Banking in Portugal

Anabela Sérgio

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9780230371422
• Topic: Commerce
• Subtopic: Services financiers

This book explains how banking institutions in Portugal were able to maintain their strength and solubility while undergoing a demanding Program of Financial Assistance from the International Monetary Fund, the European Central Bank and the European Commission from May 2011 and May 2014.

1

Introduction

Anabela Sérgio

The impact of the financial crisis on various banking and financial systems has been severe, even dramatic, and has required interventions of different kinds: bailout operations by governments; regulatory and supervisory rethinking by policy makers and supervisory authorities; and, for financial intermediaries, the definition of new strategies and refocusing of their business.

The Portuguese banking system has found itself paying for the consequences of a crisis that originated in the United States, which can be traced in more general terms to the development of the typically Anglo-Saxon originate-to-distribute (OTD) model. This book aims to describe the impact of the crisis in several fields: consolidation and the evolution of governance models; supervision and regulation; risk management in financial institutions; the performance and efficiency of the banking system; retail banking for households; and corporate and investment banking. There is also an overview of the importance of Portuguese banks and their expansion.

The discussion in the second part of this chapter of the main features of the Portuguese financial system analyzes both the European banking union and the banking situation in Portugal in relation to the crisis.

The current study considers the period between May 2011 and May 2014. During that time Portugal has been through a demanding Financial Assistance Program (amounting to €78 billion and €12 billion for bank recapitalization), the repercussions of which are explained in Chapter 2. Analysis of the problem of Portuguese sovereign debt is an important step toward assessing the impact of the crisis and the measures taken by the government and the credit authorities.

The fall of Lehman Brothers and the accountability of other financial institutions for the crisis led to a recentering of corporate governance. It is, in fact, an example illustrating that from a hazardous event a positive movement can be created. The financial crisis has demonstrated that there was a lack of governance in several financial institutions across the world, Portugal being no exception. This showed itself in a dearth of reporting, a lack of risk management, multiple failures in auditing procedures, but most of all a deep lack of knowledge by the boards of directors of several financial institutions of what products their institutions were selling, what sort of unguaranteed loans were being granted, and what risks were associated with these products/sellers. Governance models in Portugal are the subject of Chapter 3.

The purpose of Chapter 4 is to analyze and discuss issues related to the banking regulatory and supervisory framework and structures in Portugal, and the role of the country’s Central Bank in that context. Banking regulation and supervision have been subject to general and ongoing concern, which has garnered considerable scrutiny and fostered a vivid debate among academics, public policy makers, regulatory authorities, supervisory agencies, the banking community, and capital market participants. Not surprisingly, an extensive body of literature has developed as a result of the attention dedicated to the topic by both scholars and practitioners.

This analysis is followed by Chapter 5, where risk management in Portuguese financial institutions is strongly linked with the idea of commitment. Methodologically, the aim is to obtain an understanding of the Portuguese financial system in several international contexts and of its particular characteristics, in which both social and political issues are important. Facing so many challenging endeavors, there is a need for awareness of the discriminating factors that would allow Portuguese institutions to cope with the several types of risks that they face. The chapter concludes by shedding light on how solvency ratios in Portugal are in line with high international standards, despite the challenges in the sector regarding efficiency and profitability.

Chapter 6 consists of a study of the performance and efficiency of the Portuguese banking system. Its main purpose is to examine account-based indicators of profitability, risk, and operating efficiency from 1993 to 2009. First, it discusses the theoretical background of banking performance measurement, before describing the empirical investigation. Its conclusion is that on average, the profitability of the banking system measured by both ROA (return on assets) and ROE (return on equity) is below the mean of the countries included in the sample, which indicates that it is underperforming. Using the capital regulatory ratio to measure the banking system’s average capital adequacy, it is found that during the sampling period, for most of the time this ratio was below the mean of the other banking systems sampled, and consequently, from this standpoint, could be considered as undercapitalized. Furthermore, from 1993–2009 the Portuguese banking system was less efficient then its peers in terms of asset-liability management, measured by the interest expenses to total assets and interest expenses to total liabilities indicators. The chapter also concludes that, using the implicit income tax rate indicator, the Portuguese banking system is undertaxed.

Retail banking for households in Portugal is examined in detail in Chapter 7. In the last 25 years there have been relevant and decisive changes in the sector, and its size relative to gross domestic product (GDP) has grown significantly. The chapter aims to capture and analyze these changes and growth from two different perspectives: the main players, their strategies and evolution; and the main impacts on overall financial intermediation figures at a national level and in an international eurozone comparison. Two main subperiods are considered. Alhough it is a period during which retail banks and specialized consumer credit institutions assumed a significant role in the lives of Portuguese households, it must be divided into two different subperiods. The first one – which may be called “the rise of the empire” – will lead us through the 1990s and almost the entire first decade of the new millennium, until the outbreak of the financial crisis; and the second – which may be called “the fall of the empire” – will tell us the unfinished story from the outbreak of the financial crisis to the present day.

