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Executive summary

Risks to financial stability are still linked to adverse economic developments that may result from the current geopolitical tensions. Ongoing military conflicts, increased global protectionism and a slowdown in the world’s major economies can affect the Portuguese economic activity. The resurgence of public debt pressures in European countries and the possibility of further inflationary shocks limiting monetary policy easing are also risk elements. At national level, an expansionary fiscal stance under the new model of European fiscal rules and possible delays in the implementation of the RRP could constrain economic growth and debt developments.

In the last half of the year, despite some signs of slowdown, the Portuguese economy maintained a downward trend in vulnerabilities, which is in line with the progress made in recent years. The adjustment process has been structural and was interrupted only in the most acute period of the pandemic. The central macroeconomic framework for 2025 and 2026, of growth close to potential and price stability, is consistent with this process continuing. Economic activity in Portugal is expected to grow in the period 2024-26, at a pace close to potential and above that projected for the euro area. Inflation is expected to stabilise at 2% in 2025–26, in line with the euro area.

One of the dimensions of structural adjustment is the significant reduction in indebtedness. The general government debt ratio decreased by around 35 percentage points (p.p.) between 2014 and 2023, when it reached 97.9% of GDP. Despite converging towards the euro area average, this ratio remains high. Its protracted reduction will contribute to improving the Republic’s rating and lower risk premia in the cost of financing, benefiting the various sectors of the economy.

Starting from levels significantly above the European average, the indebtedness ratios of households and firms are now below the EU benchmark. At the end of the first half of 2024, the household indebtedness ratio reached 82% of disposable income, 2.6 p.p. below its end-2023 level and almost 50 p.p. below its 2009 peak. In turn, the corporate indebtedness ratio decreased by 2 p.p. in the first half of this year, to 76% of GDP, bringing the cumulative reduction to 50 p.p. from 2012, when the indicator peaked.

Risks to firms are associated with greater economic slowdown in the euro area, potentially worsened by higher energy and production costs and supply chain disruptions. Despite the stabilisation in operating profitability, the maintenance of still high interest rates weighs on firms’ debt servicing capacity, particularly in the most vulnerable sectors. However, the share of firms identified as financially vulnerable (i.e. where EBITDA is less than twice the amount of interest expenses) is projected to decline in 2024 and 2025, to around 12% and 8% respectively, compared with 14% in 2023. The improvement in firms’ financial position in recent years will play a role in mitigating these risks.

For households, the main risks are associated with developments leading to income losses, such as rising unemployment or interest rates. However, these factors are not part of the central scenario of developments in the Portuguese economy. The savings rate is also projected to increase, strengthening its resilience to shocks. Despite the significant rise in inflation and interest rates between 2021 and 2023 credit defaults remained contained. This resilience has benefited from the sustained reduction in the indebtedness ratio and the improvement in the risk profile of borrowers – further strengthened since 2018 by the effects of the macroprudential Recommendation relating to new credit for house purchase and consumer credit – as well as from positive developments in the labour market and disposable income.

The banking sector is also exposed to the potential materialisation of adverse economic and financial conditions, given the composition of its balance sheet. The materialisation of such a scenario will tend to result in higher credit risk, with no material impact of market and liquidity risk being expected. Return on assets reached 1.47% in June, but is sensitive to the expected decline in interest rates through net interest income. However, net interest income is expected to remain above the levels seen in the pre-2022 period, also given the change in the financing structure of banks.

Similarly to the rest of the economy, the banking sector has experienced remarkable adjustment in terms of liquidity, asset quality, efficiency and capital. In June the total capital ratio and the Common Equity Tier (CET 1) totalled 20.5% and 17.8% respectively, 0.66 p.p. and 1.4 p.p. higher than in the euro area. Part of this adjustment was observed over a long period of low interest rates, which significantly limited income generation through the interest margin. On average, between 2011 and 2021, the sector’s return on equity was -3.1%. In recent years, rising interest rates have made it possible for the sector to achieve higher levels of profitability, used to remunerate shareholders, strengthen its soundness and allow for the investment needed for its future viability.

Against this positive background, the credit quality of bank assets has remained stable. In the case of firms, about half of the loans have been directed towards lower-risk groups. In lending to households, the macroprudential Recommendation has strengthened the resilience of the financial sector and borrowers. It is essential that banks maintain prudent credit standards and conditions that include in their analyses all risk factors that may affect the value of their assets, including the impact of environmental factors, the materiality of which has been increasing.

Despite the favourable central scenario, institutions should be prudent in provisioning and capital conservation, enhancing their resilience and ability to finance the economy in the event of adverse shocks. In October this year, the 4% sectoral systemic risk buffer applied to banks using the internal ratings-based (IRB) approach entered into force, strengthening their resilience to real estate market devaluations. Given the current economic environment, banks’ profitability and capitalisation levels, while aiming to enhance the capacity to absorb unexpected losses associated with systemic shocks, the Banco de Portugal proposes to set the countercyclical buffer rate at 0.75% of the amount of risk-weighted credit exposures of the domestic banking sector to the non-financial private sector.

The remarkable progress in the financial position of the resident sectors since the sovereign debt crisis should not be seen as an excuse for complacency but rather as an achievement to be preserved, requiring determination in a sustained reduction of vulnerabilities, in particular in the face of climate and technological challenges. The international situation has reminded us that significant shocks may occur at any time and that timely preparation is decisive to mitigate them.

Financial Stability outlook

Vulnerabilities, risks and macroprudential policy

Main risks and vulnerabilities

The economic performance of the Portuguese economy is above that of the euro area and close to its potential. However, it is exposed to external factors, including global geopolitical tensions. Its impact materialises in the short term, largely via international trade flows, on prices or directly on economic activity. Amid an increasing fragmentation of the global economy, such impact tends to persist.

The slowdown of the Chinese economy, the resurgence of concerns about the creditworthiness of sovereign issuers and possible inflationary shocks affecting the protracted easing of monetary policy tightening of the main economies are other risk elements. The materialisation of some of these factors will impact the global economy and thus the Portuguese economy, affecting the value of financial and non-financial assets, investment and financing conditions at international level.

A scenario of adverse economic developments at national and international level, in particular if associated with a tightening and/or protraction of monetary policy, could affect negatively demand and real estate prices. Nevertheless, these effects will tend to be small, particularly in the residential segment, in the face of supply shortages in the Portuguese market, which has contributed to a significant and protracted rise in prices.

Over the past few years, the different sectors of the economy have significantly adjusted their financial positions, fostering their resilience to shocks. Particularly noteworthy is the reduction in indebtedness for the total economy, reflected in the international investment position, and the indebtedness ratios of general government, firms and households.

The improvement of the budgetary situation in recent years and the sustained reduction in the public debt ratio, as reflected in the corresponding appreciation of the Republic’s rating and risk premia in the cost of financing, have been reflected in a reduction in General-Government-related risks in the short term. However, public indebtedness is high and thus vulnerable to volatility in international financial markets. Developments in the cost of debt are constrained by global uncertainty, with consequences for the conduct of monetary policy and, at domestic level, by the expansionary fiscal policy stance and the impact of the gradual reduction in the Eurosystem’s asset purchases. Long debt maturity and the ECB’s stabilising role through the TPI are factors mitigating these risks.

Risks to firms are largely associated with more disruptive geopolitical developments and a further slowdown in economic activity in the euro area. The potential impact may be associated with higher energy and other production costs and/or supply chain disruptions. The maintenance of interest rates at high levels will continue to challenge firms’ debt servicing capacity, particularly in the most vulnerable sectors. The improvement in firms’ financial position in recent years, in terms of solvency and liquidity, will continue to help mitigate these risks. Based on the central projection scenario of the Portuguese economy, the share of firms identified as financially vulnerable by 2025 is estimated to decrease.

Households maintained a sustained reduction in the indebtedness ratio, in line with the trend that started in 2010. Since 2018, the risk profile of new borrowers has also benefitted from the macroprudential recommendation relating to new credit for house purchase and consumer credit. Despite the significant rise in inflation and interest rates between 2021 and 2023, which limited their debt servicing capacity, credit defaults remained contained. Strong labour market and real disposable income developments, as well as loan renegotiations and government support measures contributed to this result. The main risks are associated with economic developments leading to income losses, such as unemployment or rising interest rates. An increase in the sector’s saving rate should help foster its resilience to shocks.

The non-bank financial sector has become less important in Portugal over the past few years, with its weight in GDP being clearly lower than in the euro area. In addition, its interlinkages with the banking sector has also been reduced, with cross-exposures generally accounting for a very limited share of each sector’s assets/liabilities. Unlike the banking sector, the sector concentrates its exposures on non-resident counterparties, making it particularly sensitive to developments in the international financial markets. The liquidity and leverage of Portuguese investment funds compare favourably with the euro area. For the insurance sector, solvency and liquidity levels ensure resilience and room to absorb adverse developments.

In the first half of 2024, banks continued to improve their profitability, which contributed to rising capital ratios. These already reached historically high levels, similar to those in the euro area. The sector’s liquidity remained robust and asset credit quality remained stable at a historically high level.

The concentration of exposures to the real estate sector is mitigated by the limited share of mortgage loans with a loan-to-value (LTV) ratio above 80%, limiting banks’ potential losses resulting from a fall in residential real estate prices. In addition, the sectoral systemic risk buffer (SyRB) of 4%, effective since October, strengthens institutions’ resilience to the materialisation of risks impacting households and residential real estate prices. Despite the materiality of exposure to public debt, the weight of the component accounted for at amortised cost mitigates the impact of market price changes on the balance sheet value of securities, making it less sensitive to changes in interest rates, also contributing to the sector’s stability.

With this background – positive overall for banking –, there has been no deterioration in the credit quality of bank assets. For transactions with households, the macroprudential recommendation promotes the portfolio’s resilience to shocks. In the case of firms, most loans have been directed to lower-risk firms.

Despite the central scenario being benign, it is important that institutions are prudent in provisioning and capital conservation, promoting their own resilience and funding to the economy in the face of potentially adverse shocks. In this framework, given the current economic environment, banks’ profitability and capitalisation levels, whilst aiming to enhance the banks’ capacity to address systemic shocks, the Banco de Portugal proposes to set the countercyclical buffer rate at 0.75% of the total amount of risk-weighted credit exposures of the domestic banking sector to the non-financial private sector from 1 January 2026 onwards. This buffer emerged in a phase when cyclical systemic risk was considered neutral.

Other cross-cutting structural aspects remain critical to financial stability, such as those related to climate change and digitalisation. Climate change poses transition risks to the financial system, related to the devaluation of assets in fossil fuel-intensive sectors and physical risks, associated with direct damage from extreme weather events of greater frequency and severity. In the case of digitalisation, in addition to the investments needed to convert productive structures and update IT systems, there are increasing risks related to cyber risk and concentration on providers of critical systems.

Macroeconomic and market environment

Macroeconomic environment

The central projection scenario of the Portuguese economy for 2024–26 points to the maintenance of convergence towards European income levels and inflation consistent with price stability (Table I.1.1). The economy’s resilience to recent shocks reflects the reduction of macroeconomic imbalances and other structural weaknesses. In particular, declining private, public and external debt ratios involved less vulnerability to rising interest rates. The labour market has been robust and flexible.

After slowing down in 2024, economic activity in Portugal will recover in 2025–26, maintaining convergence with the euro area. In 2024, activity growth is supported by private consumption and exports. An acceleration in 2025–26 reflects a better outlook for investment, with easing financial conditions, an improvement in overall outlook and a stimulus from European funds. Investment in housing is also projected to recover gradually, supported by declining interest rates, disposable income growth and buoyant migration flows. Exports are expected to continue to make an important contribution to growth over the projection horizon, albeit lower than in 2023, reflecting the normalisation of overall consumption patterns. Tourism, despite slowing down, will continue to grow above total exports. For the euro area, the ECB projects real GDP growth in the euro area to return to rates close to historical averages over the medium term, supported by increasing real incomes, strengthening foreign demand and the fading of the dampening effects from monetary policy.

