Executive summary

Risks to financial stability arise, to a large degree, from the potential fallout that geopolitical tensions and protracted tight monetary conditions may have on economic activity. In the last half of the year, vulnerabilities have decreased on the back of improved economic conditions. Inflation is expected to continue its downward path and economic growth in Portugal should remain positive and above that of the euro area. According to the most recent projections of the European Central Bank and the Banco de Portugal, inflation is expected to decline to 2.3% in the euro area and 2.4% in Portugal in 2024, reaching 2% in 2025. The economy is projected to grow at around 2% in Portugal and 0.6% in the euro area in 2024, with more favourable projections for the following two years, with Portugal growing above 2.2% per year, at a pace higher than the 1.5% and 1.6% projected for the euro area.

At international level, the tense geopolitical context, with ongoing military conflicts in Ukraine and the Middle East, weighs on international trade flows and has an impact on economic activity. The strategic security considerations that can support the economic and financial fragmentation of the global economy and jeopardise a more inclusive re-globalisation process are particularly noteworthy. In addition, there is a risk that the ongoing adjustment in the Chinese real estate market could have a more pronounced negative impact on its economy, with repercussions for the global economy.

Maintaining monetary conditions tight for longer and/or with longer than anticipated effects impacts economic and financial conditions. The conduct of monetary policy should consider the synergies achieved through a global coordinated response, but it should also take into account the underlying reality in each economic area, which may require differentiated responses to reduce the risks of excessive tightening.

At national level, a scenario of heightened policymaking uncertainty stands out, within the framework of a new model for European budgetary rules, which will pose new challenges to fiscal policy.

A possible deterioration in macroeconomic conditions triggering abrupt corrections in financial asset prices could exacerbate risks to financial stability. Deteriorating economic conditions lead to a reduction in the value of assets and a worsening of the debt service of resident sectors, although mitigating factors, such as the reduction of indebtedness, have been consolidated in recent years.

Risks associated with the financial position of the general government have been decreasing, driven by fiscal consolidation and the resulting downward trend in the public debt-to-GDP ratio, only interrupted by the pandemic crisis, when the ratio peaked at 138% but then immediately resumed, with the ratio standing at 112% at the end of 2022 and falling to 99% in 2023. This deleveraging path was reflected in corresponding upgrades in the Republic’s rating. However, debt is still high. In this way, general government is exposed to persistently higher interest rates and volatility in international financial markets, which may spill over to other resident sectors by contagion in their risk assessments.

Firms have continued to improve their capital ratio and to reduce indebtedness. The average leverage ratio, measuring the share of debt in total equity and financial debt, decreased to 41.3% in 2023 (42.2% in 2022). In a year of economic growth, the indebtedness ratios as a percentage of GDP, gross and net of deposits, narrowed to 82% (89% in 2022) and 56% (59% in 2022) respectively. Corporate profitability has withstood the increase in debt servicing. EBITDA accounted on average for 9% of assets, down by only 0.2 percentage points (p.p.) from 2022, the highest level since the financial crisis. In the past year, there has been no material increase in insolvencies and the quality of credit granted to firms has not deteriorated, which is reflected in the decline in the ratio of non-performing loans (NPLs) to 5.0% (6.5% in 2022). In any event, the cumulative effect of maintaining high interest rates on economic activity and financing costs, together with possible increases in production costs and supply chain disruptions, could trigger the materialisation of credit risk, particularly for the most vulnerable firms.

Households also saw a decline in their indebtedness ratio, following a trend that started in 2010, reaching 85% at the end of the year (91% in 2022). The improvement in the risk profile of loans to households has benefited from the macroprudential Recommendation introduced in 2018, which includes limits to the debt service-to-income (DSTI) ratio as one of the criteria for approving new loans. Amid rising interest rates, household default mitigation has also benefited from a strong labour market and higher real disposable income. Owing to a contained increase of 0.2 p.p. in NPLs in loans for house purchase, the household segment had a 2.4% NPL ratio, higher by 0.1 p.p. than in 2022.

A scenario of protracted tight monetary policy and worsening economic conditions may also lead to lower real estate market prices through their impact on demand. However, the effects on the Portuguese banking system should be contained. Only 5% of banks’ housing loan portfolios have loan-to-value (LTV) ratios of more than 80%, lessening the impact of a potential drop in house prices. In the commercial segment, the banking sector’s exposure is contained.

The international non-banking financial sector is exposed to risks inherent in its business model, where there are fewer liquidity instruments and backstops in stress situations. In Portugal, vulnerabilities did not build up in the sector.

The situation in the Portuguese banking sector has improved further, characterised by higher levels of capital, liquidity and profitability. It has been a source of stability, helping to ensure the regular financing of the economy. The profitability of the sector increased to 1.28% of assets (0.69% in 2022), with a positive impact on capital ratios. The total capital ratio and the Common Equity Tier 1 (CET1) ratio increased by 1.5 and 1.7 p.p., respectively, to stand at 19.6% and 17.1% respectively. Liquidity indicators remained high and above 2022 levels, with the liquidity coverage ratio (LCR) reaching 255% and the net stable funding ratio (NSFR) 151%.

Should adverse conditions materialise, including in economic activity, with implications for unemployment, credit quality may deteriorate. While the total NPL ratio continued to narrow in 2023, from 3.0% to 2.7%, there was an increase in loans showing a significant increase in credit risk (stage 2 loans). The ratio of stage 2 loans to households increased by 2.2 p.p. to 10.4%, with a contribution from housing loans – mostly at a variable rate – reflecting an increase in credit risk associated with the higher debt service burden in the income of the most vulnerable households.

Preserving banks’ net interest income is key to sustaining organic capital generation, being the preferred means when setting capital buffers. In a context of lower interest rates and subsequent tightening of net interest income, Portuguese banks will need to be able to find mitigants due to its importance to the profit/loss structure.

Financial Stability outlook

Vulnerabilities, risks and macroprudential policy

Main risks and vulnerabilities

Risks to financial stability largely arise from the potential consequences that geopolitical tensions and protracted tight monetary conditions may have on economic activity. In the last half of the year, there was a reduction in vulnerabilities as a result of improved economic conditions. Inflation is expected to continue its downward path and economic growth in Portugal should remain positive and above that of the euro area.

At international level, the tense geopolitical context, with ongoing military conflicts in Ukraine and the Middle East, weighs on international trade flows and has an impact on economic activity. The strategic security considerations that can support the economic and financial fragmentation of the global economy and jeopardise a more inclusive re-globalisation process are particularly noteworthy. In addition, there is a risk that the ongoing adjustment in the Chinese real estate market could have a more pronounced negative impact on its economy, with repercussions for the global economy.

Maintaining monetary conditions tight for longer and/or longer than anticipated effects impacts economic and financial conditions. The conduct of monetary policy should consider the synergies achieved through a global coordinated response, but it should also take into account the underlying reality in each economic area, which may require differentiated responses to reduce the risks of excessive tightening.

At national level, a scenario of heightened policymaking uncertainty stands out, within the framework of a new model for European budgetary rules, which will pose new challenges to fiscal policy.

A possible deterioration in macroeconomic conditions triggering abrupt corrections in financial asset prices could exacerbate risks to financial stability. Deteriorating economic conditions lead to a reduction in the value of assets and a worsening of the debt service of resident sectors, although mitigating factors, such as the reduction of indebtedness, have been consolidated in recent years.

Risks associated with the general government’s financial position of have been decreasing, driven by fiscal consolidation and the downward trend of the public debt-to-GDP ratio, as reflected in the Republic’s ratings upgrades. However, debt is still high. In this way, general government is exposed to persistently higher interest rates and volatility in international financial markets, which may spill over to other resident sectors by contagion in their risk assessments.

Firms have continued to improve their capital ratio and to reduce indebtedness. Corporate profitability has withstood the increase in debt servicing. In the past year, there has been no material increase in insolvencies and the quality of credit granted to firms has not deteriorated. In any event, the cumulative effect of maintaining high interest rates on economic activity and financing costs, together with possible increases in production costs and supply chain disruptions, could trigger the materialisation of credit risk, particularly for the most vulnerable firms.

Households also saw a decline in their indebtedness ratio, following a trend that started in 2010. The improvement in the risk profile of loans to households has benefited from the macroprudential Recommendation introduced in 2018, including limits to the debt service-to-income (DSTI) ratio as one of the criteria for approving new loans. Amid rising interest rates, household default mitigation has also benefited from a strong labour market and higher real disposable income.

A scenario of protracted tight monetary policy and worsening economic conditions may also lead to lower real estate market prices through their impact on demand. However, the effects on the Portuguese banking system should be contained. The share of banks’ housing loan portfolios with high loan-to-value (LTV) ratios is small, lessening the impact of a potential drop in house prices. In the commercial segment, the banking sector’s exposure is contained.

The international non-banking financial sector is exposed to risks inherent in its business model, where there are fewer liquidity instruments and backstops in stress situations. In Portugal, vulnerabilities did not build up in the sector.

The situation in the Portuguese banking sector has improved further, characterised by higher levels of capital, liquidity and profitability. It has been a source of stability, helping to ensure the regular financing of the economy.

Should adverse conditions materialise, including in economic activity, with implications for unemployment, credit quality may deteriorate. While the total non-performing loans (NPL) ratio continued to narrow in 2023, there was an increase in loans showing a significant increase in credit risk (stage 2 loans), notably in housing loans – mostly at a variable rate – reflecting an increase in credit risk associated with the higher debt service burden in the income of the most vulnerable households.

Preserving net interest income is key to sustaining organic capital generation, being the preferred means when setting capital buffers. In a context of lower interest rates and subsequent tightening of net interest income, Portuguese banks will need to be able to find mitigants due to its importance to the profit/loss structure.

