Press release of Banco de Portugal on the Financial Stability Report – May 2016
The Financial Stability Report of May 2016 is released by Banco de Portugal today.
1. The nature of risks to financial stability has not changed since the publication of the latest Financial Stability Report, in November 2015. The high indebtedness of the public and private sectors, the low profitability of the financial system and the concentration of its assets in certain sectors, asset classes and geographical locations continue to challenge financial stability. These challenges, however, were sharpened by the prospective maintenance of low or even negative interest rates and an increase in market volatility which, although global, was stronger for Portuguese issuers.
2. In the short-term, the context of low interest rates may be favourable for the Portuguese economy, taking into account the high indebtedness of resident sectors. Nevertheless, it threatens the financial system profitability and, in case it promotes investment in sectors with higher risk and inappropriate asset valuation, it may raise difficulties in the adjustment process of the domestic productive structure.
3. Market volatility regarding Portuguese issuers may be related, on the one hand, to increased concerns about prospects for the ongoing fiscal consolidation and structural reform. On the other hand, is may be associated with the deterioration of market sentiment as regards European banks, in a context of transition to a more demanding regulatory framework. In the Portuguese case, this deterioration is amplified by the vulnerability of national credit institutions, especially low profitability, the quality of the balance sheet assets, and capital ratios. The new regulatory framework aims at financial stability, but still challenges the European banking system at the current juncture. The potential benefits deriving from the non-contagion of risk between the banking sector and the sovereign will only be clear in the medium term, with the full implementation of the Banking Union.
4. A significant change in market perception regarding national issuers, resulting from an abrupt reversal of risk premia, would have a widespread effect across the financial system, constraining funding costs and asset valuation, and would therefore affect the other sectors in the economy. This is especially worrying given the high indebtedness of the resident sectors and the low saving rate of the non-financial private sector.
5. Meeting the refinancing needs of the economy in international markets therefore requires action by the national authorities that is consistent with the maintenance or improvement of resident entities’ credit rating. It is also crucial that the downward trend of the non-financial private sector indebtedness continues, in a framework of maintaining or even increasing the private sector's lending, especially households’, making room for an acceleration of economic growth without threatening the economy’s external balance.
6. The aggregate financing structure and liquidity position of the Portuguese banking system continued to improve in 2015, dampening, in the short term, the potential negative effects associated with increasing risk premia or sharply declining liquidity in the wholesale financing market.
7. The increase in bank exposure to public debt securities during the economic and financial crisis has not been materially reversed, in a context of foreseeable more demanding regulatory changes in the prudential treatment of the sovereign. A prudent and step-by-step revision of the prudential treatment of sovereign debt – under discussion in international fora – must be adopted, ensuring consistent and gradual convergence towards the new framework. Simultaneously, financial institutions must adopt a prudent diversification of the debt securities portfolio, in order to minimise the risks associated with an increase in risk premia and deal with regulatory changes.
8. Against a background of low profitability, reduced interest rates and high levels of credit at risk, it is crucial to strengthen the incentives to reduce the stock of credit at risk and other non-income-generating assets in banks' balance sheets. Credit risk should continue to be appropriately evaluated and incorporated into the interest rates used by these institutions. The response to difficulties in generating income shall include a reassessment of business models and cost structure that does not jeopardise the adequacy of risk and governance control.
Lisbon, 25 May 2016