers portfolio on a consolidated basis recorded a negative change in the first half 2011, reflecting a significant volume of loan sales. It should be noted that the evolution of credit aggregates is in line with expectations in the current recessionary economic environment. In other words, the available evidence points to the absence of excessive or abrupt restrictions in credit supply. In a scenario involving prospects of strong contraction in domestic demand and permanent income, a slowdown in the demand for credit is foreseeable, particularly by households, together with a strong reallocation of credit between firms and economic sectors. Furthermore, the current and future adversity of the economic environment implies an increase in risk taken by lenders and a more rigorous, and thus more selective, loan approval process. The key principle is to promote a gradual and orderly deleveraging process in the banking system that does not compromise, but instead redirects, the funding for the economy’s most competitive sectors and firms. Banks’ deleveraging strategies should, therefore, focus on the sale of non-strategic assets, on the increased use of stable financing and on the reinforcement of capital.
      
  3. The Portuguese banking system’s current adjustment process has benefited from the positive evolution of resident customers’ deposits, particularly households. Portuguese banks have made significant efforts to secure customer resources, namely by increasing their relative remuneration and also endeavouring to include on their balance sheets customer resources currently outside the banking consolidation perimeter.
       
  4. Portuguese banks’ profitability indicators have been significantly affected by the current economic and financial environment. Profitability was particularly affected by the drop in income from financial operations and by an increase in provisions and impairments associated with credit, in the context of a strong materialisation of credit risk.
        
  5. The recent evolution of the financial situation of households and non-financial corporations clearly indicates that the inevitable indebtedness reduction is in progress, aiming at converging to a more sustainable level. Non-financial corporations, particularly those with a high level of indebtedness and low level of efficiency, will have to make structural adjustments, in order to achieve a financing structure which is more balanced and less sensitive to negative shocks, as well as to improve their competitiveness. Special reference should be made to the importance of the restructuring of public corporations, owing to their size and high levels of indebtedness. This will not only facilitate the banking system’s orderly deleveraging process, but also positively affect the competitiveness of the economy.
      
  6. The evolution of Portuguese banks’ solvency ratios remains favourable, despite the adverse macroeconomic and financial environment and the ongoing adjustment process of the Portuguese economy, converging to the new regulatory minimums defined by Banco de Portugal under the Economic and Financial Assistance Programme. In light of unfavourable market conditions for capital increases and following a recommendation made by Banco de Portugal at the beginning of the year, the main Portuguese banks have adopted  moderate dividends payment policies, enabling banks to increase their equity by incorporating retained earnings. Notwithstanding the reinforcement of Portuguese banks’ solvency ratios, the outlook for a greater materialisation of risks in the near future warrants additional reinforcements of Portuguese banks’ capital in order to ensure financial system stability, as these banks are faced with an unprecedented series of risks and challenges. In parallel, additional fiscal consolidation efforts are decisive for ensuring the sustainability of the public finances, which is also essential for financial stability in Portugal. Such endeavours, however, must necessarily be complemented by measures to overcome several of the Portuguese economy’s structural weaknesses, promoting its competitiveness and growth potential.

Signed Articles

This Financial Stability Report includes, as usual, three articles written by economists of Banco de Portugal. These articles, of the sole responsibility of the authors, are the following:

  • “Towards a CCA-based systemic risk indicator”, by Nuno Silva, Nuno Ribeiro and António Antunes
     
  • “The behaviour of domestic and non-domestic banks in the supply of credit for housing purposes: an analysis based on microeconomic data”, by Sónia Costa and Luísa Farinha
     
  • “Modelling the evolution of households’ defaults”, by Nuno Alves and Nuno Ribeiro

       

Banco de Portugal, 29 November 2011.