Macroeconomic and market environment

In 2023 the Portuguese economy grew by 2.3% in real terms (9.6% in nominal terms) and the labour market remained resilient. After two quarters of stagnation, the Portuguese economy recovered in the fourth quarter, based on private consumption, which benefited from real wage growth, and exports, in a context of improved external demand and additional market share gains. The dynamics in the last quarter of the year largely justified the upward revision of the economic activity forecasts for 2024 from December 2023. The labour market remained resilient, with employment increasing and the unemployment rate remaining low at 6.5%, 0.4 p.p. higher than in 2022. Economic growth maintained a positive differential compared with the euro area, 1.8 p.p., reinforcing the convergence of the Portuguese economy (Table I.1.1).

The inflation rate declined over the course of 2023, reaching 1.9% in December (2.9% in the euro area) and resulting in annual inflation standing at 5.3% (-0.1 p.p. than the euro area). These developments largely reflected the strong increase in energy and food prices recorded in the previous two years fading-out. In early 2024, as expected considering the base events, inflation temporarily interrupted the downward trend, standing at 2.6% by the end of the first quarter, 2.4% in the euro area. Excluding food and energy, the HICP in Portugal reached a year-on-year rate of change of 3.2% in March (3.3% at the end of 2023), 0.2 p.p. higher than the corresponding rate for the euro area (a -0.1 p.p. difference in December 2023). Prices have been growing more significantly in recent months for the services component, in Portugal and in the euro area.

In Portugal, annual economic growth is expected to stand at 2.0% in 2024, 2.3% in 2025 and 2.2% in 2026, revised upwards from the end-2023 projections, mainly for 2024 (+ 0.8 p.p.). The Portuguese economy will continue to grow more than the euro area and close to potential. The projection incorporates the positive effects of lower inflation, the expansionary impact of the measures approved in the State Budget for 2024 and the projected acceleration in external demand. The financial implementation of the Recovery and Resilience Plan (RRP) and other European funds, as well as the gradual easing of monetary and financial conditions will also benefit economic activity. Against this background, the labour market is expected to maintain a favourable position, with increases in employment projected, after peaking in 2023, real wage increases and stable unemployment.

These developments should take place against a background of continuous fundamental macroeconomic equilibria, in terms of public and external accounts. The economy is expected to have an average lending capacity of 3.9% of GDP in 2024–26, the highest since the beginning of the euro area, reflecting the further reduction in resident sectors’ indebtedness.

Inflation is expected to continue to decline in Portugal to 2.4% in 2024 (revised downwards by 0.5 p.p. compared with the December projections), 2% in 2025 and 1.9% in 2026. In the euro area, the gradual reduction of cost pressures and the impact of the ECB’s monetary policy are anticipated to translate into additional reductions in inflation to 2.3% in 2024, 2.0% in 2025 and 1.9% in 2026, in line with the ECB’s medium-term price stability objective.

Risks to economic activity and inflation at international level are associated with persisting tight monetary conditions, with effects exceeding those anticipated by the authorities. Such tightening is conditioned by the greater than expected resilience of the US economy, which postpones the US Federal Reserve’s reduction of official interest rates, with an impact on exchange rates and international financing conditions. An increased differential between interest rates in the euro area and in the United States may facilitate the expansion of economic activity in the euro area but could lead to imported inflation via the exchange rate effect.

The persistence and the possibility of geopolitical tensions escalating, coupled with elections taking place throughout the year in several countries that are significant for the global economy, are another source of macroeconomic risk. In the short term, there may be an impact on international trade flows, also penalised by changes in the confidence of economic agents, and in the longer term, reinforce a trend of global economic and financial fragmentation. The shocks that may arise in this dominion could potentially constrain commodity prices and disrupt supply chains. They can give rise to inflationary pressures and affect economic activity at international level, making the conduct of monetary policy in major economies more complex and uncertain.

Conversely, confirmation of moderating wage growth and lower unit profits, as global demand slows down – for example with the possibility of a negative shock if China’s ongoing housing market adjustment has a greater impact on its economy as a whole – are expected to contain inflationary pressures.

At national level, there are risks associated with possible delays in implementing European funds and a scenario of greater uncertainty in the conduct of economic policy in the context of new European fiscal rules.

At its meeting on 11 April, the Governing Council kept key ECB interest rates unchanged and confirmed that they would stay at sufficiently restrictive levels for as long as necessary. The latest increase in key ECB interest rates took place in September 2023. The ECB will continue to follow a data-dependent approach to monetary policy decisions. Over the past few months, financial markets have been updating the expected future path of short-term interest rates, notably by lowering the expected rate cut. Investors’ expectations about interbank market interest rates, as implied by three-month EURIBOR futures, point to a reduction of approximately 60 b.p. between 15 May (the cut-off date for this report) and December 2024 (Chart I.1.1).

After a reduction in the last quarter of 2023, market financing costs for sovereigns and the private sector have increased slightly since the beginning of the year, while the spread vis-à-vis Germany narrowed somewhat (Chart I.1.2). Over the same period, yields on euro area non-financial corporate and bank bonds increased by 30 and 10 b.p. to 3.6% and 3.8% respectively.

Interest rate implied in three-month EURIBOR futures contracts | Per cent	Yields on 10-year sovereign debt (Portugal and Germany) and corporate and bank bonds in the euro area | Per cent
Source: Refinitiv (Banco de Portugal calculations). | Note: latest observation: 15 May 2024.	Source: Refinitiv. | Note: latest observation: 15 May 2024.

The expectation of an easing in global monetary policy contributes to an increase in investor confidence and a boost in risk appetite. The faster than expected gradual reduction in inflation has created expectations about benchmark interest rates beginning to decline. These developments contributed to an increase in investors’ risk appetite and consequently, to the recent better performance of riskier assets (Chart I.1.3). In the United States, the strong stock market performance in recent months has led to higher market concentration, with larger companies accounting for a historically high share of stock market capitalisation, raising concerns about the potential overvaluation of assets, in particular those related to artificial intelligence.

Low implied equity market volatility may be underestimating vulnerabilities and leading to excessive risk-taking. Since the beginning of 2023, US and European equity market volatility indices have remained slightly below their long-term averages, which may indicate a benign risk assessment by investors (Chart I.1.4). The low levels of volatility can be explained inter alia by: (i) the better protection that shares offer against inflation, (ii) the absence of economic contraction during the process of reducing inflation, and (iii) the assumption that central banks now have more scope to ease monetary policy in case of need (Financial Stability Review, May 2024, ECB). In bond markets, volatility has remained above the historical average, in line with investors’ reaction to developments in expectations regarding inflation paths and policy interest rates.

The possibility of abrupt corrections in the value of financial assets remains high, especially if there is a deterioration in macroeconomic conditions or a less predictable disinflation process. The price of some commodities, such as energy and oil, has been increasing since the beginning of 2024 reflecting tensions in the Middle East. These developments may lead to sharper repricing of financial assets, notably if market expectations change about monetary policy easing.

Yields by asset class        | 16-11-2023 – 15-05-2024	Equity and debt market volatility | Deviations from long-term averages (points)
Source: Refinitiv. | Notes: BTC and ETH refer to cryptocurrencies Bitcoin and Ethereum, S&P500, STOXX EUROPE 600 and FTSE All World to US, European and global stock market indices, High yield bond to index iBoxx EUR Liquid High Yield.	Source: Refinitiv. | Notes: Option-implied volatility. “VSTOXX” refers to Euro Stoxx 50, “VIX” to S&P500, “MOVE” to the US Treasury curve. Latest observation: 15 May 2024.

Sectoral risk analysis

General government

In 2023 public debt reached 99.1% of GDP, having fallen by 13 p.p. since 2022. This stemmed from a combination of a reduction in public debt (-4 p.p.) and, as in the two preceding years, a positive change in GDP (Chart I.1.5). Considering public debt net of deposits, it decreased by 12 p.p. from 2022 to 95% of GDP. At the end of 2023, government deposits reached 4.3% of GDP, similar to the level seen prior to the international financial crisis, accounting for a 1.4 p.p. decrease from the end of 2022.

The public debt ratio is expected to decline further in the coming years, helping to reduce the country’s vulnerability to adverse shocks and to improve external financing conditions. In its April 2024 projections, the International Monetary Fund (IMF) anticipated further reductions in the ratio over the coming years, dropping to levels below the euro area average from 2026 onwards (Chart I.1.6).

Portuguese public debt ratio	IMF projections for public debt developments | As a percentage of GDP
Sources: Banco de Portugal and Statistics Portugal.	Source: IMF. | Note: April 2024 projections.

The cost of new public debt issuance has doubled since 2022, reaching 3.5% in 2023 (Chart  I.1.7). The cost increase was broadly based across the main instruments issued, notably Treasury bills and Treasury bonds. However, the pass-through of rising interest rates on new issuances to total interest expenditure was contained, with the cost of debt stock edging up from 1.7% to 2.1%. This reflected the large amount of stock issued at fixed rates and the average maturity of debt, which remained slightly above seven years. Medium and long-term debt issuances had an original maturity of more than 15 years. At the end of March 2024, debt redemptions still scheduled for 2024 represented 2.5% of total debt stock. For 2025 and 2026, scheduled medium and long-term debt redemptions amount to around 8% of the stock (€18 billion) each year and remain in line with previous years. This profile reflects the Portuguese Treasury and Debt Management Agency’s efforts to smooth the time profile of maturities by avoiding excessive concentrations and, therefore, minimising refinancing risk. This becomes increasingly important at a time when a growing share of debt is expected to be placed in international markets, as the reduction of the Eurosystem’s balance sheet proceeds. At the end of 2023, the Eurosystem maintained 32.1% of the national sovereign debt stock (Chart I.1.8), as a result of non-standard monetary policy operations, intensified with the pandemic emergency purchase programme (PEPP).

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.

Notably, the Portuguese Republic’s credit rating was upgraded by all major international rating agencies. In early March 2024, S&P Global Ratings raised its long-term credit ratings from ‘BBB+’ to ‘A-’.

