Press release of the Banco de Portugal on the December 2020 issue of the Financial Stability Report
The COVID-19 pandemic has conditioned economic activity in recent months, with repercussions on the financial situation of economic agents that have created important challenges to financial stability.
Until 2019, the Portuguese economy went through a period of adjustment and convergence with Europe, translated into, inter alia, a strong decrease in corporate and household indebtedness. Fiscal policy sustained the downward path of public debt as a percentage of GDP that began in 2017. The banking sector registered a structural liquidity adjustment, a reduction in operational costs, improvements in the quality of credit portfolios, a gradual recovery in profitability and a significant strengthening of capital ratios.
The measures adopted by the authorities added to this favourable context, limiting the impact of the crisis on household income and firms’ liquidity. The governments took on part of the costs that would be incumbent upon enterprises and households, mitigating and diluting those costs over time.
The banking sector assumed a pivotal role in financing the non-financial sector, which had liquidity shortages due to the suppression of regular trade flows. Monetary policy, prudential and supervisory measures safeguarded the supply of credit. The increase in indebtedness was a natural but not risk-free consequence of this process.
In this economic and health environment, the main vulnerabilities and risks to financial stability are:
- sudden and substantial falls in the value of financial assets under potential episodes of extreme volatility in the financial markets;
- downward correction of residential property prices;
- increase in enterprises’ indebtedness, which may translate into pressures on solvency;
- household and general government indebtedness, especially in the medium term;
- increase in the nexus between the banking system and public sector, expectation of an increase in NPLs and low profitability prospects in the banking sector;
- inadequacy of monetary and fiscal stimuli to the various moments of the pandemic crisis.
The measures aimed at the banking sector and the non-financial private sector should be coordinated and complement each other to preserve financial stability. The economic crisis must not become a financial crisis.
The European initiatives aimed at responding to the crisis and supporting economic recovery enabled similar conditions to be established in the various countries against a varying pre-pandemic background in terms of public and private indebtedness. The effectiveness of these support measures’ execution will allow the countries to calibrate economic support measures that promote aligned paths to economic recovery that dissipate scenarios of economic and financial fragmentation.