The resident sectors’ indebtedness will continue to decline. Real household disposable income is expected to increase in the three-year period, albeit more significantly in 2024, owing to the favourable labour market situation and fiscal measures. Over the projection horizon, the saving rate is expected to remain at historically high levels, reflecting higher interest rates than in the previous decade and a cautious behaviour of households. The labour market will continue to evolve favourably, with increases in employment and real wages, and the unemployment rate will remain low. Net lending of the Portuguese economy is expected to increase to an average of 4.1% of GDP in 2024–26, allowing for a further reduction in the resident sectors’ indebtedness.

Price growth will stabilise at 2% in 2025–26. Against a background of decelerating wage costs and moderate external pressures, average annual inflation in Portugal is expected to be around 2% in 2025 and 2026. For the euro area, inflation is also projected to decline and to stand around the target in 2025, reflecting expectations of gradually diminishing cost pressures.

Risks to these projections are balanced. For activity, risks of a downward revision remain, which are related to international geopolitical tensions and timely fulfilment of the Recovery and Resilience Plan targets. By contrast, private consumption may increase more than expected in response to projected growth in household income. For inflation, lagged effects of monetary policy are more marked in the short term generate downside risks, counterbalanced by possible shocks to international commodity prices and global supply chains, as well as by greater buoyancy in wages.

An economic downturn in Europe and China, amid increasing geopolitical risks and protectionist policies, will bring more uncertainty in the conduct of economic and monetary policy. The persistence and possibility of heightened geopolitical tensions, together with increased international tensions through tariff hikes and protectionist policies, may have an impact on international trade, leading to inflationary pressures affecting economic activity internationally. At European level, there is increasing difficulty in balancing stable government solutions and compliance with European good governance rules, which tends to be intensified in an international transition framework. This transition is significant at various levels: geopolitical, international trade, military expenditure, climate transition.

Reflecting an improvement in the inflation outlook, central banks in major advanced economies have been easing monetary policy and initiated the interest rate decreasing process this year.

The ECB began to decrease interest rates in June. Since then, the deposit facility rate, which is currently the ECB’s main key interest rate, has been reduced by 75 b.p. to 3.25%, and the interest rates on the main refinancing operations and the marginal lending facility have been reduced by 110 b.p., to 3.40% and 3.65% respectively. As a result of the entry into force of the new monetary policy implementation framework, the spread between the main refinancing operations rate and the deposit facility narrowed from 50 b.p. to 15 b.p. Liquidity conditions in the euro area remain abundant despite maturing targeted longer-term refinancing operations (TLTRO-III) and the gradual reduction of portfolios for asset purchase programmes.¹ In Portugal, excess liquidity has grown since November 2023, contrary to the downward trend observed at Eurosystem level.

The availability in the market of securities eligible under the Eurosystem’s purchase programmes has been increasing, but no significant impact on the prices of these assets is expected. Adopting measures, such as reducing reinvestments in the PEPP, following new debt issues, enabled an increase in High Quality Liquid Assets (HQLA) in the market, notably sovereign debt securities, which have thus been increasingly maintained on banks’ balance sheets. The gradual and predictable nature, albeit retaining flexibility, of reducing excess liquidity in the euro area is expected to minimise impacts on asset prices. Furthermore, the 2022 Transmission Protection Instrument (TPI) remains part of the range of instruments available to the ECB’s Governing Council to ensure that the monetary policy stance is transmitted smoothly across all euro area countries. In the United States, the Federal Reserve began to decrease interest rates in September owing to reduced upside risks to inflation and rising downside risks to the labour market. On 7 November, already after the results of the presidential elections, the key interest rate was further reduced to the target range of 4.5%–4.75%.

If inflation remains under control, the cycle of declining monetary policy rates and the normalisation of central banks’ balance sheets in the major advanced economies are expected to continue. Especially for the euro area and the United States, the reduction in the size of the balance sheet is expected to continue over the remainder of 2024 and 2025. Nevertheless, risks to inflation developments remain amid possible protectionist policies and fiscal expansion in the United States or the materialisation of other geopolitical risks that may call into question the magnitude of the projected cycle of monetary policy easing.

Financial markets environment

Since the summer, international financial markets have shown resilience to pronounced, albeit short-lived volatility spikes.

Until recently, expectations of interest rate decreases in the main economic blocks have strengthened, leading to a decline in interbank rates. In the euro area, from June 2024 onwards, as the -easing interest rates cycle began, the ECB strengthened the expectations of further declines amid a deterioration in economic data and a more pronounced disinflationary process. According to market indicators, in early November, three-month EURIBOR futures pointed to a convergence of the key interest rate to around 2% from mid-2025 onwards (Chart I.1.1).

The sovereign debt market has responded to expectations of decreases in policy interest rates (Chart I.1.2). In the United States, where sovereign debt yields were in line with expectations of declining official interest rates, yields rose from October onwards amid the upward revision of the Fed funds’ terminal interest rate, reflecting some positive macroeconomic data releases and fears of a deterioration in the fiscal situation following the election results. In the euro area, from late October onwards, there was some impact from this movement by the US Treasuries, despite intensified expectations regarding the cycle of declining interest rates. From June 2024 onwards, the spreads of the ten-year yields against Germany narrowed in most jurisdictions, with French debt spread widening amid political and fiscal instability. The positive performance of Portuguese sovereign debt, whose yield spread against Germany narrowed in this period.

Interest rate implied in three-month EURIBOR futures contracts | Per cent	Yields on 10-year sovereign debt
Sources: Refinitiv and Banco de Portugal calculations. | Note: Latest observation: 7 November 2024.	Source: Refinitiv. | Note: Latest observation: 7 November 2024.

Financing costs of euro area firms and banks in capital markets have benefited from the downward trend in key interest rates (Chart I.1.3). Interbank interest rates have been declining, but risk premia (spreads) for corporates and banks have been maintained. In a context of high macroeconomic uncertainty, the maintenance of the assets swap spreads on corporate and bank bonds may indicate some risk underestimation. Given high rollover needs in the euro area market over the next two years, negative macroeconomic surprises could raise costs, in particular for the high yield segment.

In the equity market, behaviour was not homogeneous across economic blocs, with particular emphasis on significant valuations in the United States (Chart I.1.4). Since early June 2024, US stock indices have appreciated, despite the significant market tensions experienced in early August. Similarly, the Chinese index, which was losing profitability, has had an important boost since October, reflecting the government’s announcement of stimulus packages. In Japan, despite volatility spikes, the stock market index recovered to June levels. But in the euro area, although the indices have posted gains since the beginning of the year, they did not appreciate from end-May. Significant valuations in the US market have been associated with tech firms, in particular those related to artificial intelligence, and have been further driven by the election results. In an environment of macroeconomic and geopolitical uncertainty, this significant valuation raises doubts about its sustainability.

Three-month EURIBOR and asset swap spreads on corporate and bank bonds in the euro area	Equity market indices of Portugal, Europe, USA, Japan and China | Points
Source: Refinitiv. | Note: Latest observation: 7 November 2024.	Source: Refinitiv. | Notes: Stock indices with a base value of 100 on 31 December 2023. Latest observation: 7 November 2024.

Periods of volatility in international financial markets have become more frequent, related to changes in expectations regarding monetary policy stance, political uncertainty and the outlook for technology firms, in particular those related to artificial intelligence. The episode of greatest volatility occurred in early August, triggered by worse-than-expected data from the US labour market, amplified by strong derivative positions and reinforced by the unexpected rise in interest rates in Japan, which led to a reversal of carry-trades financed with Japanese yen and significant losses in the Asian market. Other episodes of significant volatility in the US stock indices have been related to the performance of tech firms. Political uncertainty has also had an impact, in particular on the fixed income market, as was the case with the French sovereign debt.

Despite the resilience shown in the most recent shocks, the risk of sudden adjustments in the value of financial assets remains significant. So far volatility spikes and corrections in the value of assets have been quickly reversed in equity markets, which may fuel an increased risk appetite by investors. The worsening of the macroeconomic scenario, due to the materialisation of geopolitical risks, greater fragmentation of the global economy through protectionist policies, a further slowdown in the Chinese economy, a resurgence of concerns about the creditworthiness of sovereign issuers or other inflationary shocks, may constrain the expected easing of the monetary policy of major economies. To the extent that it could impact financial asset prices and financing conditions, investors and issuers must adopt appropriate mitigation strategies to safeguard financial stability.

Sectoral risk analysis

General government

Risks associated with the performance and financial position of Portugal’s general government have been diminishing over the past decade but remain in place. The positive performance is evident in Portuguese sovereign debt yield spreads in relation to sovereign debt in other euro area countries. Nevertheless, public indebtedness remains high, exposing the cost of financing public debt to potential bouts of volatility in international financial markets. However, there are also mitigating factors, such as the maturity of the debt securities portfolio and the stabilising role of the ECB, particularly via its TPI.

The Portuguese public debt ratio followed a marked downward path from 2015 until the end of 2023, interrupted only by the impact of the COVID-19 pandemic. Standing at 132.5% in 2014, the public debt ratio narrowed to 97.9% in 2023 (Chart I.1.5). The 13.3 p.p. decrease from 2022 was due to a reduction in nominal debt, which contributed 3.6 p.p., while GDP growth contributed 9.7 p.p. In the third quarter of 2024, public debt stood at 97.4% of GDP, down by 8.9 p.p. from the same quarter of the previous year.

The sustained reduction in public debt is very important for the Portuguese economy, strengthening Portugal’s credibility with international financial markets. Currently, Portugal is rated 'A' by the four main financial rating agencies, reflecting a significant improvement in the country’s perceived creditworthiness. This upgrade is particularly important in a context of limited economic growth in Europe and concerns about the public finances of other euro area economies, with a positive impact on the relative performance of Portuguese sovereign debt yields (Section 1.2).

Should non-negative fiscal balances persist, the public debt ratio is expected to continue its downward path in the coming years, helping to mitigate the country’s vulnerability to adverse shocks and improve external financing conditions. According to the International Monetary Fund (IMF) projections released in October 2024, further reductions in this ratio are expected over the coming years, to levels below the euro area average from 2026 onwards (Chart I.1.6).

Portuguese public debt ratio	IMF public debt projections | Percentage of GDP
Sources: Banco de Portugal and Statistics Portugal.	Source: IMF. | Note: October 2024 projections.

The cost of new Portuguese public debt issuance decreased slightly in 2024, from 3.5% in 2023 to 3.4% in June 2024 (Chart I.1.7). This was mainly due to financing through Treasury bonds, which offset the increase in the cost of Treasury bill issues. In 2024 the weighted average rate of Treasury bill tenders ranged from 2.8% to 3.8%, compared with 2.4% and 3.5% in 2023. In 2024 a new ten-year Treasury bond line was issued, with a 3% coupon rate, below that of Treasury bonds redeemed in 2023–24, contributing to a reduction in the average cost over the medium term.

The impact of rising interest expenditure on total financing costs is expected to be limited. Despite the increase in the cost of new issuance in 2023 and 2024 compared to 2022, it is worth noting the large amount issued at fixed rates and the average residual maturity of the stock of debt, which stood at 7.6 years in August 2024. Around 20% of the existing debt stock at the end of September will mature by the end of 2026 (Table I.1.2).

