Press release of the Banco de Portugal on the May 2023 issue of the Financial Stability Report
Over the past few months, risks to financial stability have been in line with the tense geopolitical environment, inflationary pressures and the relative turmoil in international financial markets, triggered by recent developments in US and Swiss banks. Despite reflecting idiosyncratic weaknesses, events in these institutions have resulted in a generalised uncertainty framework that warrants increased monitoring by authorities. The European Central Bank has continued its cycle of interest rate hikes, despite a recent deceleration, and has signalled its ability to support liquidity in the euro area banking sector, if needed, and to preserve monetary policy transmission.
The main risks and vulnerabilities to financial stability are:
- heightened turmoil in international financial markets, implying potential contagion effects across financial and business cycles. Any broader risk aversion would have an adverse impact on financing costs, the valuation of assets and economic activity;
- a less favourable path for the public debt ratio. The main risks associated with this process stem from a potentially more adverse economic and financial environment, with lower economic growth and more persistent inflation, triggering a more intense and lasting reaction of monetary authorities via higher interest rates;
- potential default of the most vulnerable households due to high inflation, rising short-term interest rates and a potential worsening of the unemployment rate. The predominance of the variable interest rate in the stock of loans for house purchase means that the rise in short-term interest rates leads to a relatively rapid and substantial increase in the debt burden;
- potential default of the most vulnerable firms. Despite recent evidence of the sector’s resilience, a more unfavourable economic and financial environment, characterised by lower economic growth and higher interest rates, may increase the share of vulnerable firms;
- the cooling down of the residential real estate market, with an impact on prices and the value of the collateral of loans secured by real estate. The rising interest rate environment is expected to contribute to a deceleration in residential real estate market prices in Portugal;
- the materialisation of market and credit risks to the banking sector, reflecting the interplay between more adverse developments in the macro-financial scenario variables and the vulnerabilities of the counterpart sectors.
In view of the identified challenges and risks, banks are expected to take advantage of the improved economic and financial environment to match lending conditions to their customers’ ability to pay. It is also expected that they maintain prudent provisioning and capital conservation policies allowing them to increase their ability to absorb losses and to continue to finance the economy.
As part of its tasks, the Banco de Portugal will continue to closely monitor the real and nominal conditions of the economy, acting on the basis of its risk assessment.