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Financial Stability Report – November 2013

The Banco de Portugal discloses today the Financial Stability Report. This report has a new format, as it covers the entire banking sector, the insurance sector, pension funds and mutual funds. A reference to general government is included in the section on the resident non-financial sectors.

The report also includes a chapter on the identification of risks to financial stability and, where relevant, the instruments that are deemed more effective to mitigate them. This approach is consentaneous with the assignment given to the Banco de Portugal on the macro-prudential oversight of the financial system and to preserve the financial stability of Portuguese economy.

Main results:

1. The evolution of the Portuguese economy is an essential conditioning factor of financial sector’s stability and soundness. In 2013 the correction process of macroeconomic imbalances continued to restrain significantly the Portuguese economy, against an international financial background characterised by an accommodative monetary policy stance, high levels of uncertainty and financial market fragmentation. In this context, it is worth highlighting an improvement in Portugal in the general government accounts and in the external balance. External rebalancing translated into an increase in the Portuguese economy’s lending capacity, reflecting a considerable rise in non-financial sector saving and a continued fall in investment. The banking system’s credit portfolio declined again in the first half of 2013, amid deleveraging of the economy’s non-financial sectors. In spite of that, indebtedness of these sectors remains high. At the same time, credit flows have been reallocated towards the economy’s tradable sectors, an evolution that is positive.

2. GDP developments and the reduction of disposable income have translated into a deterioration of the quality of the banking sector’s credit portfolio. In the first half of 2013 the credit at risk ratio continued to rise, which was particularly significant in the case of credit granted to non-financial corporations and contained and stable in the segment of loans to households for house purchase. Despite the rise in the credit at risk ratio, its coverage through provisioning remained relatively stable. Banco de Portugal has been undertaking initiatives to guarantee the adequate provisioning of banks’ credit portfolios.

3. Overall, banking sector’s profitability was negative in the first half of the year, especially due to a narrowing of the interest rate margin and impairment developments. The low interest rate levels currently observed affect banks’ profitability, insofar as they put pressure on their net interest income, despite the positive effect that they nevertheless have on impairments. This is especially relevant in Portugal, where the return on assets is limited by the fact that a significant part of the credit portfolio is remunerated at variable rates with small spreads that are fixed for long maturities. The cost of funding has decoupled from these variable rates after being penalised by the unfolding of the financial crisis.

4. When assessed by liquidity gaps, the Portuguese banks’ liquidity situation remained relatively comfortable in the course of the first half of 2013. Similarly to most euro area banks, the liquidity position of Portuguese banks has been reinforced due to the ECB’s action as regards both conventional and non-conventional monetary policy measures. The withdrawal of these measures, particularly those with a non-conventional nature aiming at restoring the adequate monetary policy transmission mechanism at the euro area, must be gradual and foreseeable, as the fragmentation fades.

5. Deposit growth has played a key role in the adjustment process of the banking system’s financing sources, with a view to a more sustainable structure, less sensitive to changes in risk perception by international investors. These developments confirm the banking customers’ confidence in Portuguese banks. In the first half of 2013, customers’ resources increased, reflecting resident households’ portfolio shifts and further positive contributions made by international activity. Excluding deposits, the Portuguese banking system’s financing structure continues to be quite limited by the segmentation of international financial markets, including the interbank market, making it more difficult to diversify financing sources, namely access market sources.

6. Recourse by Portuguese banks to financing by Eurosystem, although stabilising, has remained well above the euro area average. Once the constraints that hamper smooth market functioning are overcome, recourse to this financing is expected to be significantly reduced. The deepening of the Economic and Monetary Union and, in particular, the conclusion of Banking Union, including not only the Single Supervisory Mechanism, but also resolution and deposit guarantee for all banks, are essential to overcome fragmentation.

    Lisbon, 26 November 2013