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Concluding remarks by Director Luís Laginha de Sousa at the Banco de Portugal Online Conference on Financial Stability 2021

Once again good afternoon.

It has been a long day, but I hope that you’ve found it also a fruitful one.

As we reach to the end of this Conference, I would like to spend the next few minutes to highlight some takeaways that can be drawn from the remarkable group of speakers we’ve had today.

But just before moving into the takeaways, there are also other very important words I must convey.

First of all, a deep expression of gratitude to all the speakers for having shared with us their ideas, their analyses, and their thoughts.

Apart from the interesting and stimulating discussions throughout the day, the contents of the presentations provided also substantial insights and food for thought that will last well beyond this Conference. 

The gratitude is of course also extended to my colleagues from the Board and from the Financial Stability Department who have chaired the Conference Sessions. 

I would also like to thank all who attended this conference not just from Portugal but from many different countries around the world.

One last and very deserved word of appreciation for the team that made this event possible. For the sake of time, I will only mention the names of Anabela Marques, Rita Correia, Katja Neugebauer, Tiago Pinheiro, Ana Pereira and Nuno Ribeiro, but through them, I would like all other to feel included.

Moving now into the takeaways from this year’s conference.

In the first panel, which was focused on “Policy responses during black swan events” we learned the importance of the policies which have been implemented in response to the sanitary crisis, by fiscal, monetary, and prudential authorities. The purpose of such policies was to support the liquidity and solvency of families, firms, and banks.

It’s beyond dispute that the policy response was broad, swift, coordinated, and seemingly effective and, because of that response, we’ve avoided, at least until now, a deep and long economic crisis, which looked the most likely scenario at the beginning of the Pandemic.

Against this background, one thing that must be avoided is being complacent about the policy response.

And to ensure we avoid such complacency, there are many questions we should not just raise, but also try to answer: have we done enough? Could we have done more? Should there be other crisis, will different policy makers respond so swiftly and effectively as they did to this one? will they coordinate their actions? And the list of questions could continue. 

It is important to keep in mind that there are many ways in which this sanitary crisis is unique. And there is one, in particular, which is very important. I’m essentially referring to the fact that this crisis has had very favorable conditions for public intervention: it is a rare event; it came from outside the financial and economic system; it affects almost everyone; there are no economic or financial villains (at least for now); there is wide support for public intervention and moral hazard is barely a concern. 

We should then be asking ourselves: Was the swift and effective policy response we observed, the outcome of the type of crisis we are facing or was it the result from the lessons learned in past crises? 

The point I’m trying to raise is that we have to make sure that we have in place the institutions and the legal framework that would promote a similarly broad and coordinated policy response for other types of crises, should they ever occur in the future.

And we all know that it is not a question of “if” they will happen, but rather of “when” will they happen.

Moving now to session two, where the focus was the new challenges and risks for financial stability, in the aftermath of the crisis.

Here too, we can extract very important takeaways.

We might have already left behind the worst of the crisis, but that does not mean it is over.

The economy in general, and some sectors in particular, have been on life support and, as we move with the phasing out of this support, some firms and households are more than ready to live without it, but others either will not survive at all, or, in order to survive, will need additional support. 

This means that Banks are likely to experience higher credit losses going forward, which requires keeping an eye on these losses. 

In addition, we need to be ready to act before they become detrimental to financial intermediation and stability.

Although bankruptcies are a normal and necessary component on every functional and prosper economy, they become very detrimental when viable firms are the ones going bankrupt, so, as support measures are phased out, it is also important to promote the solvency of viable firms, before undesirable bankruptcies materialize. This implies that a fundamental pillar to the success of any program aimed at supporting firms’ solvency is the identification of viable ones. This is a notoriously difficult task, but Banks may have a key role to play here, given their experience in assessing firms and investments.

Apart from the identification of viable firms, which is anything but trivial, the design of the program, to support firm’s solvency, is also critical.

In particular, programs requiring co-investment of private agents, and support through equity or quasi-equity instruments may be overly complex and costly to small and medium firms. 

We may need a simpler solution to these firms, perhaps one more specifically based on grants.

I don’t want to spoil the sense of relief we have been experiencing, but we have to keep in mind that we are addressing the topics through the lenses of a Central Bank. And a Central Bank, in order to comply with its mandate in what regards the preservation of financial stability, has to be particularly aware of risks and vulnerabilities. This means that, as Central Bank, we feel that the economic recovery is not something we can take as guaranteed. Potential future coronavirus’ mutations and supply bottlenecks could have the capacity to derail the economic recovery and this means we cannot disregard additional new challenges to financial stability, some of them accentuated by the pandemic crisis.

