Statement to the press by the Governor of Banco de Portugal on the results of the stress testing exercise undertaken by Portuguese banks
Banco de Portugal and the Committee of European Banking Supervisors (CEBS) published today, on the respective websites, the results of a stress testing exercise carried out on four Portuguese banking groups (Caixa Geral de Depósitos, Banco Comercial Português, Espírito Santo Financial Group and Banco BPI).
This EU-wide exercise was coordinated by CEBS, in cooperation with the European Central Bank (ECB) and with the direct participation of the national supervisory authorities of each EU country. The aim of the exercise was to assess the resilience of a representative group of EU banks to an extremely adverse, but plausible, scenario.
As a whole, the Portuguese banking groups that were tested, directly or indirectly represent approximately three quarters of the total assets of the Portuguese banking system in 2009, of which two thirds are directly covered by Banco de Portugal.
The results published today confirm the soundness of the Portuguese banking system under a very adverse scenario, confirming the conclusions of the stress testing exercises conducted by Banco de Portugal on a periodic basis. It can therefore be concluded that:
- First and despite the impact of the extremely adverse scenario on the profitability and solvency levels of the institutions subject to the tests, the four Portuguese banking groups met a Tier 1 target capital ratio of more than 6%, both in 2010 and 2011 (for the purposes of the exercise, this figure was considered the benchmark ratio that ensures financial soundness).
- Consequently, there is no need to reinforce the capital position of Portuguese banks.
With regard to the adverse scenario, this stress test was developed assuming the materialisation of a large number of risk factors that I will now describe.
Hence, significant falls in stock prices were considered, which translated into devaluations of the banks’ share portfolios.
Second, an interest rate risk was introduced by applying haircuts to the sovereign debt in the trading book of banks. This means that the assessment of sovereign risk by the market was factored into the exercise, but not the possibility of default of EU countries. Hence, the sovereign debt held in the trading book was reassessed taking as a basis the maximum levels of government bond spreads of each EU country compared to Germany since 7 May 2010. It should be recalled that European sovereign debt markets experienced strong turbulence in this period, which was particularly acute in some countries. In addition, the deterioration of sovereign exposures, mirrored in the significant rise in the interest rates of Treasury bonds over this two-year horizon, was also indirectly reflected in estimates of the private sector’s loan losses.
Third, a fall in real estate prices was also considered. This hypothesis, which was assumed by Banco de Portugal although the evidence available points to the non-existence of an overvaluation in the housing market in Portugal, confirms the severity of the scenario used for Portuguese banks.
Four, the exercise assumed an increase in the probability of default of the private sector, which would result from the impact of faltering economic activity, increasing unemployment and rising interest rates.
Finally and according to the usual practice in the stress tests conducted by Banco de Portugal, account was also taken of the impact of the adverse scenario on the financial position of the pension funds of bank employees, which is a specific feature of the Portuguese banking system.
In sum, taking on board all the above mentioned risk factors, the results obtained confirm that the four Portuguese banks subject to this stress testing exercise accounting for a very considerable share of total banking system assets would withstand a severe additional materialisation of risks, at both global and national level. Even in such an adverse scenario, the four Portuguese banks that were involved in the tests would continue to show adequate solvency levels, measured in particular by the respective Tier 1 ratios.
Carlos da Silva Costa
Lisbon, 23 July 2010