Carlos da Silva Costa: The Portuguese banking system -
challenges and possible responses
Opening note by Mr Carlos da Silva Costa, Governor of the Bank of Portugal, at the 4th Money
Conference, Lisbon, 22 November 2019.
* * *
As prepared for delivery.
Good morning,
It is with great pleasure that I take part in the 4th edition of the Money Conference.
In this opening note I aim to comment on some of the challenges that the Portuguese banking
system faces and highlight some of the possible responses.
Let me begin with a summary of some relevant indicators.
In recent years, the Portuguese banking system has been characterised by a series of positive
developments. Portuguese banks are today more capitalised and are more stable in terms of
resource intermediation. They have abundant liquidity and have improved their productivity
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indices. Observed in quantitative terms in :
An increase in the total capital ratio from 10.3% to 16.1% (between the end of 2010 and
June 2019);
An increase in the liquidity coverage ratio (LCR) from 151.5% to 212.3% (between the third
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quarter of 2016 and June 2019);
A reduction in the loan-to-deposit ratio (LtD) from 150.6% to 88.2% (between the end of
2010 and June 2019);
An increase in the total average assets per branch from 81.5 to 94.9 million euro (between
the end of 2010 and the end of 2018).
In the first half of 2019, there was an increase in profitability of the Portuguese banking system.
The return on equity (ROE) in June 2019 was 8.4%, compared with 6% of the average of
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significant institutions supervised by the Single Supervisory Mechanism .
For this increase there were, on the one hand, factors of a structural nature, namely the increase
in the sector's efficiency and, on the other, the lower weight of losses associated with the assets
generated over the period of great credit expansion, observed in the reduction of costs with
provisions and impairments.
However, there are enormous challenges for the sector against a background of moderate future
economic growth, low interest rates and high indebtedness of public and private agents.
Thus, in the first place, banks must continue to reduce their non-performing assets in line with
the guidelines and reduction plans submitted to the supervisory authorities. It must be considered
that the ratio of non-performing loans (NPLs) net of impairments in the Portuguese banking
system remains one of the highest in Europe, notwithstanding the progress already made since
2016.
In second place, there remains a need for the banking system to continue to reinforce its
lossabsorption capacity. Despite the improvement observed in recent years, with the increase in
capital ratios, these remain below the euro area average.
Furthermore, challenges remain for compliance with the minimum requirements for own funds
and eligible liabilities able to cover losses and enable recapitalisation of the institution in case of
resolution (MREL) in a context where profitability is expected to be challenging.
In third place, it is necessary to ensure (i) that rates charged, namely on credit, reflect the
nature and risk of investments and (ii) actively accompany the credit quality of borrowers over the
time horizon of the operations.
Against a background of low interest rates, it is necessary to avoid inadequate search for yield
behaviour, whose impact on institutions' solvency may be reflected several years hence.
In it is necessary to consider that in a context of a general reduction in sovereign
fourth place,
yields - currently at exceptionally low levels - the possibility of a reassessment of risk premia
and a greater differentiation among sovereigns is higher.
This means that portfolio diversification in terms of issuers and a reduction in the correlation of
their specific risk profiles are desirable. This imperative is ever greater as the portfolio
adjustment is more easily absorbed by the market without affecting the issuers. On the other
hand, portfolio diversification allows possible regulatory developments to be anticipated.
This is also an issue of undeniable interest not only to the sovereign, but also to the Portuguese
financial system considering the incomplete Banking Union in which the doom loop remains.
In banks have to be prepared for a situation in which capital markets have a greater
fifth place,
importance in financing the real economy. This means (i) that for an identical raising of funds,
banks will have a different asset composition and (ii) that the raising of funds will be subject to
competition from non-bank financial institutions and non-financial issuers of debt and investment
instruments.
In this context it is noteworthy that at European level the non-banking financial sector has
significantly expanded its role in financing the real economy, corresponding to 55% of the total
financial sector in the euro area. Total non-banks' assets have almost doubled over the last 10
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years in the euro area. In comparison, the size of the banking sector stagnated over this period.
The most recent impetus to deepen the Capital Markets Union is in line with greater integration
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of the European financial markets , which brings new challenges and opportunities where
promoting sustainable finance gains prominence.
Attracting savings and financing through the capital markets, as an alternative to the traditional
banking sector, will bring about an increase in shared private risk on a cross-border basis,
simultaneously creating competitive pressures that will reveal an excess of installed capacity,
generating movements towards consolidation as a response to the need for greater scale and
efficiency.
In sixth place, banks, just like any other incumbent financial institutions, will face competition
from new entities based on digital transactional platforms and models that will challenge them
from a technological and market share point of view. This has made the need for investment and
absorption of new technologies more urgent in terms of both the processes and the relationship
with the market (so-called digital banking).
In this context, the banking system needs to adopt a proactive stance, assessing the
competitiveness and viability of its business model(s) in a timely way, in view of the different
segments and products.
In seventh place, an approach is needed that assimilates and anticipates, whenever possible,
the regulatory dynamic making the observance of the supervisory rules - compliance with capital
and liquidity ratios, stress tests etc. - a competitive advantage generating confidence in the
market.
In eighth place, it is essential to ensure the confidence of the capital markets and the public in
general. Such confidence is dependent on the elimination of uncertainties as to the nature and
valorisation of assets as well as business models and strategies, moving from an approach of
limited transparency to one of transparency adjusted to the information requirements, in terms of
content and form, for each stakeholder.
