Financial Stability Report December 2018

Financial Stability Report

December 2018

The data underlying the charts presented in this report can be found at the Banco de Portugal website, with some exceptions for private sources data (only in Portuguese).

Lisbon, 2018 • www.bportugal.pt Financial Stability Report | December 2018 • Banco de Portugal Av. Almirante Reis, 71 | 1150-012 Lisboa • www.bportugal.pt • Edition Financial Stability Department • Design Communication and Museum Department | Design Unit • Print 20 • ISSN (print) 1646-2246 • ISSN (online) 2182-0392 • Legal deposit No. 227536/05 Content

Overview | 5

I Financial stability outlook | 9

1 Vulnerabilities, risks and macroprudential policy | 11 1.1 Vulnerabilities | 11 1.2 Risks to financial stability | 18 1.3 Macroprudential policy | 29

2 Macroeconomic and markets environment | 35 2.1 Macroeconomic situation and short-term prospects | 35 2.2 Financial markets | 39 2.3 Residential real estate market | 44

II Special issues | 117

Investment funds as a source of systemic risk | 119

Amendment of the CRD IV-CRR: what is new? | 135

ead o Pruus gos n srie o as i trs f h ptnil des effects adverse potential the on the real estate market,where non-residentshaveplayedanimportant role. Both channels of terms in also or services and goods Portuguese for demand external on effects negative and costs funding the with particularly associated are implications Portuguese economyandfinancial sectorandtheoutlookforinterestratedevelopments.These especially at European level. The materialisation of such a scenario would certainly impact on the in various regions, and growth prospects have been revised downwards in several countries, decelerating already is output Indeed, activity. economic and markets financial international on currently anticipated by most economic agents, they have the potential to have significant effects As futuredevelopmentsintheissuesmentionedabovegain moreseriousmomentumthanthat risk toincreaseinthenearfuture. the politicalsituationineuroareacountriesareallevents thathavethepotentialtocausethis States), uncertainty over the outcome of Brexit or episodes of financial instability associated with United the notably, (most regions economic global main the in normalisation policy monetary contagion. However,theadoptionofnewprotectionistmeasures with animpactonworldtrade, been some indications of it materialising, albeit short-lasting and/or with no evidence of significant presented inpreviousissueoftheFinancialStabilityReport.Infact,recentmonthstherehave assessment the to compared intensified has risk This level. European at movement idiosyncratic abrupt and significant the reassessment of risk premia, either triggered by a global reassessment movement or a more still is Portugal in stability financial to risk main the context, this In example ofthis. an is Union, Banking the of pillar third the Scheme, Insurance Deposit European a of absence The stability. financial to risks amplifying thus crises, new to vulnerable and incomplete remain at it be achieved, been has banking unionleveloreven,atamoregenerallevel,intermsofmonetaryunion,bothwhich architecture institutional European the in progress relevant No risk, mostnotablythosestemmingfromthecurrentinternationalenvironment. Portuguese economy. This is particularly noteworthy given the still significant sources of systemic reinforced inviewofthepersistencemajorconstraints,namelylowpotentialgrowth However, itshouldbehighlightedthatthisimprovementtrendneedstocontinuedandindeed crisis, bolsteringtheirresiliencetoadverseshocks. in further, decreased system banking particular and when compared to the economy situation that preceded the Portuguese international economic and financial the in vulnerabilities Thus, levels. Thetotalcapitalratiowasboostedbytheissueofeligibleownfundsinstruments. pace while afast at impairment coverageratioscontinuedtogrow.Theliquiditypositionremainedatcomfortable further declined loans Non-performing efficiency. operational increasing and loans on losses impairment lower amid recover to continued Profitability areas. relevant of Likewise, the Portuguese banking system evolved favourably in the first half of the year in a range and capitalaccountsurplusovertheyearasawhole. current combined a maintaining of perspective the to credence give year the of half first the in the downwardpaththatstartedinmid-2017.Intermsofbalancepayments,developments continued to increase. Public capitalisation debt, net of NFC general government deposits, continued of to move along level the while further, narrowed (households NFCs) – sector corporations non-financial private and non-financial the of financial ratios a indebtedness from The developments favourable standpoint. of stability range a saw economy Portuguese the 2018 In Overview 5 Overview 6 Banco de Portugal • Financial Stability Report • December 2018 • • challenges, significant of stemming