Banco de Portugal publishes today the December 2017 Financial Stability Report.

The Portuguese economy and financial system have shown important progress in the past few years. In 2017 a series of positive developments contributed to the consolidation of the banking sector’s stabilisation, particularly the extension of the maturity of loans granted to the Resolution Fund, capital increases by some of the main banks operating in Portugal, and completion of the sale of Novo Banco.

Vulnerabilities and risks

One of the main vulnerabilities of the Portuguese economy is the high indebtedness levels of the general government, households and non-financial corporations (NFCs), which remain above those seen across the euro area. High indebtedness, together with low potential growth, makes the Portuguese economy more vulnerable to adverse shocks, particularly given that monetary policy is expected to normalise in the near future. Therefore, it is crucial to proceed with the decrease of public debt, by strengthening the structural nature of fiscal consolidation, and the deleveraging process of households and enterprises, benefiting from the favourable macroeconomic and financial environment.

As regards the banking sector, the non-performing loans (NPLs) and coverage ratios in the NFC sector improved substantially, although high heterogeneity persists across banks. Overall, between June 2016 and June 2017, there was a decrease of around €8 billion in NPLs, of which approximately €6 billion in NFCs.

However, despite recent improvements in strengthening solvency, in reducing the NPL stock and in market perception about Portuguese banks, the financial sector also continues to display vulnerabilities.

The reduction in the still high NPL stock is conditional on the continued implementation of the measures included in the comprehensive strategy. In particular, NPLs must continue on their current reduction path, in line with the plans agreed with the Single Supervisory Mechanism and Banco de Portugal, especially given the need to access international financial markets to meet regulatory requirements, including the minimum requirement for own funds and eligible liabilities (MREL).

The sector’s low profitability levels and high exposure to the sovereign, the real estate sector and emerging market economies performing poorly are other vulnerabilities that may contribute to the materialisation of risks to financial stability.

Most notable among these risks is the possibility that global risk premia may be revalued worldwide due to geopolitical developments, which would impair access to funding for more leveraged economic agents.

The protracted low interest rate environment should continue to put pressure on the Portuguese banking sector’s net interest income and profitability. Furthermore, it creates incentives for an easing in credit standards and, consequently, slower than desirable deleveraging of the economy.

Financial institutions must continue to make an adequate and forward-looking assessment of borrowers’ creditworthiness, avoiding excess risk-taking in new credit flows, namely as regards housing loans. In this respect, Banco de Portugal is considering the adoption of measures to further the assessment, by credit institutions, of private borrowers’ creditworthiness.

Macroprudential policy

To ensure that the Portuguese financial system maintains sufficient shock-absorbing capacity, without jeopardising funding to the economy, Banco de Portugal:

• maintained the phase-in period set out in European regulations on the capital conservation buffer rate;
• maintained the countercyclical capital buffer rate at 0% of total risk exposures in the fourth quarter of 2017;
• established the capital buffer rate applicable to O-SIIs, extending by two years the time limit for compliance with such rates.

Special issues and boxes

The Financial Stability Report presents three special issues: 

• “Strategy to address the stock of non-performing loans (NPL)”;
• “Risk segmentation on the interest rate spreads of new loans to non-financial corporations”;
• “Leverage ratio – the Portuguese case”.

It also includes five boxes:

• “Reduction in NFC’s leverage and investment in Portugal”;
• “Vulnerability of Portuguese enterprises to short-term interest rates rises”;
• “Real estate owned assets in the banking sector balance sheet”;
• “Financial vulnerability of Portuguese households”;
• “Housing price developments in Portugal and implications for financial stability”.