The Financial Stability Report is released by Banco de Portugal today. The following conclusions can be drawn:
In 2014, the activity of the Portuguese financial system was carried out in a context of economic recovery and correction of macroeconomic imbalances. In particular, debt of the non-financial private sector was reduced, which was reflected on the maintenance of domestic net lending.
Interest rates remained broadly low, partly as a result of the accommodative stance of monetary policy, which promoted favourable conditions for the continued deleveraging of the economy. Maintaining this situation for a long period, however, may raise risks for financial stability, namely by acting as a disincentive to savings, which are essential to finance productive investment and reduce the high external debt.
Net income in the banking sector, strongly dependent on the net interest income, was negative again, although recovering in most banks. The adjustment of the banking sector continued, partly reflecting the adjustment of the other sectors of the economy. It should be highlighted:
(i) The continued decline in assets, largely reflecting developments in credit to customers;
(ii) The increase in deposits taken in Portugal;
(iii) The resulting fall in the loan-to-deposits ratio;
(iv) The decrease in recourse to Eurosystem financing
(v) The improvements in the liquidity position, the financial operations income and the net interest income;
(vi) The maintenance of the effort to reduce operational costs;
(vii) The stability of solvency levels.
The banking sector, however, continues to be under much pressure from low profitability, reflecting reduced interest rates, the still low demand levels and the historically high impairment levels, in a context of still high non performing loans. Low sector profitability, if extending, jeopardises future capital accumulation, posing new challenges to banking business. It is essential to persist in improving the sector efficiency and to ensure appropriate risk management at the time of granting credit and during its lifetime, based on an appropriate assessment of the projects’ profitability, of the assets pledged as collateral and of the interest rates applicable in the future, substantially different from current ones.
As regards the insurance sector, return on the portfolios has also restrained profitability, against the backdrop of a decline in activity. The ongoing changes to the regulatory framework of this sector imply a strong adjustment of institutions, and may involve costs in the short term.
It is also important to monitor the financial sector’s still high exposure to sovereign debt and to the real-estate sector. Promoting banks’ efforts to diversify their portfolios and appropriately registering the value of exposures to the real-estate sector will make it possible to limit this risk. The European Central Bank and Banco de Portugal have been undertaking important work in this area. In turn, the maintenance of fiscal consolidation efforts by the Portuguese government, public debt refinancing operations benefitting from the low interest-rate environment, and the increase in sustainable financing sources by financial institutions, will play an important role in mitigating the impact of a possible sudden reversal in market sentiment.
In view of the significant fall in oil prices in 2014, the – direct and indirect – exposure of the Portuguese financial sector to oil-exporting countries is also a risk to financial stability that should be monitored.
In order to promote confidence in the financial system, which is crucial for financial stability, it is also necessary to ensure that financial institutions act in a transparent manner, appropriate to the financial literacy level of their customers. In spite of efforts developed in recent years, there is room for improvement, especially regarding the manner in which financial products are traded. A more intrusive supervision of institutions’ internal procedures is also expected.
Finally, it is necessary to pursue the correction of the still high levels of private sector indebtedness characterising the Portuguese economy that nonetheless continued to decline in 2014. In particular, the maintenance of the non-financial private sector’s deleveraging efforts, not implying restrictions to productive investment, will make it possible to limit risk premia, reduce the economy’s global exposure to possible changes in the macroeconomic context, and promote sustainable economic growth. This is essential for a robust recovery of financial institutions’ profitability. In an environment still characterised by the abovementioned challenges to financial stability, it is essential to create the conditions for pursuing this adjustment process. Financial institutions are an active part in this process and will also benefit from it. A process of sustainable economic growth is crucial to create sound conditions for the recovery of financial institutions’ profitability.