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Press Release of Banco de Portugal on the Financial Stability Report - November 2015

Banco de Portugal has released today the November 2015 Financial Stability Report, where it underlines that the main risks to financial stability in Portugal have remained virtually unchanged since the release of the May 2015 Financial Stability Report.

1. The Portuguese economy in general and the Portuguese financial system in particular have undergone a significant adjustment process over the past few years. In terms of macroeconomic balance, it should be noted that persistent and very marked external deficits have given way to a net lending capacity and a very substantial improvement in the general government structural balance. As regards the banking system, progress was made in the structural liquidity position and solvency levels have improved considerably, despite the still low profitability levels. However, this adjustment should be seen as an initial step within a necessarily long correction path of deep imbalances, accumulated over a long period.

2. The Portuguese financial system continues to be exposed to a number of still substantial challenges and risks, particularly in the current environment of low nominal interest rates.

3. The Portuguese economy continues to be particularly sensitive to international financial market developments, more specifically as regards the funding conditions of the various institutional sectors. This is particularly important due to the Portuguese economy’s still high external indebtedness. In this context, the continued fiscal consolidation and deleveraging processes among households and firms are key to financial stability in Portugal, particularly taking into account a future rise in interest rates and the subsequent increase in debt service.

4. An environment of low nominal interest rates may favour excessive risk-taking, asset overvaluation and the narrowing in profitability of financial institutions. Given these risks, credit reallocation must continue. Credit should be directed towards more creditworthy borrowers, to the detriment of non-viable borrowers, whose credit relationship should be terminated. It is essential that, when assessing new loans, both to households and firms, prudent criteria be adopted, focusing on the ability to generate future cash-flows, including in scenarios different from that currently experienced, such as higher interest rates’ scenarios. Financial institutions should also be particularly prudent when managing their assets, reassess their business models, streamline their cost structures and intensify their efforts to bring down the still high non-performing loans levels with the purpose of fostering a recovery in profitability in a sustained manner.

5. The intensification of search-for-yield behaviour worldwide, and the subsequent compression in risk premia, is also backed by the very low interest rates remaining in place for a longer period of time than initially expected. Consequently, risks to financial stability stemming from a reversal in this behaviour have risen. To minimise the chance of the risk happening and/or its impact, financial institutions must act so as to improve their risk profile (including at the level of their financing structure) and diversify their asset portfolios.

6. The vulnerability of the Portuguese financial system is exacerbated by the fact that it continues to be significantly exposed to certain asset classes, such as real estate and sovereign debt securities, and specific countries or regions (most notably emerging market economies experiencing a substantial slowdown in their economic activity, such as Angola, Brazil and China). Turning to exposures to sovereign debt securities, foreseeable changes in the regulatory framework must be taken into account.

Over the past few years, Banco de Portugal has implemented a series of measures in an effort to foster financial stability. In 2015, in its capacity as macro-prudential authority, Banco de Portugal has decided not to use the transitional period and to bring forward to 1 January 2016 the setting up of a capital conservation buffer in its entirety by credit institutions and certain types of financial corporations. Furthermore, at the end of 2015 Banco de Portugal will announce its decision on the group of domestic systemically important institutions and the related capital requirements. By the end of the year, Banco de Portugal will also establish a countercyclical capital buffer, which will be other than zero only when there is evidence of excessive credit growth in Portugal, which has not been the case in the recent past. The adoption of such measures is based on a forward-looking approach to financial stability, and on the premise that macro-prudential policy is key to prevent individual behaviour that, when assessed in aggregate terms, may bring costs to the overall economy.

Lisbon, 18 November 2015