At the end of June 2024, the Eurosystem held 29% of Portuguese sovereign debt stock, compared with 32% in December 2023 (Chart I.1.8). The decrease observed in the first half of 2024 was accompanied by an increase among non-residents and, to a lesser extent, banks. The continued gradual reduction of the Eurosystem’s balance sheet underlines the importance of maintaining competitive market access conditions. The gradual, predictable and flexible nature of the phasing-out of purchase programmes has proven essential for the market to absorb additional debt amounts. The TPI helps to ensure that the monetary policy stance is transmitted smoothly across all euro area countries.

Cost and maturity of Portuguese public debt	Structure of Portuguese public debt holders | Per cent
Sources: Banco de Portugal, Portuguese Treasury and Debt Management Agency and Statistics Portugal. | Notes: The implicit average cost of the debt stock corresponds to the ratio of interest expenditure to average debt stock. The cost of debt issued in each period is weighted by amount and maturity and includes Treasury bills, Treasury bonds, floating rate Treasury bonds and medium-term notes issued in the corresponding year. The average maturity of issued medium and long-term debt domain includes Treasury bonds and medium-term notes issued in the corresponding year.	Sources: ECB, Banco de Portugal and Portuguese Treasury and Debt Management Agency . | Note: End-of-period data.

Macroeconomic and geopolitical uncertainty, with consequences for the conduct of monetary policy, poses a risk to the debt servicing cost. It is therefore important that the sustained reduction in the public debt ratio, a key element underpinning financial stability, proceeds. To this end, the pressure to increase net public expenditure should be framed from an inter-temporal sustainability perspective and in line with the recently revised EU fiscal rules.

Non-financial corporations

The financial situation of firms continued to be robust in June 2024, despite the moderation in activity and higher financing costs than those observed until 2022.

The capitalisation of NFCs continued to increase in the first half of 2024, albeit at a slower pace than in the same period of 2023. In recent quarters, the increase in equity has been mainly driven by retained earnings. The importance of capital in the funding structure of Portuguese NFCs has been increasing compared to the run-up to the sovereign debt crisis, and this trend was not interrupted by the pandemic crisis. Firms’ capital ratio increased by 13.9 p.p. between June 2009 and June 2024 across all sectors of activity, although structural differences persist (Chart I.1.9).

NFCs’ capital ratio in Portugal, by sector of activity | Per cent
Source: Banco de Portugal. | Notes: The capital ratio measures the percentage of firms’ assets financed by equity. A higher capital ratio hints at an increase in corporate capitalisation. The dotted line corresponds to total NFCs. The quarterly ratio corresponds to the value obtained for the year ending in the quarter. Latest observation: June 2024 (quarterly economic and financial indicators in the Central Balance Sheet Database).

In terms of financing structure developments, small and medium-sized enterprises (SMEs) stand out, following a lower capital share in 2009. In this segment, the share of capital in asset financing rose by 19.0 p.p. between June 2009 and June 2024, compared with an increase of 6.5 p.p. for large enterprises. Conversely, in the same period there was a decrease in the share of obtained funding and debt to suppliers in the SME balance sheet by 12.2 p.p. and 3.9 p.p. respectively (Chart I.1.10).

NFCs’ financing structure, by size | As a percentage of assets
Panel A – NFCs	Panel B – SMEs	Panel C – Large enterprises
Source: Banco de Portugal. | Note: Figures may not add up to 100 due to rounding.

The decreasing role of financing obtained by NFCs over the past 15 years has been driven almost entirely by developments in bank lending, which accounted for 10% in June 2024, down from 19% in June 2009. Securities market financing is especially important for large enterprises (7.8% in June 2024), as seen throughout the entire period. Intragroup financing is relevant for both types of firms (Chart I.1.11).

Obtained funding, by instrument/counterparty and size | As a percentage of assets
Panel A – NFCs	Panel B – SMEs	Panel C – Large enterprises
Source: Banco de Portugal.

Portuguese firms’ debt-to-GDP ratio narrowed further in the first half of 2024, to stand at 76% in June this year. Since 2021, this ratio has been below that of the euro area and the differential between both has widened, reaching 6.0 p.p. at the end of 2023 (Chart I.1.12). In recent years, the increase in nominal GDP has been instrumental in reducing the indebtedness ratio of NFCs, both in Portugal and the euro area. In Portugal, in the first half of 2024, this effect was only slightly offset by an increase in obtained funding. In the second quarter, the amount of short and long-term debt securities issued by NFCs, largely held by resident banks, outpaced the reduction in bank loans in the first quarter of the year.

There was also a decrease in the ratio of indebtedness net of deposits to 50% at the end of the first half of 2024, compared with 58% in the euro area in December 2023. NFC deposits increased by 2.5% in the first half of 2024, and their amount remained 45% higher than in 2019.

In 2024, firms’ operating profitability stabilised after the upward path of the last decade, interrupted only by the COVID-19 pandemic. In June 2024 it stood at 9.5%, down from 9.8% in September 2023. Developments were heterogeneous across sectors of activity, with an increase from the previous year in the construction sector (0.8 p.p.) and a decrease in industry (-0.9 p.p.) (Chart I.1.13).

The pass-through of rising market interest rates to the financing costs of NFCs was swift, given the predominance of variable interest rates and the relatively short refinancing maturities. The cost of obtained funding rose from 4.5% at the end of 2023 to 4.9% in the year ending in June 2024, with this implicit cost dropping to its lowest level in the year ending in March 2022 (2.7%). At the same time, the aggregate financing expenses coverage by EBITDA was 6.9 in the year ending in June 2024, down by 0.6 from December 2023. Developments were heterogeneous across sectors of activity, most notably with a decrease in industry (-1.4) and trade (-0.6). In turn, reflecting the improvement in operating profitability, in the case of construction it increased by 0.3 (Chart I.1.14).

Developments in the indebtedness ratio and in the indebtedness ratio net of deposits(1)| As a percentage of GDP	Operating profitability on assets (EBITDA) | Per cent
Source: Banco de Portugal. | Notes: Consolidated figures. (1) The ratio of indebtedness net of deposits corresponds to the ratio of NFC total debt less deposits to GDP.	Source: Banco de Portugal. | Notes: Average operating profitability on assets is defined as the ratio of EBITDA to average assets for the period. EBITDA is an acronym for earnings before interest, taxes, depreciation and amortisation. Latest observation: June 2024 (quarterly economic and financial indicators in the Central Balance Sheet Database).

However, lower interest rates in 2024 should contribute to a moderation in the increase in the cost of financing. The average interest rate on new bank loans edged down to 5.4% in June 2024, from 5.7% in December 2023 (with a further 0.4 p.p. decrease between June and September 2024) (Section 2 – Banking System).

Cost of obtained funding and coverage by EBITDA, by sector of activity
Panel A – Cost of obtained funding (1)| Per cent	Panel B – Financing expenses coverage ratio (2)| In number of times
Source: Banco de Portugal. | Notes: (1) The costs of obtained funding include costs associated with bank loans, debt securities and other loans. (2) The financing expenses coverage ratio corresponds to the number of times the EBITDA covers such costs. The quarterly ratio corresponds to the value obtained for the year ending in the quarter. Other services include services except trade and transport and storage. Industry includes mining and quarrying as well as manufacturing. Latest observation: June 2024 (quarterly economic and financial indicators in the Central Balance Sheet Database).

In the year ending in June 2024, firms’ return on equity fell by 0.7 p.p., given the increase in financing costs, the slowdown in activity and an increase in equity. For 2023, available information is more granular, making it possible to gauge the contribution of each component of the ratio. The increase in return excluding financing expenses was, on average, higher than the negative contribution from the increase in interest expenses. However, the impact of capital accumulation unwound this effect, resulting in a decline in the ratio. These developments were heterogeneous across sectors of activity (Chart I.1.15).

The reduction in firms’ financial vulnerability has been accompanied by increased resilience to shocks which their activity has been subject to since 2019. Despite the significant rise in interest rates in 2022 and 2023, there was no increase in bank credit defaults (Section 2.3). Following similar developments in the cost of financing for State-guaranteed loans granted during the COVID-19 pandemic, the materialisation of credit risk in firms that made use of these loans is similar to other firms (Box 1). In turn, the number of insolvencies declared in the first half of 2024 (1,049) was below the average observed in 2018–19 (1,117). However, in the case of manufacturing, as well as of accommodation and food services, it exceeded the 2018-19 average. In the case of manufacturing, this is the highest figure since 2015, similarly to the first half of 2020. These sectors are among those most affected by the increase in energy and raw materials costs in 2022 and the pandemic crisis in 2020 (Box 4 – Financial Stability Report, June 2022, Chart I.1.16).

Return on equity and contributions to changes between 2022 and 2023
Panel A – ROE | As a percentage of equity	Panel B – Contributions to changes in the ROE, by sector of activity (1) (2) | Percentage points
Source: Banco de Portugal. | Notes: ROE – return on equity. Return on equity is calculated as the ratio of net income to equity. The left-hand panel data refers to data for private firms, excluding the agriculture, forestry and fishing sector. In this panel, the quarterly ratio corresponds to the value obtained for the year ending in the quarter. Latest observation: June 2024 (quarterly economic and financial indicators in the Central Balance Sheet Database). The right-hand panel data considers a universe of firms including public and private firms (also comprising the agriculture, forestry and fishing sector). (1) The breakdown by ROE contributions considers net income for the period excluding financing expenses and, separately, firms’ financing expenses. (2) The data needed to break down ROE contributions is available on an annual basis from the annual information from the Central Balance Sheet Database available in BPstat and, as such, developments are presented for 2023, instead of for the first half of 2024.

Higher financing costs and lower economic momentum in relevant trading partners in the euro area continue to put pressure on business activity, increasing credit risk heterogeneously. However, in the central macroeconomic scenario for the Portuguese economy, the share of firms identified as financially vulnerable in 2024 and 2025 is estimated to decrease. The share of financially vulnerable firms, i.e. where EBITDA is less than twice the amount of interest expenses, is projected to decline in 2024 and 2025, to around 12% and 8% respectively, compared with 14% in 2023. These developments reflect the expected downward path of market interest rates, leading to a reduction in firms’ cost of financing amid persistent economic growth. While these developments are broadly based across most sectors of activity, the reduction in vulnerability in construction and real estate activities is expected to materialise only in 2025.

Firms’ investment rate decreased slightly in the year ending in June 2024 (‑0.5 p.p.), which may be accounted for by the level of financing costs and the background of uncertainty. However, when measured as investment in real assets in relation to gross value added, the investment rate still exceeds that of 2019 (+1.4 p.p.), as opposed to that seen in the euro area (3.1 p.p.). According to its October 2024 issue of the Economic Bulletin, the Banco de Portugal foresees a reduction in the contribution of corporate GFCF to GDP (-0.3 p.p.). However, in 2025 and 2026 forecasts are moving towards a recovery in investment, reflecting an easing of financing conditions, the implementation of the RRP and a better outlook for international economic growth.

More disruptive geopolitical developments and a further slowdown in euro area activity pose the highest risk to NFCs’ activity. In particular, energy costs and other production costs and/or supply chain disruptions may have a significant impact. According to market expectations, interest rates will decline, but converge towards levels above those observed until 2022, constraining firms’ debt servicing capacity. However, the current financial position of firms, in terms of solvency and liquidity, will play a role in mitigating these risks.

Households

The strong Portuguese labour market continues to underpin household disposable income growth. In the first half of 2024, nominal disposable income grew by 9.6% year on year (6.3% in the first half of 2023), reflecting a 6.6 p.p. contribution from compensation of employees and, to a lesser extent, other income (Chart I.1.17). In the year as a whole, real disposable income is expected to grow by 6.6% (6.5% in the first half of 2024) due to lower inflation, favourable employment and wage situation, higher pensions and other transfers, and cuts in personal income tax. In 2025 and 2026, real disposable income is expected to grow at a slower pace (1.9% on average), given the expected moderation in the wage share and the fading effects of fiscal measures (Economic Bulletin, October 2024, Banco de Portugal). According to Statistics Portugal’s Qualitative Consumer Survey, in June 2024 the confidence indicator proceeded with the increase seen in recent months, reaching its highest value since February 2022.