Corporate and investment banking in Portugal is the subject of Chapter 8. Corporate banking in Portugal in the mid-1980s is related to commercial banking, which looked after the regular needs of small and medium enterprises (SMEs), mainly from the manufacturing and services sectors. The offer portfolio was mainly composed of products and services for short-term financial loans (based on working capital needs, such as overdrafts or very short-term loans) and commercial loans (based on trade financing needs, such as factoring or similar instruments). The main players in the Portuguese market were banks with a strong tradition of short-term loans.

Until the end of the 1980s, there were several restrictions on housing loans and only three financial institutions were allowed to offer them. In the early 1990s the Portuguese financial market was liberalized, with the end of the privatization phase of banks that were nationalized following the 1974 revolution. Based on market mechanisms, the model encouraged banks to broaden their offers to housing loans and construction on a large scale. The scarcity of housing in Portugal, with very restrictive letting laws, opened the door to a period of rallying real estate leverage.

After the market liberalization in the late 1980s, a new bank emerged as a disruptive player proposing a new distribution model based on segments for corporates (small business, SMEs, and large corporates). Thus the first account managers appeared specializing in dealing with corporate customers. The model that was widely adopted by the Portuguese banking system up to the end of the 1990s, although with some variations, was a dedicated account manager in the universal branches, or middle-office facilities reserved for corporates (mainly small businesses and SMEs) with centralized back offices.

In the mid-1990s, the bank loans market became more dynamic and attractive due to the expansionist budget and monetary policies of the western economies. Large companies, related to public investments and large-scale private investments in facilities and infrastructure, demanded more specialized services, such as structured loans adjusted to the project’s characteristics or financial solutions with longer maturities, requiring new structures of funding (not only classic loans, but structured high-grade debt and raising funds on capital markets). This brought corporate and investment banking closer to what we know today.

The final chapter concludes the survey by identifying the strengths and weaknesses of the Portuguese banking system when expanding its activities all over the world, focused on Portuguese-speaking countries. It also outlines the possible strategies still available for surviving the great financial crisis.

Main features of the Portuguese financial system

Evolution of the world economy and the role of central banks

The speech that Ben Bernanke, Chairman of the US Federal Reserve, gave on May 22, 2013 signaled a softening of quantitative easing (QE) and inverted the normal mode in which financial markets operated. This led to corrections in various asset classes and generated high volatility in emerging economies, which were affected by the adjustment impact of expectations concerning American monetary policy.

Emerging markets received large inflows of US capital, the so-called carry trade, due to the abundant liquidity and low interest rate policy created by the American QE program. However, the tapering in prospects opened the way to capital repatriation, the “flight for quality,” with the consequent direct depreciation of local currencies (Brazilian real, Indian rupee, Indonesian rupiah, South African rand, and Turkish lira).

In the meantime, the European Central Bank (ECB) has issued assurances that the low interest rate policy will remain unchanged for a long period, since economic recovery in the eurozone continues to be subdued.

Financial integration in Europe and the role of the ECB

The fragmentation of eurozone financial markets increased during the first half of 2012, due to the risk of a euro breakup and the consequent risk of redenomination into national currencies.

During the second half of 2012, the prospects for a European banking union and the ECB’s announcement of unconventional monetary policy measures – that is, three-year funding (long-term refinancing operations or LTRO), assignment of liquidity to commercial banks (credit easing) to prevent a credit crunch in Europe, and direct monetary transactions (DMT) – restored confidence in the eurozone, but did not eliminate the segmentation of these markets reflected in the sovereign public debt risk premiums of peripheral countries. This implies that in these countries, including Portugal, interest rates remained high in comparison to Germany and the center of Europe. Interest rate spreads were stronger in sovereign debt markets than in corporate markets.

Essentially, the ECB’s policy would buy some time until European political leaders took decisions regarding progress toward some form of political union that would stabilize the eurozone (far from an optimal monetary zone and the political union of the United States). The biggest design flaw in the current EU is the lack of the large central budget and transfer union that make monetary unions and federal currencies, such as the dollar, work. Obviously, this weakness can only be addressed by a movement toward something closer to a political union.

European banking union

A European banking union would require a single supervisor on a European scale, which would be the ECB. For Portugal domestically, this role was played by Banco de Portugal. There would also be a need for a European regulator, the European Banking Authority (EBA). In the Portuguese case, Banco de Portugal played the role of regulator.