Risks associated with the performance and financial position of the general government have been receding. However, debt remains high and is comparable to 2010 levels despite a very different fiscal balance landscape. As such, despite the public debt adjustment observed over the last decade, only disrupted by the budgetary and economic consequences of the COVID-19 pandemic, its high level exposes governments to fluctuations in the international financial market sentiment. However, there are some mitigating factors, such as the longer maturity of the debt securities portfolio, as well as the stabilising role of the ECB, in particular via its new Transmission Protection Instrument.

The possibility of a more adverse macroeconomic environment associated, for instance, with maintaining a tight monetary policy for longer than currently anticipated, would amplify servicing debt costs. Risks associated with developments in economic activity and possible increases in public expenditure are a source of additional pressure. Managing these aspects should follow an intertemporal sustainability approach and consider the recently revised EU fiscal rules. Reducing public debt further is therefore important for economic growth dynamics and its resilience, in a context where interest rates are expected to exceed those prevailing before the pandemic. The other resident sectors of the economy are subject to spillover effects from the Republic’s risk on their risk assessments.

Households

Household disposable income grew further, supported by a strong labour market. Nominal disposable income rose by 6.5% (8.2% in 2022), reflecting the contribution from the compensation of employees (Chart I.1.9). Continued employment and real wage growth has contributed to an improvement in households’ financial situation, with increases in real disposable income over the past three years (1.9% in 2023).

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.

In 2024 household income is expected to continue to evolve favourably. In particular, against the background of a decline in inflation, real disposable income is estimated to grow by 4%, reflecting wage growth and contained unemployment.

The saving rate has remained at historically and internationally low levels, standing at 6.3% of disposable income (Table I.1.2). Households have continued to prefer to invest in real assets, largely in housing, with this investment amounting to 5.3% of disposable income (5.8% in 2022). The purchase of financial assets decreased to 1.4% of disposable income (4.4% in 2022) and was based on a significant reallocation of investment in deposits towards savings certificates, concentrated in the first two quarters. Investment in savings certificates totalled €10.2 billion and accounted for 5.8% of disposable income (compared with 2.7% in 2022, concentrated in the fourth quarter). Household net lending amounted to 1.5% of disposable income (0.9% in 2022) and the saving rate was below the peak observed during the pandemic and is still below that observed in the pre-pandemic period.

The household indebtedness ratio narrowed further. In the fourth quarter of 2023, household indebtedness was 85% of disposable income (Chart I.1.10). These developments reflected an increase in nominal disposable income and a slowdown in lending to households (Section 2.2). The household indebtedness ratio has declined considerably since 2010, falling below the euro area average since 2019 and now standing close to 2001 levels. This reduction was broadly based across all income brackets, but more marked for lower-income households. In Portugal, the share of loans for house purchase in household disposable income is below the euro area average (58% in Portugal and 62% in the euro area in the third quarter of 2023) (Chart I.1.11).

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. 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).

Developments in interest rates resulted in a relevant rise in the debt service burden of loans for house purchase for the majority of indebted households, with an increase in the loan-service-to-income (LSTI) ratio, which measures the value of the instalment as a percentage of income. The average interest rate on the stock of loans for house purchase has increased significantly since 2022, reaching 4.7% at the end of 2023, a peak since 2009 (Chart I.1.12). In this context, there was an increase in the share of agreements with an LSTI of over 50%, which was sizeable in the case of lower-income households, at which exceptional government support measures were specifically targeted. It is worth noting that the share of lower-income households in the stock of loans for house purchase is currently low, in line with other euro area countries. In August 2023, agreements in the 1^st income quintile accounted for only 9% of the stock of loans for house purchase in Portugal. Nearly 70% of agreements are likely to have continued to have an LSTI of 30% or less (Table I.1.4, Financial Stability Report, November 2023).

Household credit risk did not entirely materialise. Rapid interest rate rises notwithstanding, the NPL ratio in loans to households was relatively stable, despite an increase in the ratio of stage 2 loans by 2.2 p.p. in 2023, helped by resilient employment and real disposable income, renegotiations and government support measures (Chapter 2). The improvement in the risk profile of new borrowers, as a result of the macroprudential Recommendation introduced in 2018 relating to new credit for house purchase and consumer credit, has also helped mitigate households’ default.

The reduction in short-term interest rates and in the inflation rate, combined with a strong labour market, will contribute to keeping households’ default contained. Prospects of a gradual reduction in Euribor rates over 2024 and 2025, following 4.6/4.7 p.p. increases across maturities between the end of 2021 and October/November 2023 (Chart I.1.13), anticipates an improvement in households’ ability to service debt. The share of new loans with interest rate fixation increased from 17% in 2022 to 47% in 2023, thereby reducing uncertainty around the value of debt servicing. The concentration of loans for house purchases and, to a lesser extent, consumer credit in higher-income households, which can more easily accommodate higher loan instalments, helps mitigate the risk of households defaulting. However, the potential materialisation of a more adverse economic scenario, particularly on the back of rising unemployment, and the maintenance of high interest rates for longer than currently anticipated may reduce households’ ability to service their debt, thereby enhancing a greater materialisation of credit risk.

Developments in the average interest rate on the stock of loans for house purchase | Per cent	Market expectations for developments in Euribor rates | Per cent
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: December 2023.	Source: Refinitiv (Banco de Portugal calculations). | Notes: Information up to April 2024 refers to hard data. From May 2024 onwards, the series refer to market agents’ expectations as at 15 May 2024.

Non-financial corporations

The financial indicators of non-financial corporations (NFCs) have continuously improved since the sovereign debt crisis, with a notable increase in their capital ratio (i.e. share of assets financed by equity). This trend is common to all sectors of activity (Chart I.1.14). Particularly noteworthy are developments in the capital ratio of small and medium-sized enterprises, increasing by 19 p.p. since 2012, compared with the relative stability of large enterprises, whose ratio grew by 3.8 p.p. in the last quarter of 2023.

NFCs’ capital ratio in Portugal | Per cent
By sector of activity	By enterprise size
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. Quarterly economic and financial indicators of firms in the Central Balance Sheet Database are used. The quarterly ratio corresponds to the value obtained for the year ending in the quarter. Latest observation: December 2023.

Firms’ return on assets remained high, despite interrupting the upward path followed since 2012 and only disrupted by the pandemic crisis in 2020. Return measured by EBITDA amounted to 9% of assets, down by 0.2 p.p. from 2022 (Chart I.1.15).

Return and financing costs: by sector of activity | Per cent
NFCs’ return on assets (a)	Cost of obtained funding (b)
Source: Banco de Portugal. | Notes: (a) Average return on assets defined as the ratio of EBITDA to average assets for the period. EBITDA is an acronym for earnings before interest, taxes, depreciation and amortisation. (b) The costs of obtained funding include costs associated with bank loans, debt securities and other loans. Quarterly economic and financial indicators of firms in the Central Balance Sheet Database are used. The quarterly ratio corresponds to the value obtained for the year ending in the quarter.

These developments come amid a slowdown in economic activity in Portugal and mainly in its trading partners. The turnover of industry index decreased by 3.3% in 2023. However, in line with the momentum in tourism, this index increased by 9.9% in services. Across sectors of activity, the 6.6% increase in unit labour costs in 2023 (0.5% in 2022) contributed to a decrease in NFC’s return on assets. Nevertheless, developments in production costs were heterogeneous across sectors, with the industrial producer price index remaining stable and the construction cost index increasing by 3.9% on average in 2023.

The increase in market interest rates was almost fully passed through to firms’ financing costs, which rose from a low of 2.7% in the year ending in March 2022 to 4.0% in December 2023. The predominance of variable rate loans and refinancing fostered the pass-through of rising market interest rates to financing costs. Any future replacement of fixed rate loans taken out in the period prior to the first increase in interest rates will lead to an additional impact on firms’ financing costs (Chart I.1.16).

Characterisation of the stock of loans to NFCs | Per cent
By benchmark rate (Dec. 23)	By residual maturity and type of rate
Source: Banco de Portugal. | Notes: Exposure to loans to NFCs according to the Central Credit Register. In some breakdowns, the total may not add up due to rounding.

The financing expenses coverage ratio (FECR) fell, but to levels still above pre-pandemic levels. On average, the EBITDA covered eight times the firms’ financing expenses (compared to ten times in 2022). Despite this decrease, the FECR broadly remained higher than in 2019, except in industry and trade, where the decline was most marked (-5). The only sector where this ratio increased was electricity, gas and water (+3), where profitability gains more than offset the rising cost of obtained funding.

The 1.3% increase in total debt in 2023 reflected lending by non-residents. As in previous years, external credit was concentrated in a small number of firms with access to this type of financing. The change in loans obtained from the resident financial sector was virtually nil (Chart I.1.17).

The indebtedness ratios, gross and net of deposits, narrowed respectively by 6.7 p.p. and 3.0 p.p. from 2022, to stand at 82.3% and 55.5%. Given the rise in debt, nominal GDP growth made the largest contribution to this. Firms’ deposits decreased by 3.8%. Nevertheless, the amount of deposits held by NFCs remained higher than in 2019 (+43%) (Chart I.1.17).

Developments in total debt and indebtedness ratios, gross and net of deposits
Contributions to the change in total debt (a)	Developments in the ratio of indebtedness net of deposits (b)
Source: Banco de Portugal. | Notes: Consolidated figures. (a) The NFCs’ debt-to-GDP ratio is shown at the top of each bar. (b) The ratio of indebtedness net of deposits corresponds to the ratio of NFC total debt less deposits to GDP. (c) External credit includes liabilities on account of loans and debt securities held by non-residents. (d) Includes debt securities held by residents, credit written off from assets in the balance sheet of resident monetary financial institutions, loans from households, trade credits and advances and other changes in volume and value.

The average leverage ratio, measuring the share of debt in total equity and financial debt, decreased in 2023 to 41.3% (42.2% in 2022), thereby confirming the positive developments in the position in relation to the euro area. There was also a convergence in terms of developments in the indebtedness ratio, measured as a percentage of GDP, which dropped from 89% in 2022 to 82% in 2023 (Chart I.1.18).