Changes in household nominal disposable income and contributions | Per cent and percentage points
Sources: Banco de Portugal and Statistics Portugal. | Note: (a) Net of transfers in kind.

After a sharp increase during the pandemic (12.0% in 2020), the household saving rate declined in 2022 to levels close to its pre-pandemic period, only to recover in 2023 (Table I.1.3). In the first half of 2024 the household saving rate amounted to 9.7% and is projected to reach 11.5% by the end of the year. Savings were mostly allocated to currency and deposits and to investment in real assets (6.3% and 5.2% of disposable income respectively). Over the first half of 2024, there was a slight disinvestment in savings certificates, at 0.8% of disposable income, and a stabilisation of investment in insurance, pension and guarantee schemes.

The household indebtedness ratio continued its downward trend observed over the past decade and a half. In June 2024, household indebtedness accounted for 82.3% of disposable income (83.2% on a non-consolidated basis), with a 2.6 p.p. drop from the end of 2023, standing below the euro area average (87.0%) (Chart I.1.18), as has been the case since 2019. The present figure is close to that observed in 2001. Recent developments reflect the significant increase in disposable income amid moderate growth in lending to households (Section 2.2).

In Portugal, the share of loans for house purchase in household disposable income is also below the euro area average. At the end of the second quarter of 2024, loans for house purchase accounted for 53.8% of household disposable income in Portugal, down by 2.7 p.p. from the end of 2023. The euro area average (56.8%) also decreased by 2.9 p.p. from December 2023 (Chart I.1.19).

Household indebtedness ratio | As a percentage of disposable income	Ratio of the stock of loans for house purchase to disposable income | Per cent
Sources: Banco de Portugal and Eurostat (Banco de Portugal calculations). | Notes: Non-consolidated figures for total debt. For disposable income, figures unadjusted for the balance of social transfers in kind are considered. The shaded area corresponds to the range between the third and the first quartiles of the distribution for a set of euro area countries (Belgium, Germany, Ireland, Spain, France, Italy, Netherlands, Austria, Portugal, Slovenia and Finland).

After a marked rise over the past three years, the average interest rate on the stock of loans for house purchase decreased in 2024. This interest rate reached 4.6% in the second quarter of 2024, 0.1 p.p. lower than at the end of 2023 (Chart I.1.20). This development is due to a general reduction in EURIBOR rates, as the bulk of the stock of loans for house purchase (around 70%) corresponds to variable-rate agreements (Section 2.2). In the euro area, the share of variable-rate agreements is 15%, meaning that the average interest rate on the stock of loans for house purchase continued its upward trend in the second quarter of 2024, edging up by 0.1 p.p. to 2.5%.

The reduction in short-term interest rates and in the inflation rate, combined with a strong labour market, help to contain the default rate of households. Market expectations point to the continued gradual reduction in EURIBOR rates until the end of 2025, with a slight increase throughout 2026 and 2027 (Chart I.1.1, Section 1.2). The decline in EURIBOR rates until the end of 2025 to around 2% across maturities should continue to be reflected in a reduction in instalments on EURIBOR-linked credit agreements for house purchase for all maturities and, combined with the expected increase in income, in an improvement in the debt servicing capacity of households. Despite some lag, this downward trend will also benefit borrowers with mixed-rate loans (new, transferred or renegotiated) as the interest rate was fixed for relatively short periods, typically of up to two years (Section 2.2).

Developments in the average interest rate on the stock of loans | Per cent
Panel A – House purchase	Panel B – Consumption and other purposes
Source: ECB (Banco de Portugal calculations). | Notes: The shaded area corresponds to the range between the 10th and 90th percentiles of the distribution for a set of euro area countries (Belgium, Germany, Ireland, Spain, France, Italy, Netherlands, Austria, Portugal, Slovenia and Finland). Latest observation: June 2024.

The lower debt servicing burden of loans for house purchase contributed to the 2.2 p.p. decline in the average loan service-to-income ratio (LSTI) between December 2023 and June 2024, to 23.7%. Considering as a baseline the stock of loans for house purchase in June 2024, the expected developments in EURIBOR rates until December 2025 were considered in order to quantify the impact on the debt servicing of these loans. For each agreement, income was projected for 2024 and 2025, based on the growth rate of average compensation per employee (October 2024 issue of the Economic Bulletin). Reflecting the expected favourable developments in income and the decline in EURIBOR rates, the share of agreements with an LSTI of 30% or less is estimated to increase from 74.2% in June 2024 to 77.3% in December 2024 (85% in December 2025), and the share of the stock with an LSTI of over 50% is estimated to drop from 5.5% in June 2024 to 5% in December 2024 (3.3% in December 2025). For loans in the 1^st income quintile, this share is estimated to stand at 37.4% in December 2024 (27.8% in December 2025). Loans in this quintile accounted, however, for only 7% of the stock of loans for house purchase in June 2024 (Table I.1.4).

Residential and commercial real estate market

Domestic loans to households secured by real estate accounted for 24.6% of the Portuguese banking sector’s assets in June 2024, while the stock of loans to construction stood at 8.7% of total bank loans to NFCs (compared with 23% in 2009). The weight of these items warrants careful monitoring of developments in the real estate market and in the risks and vulnerabilities to which it may expose the financial system.

Residential real estate market

As transactions recovered in 2024, house prices continued to rise. House prices rose by 7.4% in the first half of the year, year on year, after increasing by 8.2% in 2023 (Chart I.1.21). The number of transactions in dwellings increased by 3% year on year, following a 19% fall in 2023. Transactions in existing dwellings accounted for 80% of the total.

In the euro area, the residential real estate market shows signs of a rebound, with prices growing by 0.5% in the first half of 2024, following a 1.1% contraction in 2023 (Chart I.1.22). Some countries with price falls in 2023 posted less marked price decreases (Germany, France or Austria) or price increases (the Netherlands and Slovakia) in the first half of the year. Developments in the number of transactions also tended towards a smaller decline or a recovery.

Price index and number of transactions in dwellings | Per cent	Price index and number of transactions in dwellings in the euro area | Per cent
Source: Statistics Portugal.	Source: Eurostat. | Notes: The chart includes only euro area countries for which comparable information on house prices and transactions is available (Belgium, Ireland, Spain, France, Netherlands, Austria, Slovenia and Finland). Each point in the chart corresponds to one country.

In Portugal, despite some heterogeneity, the increase in prices and rents was broadly based across the main regions. In the second quarter of 2024, the median housing value reached €1,736 per square metre, corresponding to 6.6% year-on-year growth (Table I.1.5). In regions with the highest median value (Lisboa, Porto and Algarve) year-on-year growth was below the national average. The rental market was also buoyant, with rent growth outpacing selling price growth.

According to the survey of residential real estate agents and promoters,² activity in the first half of 2024 was subdued, with expectations for house sales and demand being more favourable for the second half of 2024. The expectation of a rebound in sales is accompanied by an expectation that residential real estate prices will continue to rise. Survey responses may be reflecting recent interest rate developments and recent government measures, which are likely to lead to an increase in demand for housing, with a possible impact on prices.

The shortage of housing supply contributes to higher residential real estate prices. The current shortage of housing supply in Portugal is due to low construction activity and the completion of new dwellings during the years following the great financial crisis, which restricted housing stock growth. In the past eight years (between 2015 and 2023) less than half the number of new dwellings were built than in the preceding eight years (from 2007 to 2014). In a recent paper, Lourenço et al. (2024)³ conclude that in recent years housing supply in Portugal has been unable to counterbalance the upward pressure on prices associated with demand factors. Portugal is among the countries in Europe with the fewest building permits for new dwellings (Chart I.1.23). Between 2013 and 2022, 17 dwellings per thousand inhabitants were licensed in Portugal, compared to 60 in France and 34 in Germany. Countries with a greater number of new housing permits, such as Finland, Cyprus, France and Sweden, show more moderate house price growth.

After a sharp decline between 2007 and 2014, the number of household dwellings built per year has been slowly increasing. In the first half of 2024, the number of new concluded dwellings increased by 3%, while licensing fell by 8%, countering the growth path observed since 2016 (Chart I.1.24). The survey of obstacles to construction activity points to labour shortages, a lack of materials and the difficulty in obtaining building permits as the main constraints on construction activity. The share of firms that report difficulties in obtaining credit and dealing with interest rate levels has remained contained. Labour shortages and the lack of materials are reflected in high construction costs, which pass through to the price of new dwellings. Between December 2019 and December 2023 construction costs rose by 25% (cumulative inflation in this period was 15%), and over 2024 the cost of materials stabilised although labour costs continued to rise (8.5% year-on-year rate of change in September – Chart I.1.25).

Licensed and concluded dwellings | Thousands	Year-on-year change in construction costs | Per cent
Source: Statistics Portugal. | Note: Household dwellings in new buildings.	Source: Statistics Portugal.

Supply shortages coexist with the small size of the rental market and a high number of secondary and vacant dwellings. In 2021, 922 thousand dwellings were rented, corresponding to 15% of the housing stock. A significant number of countries have a share of more than 30% of the rental market. In addition, 31% of the Portuguese housing stock is not permanently occupied, with 19% being secondary dwellings and 12% vacant dwellings. The share of vacant dwellings is among the highest in the euro area, compared to 14% in Spain, 8% in France, 7% in Ireland and 3% in the Netherlands (Housing Europe Observatory).

In 2022 the housing stock was comprised of 6 million dwellings, but part of this stock may not be in line with current demand characteristics. The less buoyant construction activity over the past decade has been reflected in ageing dwellings. Between 2011 and 2021 the number of dwellings in need of repair increased, with one-third of dwellings in 2021 located in buildings in need of repair. The rehabilitation of the housing stock, although intensified in recent years, is low (The housing stock – analysis and evolution: 2011-2021, Statistics Portugal). In turn, the increase in the number of households in recent years (9% between 2011 and 2023) has exceeded population growth (0.8%), putting additional pressure on demand. Households are currently smaller on average and therefore have different needs regarding housing characteristics.

In the recent past, the participation of non-resident buyers in the residential real estate market has increased. In the first half of 2024, non-resident residential real estate buyers accounted for 6% of the number of transactions and 10% of the amount, slightly lower than in recent years. The average purchase value of a dwelling for non-resident buyers (€345 thousand) remained above the average value for residents (€190 thousand). Among non-residents, there is also a difference in the average value of purchases between buyers with tax residence in the European Union (€280 thousand) and buyers from other countries (€408 thousand). In turn, the foreign population residing in Portugal has grown significantly, offsetting negative natural balances and contributing to the growth of total population, with an impact on house prices (Box 2). Demand from foreigners with higher purchasing power, and thus in higher segments, with possible contagion effects on other segments, has been boosted by a number of measures. As a first step, the most notable was the Golden Visa regime (Pereira dos Santos and Strohmaier, 2024), which granted residence rights to foreign buyers of a dwelling for €500 thousand or more. In turn, in recent years, tax benefits for non-habitual residents (in force since 2009) have been highlighted as a factor of attractiveness. According to the Court of Auditors’ ‘Opinion on the General State Account for 2023’, the number of registered non-habitual residents reached 115 thousand in 2023.

Loans granted to foreign (resident and non-resident) citizens have increased recently. Between December 2022 and June 2024, the share of foreign citizens in the stock of housing loans increased from 6.9% to 8.2%. The increase in the foreign resident population and demand for housing by non-residents have contributed to this growth. On aggregate, this effect also seems to be driven by a change in the demand profile, particularly with higher demand for owner-occupied and permanent housing by working-age foreigners and lower age groups. In 2023 and the first half of 2024, 18% of new loans for house purchase (excluding renegotiations and credit transfers) were granted to foreign citizens.

