Banco de Portugal publishes today the November 2016 Financial Stability Report.

Vulnerabilities and risks

1. The risks to financial stability remained virtually unchanged from the May 2016 Financial Stability Report.
2. At international level, the risks previously identified remain, namely the prolongation of the low interest rate environment, the deterioration of the economic perspectives in geographies to which domestic agents are exposed, the greater volatility of sovereign debt risk premia and the intensification of the markets’ negative perception of banks with higher levels of non-productive assets.
3. Domestically, weak potential output growth (despite the better-than-expected outcome in the third quarter) and high indebtedness in the public and private sectors may aggravate the effects of a possible materialisation of these risks. The sustained reduction in public indebtedness, based on a trend of fiscal consolidation, and in the indebtedness of companies and households, is key to financial stability. 
4. The financial system itself also has inherent vulnerabilities that may affect its resilience. These include the high stock of non-productive assets on the banks’ balance sheet and the significant exposure to sovereign debt, to the real estate sector and to companies highly exposed to depressed emerging economies. Furthermore, the Portuguese banks’ business model, like that of other European banks, is particularly sensitive to the prolonged low interest rate environment. These vulnerabilities hamper income generation and, as a result, capital, damaging investors' perception of the sector, both for the purposes of capital increase (by current and/or potential private shareholders), and for the placement of debt in the wholesale financial markets. 
5. It should be noted that over the last few months, private investors have shown interest in acquiring or strengthening their holdings in Portuguese banking groups.

Macroprudential policy

In the current context of very low interest rates, it is essential for institutions to assess their borrowers’ credit capacity correctly, taking a forward-looking approach, accounting for the effect of plausible increases in market interest rates, and borrowers’ overall indebtedness. Although these principles should be applied by the institutions when providing credit in general, they are laid down in particular in the Mortgage Credit Directive, which provides for lending to consumers for house purchase.

As the indicators do not suggest excessive credit growth in Portugal in 2016, Banco de Portugal decided to maintain the countercyclical capital buffer unchanged at 0% of risk-weighted assets.

To ensure that Portuguese credit institutions operate under the same conditions as their European counterparts, Banco de Portugal has also decided to implement the phased introduction of the capital conservation buffer (reversing the decision made previously to bring it forward) and the other systemically important institutions capital buffer.

In order to address the constraints that the low interest rate environment places on income generation, credit institutions should carry out a thorough reassessment of their business models and cost structures. This should take into consideration the challenges resulting from demographic changes and the opportunities and challenges resulting from the digitalisation of the banking business. However, this reassessment should not jeopardise the necessary investments to maintain appropriate levels of internal risk control and governance. 

At European level, it is essential to define and adopt measures that accelerate the reduction of the stock of non-performing loans on banks’ balance sheets. These measures should adopt a multidimensional approach and respond to the national specificities of these exposures, to the profitability and capital restrictions faced by banks, to the most demanding regulatory context and to the possible systemic consequences associated with exposures shared between various institutions in the banking system.

New structure of the Financial Stability Report

This report’s structure differs from that of previous editions. It starts by presenting an analysis of vulnerabilities and risks to financial stability in Portugal, with a strongly forward-looking perspective, including a set of macroprudential policy measures and mitigating factors.

This is followed by two articles on recent developments, which should be seen as autonomous but related to the previous text on the identification and assessment of vulnerabilities and risks to financial stability. The first article presents an analysis of financing flows and indebtedness positions in the first half of 2016, by resident institutional sector. The second addresses the developments in the banking system over the same period, based on consolidated accounts and prudential information.

The report also includes three ‘special issues’ that look at topics relevant to financial stability. The first, entitled ‘Recent developments in consumer lending:  A macroprudential approach’, assesses the developments in this credit segment, which has shown strong buoyancy since mid-2013.

The second, entitled ‘Efficiency of the Portuguese banking system’, looks at the development of efficiency in the Portuguese banking system, from a perspective of time and international comparison (using the stochastic frontier method), and recommends improving efficiency as a preferred path to be taken by Portuguese banks to improve profitability. 

The third special issue, entitled ‘Concepts used in analysing credit quality’, presents the main concepts used at Portuguese and European level for assessing banks’ credit quality, emphasising the significant subjectivity inherent to the application of these concepts and the current insufficient harmonisation in applying them across different countries, and even across different institutions of the same country.

Lisbon, 23 November 2016