carlos da silva costa : overview of economic and financial challenges for portugal address by mr carlos da silva costa, governor of the bank of portugal, at the centenary of credito agricola mutuo, lisbon, 25 may 2011. * * * the celebration of the centenary of credito agricola mutuo ( mutual agricultural credit ) is an appropriate timing : 1. to highlight the relevance of banking activity in modern economies ; 2. to stress the crucial role of trust in the development of this activity ; and 3. to make a brief presentation of the key measures included in the adjustment programme in the field of financial stability – one of the three capstones underlying the adjustment programme and the new growth model of the portuguese economy. 1st – the relevance of banking activity in modern economies credit institutions play an important intermediation role between savers and investors, centralising the resources of the former and channelling them to the funding of investment. this financial intermediation between savings and investment leads to : 1. maturity transformation – deposits with typically short maturities are transformed into longer - term credits ; and 2. liquidity transformation – deposits, liquid, are transformed into credits, more illiquid. through financial intermediation, benefits may be reaped of a scale effect when mobilising savings : multiple low - value individual deposits are transformed into large credit amounts, allowing for the financing of large - scale investments. finally, savings obtained in a given region ( or country ) may be channelled to finance investments in other regions ( or countries ). through this intermediation, the banking activity benefits from economies of scale, making it possible to ensure risk diversification and the implementation of procedures for effective risk management and control. this translates into a reduction of risk for a given remuneration, or, alternatively, a better remuneration of savings for the same level of risk appetite. hence, the banking sector plays a key role in the efficient allocation of resources in a given economy, as well as in the provision of essential services for making payments, thus decisively contributing to sustained economic growth. banking activity can be said to be the “ circulatory system ” of the economy. a healthy – productive and competitive – economy necessarily requires a dynamic and efficient banking sector. 2nd – the crucial importance of trust and the role of regulation and supervision this crucial function of financial intermediation of the banking sector requires a relationship of trust between banking institutions and their customers. it also requires

meet their responsibilities for the safety of the funds entrusted to them, and report to the stakeholders on the performance of the respective institution. after this general overview, i will make a brief presentation of the key measures included in the adjustment programme in the field of financial stability. 3rd – the role of financial stability in the adjustment of the portuguese economy in portugal, the banking system has been playing a fundamental role in meeting the growing financing needs of both the portuguese economy and households, offsetting the – chronic – scarcity of domestic savings through recourse to external financing, chiefly after joining the economic and monetary union. bis central bankers ’ speeches with the participation in the euro area, the country was able to reap the benefits of lower and less volatile interest rates and portuguese banks gained access to a broader and exchangerate risk - free funding market. this environment has enabled credit to grow well above the level accommodated / allowed by the deposit base, to the extent that external liquidity surpluses have been channelled through the banking system to meet internal financing needs. an overall context of ample liquidity has led to the perception that the easing of financing constraints would indefinitely be maintained. in effect, there was a false impression that, within the framework of the economic and monetary union, the capacity of banks to absorb resources, and therefore their access to the capital market, would only depend on the respective solvency levels, reputation and risk - management ability. however, when a financial system corresponds roughly to the territory of a single sovereign state, the sovereign risk strongly binds risk perception by the financial system and therefore fundamentally constrains the financing capacity of the economy. as the international financial crisis was unfolding, there has been, since late 2009, a significant differentiation of sovereign risk premium in a number of euro area economies. this situation has chiefly affected the countries where substantial and unforeseen rises in deficits and public debt were combined with structural weaknesses, particularly in terms of external indebtedness and the trend growth of the economy. with regard to the portuguese economy, imbalances result not only from the deterioration of the fiscal situation or from structural problems, but also from the persistent and significant deterioration of the external position of the economy, in a context of high levels of public and private indebtedness and low economic growth. the deterioration of expectations in international financial markets regarding the sustainability of public finances in portugal translated into a strong increase in the risk premium of the sovereign debt, with negative repercussions on