fromthelowshort-terminterestrateenvironment intheeuroareaandneedto: range a overcome still must system banking Portuguese the Finally, of newcreditagreementsforconsumersandrelatingtoresidential immovableproperty. underlying reasons for the designing of the macroprudential measure within the legal framework have debtswithlongmaturities,oftenexceedingborrowers’ workinglives.Thisisoneofthe considerable fallinincomefromthetimeofretirement,against abackgroundinwhichhouseholds link between population ageing and a public social security system that is expected to witness a In the case of households, it is also important to consider, from a financial stability standpoint, the that adequatelyassessestheirsustainability,consideringtheunderlyingpotentialrisks. bolster their to even if gradual, in interest rates in the future. Corporations’ profits increase, should be distributed in a apriority, the way as such developments, financial remain and economic must favourable less against capitalisation resilience firm in increase the Likewise, terms. historical and European both in levels low very to dropped has households of case the in which must be adjusted further. Steps should be taken to promote an increase in the savings rate, agents leveraged excessively of position financial the sector, private non-financial the regards As susceptible toadverseshockseconomicactivityandfinancingconditions. in order must continue efforts to ensurethatgeneralgovernmentindebtednessmovesalongadownwardpathisless adjustment fiscal structural level, government general the At been particularlyfavourable,butisexpectedtobecomeprogressivelylessbenign. the economic, monetary and financial environment are foreseeable, which in the recent past has risks. This requirement also stems from the fact that, even in the baseline scenario, changes in vulnerabilities discussed here are further addressed, particularly given the prevailing systemic advance in 2018, in a number of major components of the Portuguese economy, it is key that the to continued imbalances macrofinancial in correction the although and above, the Considering to residentialimmovablepropertyisalsoofparticularimportance. Banco de Portugal within the legal framework of new credit agreements for consumers and relating other initiatives,acarefulimplementationofIFRS9maymitigatethisrisk.TheRecommendation time horizonofthecreditoperation.Againstthisbackground,itisworthemphasisingthat,aswell of thecreditriskonloanagreements,basedwell-foundedexpectationslossesoverentire stressed thatthiscontexthasashort-termnatureandshouldnotpreventthecorrectassessment be should It marked. particularly been has areas/cities some in which property, immovable namely collateral, of valuation significant the and rates interest low very by amplified is risk this expansion, in the granting of loans, which tend to be procyclical. At an advanced stage of the current economic latter could be substantial. These effects could be amplified by the adoption of less prudent criteria real estate assets in banks’ balance sheets, the impact of the aforementioned reassessment on the and bonds of government share significant the Considering assets. non-financial and financial of has significant implications in real terms, could make way for reductions in it the value if of a particularly wide range premia, risk of reassessment abrupt and significant a for potential the Therefore, negative developments intheriskscenariodescribed. experience therefore may and past, recent the in sector banking the benefited have business model, banks’ of sustainability the promoting thus services, financial of provision the in digitalisation invest in technological infrastructure to take advantage of the potential associated with submitted tothesupervisoryauthorities, plans the with line in NPLs), (particularly assets non-performing of reduction the with proceed distribution ofdividends. to thecapital shocks position of banks. This warrants prudent distribution policies negative of profit, particularly as regards the of theabsorption tostrengthen the other, on and, profitability on theonehandtoensuresustainabilityofrecentimprovementinbankingsector the highindebtednesslevelsofmostresidenteconomicsectors.Inthiscontext,itisimportant It isalso key to consider the risksto the baselinescenario for economic activity developments and • • • MREL. issue debtinstruments eligible asregulatorycapital,forthepurposesofcomplyingwith financial riskmanagement,and duties, namely in terms of money laundering and terrorist financing, as well as operational and cut operating costs without jeopardising the appropriate allocation of resources to control address potentialcompetitionfromspecialisedfirms(fintech), 7 Overview

I Financial stability outlook

1 Vulnerabilities, risks and macroprudential policy 2 Macroeconomic and markets environment 3 Financial position of the General Government and of the Non-financial Private Sector 4 Banking sector