Moving now to the third session, which was focused on technological transformation.

This is an area where we have been adding new expressions to the financial world lexicon, probably in an unprecedented way: FinTechs, BigTechs, DeFi, cryptoassets, stable coins, digital currency are just a few of the examples.

These names reflect what can be described as an extraordinary technological transformation happening in financial intermediation.

I believe it’s beyond dispute the idea that “Every business is an information business” and if that is beyond dispute in general terms, it is even truer in the Banking sector, where IT and Big Data are taking a central role, be it in the relation between customers and banks, or be it in the way back offices operate.

As usual, new technologies come with old debates of whether technology is a good or a bad thing?

It’s not difficult to identify many positive impacts the technology helps materialize, but, as it happens with metal coins, there is also the flip-side of it, which, in the case of new technology, are the new risks it brings. 

Among such new risks, Cyber risk ranks very high. 

Should a successful attack to a large IT service provider to banks occur, it may quickly become an event of systemic nature. 

This is clearly an area where a lot of ground has to be covered in order to ensure we have the capacity to assess these risks thoroughly.

And if we combine the “Cyber risk” with the interlinkages between the different players, the combination can only increase the potential for a very serious problem.

As a result of what I’ve just said, it should come without surprise that we will definitely need to further develop the existing prudential measures that tackle cyber risk, and, taking into account the systemic risk involved, this will have to include also macroprudential measures.

Last but not least on the challenges brought by new technology, it is of course the multitude of new players it brings to financial intermediation.

We still have to assess whether such new players and the services they provide can pose a direct risk to financial stability. 

We should also be concerned about whether these new players and traditional banks compete in a leveled playing field. 

Banking regulation and supervision don’t often apply to BigTechs and FinTechs, which, consequently, compared to traditional banks, face little regulatory scrutiny and cost.

At the same time, and in addition to their own data, BigTechs and FinTechs may be able to access the client data that traditional banks have. 

This combination of lower regulatory requirements together with access to more data can prove to be a significant competitive advantage with the potential to disrupt traditional banks and the financial intermediation they provide.

Going forward, and given the characteristics of these new players, cross-border coordination across policy makers will certainly be key but it won’t be enough.

We will also need to involve not only financial supervisory authorities, but also competition and data protection authorities,  to make sure that all perspectives that might give rise to financial stability issues are addressed.

Although it goes without saying, for the sake of clarity, it is important to stress that the role of regulation and supervisors is not to protect Banks, the goal is to ensure that financial services, in general, and banking services, in particular, are properly provided to all economic agents who need such services. In other words, “same services, same risks, same rules”.

Moving now to the last session, the one focused on Green and Sustainable finance, which I had the pleasure and honor to Chair.

I’ll finish my summary of the conference’s sessions with a few thoughts on green and sustainable finance.

We have heard many times that climate change brings about both physical and transition risks and, in the case of transition risks, one that ranks very high derives from the climate related policies, particularly if such policies translate either into forcing firms to abruptly adjust their activities or into sudden reductions in the demand directed to some of them.

If such abrupt changes occur, they may trigger large-scale defaults and bankruptcies that will end up affecting banks’ balance sheets.

Measuring the exposure of the financial system to these risks is thus key to understanding the effect of climate change on financial institutions. 

But the challenge to measure such exposure is huge, both as a consequence of the scarcity of climate related data as well as the lack of tailored methodologies to deal with the high uncertainty, with non-linear impacts, and with the long horizon of climate related risks.

This means that, going forward, the financial regulators and supervisors must complete the work, not just on creating consistent and comparable climate-related disclosures, but also, as it was the case with Cyber risk, on upgrading the financial stability and prudential framework to incorporate climate-related risks.

But even if the regulatory and prudential framework requires time to adjust, when it comes to assessing the exposure of the financial system to climate risks, financial institutions have to take an active role and it is essential that they develop their capacity to manage these risks.

I’ve mentioned the Challenge to Regulators and Supervisors, but we have to keep in mind that the Driving Seat and the Steering Wheel of Climate Change Policies is reserved to Governments.

But I wouldn’t feel comfortable without an additional comment on this.

It’s not up to Policy makers to pick winners and losers in this transformative path towards carbon neutrality.

Policy makers have to provide “Credible and Predictable Flexibility” so that we have the right context to allow economic agents to take their decisions, be it short, medium or long-term ones.

And, with these words, I would like conclude my messages and also bring this Conference to an End.

To conclude

On behalf of the entire Board of Banco de Portugal, I would like to thank, once more, to all those who participated and made this Conference possible and we look forward to see you all in 2023, for the next edition of the Financial Stability Conference.

Good bye and thank you.