Banco de Portugal publishes today the December 2019 issue of the Financial Stability Report (in Portuguese only).
I – Vulnerabilities and risks
In 2019 the Portuguese economy continued to consolidate the progress achieved over the past few years. The current and capital account balance remained positive, although the projected surplus is clearly below that observed in the previous two years. The adjustment in the fiscal balance continued, despite projected progress being slower than in previous years when adjusted for temporary measures. Indeed, adjustments have become less intense.
Economic growth remained above estimates for potential output growth. Interest rates, which were already very low across a wide range of maturities, decreased even further. Unemployment continued to decline and consumer confidence remained high, resuming an upward path in the second quarter.
Indebtedness levels of non-financial corporations and households and, in particular, general government remained high both by historical standards and compared with the euro area, despite declining in recent years. This is especially important when linked both to the Portuguese economy’s sensitivity to external shocks and potential economic growth remaining relatively limited.
The profitability of the banking system increased. The non-performing loans (NPL) ratio continued to decline and capital ratios continued to be strengthened.
Compared with the June Financial Stability Report, growth estimates for 2019 and growth projections for the next few years were revised downwards for the euro area. Were it to materialise, a scenario of a sharper slowdown would have considerable repercussions for the Portuguese economy, given the high interconnectedness between the two geographies. In September, the European Central Bank (ECB) announced a monetary stimulus package. As a whole, this package envisages a scenario of lower interest rates during a more protracted period of time (so-called lower for longer). The decline in medium and long-term interest rates signals that the Euribor will only turn positive over a significantly longer horizon than anticipated at the time of preparation of the previous issue of the Financial Stability Report.
An environment of prolonged very low interest rates leads to a drop in financing costs, helping economic agents service their debt, in particular those that are highly indebted. Nevertheless and in contrast to short-term gains, this creates favourable conditions for the intensification of risks related to search for yield, potentially resulting in excessive risk-taking and asset overvaluation, which tend to be corrected over time. This may also deteriorate credit standards and increase indebtedness to unsustainable levels. The resulting accumulation of vulnerabilities makes economic agents more sensitive to a potentially sharper slowdown in economic activity, with an impact on their ability to service debt and possible implications for risk premia and asset valuation. Given the materiality of bank exposures to fixed rate government debt securities, real estate assets or assets benefiting from similar collateral, the potential reversal of risk premia and a decrease in the value of these assets remain a significant risk to financial stability.
Furthermore, it is vital that banks adequately address risks linked to the digitalisation of the financial sector and the entry of new players in intermediation, risks arising from climate change (physical and transition risks) and the respective transmission mechanisms to the financial sector and the economy as a whole, as well as risks of money laundering and terrorist financing.
In an international environment favourable to the accumulation of vulnerabilities and intensification of risks to financial stability, concluding a robust Banking Union continues to be imperative to effectively reduce the fragmentation of the institutional architecture of the European financial sector.
In sum, given the environment of heightened uncertainty surrounding developments in economic activity and overvaluation of a wide range of financial and real assets, including residential real estate, economic agents should continue to adjust their financial position to increase their resilience to future shocks. Credit institutions in particular should pursue cautious policies to control their exposure to risk and strengthen their ability to absorb the risks listed in this Report, were they to materialise, including in their dividend distribution policy.
II - Macroprudential policy
From the implementation of the Recommendation on new credit agreements for consumers on 1 July 2018 until September 2019, a considerable convergence was observed towards the limits established therein.
The phased implementation of the buffer requirement applied to other systemically important institutions (O-SII) continued, reaching half of the buffer requirement for each institution.
The countercyclical capital buffer was kept at 0% of risk exposures. Most indicators used to calculate the countercyclical capital buffer do not point to an accumulation of cyclical systemic risk. In addition, although in the first half of 2019 the composite indicator for domestic systemic risk (d-SRI) continued the recovery observed since 2015, this indicator still remains negative, and consequently does not signal an accumulation of cyclical systemic risk.
As macroprudential authority, Banco de Portugal monitors developments in corporate and household indebtedness, the resilience of credit institutions and credit standards, and takes appropriate action, if necessary.
III - Special Issues and boxes
The December Financial Stability Report has two special issues:
- ‘A review of the literature on the impact of the increase in financial institutions’ capital ratios’;
- ‘Housing price assessment methodologies applied to Portugal’.
It also includes five boxes:
- ‘Assessment of residential real estate markets by the European Systemic Risk Board’;
- ‘New European framework for covered bonds’;
- ‘Developments in non-financial private sector indebtedness in Portugal and the euro area in the past 30 years’;
- ‘Revision of the ECB’s supervisory expectations for prudential provisioning of new non-performing exposures’;
- ‘Basel III – What still needs to change?’.