Developments in the financing structure in Portugal and in the euro area (a)
Leverage ratio (b)| Per cent	Indebtedness ratio (c)| As a percentage of GDP
Sources: Banco de Portugal and Eurostat. | Notes: (a) Consolidated figures. Latest observation for Portugal: December 2023. The euro area series is released annually. Latest observation for the euro area series: December 2022. The shaded area represents the interquartile range, calculated based on the distribution of leverage ratios of NFCs in euro area countries, i.e. it corresponds to the area defined by the value of the country identified as in the 75th percentile and the value of the country identified as in the 25th percentile. (b) Leverage ratio defined as the ratio of financial debt to the sum of equity and financial debt. The value of financial debt corresponds to the stock of loans and debt securities, while the value of equity corresponds to the stock of shares and other equity (liabilities) of NFCs. (c) The indebtedness ratio corresponds to the ratio of the country’s total debt to GDP. Figures are calculated on the basis of the National Financial Accounts. Quoted financial instruments, according to the National Account methodology, are measured at market value.

The reduction in structural vulnerabilities of Portuguese NFCs has resulted in greater resilience to the shocks to which economies have been subject in recent years, and systemically relevant risks to the Portuguese financial system have not materialised. In particular, there was no material increase in the number of insolvencies declared by NFCs (+73, totalling 473), remaining below the average in 2018-19 (558). Similarly, the quality of bank lending to firms has not deteriorated (Section 2.3).

Nevertheless, firms’ activity and their financial situation may be affected by the cumulative effect of maintaining high interest rates on economic activity and financing costs, together with possible increases in production costs and/or supply chain disruptions. For firms that are most vulnerable or more exposed to specific shocks, these developments may lead to the materialisation of defaults. The share of financially vulnerable firms (with a FECR below 2) is estimated to have increased in 2023 and to stabilise at around 18% in 2024, albeit to below sovereign debt crisis levels (around 29%). Sectoral heterogeneity in the share of vulnerable firms, higher in construction and real estate activities (Box 2), as well as within each sector, warrants close monitoring of these firms’ financial situation by credit institutions.

Residential and commercial real estate market

Residential real estate market

House prices have started to fall in the euro area. Residential real estate prices fell by 1.1% in the euro area in 2023, the first price correction since 2013. Some countries saw sizeable corrections, such as Germany and Finland, where the prices of dwellings fell by 8.4% and 5.6% respectively. In other countries, like Croatia and Portugal, house prices continued to rise by 11.9% and 8.2% respectively. The reduction in the number of transactions in dwellings was broadly based across countries (Chart I.1.19). While house prices and the number of transactions grew across the majority of countries in 2021, most countries saw a reduction in the quantity of dwellings traded already in 2022, despite the continued increase in prices. In 2023, there was a market adjustment and the fall in the number of transactions in dwellings was accompanied by a correction in prices (Charts I.1.20 and I.1.21).

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

House prices grew by 8.2% in Portugal, 4.4 p.p. less than in 2022. Following quarterly growth of 3.1% in the second quarter of 2023, prices decelerated in the second half of the year (quarter-on-quarter rate of change of 1.8% and 1.3% in the third and fourth quarters). The price of existing dwellings rose by 8.7%, above that for new dwellings (6.6%).

136,499 dwellings were traded, totalling €28 billion and accounting for decreases of 18.7% and 11.9% respectively compared to 2022. The fall in the number of transactions was more marked for existing dwellings, at 21.4% (down by 16.5% in value) than for new dwellings (6.1%, up by 2.6% in value). Transactions in existing dwellings accounted for 80% of total transactions in dwellings. Typically, the price and quantity traded in that market change more sharply than those of new dwellings.

Price index and number of transactions in new and existing dwellings | Per cent	Changes in prices and in transactions in dwellings – total | Per cent
Source: Statistics Portugal.	Source: Statistics Portugal.

The median value of transactions in dwellings increased further. In the fourth quarter of 2023, the median value per square metre rose by 7.9% year on year in Portugal, 7.5% in the Lisboa Metropolitan Area (LMA) and 7.7% in the Algarve. The LMA and Algarve regions have the highest median housing value, exceeding that associated with the 3^rd quartile of sales at national level. The median value of bank appraisals on housing also increased further, by 5.3% at the end of 2023.

The average time it takes to sell real estate properties stabilised at around six months. New dwellings, often placed on the market early in construction or at the design stage, have longer absorption time than existing dwellings (in 2023, 11 months compared with five months), albeit decreasing slightly in recent quarters (Chart I.1.22). Up to 2021, the number of available-for-sale dwellings followed a downward trend, most notably used dwellings. In 2022 and 2023, there was an increase in the number of listed dwellings (around 5,000 dwellings per year), helped by a reduction in residential real estate transactions (Chart I.1.23).

Absorption time | In months	Number of listed dwellings | Thousands
Source: Confidencial Imobiliário (Banco de Portugal calculations). | Notes: This data includes only transactions carried out through real estate agents. Absorption time is the average number of months between placing on the market and trading.	Source: Confidencial Imobiliário (Banco de Portugal calculations). | Note: This data includes only real estate placed on the market through real estate agents.

Supply developments were constrained by low construction activity during the years following the great financial crisis, restricting housing stock growth. After the sharp decline during the financial crisis and the sovereign debt crisis, the number of household dwellings built per year has been slowly increasing. 277 thousand new dwellings were built between 2007 and 2014, amid a marked loss in momentum in licensing and construction. Between 2015 and 2023, despite the gradual recovery in market activity, 125 thousand new dwellings were constructed. The licensing and construction of new household dwellings accelerated in 2023, increasing by 6% and 7% respectively (after 3% in licensing and construction in 2022) (Chart I.1.24). However, the rebound in construction activity has been slow and the number of new completed dwellings is still limited, despite the growth path followed since 2016.

Real estate market prices also reflect the still high construction costs. Between December 2019 and December 2023, the cost of construction materials and labour rose by 26% and 25% respectively. However, the construction materials cost index started a downward trend in mid-2022, decreasing by 2.2% in 2023 (Chart I.1.25). In turn, labour costs rose further, by 7.3, % in 2023, in line with the increase observed in previous years.

Licensed and concluded dwellings | Thousands	Index and year-on-year change in construction costs | As an index 2021=100 and per cent
Source: Statistics Portugal. | Note: Household dwellings in new buildings.	Source: Statistics Portugal.

In recent years, construction activity has been constrained by labour shortages. According to the survey of obstacles to construction activity, half of the responding construction firms reported obstacles to activity and 30% of firms reported difficulties in recruiting staff. Construction activity is still constrained by a lack of materials, dampened in 2023. The share of firms that report difficulties in obtaining credit and dealing interest rate levels has remained contained. Finally, firms in the sector report a slight increase in difficulties in obtaining construction permits.

Over the past years, the increase in the participation of non-resident buyers has driven the residential real estate market in Portugal. Portugal’s geographical location and its safety and stability support demand from non-residents and foreign citizens residing in Portugal. The growth of the foreign population residing in Portugal, which increased from approximately 400 thousand people in 2016 to nearly 800 thousand in 2022, has had an impact on house prices.

In 2023, non-resident residential real estate buyers accounted for 8% of the number of transactions and 13% of their amount. The number of transactions by non-residents dropped by 3%, with a decrease in buyers from other EU countries (-14%) and an increase in buyers from outside the European Union (Chart I.1.26). In 2023, the average transaction value for non-resident buyers was €343 thousand, 77% higher than that for resident buyers (€194 thousand). The average transaction value of buyers from outside the European Union was €405 thousand, significantly higher than the €277 thousand spent by buyers from other EU countries.

The weight of non-resident buyers is very significant in the Algarve, the Norte region and the LMA. House purchases by non-resident buyers were mostly in Algarve (29.9% of the total), followed by the Norte region (17.5%) and the LMA (15.6%), contributing to higher price growth in these regions and to a higher median housing value.

Foreign direct investment (FDI) in (residential and commercial) real estate totalled €3.9 billion, up by 22% from 2022 (up by 49% between 2021 and 2022), with the most notable investors coming from the United Kingdom (12%), the United States (10%), China (9%) and France (9%). In the case of residential real estate, non-resident buyers in the Lisbon urban rehabilitation area accounted for 33% of the number of transactions in dwellings and 41% of the amount invested. Notable from outside the European Union are US (16% of real estate purchases by foreign citizens), UK (9%), Chinese (8%) and Brazilian buyers (6%) and, from within the European Union, French (13%) and German buyers (5%). UK and US buyers increased their investment compared to 2022; the other nationalities mentioned reduced the number and value of transactions, particularly Chinese buyers, who reduced the amount invested in house purchases by 46%.

Total transactions in dwellings in Portugal and share of non-residents
Source: Statistics Portugal. | Notes: Including transactions by natural and legal persons. The term “non-residents” refers to citizens having their tax domicile outside Portugal. In the case of natural persons, the tax domicile is the place of habitual residence. In the case of legal persons, the tax domicile is the place of the head office or effective management or, in the absence thereof, their permanent place of establishment in Portugal.

There are signs of overvaluation in the Portuguese residential market. 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, in the third quarter of 2023, 23% above its long-term average while the price-to-rent ratio stood 29% above that average (Chart I.1.27). The real house price index is also above its long-term trend: 16% higher at the end of 2023 (Chart I.1.28). Likewise, two models based on macroeconomic determinants point to some overvaluation in the residential real estate market (Chart I.1.29).

However, these estimates should be interpreted with special care due to methodological limitations and consequent uncertainty associated with the results. In particular, they 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 in this market over the past few years. The Google search-based housing demand indicator presented in Box 1 can be used as an additional house price assessment tool.

The share of transactions financed with recourse to credit stood at 46% in 2023, similar to the average in 2018-23 (Chart I.1.30). This indicator stood at 76% in the period before the sovereign debt crisis. In 2023, there was a substantial volume of credit transfers between institutions (Section 2.2), accounted for as new loans for house purchase by home credit institutions. This increase in transfers is the result of legislative measures that facilitated early repayments of loans for house purchase amid rising interest rates. The impact of these loans transferred from one institution to another is estimated at 13 p.p., i.e. excluding renegotiations and transfers, the share of new transactions financed with recourse to credit is estimated to have stood at 33%.