There are ongoing signs of overvaluation in the Portuguese residential market. In the first half of 2024, statistical indicators remained above the values taken as a benchmark to signal potential episodes of overvaluation. The ratio of the house price index to household income was 24% above its long-term average while the price-to-rent ratio stood 28% above that average (Chart I.1.26). The real house price index is also above its long-term trend, at 15% (Chart I.1.27).

Likewise, two models based on macroeconomic determinants continue to point to some overvaluation in the market (Chart I.1.28). However, these model-based estimates should be interpreted with special care due to methodological limitations and consequent uncertainty associated with the results. Moreover, the estimates might not appropriately capture the participation of non-residents in the market and the role played by tourism in determining housing supply and demand. Both have been key factors to price developments over the past few years. The limited supply of new dwellings and the similarly limited stock of dwellings available in the market mitigate the impact on prices if demand wanes.

House prices and evaluation measures in real terms | Index 2015=100
Sources: ECB and OECD (Banco de Portugal calculations). | Notes: Overvaluation and undervaluation periods correspond to situations in which at least two models out of three identify an imbalance in house prices. For further details on this methodology, see the Special Issue entitled “Housing price assessment methodologies applied to Portugal” in the December 2019 issue of the Banco de Portugal’s Financial Stability Report. Latest observation: 2024 Q2.

Higher interest rates, following a period of tighter monetary policy that started in mid-2022, contributed to a reduction in the share of credit in total transactions in dwellings, reaching values close to those observed during the sovereign debt crisis. In the first half of 2024, new loans for house purchase (excluding transfers) accounted for 35% of the amount of transactions in dwellings, below the average over the period 2018-23 (Chart  I.1.29). Since 2016, house prices have almost doubled, while the stock of loans for house purchase has grown moderately, by 5%.

Transactions in dwellings financed with recourse to credit | Per cent
Sources: Banco de Portugal and Statistics Portugal. | Notes: Information available up to December 2014 does not make it possible to isolate new loans associated with renegotiations. However, these loans are estimated to account for a residual share of the total volume of new business and therefore have no impact on the historical comparison presented. In turn, nor is it possible to isolate the impact of credit transfers between banks up to 2019. Latest observation: 2024 Q2.

Commercial real estate market

In the first half of 2024, the commercial real estate market remained resilient, in line with developments in 2023. The shortage of quality supply has been identified by market participants as the main factor supporting the increase in value of commercial real estate. According to JLL and Cushman & Wakefield, the retail segment remained attractive and still accounts for a significant share of investment in commercial real estate. In contrast to the euro area, the office segment in Portugal was particularly resilient. The size of the industrial and logistics segment in Portugal is significantly smaller compared to the largest euro area economies, but has grown the most in recent years, with a successive increase in the value of real estate assets. Finally, there is sustained growth and price resilience in the accommodation segment, linked to the momentum and favourable outlook for the tourism sector.

In the first half of 2024, the share of investors assessing commercial real estate as being expensive or very expensive decreased slightly from 2023.⁴ Less than one-third of investors considers that the commercial real estate market is in a contractionary phase. In some euro area countries, following a price correction in 2023, the share of investors assessing commercial real estate as being expensive or very expensive or that the market is contracting has also declined.

Investment in the commercial real estate market totalled €675 million in the first half of 2024, an 18% fall compared with the same period one year earlier. Investment in the Portuguese commercial real estate market continued to be dominated by non-resident investors, mostly institutional investors, which accounted for 70% of the total amount invested in the first half of the year (over 80% between 2014 and 2023). This renders the market more sensitive to international developments. The market is also characterised by a concentration of amounts invested in a relatively limited number of very high-value real estate assets.

The evidence does not indicate an increase in risks and vulnerabilities in the commercial real estate market in Portugal, which remain low. The banking sector’s exposure to commercial real estate is contained and diversified (Section 2.4 Concentration) and capital requirements for this type of credit are higher than those for credit secured by residential real estate. In addition, risks related to the activity of real estate investment funds are low (Section 1.3.5 Non-banking financial sector). These factors contribute to adverse developments in this market having a small impact on the stability of the financial system.

Non-banking financial sector

In June 2024, the financial assets of the Portuguese non-bank financial sector accounted for 87% of GDP, remaining stable from 2023, which compares with 370% in the euro area. These financial intermediaries include investment funds (11%), insurance corporations and pension funds (26%) and other intermediaries and financial auxiliaries (50%) (Chart I.1.30). The diversity of activities performed, differences in each country’s financial architecture and context specificities, among other factors, result in rather heterogeneous size and composition of the non-bank financial sector across euro area countries. In Portugal, this sector’s interlinkages with the other institutional sectors, financial and non-financial, are limited and have decreased over the last decade (Box 3).

Relative size of financial subsectors (in Portugal and the euro area) and their interlinkages (in Portugal)
Sources: ECB and Banco de Portugal. | Notes: Non-consolidated figures. The following were considered in the calculation of financial assets: deposits, debt securities, loans, shares and other investment fund units and listed shares.

The dispersion of assets and liabilities by non-resident counterparties limits contagion effects, should risks materialise in the non-bank financial sector. In Portugal, a large share of the non-bank financial sector’s financial assets corresponds to liabilities of non-resident counterparties (40%), mainly in the case of collective investment undertakings (investment funds, insurance corporations and pension funds). As regards borrowing, the main counterparty sector also corresponds to non-resident entities (35%).

However, there are still strong interlinkages with other resident sectors. In particular, the non-bank financial sector’s role in financing non-financial corporations, chiefly by captive financial auxiliary institutions and lenders, is noteworthy, reflecting relations between economic groups. Likewise, households hold investment fund shares and claims on pension funds.

Investment funds

In the first half of 2024, subscriptions net of write-offs of investment fund shares were negative (-€64.3 million). Positive net subscriptions of securities investment funds (SIFs) did not offset the negative flows in real estate investment funds (REIFs). However, due to positive changes in value and volume of assets under management, the stock of shares/units increased by €985.8  million.

In particular, the value of non-financial (real estate) assets under management rose by 2.3%. These assets are exclusively concentrated in funds whose predominant investment strategy is real estate (REIFs), accounting for 86% of their portfolios in June 2024. In the first half of the year, new REIFs were also launched. SIFs, which hold 58% of investment funds’ total assets, can be equity, bond or mixed funds, presenting a more diverse asset structure. In this period, SEIFs particular emphasis can be placed on the increase in the value of shares and other equity (Charts I.1.31 and I.1.32).

Investment fund assets, by investment strategy and instrument (June 2024)
Panel A – Investment funds	Panel B – Real estate investment funds (REIFs)	Panel C – Securities investment funds (SIFs)
Source: Banco de Portugal.

Investment fund assets – change in position, transactions and other changes in value and price in the first half of 2024 | Million of euros
Source: Banco de Portugal. ‘OCVP’ refers to other changes in value and price; including appreciation/depreciation, reclassifications and other changes in volume not explained by transactions.

In Portugal, in June 2024, closed-ended REIFs accounted for 69% of shares/units issued by REIFs, thereby mitigating liquidity risk. The likelihood of this risk materialising increases when the redemption frequency of shares/units permitted by the fund management policy exceeds the period required for portfolio assets to be sold without incurring significant loss. Due to the illiquidity of real estate assets this risk is higher in REIFs, especially in open-ended funds that typically offer daily liquidity to investors at market value. In turn, closed-ended REIFs are less sensitive to changes in market conditions, given that they issue a fixed number of shares/units that are not tradable continuously. Note also that REIF managers have set redemption fees relatively discouraging of a massive withdrawal of capital.

Maintaining a portfolio of liquid assets helps to mitigate liquidity risk. For Portugal, in June 2024 currency and deposits in the asset portfolio of investment funds accounted for 9.2% of the total, compared with 5.9% in the euro area. Also, in this context and over the same period, assets in the form of currency and deposits amounted to 11.0% of total assets of open-ended REIFs, exceeding the average for investment funds (9.2%).

High levels of leverage increase the materialisation of losses stemming, among other factors, from sales of assets made under unfavourable conditions to address the redemption of shares/units. Leverage can arise from financing the fund’s activity through debt or, synthetically, by taking negative/passive positions in the derivatives market. In June 2024, loans and securities issued accounted for 4.5% of total assets in investment funds, while financial derivatives accounted for a negligible amount. In the euro area, the equivalent ratio, including derivatives and other liabilities, is 8%.

Half of the investment fund shares/units issued in Portugal are held by households, accounting for 3.8% of their total financial assets (Chart I.1.33). The materialisation of losses in this sector would therefore hit households’ investments negatively. Investment in shares/units by households is concentrated in SIFs, of which they hold 62% of shares/units issued. The diverse investment strategy adopted by this type of fund, including in shares/units issued by non-resident investment funds, acts as a mitigating factor for loss materialisation. In addition, the maturity of debt held by SIFs remained at historically low levels during the first half of 2024, thus reducing the responsiveness of these portfolios’ value to changes in market interest rates. In turn, shares/units issued by REIFs are mostly held by non-residents (37%) and financial sector entities (21%).

Holders of investment fund shares/units, by investment strategy (June 2024) | EUR billions
Panel A – Investment funds	Panel B – REIFs	Panel C – SIFs
Source: Banco de Portugal. | Notes: Key: NFCs: non-financial corporations; GG: General government; Hous.: Households; RW: Rest of the world; FS: Financial sector.

Insurance corporations and pension funds

In the first half of 2024, the downward trend in life insurance was interrupted, and it rose by 19.5% from the first half of 2023. As the interest rate regime normalises, the life insurance business model has been realigned towards more traditional formats, leading to a significant increase in guaranteed-return products (31.9% compared with the first half of 2023), to the detriment of unit linked products, where risks rest with the policyholder (-1.5% y-o-y). As regards amounts paid, including redemptions, there was a year-on-year decline of 3.3%.

In the non-life segment, there was an overall increase in production of 11.1%, year on year, across core business segments, namely sickness (18.5%), motor vehicles (11.4%), work-related accidents (9.8%), and fire and other damage (6.1%). The delinquency rate rose by 1.2 p.p. compared with the first half of 2023, with heterogenous developments across core business segments.

The amount of contributions paid to pension funds grew by 48.6% (y-o-y. r. c.), driven by extraordinary contributions to a number of funds and increased subscriptions of funds that finance retirement plans. Benefits paid also increased compared to the same period one year earlier (5.4%).

Total financial assets of the insurance sector and pension funds rose by 1.1% in the first half of 2024. Financial assets of the insurance sector increased by 1.5%, while in the case of pension funds the increase was 0.1%. In terms of transactions, there was a reduction in deposits and an increase in long-term debt securities and investment fund shares/units issued by non-residents. Among changes in volume and price, the valuation of shares and other equity stood out.

The share of government bonds in the investment portfolios of insurance corporations and pension funds has decreased. Despite still accounting for the largest share of the assets of insurance corporations (34.4%), in the case of pension funds, investment fund shares/units are now the weightiest asset (38.9%) (Chart I.1.34).

Assets of insurance corporations and pension funds | As a percentage of the total portfolio
Source: Insurance and Pension Funds Supervisory Authority.

The lower market interest rates will tend to lead to the partial unwinding of the favourable impacts of the increase in discount rates observed in 2023. Given that in these sectors the duration of liabilities is longer than that of assets in the portfolio, all else being equal, and for the same decrease in interest rates, the increase in liabilities exceeds the valuation of assets.

In terms of market risk, the predominance of sovereign securities in investment portfolios minimises any losses stemming from investors’ risk-averse behaviour. Exposures to private debt and securities investment funds are the main channels of exposure to this risk.

