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Press release of Banco de Portugal on the June 2018 Financial Stability Report

Banco de Portugal publishes today the June 2018 Financial Stability Report.


Vulnerabilities and risk

The reduction in the indebtedness ratios of firms and households, together with positive developments in the banking system, have made the Portuguese economy more resilient to the materialisation of risks to financial stability. 

In 2017 total debt of non-financial corporations and households, measured as a percentage of gross domestic product, decreased further, following the trend seen since 2010. This was accompanied by an increase in the equity ratio of non-financial corporations, which, in 2017, reached a peak in the historical series. This rise was particularly substantial among small and medium-sized enterprises and coincided with an upturn in corporate investment, led by enterprises with lower financial debt ratios. 

Despite this progress, the indebtedness ratios of firms and households are still among the highest in the euro area, against a background of low potential growth, which means that an increase in financing costs (even if gradual and accompanied by  a recovery in income) may impact on their capacity to service their debt. In the case of households, consumer credit and new housing loans have increased, reflecting looser credit standards. 

Portuguese banks saw improvements in various areas in 2017: in profitability, operational efficiency, the quality of assets and capital ratios. Profitability in the resident banking system returned to positive territory, chiefly mirroring lower provisions and new impairments. The efficiency of the banking system, measured by the cost-to-income ratio, also rose, following an increase in net operating income higher than that in operating costs. In turn, the asset quality of Portuguese banks improved, reflecting a narrowing of the non-performing loans (NPLs) ratio by 4.6 percentage points from the peak that was reached in June 2016. The stock of NPLs in the Portuguese banking sector’s portfolio decreased by €13.5 billion over that period, and was accompanied by an increase in the impairment coverage ratio. Between the end of 2016 and the end of 2017, the solvency ratios of the Portuguese banking system improved substantially, mostly as a result of an increase in own funds. Elsewhere, several supervisory activities were carried out with the purpose of strengthening internal control and governance mechanisms, as well as to stabilise the management teams in several institutions, using particularly demanding assessment procedures. 

Despite favourable developments, the banking system continues to show some vulnerabilities: profitability levels, albeit increasing, remain low; the stock of NPLs is still substantial; and high exposure to public debt and to the real estate sector leaves the banking system particularly sensitive to adverse developments in the prices of such assets. 

The national strategy of reducing the banking system’s non-performing assets must be pursued, based on the revision of the legal, judicial and fiscal framework, the supervisory activities carried out under the Single Supervisory Mechanism, compliance with the plans to reduce NPLs submitted to supervisory authorities, and the integrated management of NPL portfolios. The current climate must also be seen by institutions as an opportunity to proceed with their structural adjustments, particularly as regards operating costs, which help increase their resilience and make it possible for them to face future challenges more easily, most notably the growing regulatory requirements (more specifically, the minimum requirement for own funds and eligible liabilities – MREL) and the competition of new firms specialised in the provision of digital financial services (FinTech).

Prices in the residential real estate segment have grown particularly robustly. In the second half of 2017 some signals emerged (albeit limited) of overpricing in this segment. Following a marked fall between 2007 and 2013, commercial real estate prices are now showing signs of recovery, but rising more moderately than in the residential segment. In 2017, 80% of investment in the Portuguese commercial real estate market was made by non-residents, mostly funds. Although Portuguese banks are not the main drivers of the real estate market, a possible price decrease in this market would have negative effects on the banking sector, constraining the sale of real estate held by credit institutions and hampering the reduction in NPLs associated with credit secured by real estate. 

The reduction in the aforementioned vulnerabilities, in the context of a favourable macrofinancial environment, is key to safeguarding the resilience of the Portuguese economy, including its financial sector, given a series of risks that may yet materialise, such as the potentially substantial and sudden revaluation of risk premia at global level associated with geopolitical risks and/or changes in the risk appetite of international investors. 

Finally, although in the wake of the financial crisis there has been some momentum behind making the euro area’s institutional architecture more united over risk-sharing and more capable of giving a firm response to future crises, the Banking Union remains incomplete, which also poses risks to financial stability. 


Macroprudential policy

To ensure that credit institutions and financial corporations do not take excessive risks when granting new loans and that borrowers have access to sustainable financing, Banco de Portugal, as the national macroprudential authority, issued a recommendation on credit agreements for consumers (residential immovable property, credit agreements secured by a mortgage or equivalent guarantee, and consumer credit agreements) effective from 1 July 2018, which introduces limits to certain criteria that institutions must comply with when assessing the solvency of borrowers. 

Still in terms of macroprudential policy, Banco de Portugal: 

  • maintained the countercyclical capital buffer rate at 0% of total risk exposures in the second quarter of 2018; 
  • maintained the phase-in period on the capital conservation buffer rate; 
  • reciprocated the macroprudential measure imposed by the Finnish authority (Finanssivalvonta) in 2017 on exposures secured by residential real estate located in Finland. 

Special issues and boxes

This Financial Stability Report includes three special issues:

  • “Monitoring systemic liquidity risk in the Portuguese banking system – some indicators”; 
  • “Direct and indirect interlinkages in the Portuguese financial system”;
  • “A safe asset for the euro area: the ‘Sovereign Bond-Backed Securities’ initiative (‘SBBS’)”.

It also includes three boxes: 

  • “Implementation, at European level, of macroprudential tools for credit standards for loans to households”; 
  • “Relevance of the legal framework in the recovery of NPLs”; 
  • “Action Plan to tackle non-performing loans in Europe – main measures and state of play on their implementation”.