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, neither is it possible to isolate the impact of credit transfers between banks up to 2022. Latest observation: 2023 Q4.

Since 2016, house prices have almost doubled, while the stock of loans for house purchase has grown moderately, by 5%. Marked house price growth makes the banking system and the economy more vulnerable to a price correction in this market. In Portugal, however, the effect is mitigated by more moderate growth in the stock of loans for house purchase.

The limited supply of new dwellings and the likewise limited accumulated stock of available dwellings mitigate the impact on prices if demand wanes. The banking sector’s exposure to the construction sector is also limited. In 2023, the stock of loans to construction accounted for 9% of total loans to NFCs, in contrast with a share of 23% in 2009.

According to the survey of residential real estate agents and promoters,¹ expectations regarding house sales and demand recovered in 2024, after a compression trend in 2023. The expectation of a rebound in sales is accompanied by an expectation that residential real estate prices will continue to rise throughout 2024.

Commercial real estate market

In 2023, global commercial real estate prices were adjusted downwards, in response to rising financing costs and new remote working models. In the euro area, the prices of these assets decreased by 8.2% (after 1.5% in 2022), even falling by around 11% in France, Ireland as well as the United States. These developments were broadly based, with the exception of Portugal (Chart I.1.31).

Changes in the Commercial Property Price Index | Per cent
Source: Morgan Stanley Capital International (MSCI).

In contrast to the euro area, commercial real estate prices in Portugal remained resilient across segments, growing by 1.2% in 2023 in aggregate terms (2.5% in 2022). The shortage of quality supply has been identified by market participants as the main factor supporting increase in value in Portugal. In the euro area, by contrast, supply shortages are less severe and all market segments have experienced a devaluation (Chart I.1.32). The retail segment grew by 1.9% in Portugal and contracted by 5.2% in the euro area. Despite rising interest rates, private consumption growth has helped support the momentum in this segment. The latter has remained attractive to investors and its yields have risen. In the office segment, devaluation reached 11% in the euro area, while in Portugal the valuation of assets accompanied by a slowdown in activity in terms of transactions was maintained due to a mismatch between supply and demand, the latter targeting high-quality assets in prime areas. Also in the industrial and logistics segment, prices remained robust owing to supply shortages, while in the euro area they decreased markedly, by 5.9%. Finally, in the accommodation segment, growth remained strong, at 4.6%, linked to the momentum of and favourable outlook for the tourism sector.

Changes in the Commercial Property Price Index by segment | Per cent
Source: Morgan Stanley Capital International (MSCI).

In 2023, the share of investors assessing commercial real estate in Portugal as expensive or very expensive increased.² There was, however, a recovery in confidence for investment in this sector, with fewer investors considering that the commercial real estate market in Portugal is in a contractionary stage (Chart I.1.33). In some euro area countries, reflecting the price correction in 2023, the share of investors assessing commercial real estate as being expensive or very expensive has declined, with the share of investors assessing that the market is contracting also decreasing.

Views from market participants as to commercial real estate prices | Per cent
Sources: Global Commercial Property Monitor, Royal Institution of Chartered Surveyors – RICS. | Notes: Data for the fourth quarter of 2023. For Portugal, the figures for the fourth quarter of 2022 are also included.

Investment in the commercial real estate market totalled €1.7 billion, the lowest figure since 2016 and a 50% reduction from 2022. Investment in the Portuguese commercial real estate market is dominated by non-resident investors, mostly institutional investors, which accounted for 70% of the total amount invested (80% in previous years). 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 banking sector’s exposure to commercial real estate is limited, both in comparison to other countries and with the exposure of the residential real estate sector. Loans to firms secured by commercial real estate are concentrated in SMEs and spread across sectors of activity. In many cases, the property securing the loan is a property owned by the firm to carry out its business and not as a real estate asset held from an investment perspective to generate income from rental or sale (Box 2). In addition, capital requirements for this type of credit are higher than those for credit secured by residential real estate, which will tend to mitigate the impact of any adverse market developments on banks. In September 2023, loans to NFCs secured by real estate accounted for 30% of total loans to NFCs on a consolidated basis, the fourth lowest figure for known data in the euro area (Chart I.1.34).

Loans to NFCs secured by real estate in Portugal and in the euro area – September 2023 | As a percentage of total loans to NFCs
Sources: ECB and Banco de Portugal. | Notes: Consolidated data. Ratio obtained from figures net of impairments. Includes loans to NFCs secured by (commercial or other) real estate. Data not available for Spain or Ireland.

Total assets of real estate investment funds (REIFs) accounted for 7.3% of GDP at the end of 2023, below the euro area, at 8.9%, with 68% of the shares issued by REIFs relating to closed-ended funds, with lower liquidity risk. Risks related to REIF exposure to the commercial real estate market are assessed as low (Box 2, Financial Stability Report, November 2023).

The evidence does not indicate an increase in risks and vulnerabilities in the commercial real estate market in Portugal. Given the banking sector’s limited exposure to commercial real estate, adverse developments in this sector have a small impact on the stability of the financial system.

Non-banking financial sector

The downward trend in the share of non-bank financial sector assets and in interlinkages between sub-sectors of the financial sector continued (Chart I.1.35). Investment funds and insurance corporations and pension funds (ICPFs) stand out in terms of interlinkages, as deposits and debt and equity securities issued by banks account for a sizeable share of these entities’ assets. As institutional investors pooling and channelling funds from savers, they reduce risk by diversifying investments. This is how exposures to the banking sector come to be predominant among interlinkages between sub-sectors of the financial system.

The relative importance of the ICPF sector has decreased over time, due to the reduction in assets under management associated with life insurance products and, to a lesser extent, with pension funds, only partially offset by the increase in non-life insurance business. From the onset of the pandemic crisis in 2020 onwards, exceptional regimes have lifted the loss of tax benefits associated with the early redemption of specific retirement savings plans (PPR, in the Portuguese acronym), with an impact on this activity. In 2023, developments in the assets of ICPFs were strongly influenced by the extinction of the Caixa Geral de Depósitos Employees’ Pension Fund, whose assets and liabilities were absorbed by social security funds.

Relative size and interlinkages in the financial system, in Portugal and in the euro area
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. In the case of banks, the latest figure for financial assets as a percentage of GDP available for the euro area refers to December 2022.

In the euro area, during the period of very low interest rates, vulnerabilities to adverse shocks in the non-bank financial sector built up. Until 2022, the very sharp growth of this sector, in particular investment funds, was accompanied by higher risk-taking in terms of asset quality and investment maturity. In some cases, leveraging has also increased, either directly or via the derivatives market, while liquidity buffers have not been strengthened.

In this context, high interest rates have reduced incentives for excessive risk-taking, associated with lower risks and vulnerabilities to financial stability, despite transition risks. However, keeping rates unchanged for longer than expected and an unanticipated pace of withdrawal of non-standard monetary policy measures can lead to higher financial market volatility and to credit risk materialisation, affecting the asset portfolios of these intermediaries. The key risk drivers for the euro area also include a growing concentration of exposures to equity securities by increasingly fewer issuers. This will make it more possible for episodes of idiosyncratic weakness to become systemic.

In Portugal, there is no evidence of a build-up in vulnerabilities. Also, the balance sheet has not grown exponentially nor have asset maturity or leveraging increased. Nevertheless, the Portuguese non-bank financial sector is exposed to contagion risks should risks in this sector materialise in the euro area.

In the longer term, the activity and intermediation capacity of these sub-sectors may decrease somewhat, if the remuneration of savings in investment funds, pension funds or life insurance products fails to be attractive. Changing circumstances, among other aspects, in terms of taxes or funding of reforms may contribute to these investments becoming less attractive. In addition, the currently low household saving rate tends to limit new subscriptions, which may pose challenges to liquidity management.

Investment funds

The stock of shares/units issued by investment funds rose by €3.9 billion in 2023, totalling €40 billion (15% of GDP) in December. This change was mainly due to the increase in the value of existing shares/units (€2.1 billion) and the reclassification of NFCs in the real estate sector into REIFs, with an impact of €1.9 billion. As regards securities investment funds (SIFs), value losses recovered somewhat.

The amortisation and redemption of shares/units issued by investment funds were close to the amount of subscriptions. Securities investment funds (bond, equity, mixed and other) remained fairly buoyant, with positive net subscriptions, while REIFs had negative net subscriptions but continued to be the most prominent investment policy (36% of the total shares/units issued in December 2023) (Chart I.1.36). The increase in the stock of shares/units in 2023 contrasts with the reduction seen in 2022, when there were sizeable negative transactions, most notably for REIFs and bond funds.

Total shares/units issued by investment funds: stocks, transactions and other changes, by type of fund | EUR billions
End-of-period positions	Transactions and other changes in value and price
Source: Banco de Portugal. | Note: ‘OCVP’ refers to other changes in value and price; including appreciation/depreciation, reclassifications and other changes in volume not explained by transactions.

Households continue to be the main investor sector in investment funds. Households held 50% of the value managed by REIFs and 92% of that managed by SIFs. By contrast, the financial sector’s exposure to these assets has been declining, to stand at 14%.

Commercial real estate is the main asset in REIF portfolios. Assets in this segment totalled €9.5 billion of investment (or 75% of real estate assets in the funds). Unlike in the euro area, this real estate segment has not depreciated (Real Estate Section). The occupancy rate of real estate in the funds’ portfolio remained above 85% in December 2023.

Any price corrections in the real estate market, particularly in the commercial market segment, could put pressure on the liquidity of REIFs. Nevertheless, in the Portuguese market some factors mitigate liquidity risk materialisation among REIFs. Closed-ended funds, which are less exposed to this risk, account for more than 60% of shares/units issued. The liquidity ratio of open-ended REIFs has been increasing, standing slightly below the euro area average, with residual debt financing. In addition, existing redemption fees discourage a massive withdrawal of capital (Box 2, Financial Stability Report, November 2023).

