The Banco de Portugal publishes today the June 2020 issue of the Financial Stability Report (in Portuguese only).

Vulnerabilities and risks

The COVID-19 pandemic has given rise to a highly uncertain environment, particularly challenging to financial stability at national and international level, taking into account the abrupt, intense, comprehensive and persistent shock to the economy.

Contrary to the previous international financial crisis, this shock is exogenous to the financial sector and not directly related to the prior accumulation of macroeconomic and financial imbalances. However, the pandemic has emphasised a series of risks identified in previous issues of this Report, whose impact may be amplified by pre-existing vulnerabilities.

The pandemic was immediately reflected in an increase in risk premia and an abrupt devaluation in international financial markets. This occurred when there were already signs of overvaluation in some market segments, and was compounded by the stronger demand for liquidity in certain segments of the financial sector at international level. In Portugal this type of behaviour is not as material as in other countries, given the relatively low weight of other financial intermediaries in Portugal, namely investment funds. In addition, Portuguese banks have reduced their sensitivity to changes in the risk perception of international investors, as a result of a considerable change in their funding structure since the financial crisis.

A number of factors will tend to mitigate the impact of the pandemic, at least in the short term.

On the one hand, this impact will tend to be mitigated by the increased resilience of the financial sector and in particular of the banking sector, promoted in the past few years by the adoption of new regulatory standards and supervisory practices at national and international level. These developments in the banking sector have translated into, among others, a strengthening of the banking sector’s capital ratios and liquidity positions.

On the other hand, in the wake of the previous economic and financial crisis, several countries including Portugal, have conducted adjustment processes within their economies that resulted inter alia in a strong reduction in the indebtedness level of enterprises and households.

The magnitude and speed of the national and international authorities’ response are also added to the mitigation factors identified above, making it possible to share the costs of the pandemic, across sectors and countries as well as over time. 

This notwithstanding, the pandemic crisis will be a test to the resilience of the national and international financial sector.

The nature and implications of the pandemic crisis require a coordinated response at European level. The effectiveness of the measures will be greater, the stronger their articulation across the different authorities, different countries or economic blocks. Thus, it will be important to create the conditions for countries – even if starting from different positions – to be able to take concerted and proportionate action to face the challenges posed.

Macroprudential policy

The flexibility in complying with some capital requirements and the existence of voluntary capital buffers create room for the financial system to absorb potential losses and finance the economy.

In response to the shock triggered by COVID-19, the Banco de Portugal has also decided the following:

similarly to the European Central Bank, to be flexible in accepting the capital conservation plans of less significant institutions that decide to operate temporarily below additional capital expectations (P2G) and the combined buffer requirement; to maintain the countercyclical capital buffer rate at 0% of the total risk exposure amount and to postpone by one year the phase-in period of the capital buffer for other systemically important institutions (O-SIIs);

to exempt new personal credit with maturities of up to two years and duly identified as intended to mitigate households’ temporary liquidity shortage situations from compliance with the DSTI (debt service-to-income) ratio limit and with regular principal and interest payments.

Special issues and boxes

The June Financial Stability Report has two special issues:

• “Policy measures relevant to financial stability in response to the COVID-19 pandemic”;
• “Interaction between minimum regulatory requirements and capital buffers”.

It also includes seven boxes:

• “The importance of credit moratoria in the context of the COVID-19 pandemic”;
• “Bank exposure to sectors most sensitive to the impact of the COVID-19 pandemic”;
• “The financial situation of Portuguese households in pre-crisis periods”;
• “The capitalisation of non-financial corporations in pre-crisis periods – the importance of retained earnings”;
• “Interlinkages in the Portuguese financial system”;
• “The importance of cyber risk in the context of the COVID-19 pandemic”;
• “An analysis of household credit flows in 2019 based on microdata”.