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    IMF Publishes Reports Under 2019 Article IV Consultation with Portugal

    July 12, 2019

    IMF published its staff report and selected issued report in context of the 2019 Article IV consultation with Portugal. The IMF Directors commended the marked decline in non-performing loans (NPLs), agreeing that bank balance sheets have improved significantly in recent years. They encouraged further efforts to improve asset quality, efficiency, and governance, also calling for a continued vigilance of mortgage market developments and for the authorities to stand ready to adjust macro-prudential policies, if needed. With respect to the financial supervision reform bill, Directors encouraged the careful consideration, in Parliament, of the concerns raised by ECB, Banco de Portugal (Central Bank of Portugal), and other domestic supervisors.

    The staff report highlighted that the banking system in the country has continued to repair its balance sheets and strengthen its fundamentals. Capital ratios have been boosted by capital augmentations, with the common equity tier (CET) 1 capital ratio edging up to 13.2% in the fourth quarter of 2018, from 11.3% at the end of 2014. The 2017–2018 capital augmentations have helped banks absorb losses from their legacy asset reductions and improve buffers (in conjunction with provisions) against a deterioration in asset quality. As elsewhere in Europe, banks in Portugal exhibit high concentrated exposures to the real estate market and to the sovereign. According to a simulation exercise presented in the April 2019 Global Financial Stability Report of IMF, sharp rise in government bond yields could generate substantial losses for Portuguese banks in the EBA Transparency Exercise due to mark-to-market accounting rules. Under the severe scenario (benchmarked June 2018) in which yields on BBB rated bonds increase by 250 basis points, tier 1 capital ratios would decline by about 1.5 percentage points to levels slightly lower than in 2010. 

    Overall, the asset quality has improved, with NPL ratio declining 8.4 percentage points from its June 2016 peak to 9.4% in the fourth quarter of 2018. Consistent with the NPL-reduction strategy pursued by the authorities, Portuguese banks have been reducing their legacy assets with a mix of cures, write-offs, sales, and foreclosures. However, NPL ratios are still among the highest in the Euro area. Low interest rates, high operating costs, and impairments continue to weigh on profitability, which is also subject to headwinds from heightened competition in the provision of financial services by non-bank financial institutions and the need to obtain costlier “bail-in-able” minimum requirement for own funds and eligible liabilities (MREL) resources. The IMF staff recommends that supervisors should ensure that banks continue to follow through their NPL-reduction targets and strengthen their corporate governance, internal controls, and risk management. The supervisors should also encourage banks to continue to step up efforts to improve operational efficiency and profitability. It should be ensured that banks’ capital ratios are resilient to a potential weakening of the economy and changes in risk premia.

    The report also highlights that the government has sent to Parliament a Bill to reform the financial sector supervisory and resolution frameworks; however, further discussion is needed on several aspects of the proposed reform. The Bill would create a new resolution authority separate from supervisors and give a permanent structure and legal personality to the mechanism for coordination of supervisors, vesting it with new powers, including in the macro-prudential policy area. In addition, the Bill would modify some aspects of the governance of existing supervisory bodies. Although the Bill was submitted after a process of consultation among the government and the financial supervisors, it does not represent a consensus.

    The three sectoral supervisors whose functions would be affected (Banco de Portugal, the Securities and Exchange Commission, and the Insurance and Pension Funds Regulator) have communicated substantive concerns to Parliament. These include concerns over the way the newly created entities would interact with the sectoral supervisors, the potential implications of the new framework for these supervisors’ independence and effectiveness, and the new entities’ funding costs. Banco de Portugal and ECB also see some provisions in the Bill as inconsistent with the European institutional framework. The IMF staff is of the view that different architectures can achieve core policy objectives; however, to deliver on those objectives, any chosen architecture should guarantee the independence of the supervisory authorities, be cost-efficient, and ensure that sensitive decisions can be made soundly and quickly, especially when time is of the essence. The comments on the Bill issued by the three national supervisors and the ECB raise legitimate concerns in all these respects. These concerns deserve full examination in Parliament before the Bill is turned into law. 

     

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    Keywords: Europe, Portugal, Banking, Insurance, Securities, Article IV, NPLs, Macro-Prudential Policy, CET 1, MREL, Governance, Resolution Framework, Central Bank of Portugal, ECB, IMF

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