Portuguese banks are risking more, both in credit and in investments, in the search for profitability. Banco de Portugal warns that cautious policies must be pursued.
The interest rates of the European Central Bank at historical lows are throwing the Portuguese banking sector at greater risk, both in terms of assets and the granting of credit. The warning is made by Bank of Portugal in the December Financial Stability Report, which points to the need for the financial system to increase its resilience, when the economic slowdown is creating pressure.
“The prolongation of the very low interest rate environment translates into increased challenges in the generation of profitability in traditional financial intermediation activity,” says the Bank of Portugal.
The last financial stability report had been published in June, i.e. before the ECB cut the interest rate on deposits. The rate rose to -0.5%, which in practice means that banks have to “pay” to have excess liquidity parked at the central bank, despite having been accompanied by a system of steps to mitigate the impact.
On the one hand, the context of very low interest rates “has been reflected in financing costs at a global level”, which makes it possible to alleviate debt service and improve the capacity of these agents to finance themselves at lower costs. On the other hand, asset markets (equities, bonds and real estate) have been appreciating significantly and may not only become unadjusted for risk but may also be subject to correction.
“The maintenance of the lower-for-longer interest rate environment increases risks to financial stability, both nationally and internationally. The main risks result, in general, from the incentives for excessive risk taking (search-for-yield), also reflected in the deterioration of the criteria for granting credit and the potential increase in indebtedness to unsustainable levels,” says the regulator.
One of the ways in which banks can cope with excess liquidity is by investing in Portuguese public debt, which has led to several warnings. The trend towards increased exposure to debt has continued since June, accompanied by an increase in the average duration of the portfolio, with the Bank of Portugal once again warning of the high sensitivity to market risks, particularly for yield corrections, and for the risk of contagion in case of a crisis.
Portuguese banks do not differentiate risk from individual customers in spreads
“In terms of banking activity, the context of low interest rates may also have undesirable consequences for the preservation of financial stability. By posing a challenge to the financial margin sustainability of new loans, due to the unfavourable price effect, it strengthens incentives to expand lending,” continues the regulator.
If, in the short run, the net effect may be positive on banks’ profitability, the Bank of Portugal warns of a possible mismatch between interest rates on operations and the risk assumed. And it is already seeing this in the case of loans for households to buy houses.
A year and a half ago, the institution led by Carlos Costa implemented a series of measures to curb credit with the aim of reducing the risk of non-performing loans. “New housing loans have been granted to borrowers with a lower risk profile, also reflecting the effects of the macro-prudential policy measure adopted by Bank of Portugal”.
“However, there are signs of reduced differentiation in the spreads of new housing loans according to the credit risk of borrowers, which have been decreasing over time”, points to the spread war that has led to a minimal differentiation between the supply of different banks.
Consumer credit has also sounded the alarm bells at the BoP. On the one hand, the stock has maintained a high annual rate of change (close to 10%). On the other hand, new consumer credit, especially personal credit, increased again after a slowdown observed since mid-2018. In addition, the maturities associated with new car loans and personal loans have increased.
“Maturity is a very relevant parameter in the assessment of credit risk. From the banks’ perspective, the extension of maturities in consumer credit signals that credit exposures, potentially without any collateral associated or associated with less liquid assets and/or with depreciation periods shorter than the maturity of the loan, will be exposed to fluctuations in the economic cycle for longer periods”, he explains. “In this context, it may be a conditioning factor on the future evolution of NPL [non-performing loans] and on the cost of credit risk”.