Allow me to elaborate on this latter aspect.
Regarding institutions' governance, to avoid the materialisation of events that may jeopardise
their financial soundness, it must be ensured that the four lines of defence are fully operational
and focused on the sustainability of the institution and the safeguard of public confidence in its
activity.
Thus, the Board of Directors is responsible for ensuring sound and prudent management as well
as anticipating and adapting the business model based on developments in the business
environment. Namely, it is responsible for interpreting shareholders' appetite for risk, both in
terms of capital requirements and risk taking and acting with diligence, neutrality and
conscientious respect for the interests of the depositors, investors, creditors and customers in
general, whilst retaining the principle of risk-sharing and the safety of the funds entrusted to it.
The supervisory bodies and control functions are responsible for rigorously and substantially
overseeing the remits conceded by law.
Particular regard should be given to the role of the supervisory body for the relevance and
coverage of the competences attributed to it by law, including overseeing the management body
of the undertaking; verifying the precision of the reporting documents and correct assessment of
its assets and results; and overseeing the effectiveness of, inter alia, its risk management,
internal control and internal audit systems.
The internal control mechanisms (compliance, risk management control and internal audit) are
also essential, especially to guarantee suitable control of risks incurred in banking activity.
The external auditor is responsible for exhaustively certifying the veracity and completeness of
the information, namely the risks that the institution incurs and the costs for the different
stakeholders.
For the duties of independence, integrity and objectivity attributed to it by law, as well as the
public interest duties that such a function covers, the external auditor is the element that has the
greatest influence on the external credibility of the financial statements, to which, naturally, the
legal certification of the accounts contributes.
Finally, it is the supervisor's responsibility, as I said when I took office in 2010, "to apply the
principle of systematic doubt [...] to carry out a role that is countercyclical". This implies a "check
[...] on the soundness of its fundamentals, its future risks and the way these are recorded on the
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supervised institution's balance sheet" .
This demands the adoption of a perspective that is sceptical, intrusive and proactive, not only in
verifying the veracity of the information and its compliance with the regulatory framework, but
also in monitoring the sustainability of the institution vis-à-vis the risk taken and its ability to
absorb that risk. The supervisor is also responsible for demanding a capital enhancement to
address the business model/risks incurred and the risks of the economy (stress testing).
Considering the need to permanently reinforce the mechanisms designed to prevent or mitigate
risks to financial system stability, Banco de Portugal is due to launch a public consultation into a
Notice that will repeal and replace Notice No 5/2008 relating to internal control, in light of the
developments in European and Portuguese legislation, the guidelines of the European Banking
Authority, international best practice, reflection and practical supervisory experience accumulated
by Banco de Portugal, as well as for reasons of legal certainty and security.
This consultation will take place in a context in which, in the significant institutions supervised by
the Single Supervisory Mechanism as a whole, there remains a significant number of
opportunities for improvement at internal governance, risk management, data aggregation,
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reporting and internal audit.
Being undoubtedly a common aim, I hope that you are able to participate actively in this
consultation, contributing with your experience to the final design of a fundamental instrument in
the defence of financial stability.
Thank you all.
1
Banco de Portugal (2019), Séries Longas - Setor Bancário Português 1990-2018, , available at
www.bportugal.pt/sites/default/files/anexos/documentosrelacionados/series_longas_setor_bancario_portugues.xlsx and Banco de Portugal (2019), Sistema Bancário
Português: desenvolvimentos recentes - 2.o trimestre de 2019, available at:
www.bportugal.pt/sites/default/files/anexos/visaosistemabancarioportuguesdados_pt.xlsx both in Portuguese
only.
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First date from which data are available.
3
Banco de Portugal (2019), Portuguese Banking System - 2nd quarter 2019, available at:
www.bportugal.pt/sites/default/files/anexos/pdf-boletim/overviewportuguesebankingsystem_2019q2_en.pdf and
ECB (2019), Supervisory Banking Statistics Q2 2019, available at:
www.bankingsupervision.europa.eu/banking/statistics/html/index.en.html.
4
Guindos, L. (2019), "Key vulnerabilities for euro area financial stability", remarks at the meeting of the Financial
Stability Contact Group, Frankfurt am Main, 2 October.
5
See discussions within ECOFIN informal session, September 2019
(eu2019.fi/documents/11707387/15400298/CMU+Reboot+Informal+ECOFIN+final+Issues+Note+2019-09-
09_S4.pdf/05142af6-25f0-74d0-7d2a7eb68a2bcb39/CMU+Reboot+Informal+ECOFIN+final+Issues+Note+2019-09-09_S4.pdf) and the Next CMU
High-level Group (joint initiative between finance ministers of Germany, France and Netherlands:
minefi.hosting.augure.com/Augure_Minefi/r/ContenuEnLigne/Download?id=7AEFAF36-7449-471F-B86F08E8B9E1CE71&filename=1470%20%20Savings%20and%20Sustainable%20Investment%20Union%20joint%20press%20release%20(004).pdf e
www.economie.gouv.fr/files/2019-10/The_Next_CMU_HL_DO.pdf).
6
Costa, C. (2010), Address on the occasion of his taking office as Governor of Banco de Portugal, 7 June,
available at: www.bportugal.pt/en/intervencoes/address-mr-carlos-costa-occasion-his-taking-office-governor-
banco-de-portugal.
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See www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.srep_methodology_booklet_2018~b0e30ced94.en.pdf
p. 9.