(Regulation (EC)No.479/2009),i.e.grossgeneralgovernmentconsolidateddebtatnominal orfacevalue,theso-calledMaastrichtdebt. procedure deficit excessive the in used definition the to according calculated is debt Public households. and corporations non-financial of credits trade EA 2017referstoeuroareaaverages Sources: EurostatandBancoin 2017.Indebtednesscomprisestotaldebt(loans,securitiesand de Portugal.|Notes: households) | Chart I.1.1• dropped somewhatandisnowbelowtheeuroareaaverage(ChartI.1.1). has it recently although crisis, financial and economic international the of onset the after period the in significantly increased rate saving the (NFCs), corporations non-financial the Regarding agents. economic these for vulnerability additional an is EU the with compared rates savings particularly financial institutions, but also large enterprises. Furthermore, the very low level of agents, economic other by markets financial international to conditions access premiumand risk sovereign the constrains 2018) of half first the of end the at GDP of (124.9% indebtedness investors. Despitetherecentsubstantialdecrease,stillhighlevelofgeneralgovernment in incomeandfundingcosts,namelythoseassociatedwithchangestheriskperceptionof developments adverse to sensitive remains economy Portuguese the Therefore, crisis. financial the to leading period the in imbalances external of build-up the reflecting 2018), of half first the in GDP of 92.7% (approximately area euro the in highest the among remains debt external net by high indebtedness levels. In fact, and in spite of the reduction that started in mid-2015, Portugal’s the adjustment seen over the past few years, the Portuguese economy is still characterised Despite 1.1 1 Vulnerabilities, risks and

Total debt one ofthemainvulnerabilities for thePortugueseeconomy High indebtednessamidlow potentialgrowth continues tobe 100 125 150 50 75 macroprudential policy Vulnerabilities -6 2010 Total debtandsavings(generalgovernment,non-financialcorporations Percentage ofGDP -3 2014 General government General 2008 0 2018 S1 2017 2018 S1 AE 2017 AE 2014 2017 Gross savings 3 2008 Non-financial corporations 2008 6 AE 2017 2010 2010 2018 S1 9 2017 2014 Households 12 AE 2017 AE 15 11 Vulnerabilities, risks and macroprudential policy 12 Banco de Portugal • Financial Stability Report • December 2018 quarrying, comparedwithhigherriskfirms. in sectorssuchastrade,accommodationandfoodservices, andmanufacturing,mining bank loans to exporting corporations and companies with higher credit quality, particularly NFCs’ capitalisation. the non-resident sector, an increase in loans granted by the domestic financial sector and greater was seenalongsideareplacementofcorporatefundingsources, withareductionindebtheldby (NPLs) loans non-performing loans, bank decreased further,whileperformingloansroseandtheoverall stockofloansalsodeclined.This regards As I.1.2). (Chart pace slower a at but debt, As mentionedabove,inthemostrecentperiod,NFCshavecontinuedtoreducetheirnominal Sources: BancodePortugalandEurostat.|Note:Totaldebt(includesloans,securitiestradecredits)onaconsolidatedbasis. rate interest floating a to linked is debt household of share substantial a that Given servicing. debt their curtail may juncture this NFC Furthermore, profitability. and income household on both effects, adverse have may area euro the and Portugal in output growth. The current prospects of a slowdown in economic activity in the coming years The high indebtedness levels of the NFPS are a significant constraint for the Portuguese potential However, there was a marked slowdown in the deleveraging process compared with the previous year. alsoan but thesesectors of upturn in economic activity as of 2014, which is the largest contribution to this momentum since 2015. adeleveraging only not reflect ratios debt lower The capitalisation. in peak seenattheendof2012.Thesedevelopmentswereaccompaniedbyaverysubstantialincrease historical the since p.p. 29 by down GDP, of 97.3% for accounted debt consolidated total NFCs’ date, disposable of (104% GDP of 71% at stood income), down by 24 p.p. from indebtedness the peak in 2009, but still far above household the euro area average. On the same 2018 June In peak. its from decreased significantly has GDP, of percentage a as (NFPS), sector private non-financial the of Debt 3. 2. 1. Chart I.1.2• that they would do so very gradually and would be linked to an economic upturn in the euro area. sensitive to isparticularly sectors these in interest rate changes. However, if the key ECB debt service interest rates were to increase, projections indicate loans, short-term comprises chiefly

For moredetails,seetheOctober2018issue of theEconomicBulletin For moredetails,seeSection3.2.2“Non-finan cial corporations”. It shouldbenoted,however,thatoverthepas t fewyearsrecoursetofloatingratefunding by households hasdecreased. Em percentagem do PIB 100 150 200 250 300 50 0 UI YN EM RF SS TE TL RS EL PT LT DE SI GR LV IT EE AT SK ES FI FR MT BE NL CY IE LU Non-financial corporations’totaldebt| 2 Furthermore, there is still a positive differential in the growth of domestic of growth the in differential positive a still is there Furthermore, 2017 3 Média da área do euro (2017) . Percentage ofGDP 1 and that the NFC funding structure