Insurance corporations and pension funds (ICPFs)

Liabilities of insurance corporations and pension funds in the form of technical reserves decreased by 3.7%.³ In the insurance sector, gross written premiums declined by 1.9% compared to 2022, while amounts paid rose by 12.1%. Written premiums in life insurance decreased by 14.3% and contributions to pension funds fell by 32%. In turn, written premiums in non-life insurance rose by 10.4%, reflecting the increase in economic activity and prices.

Developments in life insurance and pension funds were largely driven by the dynamics of the PPR market. Early redemptions increased by 57.2% in 2023, benefiting from the measure that lifted the tax burden levied on the early redemption of these instruments if the funds withdrawn were used to repay loans for house purchase. Subscriptions fell by 5.3%, which may be explained by the higher return on alternatives for investing savings (Section 1.3.2).

The asset portfolio of insurance corporations decreased by 0.7%, while that of pension funds fell by 11.2%, according to the Insurance and Pension Funds Supervisory Authority. Had the Caixa Geral de Depósitos Employees’ Pension Fund not been terminated, it would have increased by 5%.

Insurance corporation and pension fund assets are highly exposed to sovereign and private debt markets and to investment fund shares. In December 2023 the share of private and public debt in the investment portfolios of insurance corporations and pension funds accounted for 62% and 50% respectively (Chart I.1.37). As of 2021, insurance corporations’ exposure to sovereign debt securities has decreased in absolute terms and as a share of the portfolio, having been replaced by an increase in the stock of shares/units. In 2023, exposure to investment funds accounted for 21% and 36% of the portfolios of insurance corporations and pension funds respectively. Given their exposure, these sectors are exposed to credit and market risks, albeit differently. In the case of insurance corporations, exposure to interest rate risk is mitigated by the short duration of assets in the portfolio, but the creditworthiness of the securities issuers is at the lower end of the investment grade category. For pension funds, the credit quality of securities is higher, but exposure to market risk is also higher.

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

In 2024, taking into account the expected developments in interest rates, some unwinding of the positive net impact in 2022 and 2023 on the financial position of life insurance and pension funds is expected. 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 increase in interest rates, the reduction in liabilities exceeds the devaluation of assets. Due to the “discount effect”, the increase (decrease) in market interest rates tends to be favourable (unfavourable) to these financial intermediaries.

However, the maintenance of high interest rates tends to increase the credit risk of households and firms across the financial sector. Together with possible episodes of liquidity risk materialisation, credit risk materialisation could lead to losses for ICPFs, should the financial situation of the issuers of the securities in the portfolios deteriorate.

For some non-life business segments, the negative impact of rising inflation on the profitability of these business lines tends to dissipate. In particular, this affects those with liabilities with a shorter duration and/or higher costs for settling claims (e.g. motor vehicle insurance, due to increased repair costs of insured vehicles and/or medical expenses associated with personal injury).

The Insurance and Pension Funds Supervisory Authority considers that the solvency levels of the insurance sector make it resilient and create room to absorb adverse developments.⁴ In addition, the Portuguese insurance sector has a contained liquidity risk, stemming in particular from the share of liquid assets in investment portfolios.

Other financial sub-sectors

Other financial intermediaries (OFIs) and captive financial auxiliary institutions and lenders are a very mixed group of financial intermediaries that are not allowed to take deposits. Financial auxiliaries are entities whose business is to facilitate financial intermediation; however, they do not handle the intermediation themselves. These three types of entities correspond to other financial intermediaries and financial auxiliaries (OFIFA).

At the end of 2023, captive financial auxiliary institutions and lenders accounted for 72% of OFIFA’s total assets. These include holding companies, money lenders (granting credit secured by pledge over assets) and special purpose vehicles (SPVs) that raise open market funds to fund firms within the group. The assets of these entities decreased by 4.6% from 2022, with a notable impact of the relocation of a relevant holding company to another country. Other financial intermediaries other than ICPFs are a residual and diversified category, which includes credit securitisation companies.

Macroprudential policy

The strategy and instruments of the Banco de Portugal as the national authority responsible for implementing macroprudential policy were defined in 2014. The implementation of macroprudential policy has been characterised by a preventive attitude, anticipating and responding to factors that may indicate the build-up of sources of systemic risk. This approach requires a systematic adaptation of methodologies for signalling risk and estimating the impact of measures.

Macroprudential policy has adapted to the various phases of the financial cycle (Special issue “Macroprudential policy at different phases of the financial cycle: the Portuguese case”). In a context where uncertainty about the materialisation of risks to financial stability remains elevated – driven by high interest rates and a potential deceleration in economic growth – macroprudential measures have been instrumental in ensuring that the financial system has sufficient capital buffers to absorb unexpected losses, thereby continuing to finance economic activity.

In 2023, developments in the financial cycle were not indicative of a build-up of systemic risk in Portugal. This was due to the narrowing of the current account deficit, the reduction in credit to firms and households and the increase in GDP. House price developments pointed to the opposite direction (Chart I.1.38).

The potential impact on GDP of an extremely negative event stemming from a build-up of cyclical systemic risk or a period of financial stress remained relatively low in the last quarter of 2023. According to the Growth-at-Risk (GaR) model, the year-on-year rate of change in GDP one year ahead in the case of an extreme negative event, with a 10% likelihood of materialising, is -1.6% (compared with -1.7% in the previous quarter and -4.1% in the first quarter). The slight worsening compared to the second quarter (-1.1%) was due to the financial stress indicator (Country-Level Index of Financial Stress – CLIFS), while the contribution of GDP was less negative (Chart I.1.39).

Domestic cyclical systemic risk indicator | Standard deviations from the median	Contributions of explanatory variables to Growth-at-Risk | Per cent and percentage points
Sources: ECB and BIS (Banco de Portugal calculations). | Notes: The domestic systemic risk indicator (d-SRI), developed by Lang et al. (2019), is an aggregate indicator aimed at identifying the accumulation of cyclical imbalances created in the domestic non-financial private sector. For a detailed description of the d-SRI for Portugal, see Financial Stability Report, June 2019.	Sources: ECB, Banco de Portugal and Statistics Portugal (Banco de Portugal calculations). | Notes: Growth-at-Risk is the estimate of the 10th percentile of the distribution of the year-on-year rate of change in GDP for Portugal over a one-year projection horizon, based on information available from the first quarter of 1991 to the quarter of the projection. The template includes GDP, CLIFS and the d-SRI as explanatory variables. Contributions are presented in percentage points.

The Banco de Portugal identified seven banking groups as other systemically important institutions (O-SIIs). For each O-SII, the Banco de Portugal has also set the corresponding capital buffer requirements, as a percentage of the total risk exposure amount. In the case of the LSF Nani group, the buffer was also applied to Novo Banco.

The Banco de Portugal introduced a sectoral systemic risk buffer (sSyRB) of 4% with effect from October 2024 on the risk-weighted exposure amount of households’ portfolio secured by residential real estate for banks using the internal ratings-based (IRB) approach. This preventive buffer aims to increase the resilience of institutions in view of possible future systemic risk materialisation in the residential real estate market in Portugal, stemming from a potential reversal of the economic cycle and/or an unexpected significant correction in residential real estate prices. It thus complements the macroprudential Recommendation as regards the conditions for credit agreements. In addition, the sectoral capital buffer may also contribute to discourage the excessive exposure of the banking sector to real estate by changing the relative cost in terms of capital requirements associated with different asset classes.

With a view to increasing the banking system’s resilience to a sector-specific systemic risk, the sSyRB is considered a more effective tool than the CCyB (Box 3).

The interest rate hike that took place from the second quarter of 2022 led the Banco de Portugal to review its macroprudential Recommendation for lending for house purchase in 2023. The interest rate shock considered in the debt service-to-income (DSTI) ratio decreased from 3 p.p. to 1.5 p.p. This revision was applied to agreements with a variable or mixed rate and with a maturity of more than 10 years, with the decrease being proportional for the other maturities.

Overall, institutions continued to comply with the guidance set out in the macroprudential Recommendation relating to new loans for house purchase and consumer credit. The risk profile of borrowers of new loans for house purchase continued to improve, with the share of credit granted to high-risk borrowers declining. Of the total amount associated with new loans for house purchase and consumer credit, 91% was granted to borrowers with a DSTI ratio of 50% or less. Regarding the loan-to-value (LTV) ratio, almost all new credit recorded a value of 90% or less, with the LTV ratio for 68% of new agreements being less than or equal to 80%. The average LTV ratio of new loans for the purchase of own and permanent residence fell by almost 10 p.p. from the third quarter of 2018 and by 6 p.p. from 2022, standing at 69% (Macroprudential Recommendation on new credit agreements for consumers – progress report, March 2024). Note that banks apply the criteria of the macroprudential Recommendation to all new credit granted, which may include that from borrowers transferring their loans from another institution.

So far, the European Systemic Risk Board (ESRB) has classified Portugal’s macroprudential policy as adequate and sufficient to mitigate the systemic risks and vulnerabilities identified in the residential real estate market. The Banco de Portugal, as macroprudential authority, has not been the subject of any specific warning or recommendation by the ESRB. In 2023, Portugal continued to be assessed as medium risk, as in the previous 2019 and 2021 assessments.

The review of the EU operational framework for macroprudential policy is ongoing (Report from the European Commission COM/2024/21) and is currently at the stage of assessment and stakeholder consultation. This review aims at ensuring the effectiveness of macroprudential policy, as well as equipping authorities with macroprudential tools targeting sectors other than banking and other sources of systemic risk, such as climate and cyberspace. Particular emphasis was placed on three main areas: (i) use and release of capital buffers; (ii) consistency in the use of the macroprudential toolkit for banks by national authorities and (iii) ability of the macroprudential toolkit to address conventional risks and new sources of risk, notably cyber, climate change and commercial real estate-related risks. Regarding the non-banking sector, the aim is to mitigate the build-up of systemic risk, manage the impact of systemic events caused by liquidity imbalances, excessive leverage, interconnectedness among non-bank financial institutions (NBFIs) and between them and banks, and address the lack of consistency and coordination among national macroprudential frameworks across the EU.

