September 12, 2018

IMF published its staff report and selected issues report under the 2018 Article IV consultation with Portugal. The Directors welcomed improvements in the resilience of the banking sector through higher capital and increased profitability. They noted that, while progress has been made in reducing the stock of non-performing loans (NPLs), further steps are needed to strengthen the banking sector, including a concerted effort to bring down the level of NPLs. Directors encouraged the authorities to continue to focus on preserving credit standards, monitoring mortgage markets, and employing macro-prudential measures, where necessary.

The staff report highlights that balance sheets of banks strengthened in 2017, with capital augmentations and improved macroeconomic conditions. The average common equity tier (CET) 1 ratio rose 2.5 percentage points since end of 2016 to 13.9% at end of 2017. During this period, NPLs fell by EUR 9.4 billion, from EUR 46.4 billion at end of 2016, largely due to write-offs and sales of business loans and debt recovery (cures) for household loans, thus bringing the NPL ratio to 13.3% of gross loans from 17.2%. Although declining, the stock of NPLs remains a concern. At the end of 2017, the stock of NPLs stood at EUR 37 billion (13.3% of total loans), with about half of the NPLs covered by provisions. The authorities have been pursuing an NPL resolution strategy based on three pillars. First, supervisory actions (under the Single Supervisory Mechanism, or SSM), which include requesting regular updates of banks’ NPL reduction strategies, setting targets for NPL reduction, and monitoring and enforcing implementation. Second, legal, judicial, and fiscal reforms to remove impediments to NPL resolution. Third, measures to improve management of NPLs and develop secondary markets for troubled loans. Staff welcomes the progress made so far in the implementation of the NPL resolution strategy, as reflected in the significant reduction of the NPL stock and encourages the authorities to maintain this momentum and to press banks to strengthen their risk management and corporate governance.

Most banks posted profits. Meanwhile, the impairment coverage ratio increased to 49.4% in the end of 2017, from 45.3% at the end of 2016. The liquidity coverage ratio reached 173.4% at the end of 2017 (minimum 100% is required since January 2018). The Banco de Portugal deployed macro-prudential measures to prevent the financial sector from taking excessive risk in a context of low interest rates and heightened competition. Against the background of gradually rising loan maturities, loan-to-value (LTV) and loan-to-income ratios in mortgage and consumer credit, the measures aim to prevent over exposures to residential mortgage and consumer loans by financial institutions and to minimize the risk of default by households. Staff welcomes the activation of these macro-prudential tools at this juncture, when credit standards were starting to ease. While supporting the measured approach taken, staff calls on the authorities to closely monitor the effectiveness of these measures and to supplement them. Despite the improved economic outlook, generating strong and sustained bank profitability will be challenging. Net interest income, the main source of Portuguese banks’ profits, remains moderate and may come under renewed pressure as deposit rates bottom out, funding costs may increase due to minimum requirement for own funds and eligible liabilities (MREL) issuances, and competition from fintech and nonbank financial institutions is expected to intensify. 

One of the topics of discussion in the selected issues report is reforms in the legal and institutional framework for debt enforcement and insolvency in Portugal. The report notes that the authorities have implemented ambitious reforms in the legal and institutional framework for insolvency and debt enforcement. The objective was to increase the efficiency of the legal and institutional framework for debt enforcement and insolvency and to increase debt recovery and resolve NPLs to restore financial stability. However, despite the improvements in institutional performance and efficiency gains, some challenges persist. 

 

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Keywords: Europe, Portugal, Banking, NPLs, Macro-prudential Measures, Article IV, IMF

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