According to the Portuguese Insurance and Pension Funds Supervisory Authority, the consolidated solvency levels of the insurance sector provide some room to absorb the impact of adverse developments, also associated with a liquidity risk profile that tends to be contained. This stems from the high levels of asset liquidity in investment portfolios, the limited use of financial derivative instruments (and underlying margin exposure), and developments in the life insurance business model in a higher interest rate environment than before 2022. In the case of non-life insurance, there is also the use of risk management and transfer practices, such as reinsurance.

Other risks and challenges for financial stability

Cybersecurity threats remain a high risk to financial stability worldwide, as they can disrupt critical operations, compromise sensitive data and undermine public confidence. The complex geopolitical situation, the continuous digital transition of the sector, as well as successive technological innovations, notably Artificial Intelligence, help to exacerbate the systemic and disruptive potential of a possible cyber incident. Authorities such as the IMF or the European Union Agency for Cybersecurity (ENISA) have reported an increasing number of incidents and associated losses. In Portugal, the National Cybersecurity Centre recorded about two thousand incidents in 2023, of which 10% affected domestic banking, nearly three times more than those experienced four years earlier. Recent update flaws in widely used software systems and attacks on public digital services illustrate the disruptive potential and the need for a proactive stance on institutions’ digital operational resilience.

In terms of the domestic banking system, the operational cyber resilience test conducted by the Banco de Portugal in 2024 improved the understanding and ability to assess this sector’s cyber resilience (Box 4). This exercise was key in fostering awareness of the systemic potential of cyber risk, by effectively assessing how institutions are impacted by a severe incident and their ability to respond to and recover from it. It also helped to pinpoint individual and system-wide vulnerabilities, and actions to mitigate them. In addition, the Banking Industry Forum on Cybersecurity and Operational Resilience (FICRO in the Portuguese acronym) contributes to the operational resilience of the banking sector, in particular with two working groups operating under its framework: TIBER-PT, which conducts advanced cybersecurity tests, and CIISI-PT, which promotes information sharing.

Across the financial sector, regulatory developments and cooperation initiatives with supervision authorities have also contributed to more robust cyber resilience. The ongoing transposition of the Directive on measures for a high common level of cybersecurity across the Union (NIS2) into national law, as well as efforts undertaken by institutions to comply with the Digital Operational Resilience Act (DORA), directly applicable from 17 January 2025, contribute to a system more prepared and robust against cyber risk.

Climate change is also becoming increasingly important among the current risks and challenges facing the financial system. Institutions must consolidate their efforts, resources and skills to ensure the organic integration of climate-related and environmental factors into the different dimensions of their activity, enabling them to assess and mitigate their short, medium and long-term impacts on the various “traditional” prudential risks (e.g. credit, market, liquidity).

Developments in the prudential regulatory framework applicable to credit institutions are crucial to that indispensable change (e.g. implementation of sustainability disclosure standards for SMEs), with recent changes being implemented through the CRD6 and CRR3, published on 19 June 2024. In this regulatory framework, and aiming at sound risk management, institutions must test their resilience to the long-term impacts of ESG factors, starting with climate factors, applying credible scenarios developed by international organisations. The EBA is developing guidelines for credit institutions as part of its climate stress scenario analysis, as well as the content of (transition) plans under the CRD and indicators and methodologies for identifying, managing and mitigating climate-related financial risks. These guidelines are expected to be published over the coming years.

It has become increasingly important to identify areas where the environmental “credentials” of the institution and/or of the products marketed can be challenged and to adopt transparent, consistent practices based on sound sustainability and regulatory compliance policies, taking into account the marketing of retail financial products with sustainable characteristics and the growing provision of sustainability information in line with regulatory developments. Likewise, reputational and litigation risks associated with alleged greenwashing practices, which are particularly evident in asset management, must also be incorporated by institutions into their risk management policies and procedures. These risks can become a material factor, with negative consequences not only for institutions and for financial stability, but also for their customers. This topic was the discussed in the EBA Final Report (EBA/REP/2024/09) published in June 2024 at the request of the European Commission to the three ESAs.

These dimensions are all the more important amid insufficient insurance loss coverage stemming from the materialisation of climate risks (climate insurance protection gap). In a context where natural disasters tend to be more frequent and intense, this gap hampers the recovery in economic activity and increases losses in the value of real estate of households and firms provided as collateral in credit operations and can thus have material impacts on credit institutions and financial stability.

Also in terms of climate transition and given the need for substantial private and public investment, challenges related to the adequacy of the institutional architecture of the European Union remain relevant. In this context, note that the Eurogroup’s Action Plan was approved in May 2024. The Plan aims to provide a decisive push towards the materialisation of a Capital Markets Union (CMU). In October, the Eurogroup continued to monitor the priority areas for policy action and concrete initiatives to pursue this plan, including on how capital markets could be developed to support small and medium-sized enterprises in the EU, as well as on the key role that the European Investment Bank (EIB) could play towards this objective. The conclusions of the “Draghi Report”, presented in September 2024, which will certainly feed into the European Commission’s work on a new plan for Europe’s sustainable prosperity and competitiveness, bring to the fore the crucial role of the CMU in promoting sustainable economic growth and the financial stability of the European Union. The report also states that completing the Banking Union is complementary to progressing towards the Capital Markets Union and is key to enabling banks with cross-border operations to be “country blind” in terms of risk.

Turning to the prevention of money laundering and terrorist financing (ML/TF), the Banco de Portugal has finalised its Report on Public Consultation No 10/2023 and publication of Instruction No 8/2024 of 5 June 2015, which sets out the items of information to be reported annually to the Banco de Portugal by the financial entities subject to its AML/CFT supervision. In terms of on-site supervision, a cycle of inspections was launched to assess the ML/TF prevention control environment of seven payment institutions. In turn, as regards off-site supervision, work continued on the three enhanced supervisory actions to continuously monitor a limited set of supervisory measures issued on highly critical AML/CTF topics. Also noteworthy was the work conducted by the workstream specifically created under the aegis of the Banco de Portugal’s Forum on the Prevention of Money Laundering and Terrorist Financing (‘ML/TF Forum’) to draw up a document of “Best Practice on ML/TF control mechanisms in the context of digital fraud”, to strengthen the empowerment of supervised entities in this matter. Finally, also worth mentioning is the preparation of the second meeting of the ML/TF Forum in December 2024.

Macroprudential policy

Developments in the financial cycle are currently characterised by the lack of signs of a build-up or materialisation of cyclical systemic risk, with the risk environment remaining neutral. In the first quarter of the year, there was a slight decline in the domestic cyclical systemic risk indicator (Chart I.1.35), as a result of a narrowing of the current account deficit, a contraction in credit granted to non-financial corporations (NFCs) and households, and GDP growth. Conversely, house price growth continues to exert pressure to increase cyclical systemic risk, although the magnitude of this contribution has declined compared with previous years.

The potential impact of extreme events arising from the materialisation of cyclical risk on economic growth eased compared with the same period a year earlier. According to the Growth-at-Risk (GaR) model, the materialisation of extreme events (with a probability of up to 10%) would imply a year-on-year rate of change in GDP of less than 0.06% (Chart I.1.36), resulting in a stagnation in economic activity growth.

The COVID-19 pandemic illustrated the importance for macroprudential authorities to ensure that the financial system has sufficient resilience to face unexpected losses. During this period, several European macroprudential authorities released buffers, in part or in full, to support the flow of credit to the economy. Aiming to strengthen resilience early on in the financial cycle following the COVID-19 pandemic, 15 European Economic Area (EEA) countries implemented a positive countercyclical capital buffer (CCyB) rate in the phase of the financial cycle where risks are considered neutral.⁵

Considering the current economic context and the macroeconomic scenario, as well as the current levels of profitability and capitalisation of the banking sector, the Banco de Portugal proposes to apply a new CCyB rate of 0.75% at the current phase when cyclical systemic risk is at a level considered neutral (i.e. not in a phase of excessive accumulation or materialisation of cyclical systemic risk). Should cyclical systemic risk materialise in the future, the Banco de Portugal will release the countercyclical capital buffer, in full or in part, depending on the materiality of the shock. In the same vein, the buffer rate may increase in the future if justified by the accumulation of risks (Special issue “The countercyclical buffer in a neutral risk environment in Portugal").

The 4% sectoral systemic risk buffer (sSyRB) has been in place since 1 October 2024. It applies to the portfolio of loans to households secured by residential real estate for banks using the internal ratings-based (IRB) approach. It aims to increase the resilience of credit institutions in view of a possible materialisation of systemic risk in the residential real estate market in Portugal, to which the banking system is materially exposed.

The increase in releasable capital buffers (CCyB buffer and (s)SyRB buffer) at the start of the financial cycle will allow institutions to better absorb losses resulting from unexpected systemic shocks, without significantly constraining lending, and mitigate potential negative effects on economic activity. By introducing a CCyB rate of 0.75%, Portugal ranks close to a number of euro area countries as regards releasable capital buffers (Chart I.1.37). In terms of impact on the financial system, the sSyRB accounts for approximately 0.26% of the banking system’s total risk-weighted assets (RWAs), taking as a reference June 2024.⁶

Total releasable buffers for a set of euro area countries | Per cent
Sources: Banco de Portugal (based on information collected from other macroprudential authorities) and European Systemic Risk Board (ESRB). | Notes: Including all announced buffers that have not yet entered into force. For Portugal, the CCyB is planned to enter into force on 1 January 2026 and, for Spain, on 1 January 2026. As for Latvia, the CCyB rate of 0.5% will apply from 18 December 2024 and then increase to 1% from 18 June 2025 (for calculation purposes, the 1% rate was considered). For Greece, the CCyB rate of 0.25% will apply from 1 October 2025 and should then increase until it reaches its target rate of 0.5%.

The Banco de Portugal continues to foster the adoption of prudent credit standards. The Recommendation of the Banco de Portugal on new credit agreements for consumers (the “Recommendation”) establishes, among other things, an upper limit of 50% for borrowers’ debt-service-to-income ratio, considering a future increase in interest rates, as well as a an upper limit of 90% for the ratio of the amount of the loan for the purchase of own and permanent residence to the minimum between the property’s purchase price and appraisal value (loan-to-value – LTV). These limits aim to promote the adoption of prudent lending standards, thus contributing to strengthening the resilience of borrowers and institutions against risks arising, for example, from possible increases in interest rates, falling real estate prices or negative changes in income.

In the first half of 2024, institutions continued to broadly comply with the guidelines set out in the Recommendation. The share of credit granted to high-risk borrowers remained at very low levels. Of the total amount associated with new loans for house purchase and consumer credit, 92% was granted to borrowers with a DSTI ratio of 50% or less (Chart I.1.38). All credit granted during this period recorded an LTV of 90% or less, with the LTV for 66% of new agreements being less than or equal to 80% (Chart I.1.39). These figures may have been affected by borrowers aged 35 or less postponing loan agreements until the entry into force of the Municipal Real Estate Transfer tax and stamp duty exemptions, according to information reported by credit institutions (Chart I.1.40).

The average actual DSTI (calculated without the interest rate shock) decreased slightly to 26.3%, as a result of the reduction in the benchmark rate for variable rate loans (Chart I.1.41). This slight decrease may be related to the current low number of variable rate loans on new agreements, which account for 15% of the total (compared to 80% with a mixed rate and 5% with a fixed rate) in the first half of 2024, as opposed to 90% of the agreements concluded in 2022, in the period before the interest rate rise.