2016 2017 S1 2018 S1 PT as the recent revision by Moody’s. Currently, the three major credit rating agencies classify as substantiated in a decrease in risk premia and the upgrades to sovereign debt rating, such sovereign, and banks Portuguese the of perception investors’ international in improvement an adjustment inthegeneralgovernmentandanupturn economicactivity,hascontributedto the with together This, efficiency. operating improve and NPLs) particular (in assets performing consolidation process,whichhasmadeitpossibletoimprove itssolvencylevels,reducenon- Over the past few years, the banking sector has also undergone a substantial adjustment and factors, forone-off adjusted deficit, fiscal government general The Sources: BancodePortugalandEurostat.|Note:Totaldebt(includesloans,securitiestradecredits)onaconsolidatedbasis. Chart I.1.3• (-1.2% inJune2018). negative slightly remained sector financial resident the by granted purchase house for loans in pace (annual rate of change of 14.2% in June 2018). On the other hand, the annual rate of change is, ontheonehand,anincreaseinconsumercredit,whichcontinuedtogrowataparticularlyfast growth this Underlying I.1.3). (Chart 2017 June from 0.6% by rose debt household nominal Total 4. balance isnotinterrupted. structural the in adjustment the that key is it shocks, adverse against economy Portuguese the of resilience the strengthen to order in Therefore, Union. European the in highest the among still is debt public Portuguese above, mentioned as However, government). General 3.1 (Section earlier year one period same the from decrease p.p. 1.1 a for accounting 2018, of half first the concerning aconcessionofland.Formoredetails, seetheOctober2018issueofEconomicBulletin Créditos These operationscorrespondtothetransfer from theResolutionFundtoNovoBanco,aloangrantedbyStateFundo de Recuperação the planstodecrease non-performing assets and itiskey thatthiseffort continues tobepursued inlinewith Portuguese banks have reduced thevolume ofNPLsfurther, Percentage of disposable income 100 150 200 250 50 0 (Credit RecoveryFund) and the ruling by theSupremeCourtofJusticeregarding the paymentofcompensationinajudicial proceeding TN YL EF EE RG TD ES TS TL PT LV LT SI IT SK EE DE AT GR FR ES BE FI IE LU CY NL MT Households’ totaldebt| 2017 Percentage ofdisposableincome Euro area average (2017) average area Euro . 4 to a 09 o GP in GDP of 0.9% at stood 2016 2017 Q2 2018 Q2 PT 13 Vulnerabilities, risks and macroprudential policy 14 Banco de Portugal • Financial Stability Report • December 2018 stability perspective”). n troit financing, terrorist and resources tosupervisoryduties,particularlythoseregardingthepreventionofmoneylaundering up their efforts to improve operating efficiency, without jeopardising the appropriate allocation of is not enough to counterbalance the respective costs. However, the banking system should keep capital on return the systems, banking European other with line In banks. some among NPLs of past few quarters was largely due to a decrease in credit impairments, despite the still high levels operating efficiency and improved profitability significantly year-on-year (Section 4.1 Profitability). sector’s The recovery in profitability over banking the thePortuguese of 2018 half first the In reverse therecenttrend. between the business cycle and lower impairment flows, the stock of NPLs may stagnate, or even performing assets.However,amidaslowdownintheeconomy,togetherwithpositivelink in realestatepriceshavecreatedafavourableenvironment,supportiveofthereductionnon- The increase in solvency of major banks, improvements in economic activity and developments substantiated intheplanstoreducenon-performingassetssubmittedsupervisoryauthorities. from loans to NFCs (Section 4.2 Asset quality). This reflectsstemmed thebillion strategies€12 adoptedaround bywhich the sector,of as billion, €18 approximately by NPLs reducing adjustment, substantial a undertaken has system banking Portuguese the 2016, June in peak historical the to p.p., 3.6 by declined ratio NPL 11.7%, and the impairment coverage ratio rose by 7.1 p.p., to 52.9%, from the one year earlier. Since 2018 June In impairments. by assets such of coverage the increasing in and NPLs of stock the reducing in made been has progress good 2016, Since compliance withtheminimumrequirementforownfundsandeligibleliabilities(MREL). projections point to the need, in the short to medium-term, to issue eligible instruments for performing assets submitted to supervisory authorities. This will be more relevant as the the increase To banks. resilience ofthebankingsector,itiskeythatbanksproceedwiththeirplanstoreducenon- Portuguese on impact positive a with also debt, public Portuguese in 7. 6. 5. Portuguese sovereign debt as investment grade, competition, giventhatthisDirectivehasenteredintoforce onlyrecently increased of evidence any without yet as but banks, by services fintech of use the in resulted has PSD2 the of introduction the date, to However, sector. banking the in efficiency greater competition inmanyactivitiesbytechnology-basedcompanies, butarealsoanopportunityfor particularly digitalisation,posenewchallengesintermsofcybersecurityandpotentiallyincreased sector, intermediation financial the in technology new of introduction the and 2) PSD Directive, Services Payment Revised the (namely framework regulatory new The strengthened. be must shift run, more specifically, those related to staff changes. In turn, investment behind the technological expected gains,theoperatingadjustmentprocesstendstoentailadditionalcostsinshort The low interest rate environment poses challenges to banks in terms of profit generation. Despite prudent allocationofprofitsanddistributiontheirdividends. the regards as particularly challenges, some face to continues system banking Portuguese the Entry intoforceon13November2018. cases suchas,DanskeBank(EE),ING(NL)On theimportanceofthissubject,seerecent andVersobank(EE). More recently,inOctober2018,Moody’salso reviseditsratingtoBaa3,withastableoutlook. outlook. stable a with BBB, to BBB- from notch, one by rating the upgraded also DBRS 2018, April In grade. investment to (S&P) Poor’s & Standard and Fitch by upwards revised were debt long-term Republic’s Portuguese the to assigned ratings the 2017 of half second the in specifically, More 6 aswellriskmanagement.Assuch,anddespiterecentprogress, 5 thusexpandingtherangeofpotentialinvestors 7 (Box 2 “Fintech – financial financial – “Fintech 2 (Box