A deposit guarantee fund would be required on a European scale to cover deposits up to €100,000, which already occurs nationally. Furthermore, there would have to be decision-making mechanisms on bank closure and rescue on a European scale, with the consequent European rescue funds. In Portugal assurances were issued by the Portuguese government and treasury, as has been seen with the cases of the country’s banks BPN, BPI, BCP, and BANIF, which were financed by contingent convertible bonds (COCOS) funded by the Troika Program cooperation between the International Monetary Fund (IMF), the European Commission, and the ECB.

However, agreement has only been achieved on the European supervisory agency, the ECB, since the EBA was already, to a certain extent, performing this regulatory role on a European scale.

The financial crisis and the Portuguese banking system

When Portugal joined the eurozone, its banking system started to use European wholesale funding markets for its needs arising from insufficient internal savings, which are expressed in the retail market through the deposits of residents. The Portuguese external deficit reflected a national savings gap in relation to investment. In other words, we could say that the Portuguese banking system was the agent that went to the external market to seek the external savings required to finance the country.

Based on this funding model, the Portuguese banking system grew in terms of mortgage loans and consumer credit, in real estate and construction, following credit facilities linked to the dramatic decrease in interest rates. This led to a loan-to-deposit ratio well over 100%, which implied that internal savings, in the form of deposits in the Portuguese banking system, were insufficient to fund the necessary credit, whereby the banks resorted to external savings/debt. The closure of the Portuguese economy to financing from external markets also dramatically affected external funding to the banking system.

Due to the deterioration of the economic situation, the financial crisis caused an increase in loan defaults by companies, as well as by individuals who became unemployed and required fresh capital.

The Economic and Financial Assistance Program, following the guidelines that Banco de Portugal had been issuing for some time, led to a deleveraging of the Portuguese banking system, with loan-to-deposit ratios having shifted from 143.2% in 2010 to 128% in 2011 and 117.4% in 2012. It is important to note that this has been an extremely difficult period for Portuguese banks, since this was, additionally, carried out in the context of the required strengthening of Core Tier 1. This forced the banks to sell assets, restrict credit to the economy, and compete for deposits, leading, in fact, to exaggerated increases in deposit interest rates.

Hence, this period also resulted in liquidity problems for the economy and the threat of a credit crunch, which were mitigated by the ECB’s assignment of liquidity to the Portuguese banking sector, approximately €48.742 million up to May 2013.

The significant reduction in leverage, capital strengthening, and the impressive growth of deposits in the Portuguese banking system (remarkable in the context of the peripheral countries in difficulties, such as Spain and Greece) have contributed to a notable adjustment of the balance sheet of the country’s banks. However, profitability remains a serious concern.

A credit pricing problem also persists. At the moment there is no serious problem of liquidity for the banking system in terms of credit lines for good companies, namely those producing and selling tradable goods. The real issue is the credit risk of companies with very weak equity, which unfortunately covers a large majority of Portuguese non-exporting SMEs.

On the other hand, the success of the Adjustment Program in terms of the country’s external position, with the elimination of the current and capital account deficits, has considerably improved the perception of Portuguese risk. This will also facilitate the path for large companies and banks to return to external markets, with a softening of their funding costs, which will be good for credit pricing.

In 2012, the non-financial private sector generated savings that exceeded investment, both due to increased individual savings, reflected in higher deposits, and as a result of low business investment, which is very negative for the future growth of the economy. Nevertheless, the public deficit offsets private savings.

Net interest income will continue to be subject to strong pressure derived from a series of factors, namely low demand for credit; weak profitability of mortgage loans, with bank refinancing costs well above the lending rates applied and whose spread cannot be changed; the continuation of high funding costs in relation to the center of Europe; as well as low short-term interest rate levels and the squeezing of net interest income associated with demand deposits. Additionally, the banking sector has downsizing costs due to the lower demand for credit, which is particularly evident in mortgage loans and consumer credit.

In t...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• List of Figures
• List of Tables
• Foreword
• Notes on Contributors
• 1. Introduction
• 2. The Impact of the Financial Crisis on Portuguese Banks: The Problem of Portuguese Sovereign Debt
• 3. Consolidation and the Evolution of Governance Models in Portuguese Financial Institutions
• 4. Banking Supervision and Regulation in the Euro Area: The Case of Portugal
• 5. Risk Management in Portuguese Financial Institutions
• 6. Performance and Efficiency of the Portuguese Banking System
• 7. Retail Banking for Households in Portugal
• 8. Corporate and Investment Banking in Portugal
• 9. Portuguese Banks and Their Expansion in Portuguese-Language Countries
• Index