Banking system

In 2023, the situation in the Portuguese banking sector improved further, characterised by higher levels of capital, liquidity and profitability.⁵ The increase in the return on assets to 1.28% had a positive impact on capital ratios, and it maintained a robust liquidity situation and stable asset quality. This outcome was achieved against a background of disinflation and slowdown in economic activity, but with monetary policy and market interest rates above those of 2022.

Improved profitability was based on the increase in net interest income, from 1.65% to 2.80% of assets, reflecting the rapid pass-through of the rise in key interest rates to interest rates on bank loans, and only then passed through to deposit interest rates. The resulting increase in total operating income made it possible to accommodate the increase in impairment costs and provisions, which nevertheless remained contained.

The total gross NPL ratio decreased further in 2023, by 0.3 p.p., despite a slight increase, of 0.2 p.p., in the ratio for loans to households for house purchase. Similarly, the ratio of stage 2 loans increased by 2.2 p.p. in the household segment, most notably loans for house purchase, contributing to the increase in the ratio for the total portfolio.

Against the background of an increase in the burden on the stock of loans for house purchase, mostly for variable rate agreements, labour market resilience and recovery in real household income made a contribution to containing default, as did the low weight of lower-income borrowers in the total portfolio. The specific government support measures and the proactivity of borrowers are also relevant to mitigate the rise in monthly instalments, through a timely renegotiation of the original contractual conditions with the creditor institution (trade renegotiations) or the transfer of the credit to another institution. The increase in these operations, amid lower demand for new loans for house purchase, was boosted by increased competition among institutions and the temporary suspension of payment of the early repayment fee for variable-rate loans for house purchase. In many situations, the new conditions resulted in a fixed interest rate, typically for a period of between 2 and 5 years, reducing the uncertainty in the debt service for the debtor and stabilising the interest income for the bank during that period.

The balance sheet of the Portuguese banking system maintained a concentration of exposure to real estate assets and sovereign debt securities. Exposure to real estate includes loans to households secured by residential real estate, where the collateral risk, if it falls below the amount of credit, is mitigated by the small share of loans with LTV above 80%. In the sovereign debt securities portfolio, in addition to increasing geographical diversification, the share of the portfolio valued at amortised cost, which is expected to be held to maturity, increased and its average duration was reduced for the major banking groups.

The various liquidity indicators continue to signal a robust position and thus the sector's lower sensitivity to disturbances in international financial markets. Similarly, banks’ capital was strengthened to a level similar to that of the euro area, enhancing the ability of institutions to absorb adverse shocks and to continue funding the economy in the less favourable stages of economic cycles.

Profitability

Return on assets (ROA) increased by 59 b.p. compared to 2022, standing at 1.28% (Chart I.2.1), representing a peak over the last decade. These developments were broadly based across the Portuguese and euro area banking systems, although more marked in Portugal, with a ratio of 0.57 p.p. higher than that of the euro area in September 2023. The dispersion among institutions in the banking system remained broadly unchanged, with increases both in the 10^th and 90^th percentiles (Table I.2.1).

Developments in ROA were marked by a rise in net interest income (1.15 p.p. contribution), which accounted for 2.8% of average assets in 2023. The increase in provisions and credit impairments and, to a lesser extent, in operating costs contributed to mitigating that rise. Recurring operating income, which includes the typically most stable components of income (net interest income and net fees minus operating costs), increased by 1.07 p.p. of average assets to 2.14%. It was the largest contribution of net interest income to ROA growth in Portugal that led this ratio to be higher than that of the euro area.

ROA and contributions to change | Per cent and percentage points of average assets
Source: Banco de Portugal. | Notes: Return on assets (ROA) consists of the net result as a percentage of average assets. ‘Other results’ includes other operating results, negative goodwill, appropriation of income from subsidiaries, joint ventures and associates, income from non-current assets held for sale and not qualifying as discontinued operations, increase or decrease in the fund for general banking risks, results from contractual changes/renegotiations of cash flows, profit or loss of discontinued operations before tax and tax on profit for the year.

The significant increase in net interest income was largely the result of a rise in interest received exceeding the rise in interest paid. This increase stemmed mainly from interest received on variable-rate loans and the positive contributions of the debt securities portfolio, in particular the increase in interest received on securities issued by general government and NFCs. Interest on deposits also increased, especially for households, which dampened the positive effect observed on the assets side. The rise in interest rates was accompanied by a transfer from demand deposits to time deposits.

In 2023 the difference between lending and deposit rates on agreements with the non-financial private sector (NFPS) increased for both the stock and new business. The increase was more significant for the stock, surpassing that of the new business in the last two years. These developments result from an average rate on new loans lower than that observed in stocks (Section 2.2) given the prevalence of variable-rate loans. The difference between the interest rates on stocks of loans and time deposits is higher in Portugal than in the euro area (Chart I.2.2), which explains the net interest income in the first three quarters of 2023 in Portugal (2.73%, compared with 1.39% in the euro area).

As mentioned above, recent developments in net interest income benefited from the context of rising interest rates. In a central scenario of future interest rate reduction, the adjustment by a large part of banks’ interest rate risk management strategies, which are also influenced by the higher share of fixed or mixed-rate loans for house purchase, will have a positive impact on future results. The use of hedging interest rate risk through financial derivatives and the higher share of the mixed interest rate in the loan portfolio contribute to smaller reductions in net interest income (as a percentage of Tier 1) in a scenario of a parallel decline in the interest rate curve. These developments are particularly relevant given the importance of net interest income in Portuguese banks’ income structure, a key element in sustaining organic capital generation, being the preferred means when setting management capital buffers.

Despite the increase in operating costs, operational efficiency in view of the cost-to-core income ratio improved in 2023. Importantly, lower values of this ratio are associated with higher efficiency, ceteris paribus. Portugal has one of the lowest ratios at European level, with operating costs, as a percentage of total assets, similar to those in the euro area and higher operating income (Box 4). This ratio decreased to 39.4% (-15.3 p.p.) due to the aforementioned increase in net interest income (Chart I.2.3). The increase in operating costs, by 3.3% year on year, stemmed from administrative expenses, of which IT costs are noteworthy, and, to a lesser extent, staff costs. Most institutions justified these developments with the general increase in prices and, in addition, with digital transformation spending.

The loan loss charge rose by 0.16 p.p., to stand at 0.45%. The increase in this ratio occurred following the increased flow of credit impairments, which may indicate an increased risk perception by institutions in a context of higher interest rates. This change corresponds to a reversal of the downward trend that began in 2021, with a similar figure as in 2018 (Chart I.2.3).

Difference between interest rates on loans and deposits of the NFPS         | 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 include 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 commissions. The loan loss charge consists of the flow of credit impairments as a percentage of total average gross loans to customers.

Credit standards

Loans to households

In 2023 the stock of bank loans to households remained relatively stable. In December, the annual rate of change (ARC) adjusted for securitisation and loan transfers was -0.4%, the lowest since 2017. This reflects a decline in the rate adjusted for the housing loans stock to -1.4% in December 2023, amid subdued growth in the stock of consumer loans. In the first quarter of 2024, there was a slight acceleration in both segments (Chart I.2.4). In the housing segment, the rate not adjusted for securitisation and loan transfers stood at -0.6% in March 2024, below that of the euro area (-0.3%).

Annual rate of change adjusted for 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. March 2024.

New loans for house purchase contracted by 11.8%, a less sharp fall than in the euro area, where new loans (excluding renegotiations) fell by 33%. These developments were broadly based across most countries, with declines of around 50% in some (Charts I.2.5 and I.2.6). In Portugal in the year ending in September, new loans for house purchase (excluding renegotiations) recorded a year-on-year fall of 18.9%, showing some recovery in the last quarter of the year.

New loans for house purchase excluding renegotiations (12-month cumulative figures) | € thousands and per cent	Annual rate of change in the stock and year-on-year rate of change in new loans for house purchase in 2023 | Per cent
Source: Banco de Portugal. | Note: The red bars highlight the values of the year-on-year rate of change in the stock of loans for house purchase in 2023 in Portugal and the euro area.

Early repayments of loans for house purchase totalled €11.2 billion – 69% more than in 2022 – and accounted for 11% of the year-end stock of loans for house purchase. Partial early repayments gained relevance, but total early repayments continued to account for the most significant share, corresponding to 83% of total repayments (91% in 2022). Early repayment reduces borrowers’ debt level and service and, consequently, the impact that future adverse changes in interest rates may have on debt service, as well as life insurance costs, helping to reduce households’ financial vulnerability. Total early repayments include house exchanges and transfers of loans to other institutions, so the impact on household vulnerability is more limited within that component.

2023 was marked by an increase in transfers of loans for house purchase between banks. The government measure suspending the early repayment fee in the case of variable-rate loans for the purchase of own and permanent residence, introduced at the end of 2022, encouraged these transactions. According to the information given by institutions, these transfers were also stimulated by the actions of credit intermediaries, which are likely to have made a contribution to reducing the costs associated with the search for information. The increase in transfers started at the end of 2022 and intensified throughout 2023. A preliminary analysis indicates that the weight of transfers in total new loans for house purchase granted by institutions (excluding renegotiations) is likely to have been 8% in 2022 and 27% in 2023.⁶ New loans for house purchase, excluding renegotiations and transfers, are likely to have declined by around 30% in 2023.