The publication of Decree-Law No 44/2024 of 10 July 2024 laid down the conditions under which the State may provide personal guarantees to credit institutions, with a view to enabling loans for the purchase of own and permanent residence to young people aged 35 or less up to the full transaction value. Housing loans granted by institutions above 90% of the transaction value interfere with the limit set in the Recommendation (and will require close monitoring by the Banco de Portugal, which will act, where necessary, to mitigate the impact of excessive risk accumulation undermining financial stability).

The government guarantee may contribute to increasing household debt and credit risk in a scenario where the borrower’s income and factors influencing market interest rates remain constant. Moreover, given the limited and unresponsive supply of the Portuguese housing market, a significant increase in demand may lead to a rise in house prices. In this context, the Banco de Portugal informed the institutions (Circular Letter No CC/2024/00000032, published on 15 October 2024) on how it will monitor housing loans granted using the government guarantee and on its expectations concerning the rationale behind deviations from the Recommendation and on prudential aspects.

The Recommendation and the limits set therein remain unchanged and are expected to continue to be followed by the institutions. Thus, in the light of the ‘comply or explain’ procedure, institutions exceeding the limits (e.g. LTV, DSTI, maximum maturity) or that do not comply with the regular payment requirement laid down therein should justify it from a prudential and risk assessment perspective. This justification always applies to each of the agreements where those limits are not respected.

The Banco de Portugal monitors the materiality of these loans and their risk profile both at the time the loan was granted and over time. It therefore assesses the extent to which loans covered by the guarantee translate into an increased risk for the institutions’ portfolios and the banking system as a whole. If, in the context of this assessment, there is a significant increase in risk in credit institutions’ portfolios, the Banco de Portugal may act at the macroprudential level, using the instruments it has at its disposal to mitigate or reduce the risks identified.

Finally, it is important to mention the reflection made at international level on the challenges to macroprudential policy arising from cyber risks. These challenges stem from the fact that these risks are systemic, i.e. they can spread quickly across the financial system and the wider economy. Thus, the European Systemic Risk Board (ESRB) and the European Central Bank (ECB) have been involved in establishing an operational framework to mitigate this type of risk.⁷ Box 4 analyses the results of the stress test conducted by the Banco de Portugal to assess the resilience and responsiveness of the banking system to a major cyber incident.

Banking system

The positive developments that have been consolidated in recent years in the Portuguese banking system reflect the deleveraging process of the sector over the past fifteen years as well as recent favourable cyclical factors such as the rapid rise in interest rates in 2022 and 2023 and growth of the Portuguese economy above its potential. In the first half of 2024, banks continued to operate in an environment characterised by robust liquidity, stable asset credit quality and increasing levels of profitability with a positive impact on capital ratios.

Return on assets continued to rise to historically high levels, standing at 1.47% in June 2024. These developments continued to benefit from net interest income growth, despite the slowdown owing to the significant rise in interest rates on household deposits. In the coming half-years, net interest income is expected to decline, given the reduction in interbank market interest rates since the end of last year and the prevalence of variable-rate loans. However, net interest income is expected to remain above the levels observed in the period of very low interest rates. The higher share of loans for house purchase with fixed or mixed interest rates granted in recent years and the reliance on hedging interest rate risk through financial derivatives will help mitigate the impact on net interest income. The increase in the return on assets was also supported by the reduction in credit impairments, standing at record lows, reflecting benign labour market prospects and expectations of further interest rate reductions.

The total assets of the Portuguese banking system increased by 4.4% in the first half of 2024, mainly due to an expansion in the debt securities portfolio. This portfolio mainly consists of government debt (68%), a component that has increased significantly in recent years and accounts for 17% of total assets (+1.5 p.p.) compared with December 2023). Recent developments in this portfolio reflect the sector’s robust liquidity position, which translates into an increasingly lower loan-to-deposit ratio (75%), supported by an increase in customer deposits and contained developments in loans for house purchase and corporate loans. Banks also continue to be significantly exposed to real estate (34%), mostly in the form of loans to households secured by real estate. The sectoral systemic risk buffer introduced by Banco de Portugal and the low share of loans to households secured by real estate with a loan-to-value (LTV) ratio of more than 80% contribute to banks’ resilience against potential adverse developments in the residential real estate market.

Indicators on asset credit quality remained stable, with new defaults remaining contained. The gross non-performing loans (NPLs) ratio decreased marginally to 2.6% in June 2024. The ratio of stage 2 loans decreased to 10% (-0.7 p.p. than in December 2023), with the decline being broadly based across the main segments. These developments have benefited from a benign macroeconomic environment and, in terms of loans for house purchase, from the government-introduced measures to support debtors. The ongoing transition to lower interest rates should contribute to reducing borrowers’ credit risk, with some stage 2 loans moving back to stage 1.

Total own funds of the Portuguese banking sector continued to increase through organic generation of capital. The sustained increase in the sector’s solvency levels has allowed them to converge towards the euro area average, with Common Equity Tier 1 capital more prominent in Portugal (CET1).

The 75 basis point (b.p.) decrease in ECB interest rates so far and the expectation of further reductions in the near future reduce the degree of monetary policy tightening and alter the banks’ lending and borrowing environment. Banks should prioritise taking advantage of the positive phase of the business cycle to prudently build up impairments and conserve capital, so as to safeguard their resilience and funding to the economy in the face of potential adverse shocks.

Considering the current economic context and the macroeconomic scenario, as well as the current levels of profitability and capitalisation of the banking sector, the Banco de Portugal implemented a sectoral systemic risk buffer in October 2024 and proposed to apply a CCyB rate of 0.75% at the current stage where cyclical systemic risk is considered neutral (i.e. it is not in a phase of excessive accumulation or materialisation of cyclical systemic risk). If cyclical systemic risk materialises, the Banco de Portugal will release the countercyclical capital buffer in full or in part, depending on the materiality of the shock (see the Special Issue “The countercyclical capital buffer in a risk-neutral environment in Portugal”).

Profitability

1. In the first half of 2024, return on assets (ROA) increased by 0.31 p.p. compared with the same period in 2023, standing at 1.47%. The dispersion among institutions in the banking system remained broadly unchanged, with increases in the 10^th and 90^th percentiles of this indicator’s distribution (Table I.2.1).

2. Developments in ROA reflected the positive contribution of net interest income (0.31 p.p.) and of net provisions and impairments (0.26 p.p.). The net interest income contribution was lower than in the first half of 2023. This contrasts with the contribution made by net provisions and impairments, turning from negative to positive through a reduction in credit impairments. Conversely, income from financial operations (-0.10 p.p.) and operating costs (-0.08 p.p.) made a negative contribution to change in ROA. The contribution from income from financial operations is largely explained by the base effect of an institution’s recognition of gains on the sale of a subsidiary in the first half of 2023. The contributions of net interest income and operating costs were reflected in recurring operating income, with net fees and commissions having a residual contribution (0.02 p.p.). This aggregate incorporates the typically more stable components of income and contributed 0.25 p.p. to the change in ROA, in line with that recorded in 2022.

The more moderate growth in net interest income as a percentage of average assets reflected the significant rise in interest paid, mainly as a result of higher interest rates on household deposits. In the first half of 2024, the interest income component continued to increase, underpinned by developments in interest on loans to customers (Table I.2.2) that benefited from the interbank market interest rate pass-through observed in 2023. The debt securities portfolio, in particular securities issued by general government, also made positive interest income contributions. Regarding interest paid, the main contribution was associated with households’ deposits, also reflecting their weight in the financing of the banking system, and to a lesser extent, the contributions of non-financial corporations’ (NFCs) deposits and the contributions of securities issued.

4. The difference between interest rates on loans and deposits agreements with the non-financial private sector (NFPS) narrowed for both stock and new business in the first half of 2024 (Chart I.2.1). The decrease in new business reflected an increase in the average interest rate on new deposits that surpassed the increase in the average interest rate on new loans. Developments in the interest rate on new deposit operations resulted in an increase in the average interest rate on stocks, which was accompanied by a slight decrease in the average interest rate on the stock of loans to the NFPS. Despite the decrease observed in this period, the difference between the interest rates on stocks of loans and time deposits remained higher in Portugal than in the euro area (by 2.6 p.p.).

   The cost-to-core-income ratio narrowed, despite higher operating costs. This ratio decreased by 1.48 p.p. year on year to 39.9% due to the aforementioned increase in net interest income (Chart I.2.2). The increase in operating costs originated from staff costs and, to a lesser extent, from other administrative expenses. The weight of these items remained, however, relatively stable, standing at 0.78% (a change of 0.01 p.p.) and 0.47% (a change of 0.01 p.p.) in average assets respectively.

   The cost of risk decreased by 0.34 p.p. to 0.12%, reaching historically low levels (Chart I.2.2). These developments largely reflected a decline in the flow of credit impairments, which may indicate an improvement in banks’ perception of their customers’ credit risk, reflecting a benign outlook for economic activity and the labour market and expectations of further reductions in market interest rates.

Rate differentials between NFPS loans and deposits | Percentage points	Cost-to-core-income and loan loss charge | Per cent
Sources: ECB and Banco de Portugal. | Notes: The non-financial private sector includes NFCs and households. The series refers to the reporting on an individual basis of the other monetary financial institutions resident in Portugal. New business includes average annual rates weighted by their respective amounts. (a) Difference between the interest rates on loans and on time deposits.	Source: Banco de Portugal. | Notes: Cost-to-core-income consists of the ratio between operating costs and the sum of net interest income and net fees and commissions. The loan loss charge consists of the flow of credit impairments as a percentage of total average gross loans to customers.

In the first half of 2024, the Portuguese banking system’s ROA was 0.76 p.p. higher than the euro area average (Table I.2.3), with particular emphasis on the higher contribution of net interest income and a sharper decrease in provisions and impairments. The difference in developments in net interest income between Portugal and the euro area mainly reflects a higher increase, in Portugal, in the difference between the interest rates applied to credit granted and to deposits in the NFPS (Chart I.2.1). Variable interest rates associated with most loans for house purchase in Portugal rose more sharply and exceeded interest rates applied in the euro area, where variable rate financing is less significant. Deposit interest rates in the euro area have increased more strongly than in Portugal.

7. Amid the declining interest rates, the profitability of the Portuguese banking system is expected to decrease, reflecting a lower contribution from net interest income. However, this contribution should remain relevant. Amid an easing of the monetary policy framework, the reduction in interbank market interest rates should contribute to a gradual decline in the difference between lending and deposit interest rates, as a result of a distinct speed of pass-through to these components. In addition, the spread between those interest rates is expected to remain above the levels observed prior to 2022, while also mitigating the negative impact on net interest income. In addition, the adjustment that banks have made since the 2008 financial crisis, by increasing the share of customer deposits in their funding and reducing liabilities represented by securities, contributes to a lower cost of funding, resulting in higher net interest income. In the special issue “Interest rate risk in the banking book”, the parallel interest rate reduction exercise (200 b.p.) signals a reduction in net interest income in most banks in the Portuguese banking system, although it remained above the levels observed in the period of very low interest rates for the total banking system. Hedging interest rate risk through financial derivatives, in the current context where there is a higher share of loans for house purchase with fixed or mixed interest rates, may also contribute to mitigating the impact of lower interest rates on net interest income.

Credit standards

Loans to households

In June 2024, the adjusted annual rate of change in the stock of bank loans to households was 1.2%, having been on an increasing trend since the beginning of the year (Chart I.2.3). This development was driven by the continued growth in the stock of consumer loans (6.7% in June 2024), as well as the recovery in the stock of loans for house purchase (0.1% in June 2024). Alongside the recovery in new loans for house purchase, developments in the stock of loans continued to reflect a volume of early repayments above that observed before the interest rates hikes began.

Adjusted annual rate of change in the stock of loans to households | Per cent
Source: Banco de Portugal. | Notes: Annual rates of change are calculated on the basis of end-of-month stock changes in bank loans, adjusted for changes not defined as transactions, namely, reclassifications, write-offs and exchange rate and price revaluations. ARCs are also adjusted for securitisation and loan transfers. Latest observation: June 2024.

The half-yearly flow of new loans for house purchase (excluding renegotiations) has recorded year-on-year increases since December 2023 (Chart I.2.4). The growth trend in recent months in new loans for house purchase was observed in most other European countries. Portugal recorded the second highest year-on-year rate of change in the first half of 2024 (Chart I.2.5). Credit transfers between institutions, however, continued to represent a significant share in total new business. Between January and June 2024, transfers totalled €2.1 billion, up 54% from the same period a year earlier, albeit showing a downward trend since March 2024. In June 2024, these accounted for 23% of new loans for house purchase (excluding renegotiations) and 37% of early repayments in full. In the first half of the year, excluding these operations, new loans for house purchase grew by 20% year on year.

New housing loans (6-month cumulative values) | EUR thousands and per cent	Annual rate of change in the stock and year-on-year rate of change in new housing loans between January and June 2024 | Per cent
Source: Banco de Portugal. | Notes: The annual rates of change in Chart I.2.5 are not adjusted for securitisation and loan transfers, owing to unavailability of information for euro area countries. These operations have been residual in Portugal recently, so the rate of change and the adjusted rate of change are very close. Latest observation: June 2024.

Early repayments of loans for house purchase totalled €6.1 billion in the first half of 2024, 8.8% more than in same period a year earlier, and accounted for 0.9% of the stock of loans for house purchase in June 2024. After losing some relevance in 2023, early repayments in full recovered in comparison with partial repayments over the past year, thereby increasing their share to 88% of total repayments in June 2024, 7 p.p. higher than in June 2023. Partial early repayment reduces borrowers’ debt level and service and, consequently, the impact that future changes in interest rates may have on debt service, as well as life insurance costs, helping to reduce households’ financial vulnerability. Early repayments in full, in addition to situations where borrowers simply settle the debt without any new associated credit, also include situations of residential real estate exchange and the transfer of loans to other institutions. In the latter, the positive impact on household vulnerability will be more limited.

Developments in interest rates on new loans for house purchase reflected the overall reduction in Euribor rates. In June 2024, the average interest rate (annualised agreed rate – AAR) on new loans for house purchase fell by 0.4 p.p. compared with the same month a year earlier, standing at 3.7%, which was similar to the euro area average. On the other hand, the average annual percentage rate of charge (APRC) which includes other charges such as loan-related fees, insurances required to obtain the credit or taxes associated with the mortgage registration, stood in June 2024 at 6.3%, the same as in June 2023, 2.4 p.p. above the euro area average.

The share of new loans for house purchase with a fixed or mixed interest rate in the total amount of new loans has increased slightly since the beginning of 2024, after the significant increase observed in 2023. In January 2024, the amount of these operations represented around 71% of the total amount of loans for house purchase granted in that month, while in June 2024 that proportion reached 77% (Chart I.2.6). The increase in the share of these operations since the second half of 2023, which include credit transfers, has been reflected in an increase in the share of fixed or mixed rate loans in the total stock of loans for house purchase, from 13% in June 2023 to 30% in June 2024 (Chart I.2.6).

Monthly flow of new loans and stock of housing loans by type of interest rate   | Per cent
Source: Banco de Portugal. | Notes: The 'mixed rate’ classification is based on the date the agreement is signed, from which a fixed rate period is in force that differs from one agreement to another. The share of the mixed rate stock may include agreements that are already within the variable rate period or close to the end of the fixed rate period.

According to the Bank Lending Survey (BLS), credit standards for loans for house purchase to households remained broadly unchanged throughout the first half of the year, while consumer credit standards became tighter (Chart I.2.7). Institutions also reported a slight decrease in demand for loans for house purchase compared with the previous half-year. In the euro area, banks reported a slight easing of credit standards throughout the first half of 2024 for housing and tighter standards for consumption. In the October 2024 BLS, regarding the third quarter of 2024, Portuguese banks reported a slight increase in demand for loans for house purchase – which is expected to continue into the last quarter of 2024, due to expectations of lower key interest rates and the government’s recent measures to support house purchase by young people –, as well as a continued tightening of their credit standards.

Comparing the first six months of 2024 with the same period a year earlier, the amount of new consumer loans increased by around 9%, which contributed to increasing the adjusted annual rate of change in the stock of consumer credit since the beginning of the year, reaching 6.7% in June 2024 (Chart I.2.3). The average interest rate and APRC on consumer loans increased by 0.8 p.p. and 1.1 p.p. respectively in September 2024, compared with the same month a year earlier, standing at 8.8% and 11.2% respectively, compared to 7.7% and 8.5% in the euro area. The spread has increased relative to the corresponding rates on loans for house purchase, which has been ongoing since November 2023, confirming the increasing tightening of consumer credit standards. In contrast to loans for house purchase, most of these agreements have a fixed interest rate. As at June 2024, variable interest rate agreements accounted for only 8.0% of consumer credit stock.

Supply and demand for housing loans | Diffusion index
Panel A ― Supply	Panel B ― Demand
Sources: ECB and Banco de Portugal. | Notes: Credit supply corresponds to credit standards reported by banks. An increase (decrease) in the diffusion index means an increase (decrease) in restrictiveness by institutions and an increase (decrease) in demand in the credit segment. The last observation for each variable corresponds to the institutions’ expectations for the fourth quarter of 2024 (dashed part).

Lending to non-financial corporations

In the first half of 2024, the annual rate of change in the stock of loans to firms remained negative, albeit gradually increasing. The annual rate of change in the stock of loans granted by resident banks was -0.5% in June 2024, compared with a change of -1.1% at the end of 2023. There was some heterogeneity across sectors: some still recorded negative but more moderate rates, such as industry (-7.3% in June 2024) and accommodation and food services (-2.6%). The construction, real estate activities and professional and administrative activities continued to grow (1.9%, 3.8% and 5.4% respectively). By firm size, loans continued to decline for small and medium-sized enterprises, while micro-enterprises continued to grow (5.4%). In turn, loans to large enterprises recovered slightly (0.6%) (Table I.2.4).

The two factors that have contributed most to the fall in credit demand by firms in Portugal since the second half of 2022, have been the general level of interest rates and the decline in financing needs for investment. These contributions became less negative as of the last quarter of 2023. Regarding supply conditions, the most important factors explaining the tightening of credit granting in 2023 were linked to the risks associated with the economic situation and the creditworthiness of borrowers. In the first half of 2024, banks did not report material changes in these factors.

New loans to firms in the lowest credit risk class continued to account for around half of total loans to non-financial corporations granted in the first half of 2024 (Chart I.2.9). The share of loans granted to firms in the intermediate risk and high risk classes have remained relatively stable since 2019.

Driven by developments in new business and improved financial indicators that firms have been recording in recent years, the share of the stock of loans to firms in the high credit risk class continues to decline. Despite the adverse economic shocks to firms in recent years, the share of loans associated with low risk firms has continued to increase, accounting for about half of total loans granted to firms. In turn, the share associated with the high risk class decreased from 24% in December 2019 to 16% in June 2024.

The average interest rate on new loans to firms decreased from 5.7% in December 2023 to 5.4% in June 2024, reflecting the reduction in Euribor rates at different maturities and a slight narrowing of spreads (Table I.2.5). The average interest rate on the stock of credit fell slightly from 5.5% in December 2023 to 5.4% in June 2024.

Spreads on new loans reflected risk differentiation over the first half of 2024 and remained higher for high risk firms (Table I.2.5). However, spreads in both low risk and high risk classes became narrower on both new business and stock.

Credit quality of assets

The gross NPL ratio declined marginally in the first half of 2024, standing at 2.6% in June 2024 (Table I.2.6). The evolution of the ratio reflected a 0.3% reduction in the total NPL stock and 1.3% growth in performing loans (denominator component). The change in the stock of NPLs was the result, on the one hand, of a 3.5% reduction in the NFC segment and, on the other hand, of an increase in the household segments, both for house purchase (+9.3%) and for consumption and other purposes (+1.9%). As for the increase in performing loans, about half was due to cash balances at central banks and other credit institutions and the other half to performing loans from both household segments.

In this context, slight changes were observed in the gross NPL ratios of the main segments of loans to the non-financial private sector, with no significant changes in dispersion across institutions. High interest rates have put pressure on the financing costs of firms and households, affecting the quality of the banking sector’s credit portfolio. Nevertheless, the benign macroeconomic environment has allowed flows of new defaults to remain at relatively contained levels.

In loans for house purchase, the gross NPL ratio increased by 0.1 p.p. in the first half of the year, to 1.4%, owing to a flow of new NPLs higher than that of cures (Table I.2.7). The increase in the stock of NPLs in this segment is particularly affected by high market interest rates, which serve as a benchmark rate for loans for house purchase in Portugal, predominantly granted at a variable rate. For loans for consumption and other purposes, the NPL ratio remained at 6.2%, despite the flow of new NPLs net of cures, offset by sales and write-offs of NPLs, as well as an increase in total loans (denominator effect).

In loans to NFCs, the gross NPL ratio decreased by 0.1 p.p. from December 2023, to 4.9%. This change resulted mainly from a decrease in the stock of NPLs, due to sales and write-offs, partially offset by a slightly higher inflow of new NPLs than cures.

The NPL impairment coverage ratio decreased to 55.1%, showing distinct developments for firms and households (Table I.2.6). The decrease in the coverage ratio, along with the reduction in the gross NPL ratio, resulted in the stabilisation of the NPL ratio net of impairments at 1.2%.

In NFCs, the decrease in the stock of NPLs led to a reduction in the respective accumulated impairments, resulting in a 0.8 p.p. increase in the coverage ratio, to 61.5%. These dynamics, in a context of a stable gross value of the loan portfolio to NFCs, prompted a 0.1 p.p. decrease in the NPL ratio net of impairments, to 1.9%.

In households, the coverage ratios of loans for house purchase and loans for consumption and other purposes decreased by 1.0 p.p., to 37.0% and 59.3% respectively. In both cases, the reduction in the ratio was due to an increase in the NPL stock that was higher than in their accumulated impairments, resulting in an increase in NPLs net of impairments. In this context, the net NPL ratio in the housing segment increased by 0.1 p.p., to 0.9%, and remained at 2.5% in the consumption and other purposes segment.

The gross NPL ratio of the Portuguese banking sector was 0.8 p.p. above the euro area average in June 2024. The spread was significantly lower for the net NPL ratio (+0.1 p.p.) owing to the higher level of impairment coverage compared to the euro area average (+12.2 p.p.).

In the first half of 2024, the stage 2 loan ratio decreased by 0.7 p.p. to 10.0%, following a worsening in 2023 (Table I.2.8). The decline in the ratio was broadly based across the main segments and more pronounced in NFCs and households for house purchase. In these segments, the change in the ratio was almost exclusively due to the decrease in stage 2 loans (numerator effect). However, both NFCs and households (housing and consumption and other purposes) continued to record positive net transfers to stage 2 (i.e. performing loans with a substantial increase in credit risk since recognition), mostly of loans previously recorded as stage 1, offset by regular and extraordinary amortisation. Initially, the transfer of loans from stage 1 to stage 2 reflected an increase in the credit risk of some borrowers stemming from the rapid rise in financing costs in 2023, which was partially reversed by the decline in interest rates during the first half of 2024. Against a background of declining interest rates, in line with the decrease in the inflation rate, and low unemployment, the credit risk of firms and households is expected to fall, with a reversal of some loans from stage 2 to stage 1.

The ratio of forborne loans due to the borrower’s financial difficulties decreased by 0.2 p.p. to 2.4% in the first half of 2024 (Table I.2.8). This change stems from a 7.5% decrease in forborne loans.