Those borrowers that transferred loans sought more advantageous pricing conditions (narrowing of spreads) and increased medium-term predictability of monthly credit-related expenses through a fixed interest rate for a longer period. With reference to the stock of loans for house purchase, more recent agreements accounted for a larger relative share in credit transfers, the instalments of which are very significantly impacted by the increase in interest rates. In terms of amount, around 75% of the transfers are loan agreements that had originally been entered into between 2018 and 2022, compared with 50% of their share in the stock. Loans granted under transfers show a higher share of mixed rate (63%) than the remaining new loans (39%). In the case of a mixed and variable rate, the most common reference rate was the 6M Euribor, and there were no significant differences in the relative weights of the three most usual reference rates. In cases where old and new loans were granted at variable or mixed rates, the average spread reduction is estimated to have been around 0.4 p.p. Although to a lesser extent in terms of volume, the decline was more pronounced for loan agreements that had originally been entered into between 2011 and 2016, a period of tightening of credit standards by banks and pricing conditions/spread less in line with business practices associated with the higher interest rate cycle. In addition, on average, there was no increase in the residual maturity of loans with the transfer.

The borrowers’ proactivity to mitigate the rise in monthly instalments, which was also reflected in a large volume of changes in the original contractual terms (trade renegotiations), benefited from increased competition among institutions amid lower demand for new loans for house purchase. In both trade renegotiations and credit transfers, it is particularly important for the system’s stability that banks conduct a thorough assessment of borrowers’ credit risk considering the suitability of the new contractual terms to their ability to pay and the risk they pose.

The average interest rate (annualised agreed rate – AAR) on new loans for house purchase increased from 0.8% in December 2021 to 3.2% in December 2022 and to 4.1% in December 2023. The annual percentage rate of charge (APRC), which includes charges other than interest, has also increased in recent years, standing at 6.3% in December 2023. According to the April Bank Lending Survey (BLS), competition between institutions, in the first quarter of 2024, promoted the narrowing of the spread applied to medium-risk loans for house purchase.

New loans for house purchase with a fixed or mixed interest rate increased in 2023, accounting for 47% of the amount of new loans. These developments intensified in the second half of the year, with these agreements accounting for 75% of lending in December 2023. Lending for house purchase with a fixed or mixed interest rate ranges between 16% and 79% across the largest credit institutions. Regarding mixed interest rates, about 57% of the amount of new loans has an initial rate fixation period of up to and including 2 years and 27% between 2 and 5 years. However, despite the stock of variable-rate loans for house purchase still being predominant, the increase in new loans with a fixed or mixed interest rate throughout 2023 made a contribution to the decrease in the share of variable-rate loans in the stock from 89% in December 2022 to 80% in December 2023 (Chart I.2.7).

Monthly flow of new loans and stock of loans for house purchase by type of 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.

New consumer loans decreased by 2% in 2023. The annual rate of change adjusted for the stock of consumer credit was 5.1% in December 2023 (5.9% in March 2024) (Chart I.2.4). The average interest rate and APRC for this segment increased by 1.1 p.p. and 1 p.p. in 2023, standing at 9.1% and 11.3% in December respectively (9.5% and 11.8% in March 2024). In March, both rates are higher than those of the euro area, standing at 7.8% and 8.6% respectively. In contrast to loans for house purchase, most of these agreements have a fixed interest rate. As at March 2024, variable rate contracts accounted for only 13.7% of consumer credit stock.

According to the January Bank Lending Survey (BLS), credit standards for loans for house purchase to households remained broadly unchanged in the fourth quarter of 2023 (Chart I.2.8). Institutions also reported a slight decline in demand for loans for house purchase in the fourth quarter of 2023 owing to the level of interest rates and consumer confidence (similar profile for the consumption and other purposes segment). For the first time since 2021, banks in the euro area reported an easing of credit standards for loans for house purchase in the first quarter of 2024, together with a slight decline in demand for loans for house purchase.

Supply and demand for housing loans | Diffusion index
Supply	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 expectations of the institutions for the second quarter of 2024 (dashed part).

Lending to non-financial corporations

The annual rate of change in the stock of loans granted by resident banks to non-financial corporations was -0.7% in December 2023, compared with a change of -0.1% in the euro area. Developments by sector of activity showed differentiated patterns, being positive in construction and real estate activities (1.2% and 2.2% respectively) and negative in other sectors, particularly industry (-8.9%) and accommodation and food services (-4.1%). By size, microenterprises maintained positive year-on-year rates of change in 2023 (3.8% in December), while the remaining types showed negative annual rates of change, notably medium-sized enterprises (-5.8% in December 2023) (Table I.2.2). The reduction in the stock of loans to NFCs stems from the decrease in the amount of new loan agreements in 2023, which, together with an increase in loan renegotiations, resulted in a similar volume of new business between 2022 and 2023. Adding to this effect is the increase in repayments by firms whose liquidity positions were enhanced during the pandemic through the moratoria and State-guaranteed loans (Box 3 – March Economic Bulletin). This contrasted with developments in financing from non-residents, which showed a positive flow in 2023, accounting for around 1% of GDP (Section I.1.3.3).

According to the BLS, banks reported that credit supply conditions remained stable from the second half of 2023 onwards, following a tightening in the first half of the year, and were expected to continue stable (Chart I.2.9). Following the beginning of the interest rate increase, the dynamics observed in Portugal and the euro area are very similar in terms of supply, while demand decreased more sharply in Portugal. The decline in credit demand was more moderate from mid-2023 onwards, a trend expected to continue.

Supply and demand for loans to NFCs | Diffusion index
Supply	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 expectations of the institutions for the second quarter of 2024 (dashed part).

The general level of interest rates and, to a lesser extent, lower financing needs for investment are likely to have played a role in the reduction in credit demand by firms observed from the third quarter of 2022, albeit decreasingly (Chart I.2.10). In 2023, rising interest rates affected business investment, which presented an annual rate of change of 1.5% that is estimated to rise to 3% in 2024, driven by the implementation of European funds. As of the first quarter of 2023, financing through internal financing also contributed to lower demand. From the third quarter of 2023 onwards only debt refinancing, restructuring or trading made a positive net contribution.

Determinants of firms’ demand for credit | Diffusion index
Sources: ECB and Banco de Portugal. | Note: A positive (negative) figure in the diffusion index means an increase (decrease) in demand by firms.

New loans to firms rated in the lowest credit risk class continued to account for around half of new loans. In turn, the share of loans granted to firms in the higher-risk class remained constant at 16% of loans to NFCs granted in the respective period (Table I.2.3).

The share of the stock of loans granted to firms in the highest credit risk class has been declining sustainedly since 2019, despite the shocks which the economy and firms have been subject to in recent years. The share of loans to lower-risk firms continued to increase, to half of the total, to the detriment of loans to higher-risk firms. These developments are consistent with the persistent improvement in firms’ financial indicators in recent years (Subsection I.1.3.3).

The average interest rates on new loans granted in 2023 amounted to 5.5%, notably reflecting the developments in the Euribor rates. The average interest rate on the stock of loans to NFCs was 5.7% in December 2023, the highest since the sovereign debt crisis. In the euro area, an average rate of 5.2% was observed in December 2023.

Spreads on new variable-rate loans narrowed somewhat in 2023, with the differential between firms in the higher and lower risk classes remaining broadly the same. In 2023, average spreads across all risk classes were lower than those observed in 2021 and 2022, which, notably, may have been driven by increased competition between institutions, as also reported in the BLS.

Loan pricing by banks takes several factors into account, including the institutions’ and borrowers’ characteristics, as well as the macroeconomic and financial environment. Banks should be able to identify borrowers’ vulnerabilities and, all things being equal, higher interest rates are expected to be offered to riskier borrowers. The results of an analysis based on individual information by loan and borrower show that the interest rate charged on new loans tends to be higher for more indebted firms and lower for firms with higher liquidity and profitability. In the period under review, despite some heterogeneity over time, loan pricing appears to have responded more significantly to changes in firms’ liquidity than to changes in their leverage or profitability (Special issue: “The importance role of firms’ characteristics on setting bank interest rates”).

Credit quality of assets

The total gross NPL ratio continued its downward path, decreasing by -0.3 p.p. in 2023, to stand at 2.7% in December (Table I.2.5). This development was accompanied by the NPL ratio net of impairments, which dropped to 1.2%. The decrease in non-performing loans (“unlikely to pay or less than 90 days past due” and “more than 90 days past due”) led to a numerator effect that contributed -0.3 p.p. to the change in the total gross ratio compared with 2022. This ratio would have narrowed further but for the decrease in NFCs and cash balances at central banks (denominator effect, 0.1 p.p.).

Owing to the increase in NPLs in loans for house purchase, the household segment had a higher NPL ratio than in 2022 by 0.1 p.p., standing at 2.4%, still significantly below pre-pandemic figures (3.7% in 2019). The slight increase in the household ratio was due to a higher flow of new NPLs than of cures, albeit partly mitigated by the amount of write-offs and NPL sales. For loans for house purchase, the increase in NPLs was due to the “unlikely to pay or less than 90 days past due” component. The rise in key interest rates in 2023 is likely to have contributed to the increase in this component, given the predominance of variable rate loans in the stock of loans for house purchase.

In loans to NFCs, the gross NPL ratio stood at 5.0%, a 1.5 p.p. decrease. In this segment, the decrease in NPLs more than offset the reduction in performing loans. The lower flow of NPLs compared to cures was the main factor behind the reduction in NPLs, but there were also contributions from write-offs and NPL sales (Table I.2.6). The decrease in the gross NPL ratio was broadly based across sectors of activity.

The heterogeneity of the gross NPL ratio among institutions, assessed through the difference between the 90^th and 10^th percentiles, decreased by 0.6 p.p. This was particularly due to the reduction in the ratio of institutions with higher amounts compared with the other institutions. The NFC segment was behind these developments, as there was an increase in heterogeneity in the household segment due to the increase in the 90^th percentile.

The NPL impairment coverage ratio remained at 55.5%, with different developments for firms and households. In NFCs, despite the reduction in impairments, the decrease in NPLs led the coverage ratio to increase by 4.9 p.p. to 60.9%. In households, the impairment coverage ratio decreased by -4.5 p.p. to 50.6%, mainly due to a reduction in impairments in the segment of consumption and other purposes, but also due to an increase in NPLs in the housing segment.