a hedgingstrategies(ChartI.1.5). portfolio hasincreased,whichalsoboostsbanks’exposure tointerestrateriskintheabsenceof gains may be limited. In this respect, the residual average maturity of the government bond diversification correlated, positively are debt sovereign European in changes yield that extent, the to and Moreover, system. banking Portuguese the for vulnerability a constitutes exposure Against abackgroundofgeopoliticaluncertaintyandpotentialreassessmentriskpremia,this Sources: EuropeanCentralBank(BancodePortugalcalculations). Chart I.1.4•Bankingsystem’sexposuretosovereigndebtsecurities| the endof2011). at than more p.p. (2.8 banks resident of assets total of 3.2% for accounted countries two the by notably Spain and Italy (Chart I.1.5). In fact, in the first half of 2018, exposures to securities issued also increaseditsexposurestogovernmentbondsissuedbyothereuroareacountries,most far above that of the banking sector (Chart I.1.6). Since 2011 the Portuguese banking system has to thedomesticsovereignhavedecreasedinrecentyears,butitsweighttotalassetsremains exposures sector, insurance the of case the In I.1.4). (Chart area euro the in highest the among the domestic sovereign (around 9% of total assets), which has followed an upward path and is still (12.7% of total assets of resident banks as at June 2018), mainly in the form of securities issued by is anothersourceofvulnerability.Inparticular,itsexposuretogovernmentbondsremainshigh classes asset specific in investment system’s banking Portuguese the of concentration high The related assets a substantialshare ofitsassetsonpublicdebtandproperty- The Portuguesebankingsystem continues to concentrate 10 12 0 2 4 6 8 Portugal Italy Spain Percentage oftotalassets Euro area Euro

15 Vulnerabilities, risks and macroprudential policy 16 Banco de Portugal • Financial Stability Report • December 2018 debt instrumentsatamortisedcost, these of proportion significant a reclassified banks Portuguese most standard, accounting new changes inthemarketvalueofdomesticpublicdebt. 9. 8. 9). (IFRS framework accounting new the under bonds ratios immune to capital changes in regulatory the value of make public debt, to as well banks as the allowing reclassification of 2018), government January 1 of (as filter prudential a of removal the incorporates impact This strategies). hedging any (excluding ratio capital regulatory the on b.p. government 47 approximately of domestic impact direct on negative a yields have would in banks Portuguese by rise held bonds b.p. 100 a ratio, 1) (CET 1 Tier Equity Common a the of that given markets, financial in reassessments substantial shareofthesesecuritiesisrecordedatfairvalue.Accordingtoasensitivityanalysis premia risk to sensitive particularly them makes banks, Portuguese by held class, asset this to exposures of amount high the However, euro areasovereignissuers,withnegativeyieldsacrossawiderangeofmaturities. other than attractive more debt sovereign Portuguese in investment make yields bond higher a positiveimpactonbanks’regulatorycapitalratios.Inverylowinterestrateenvironment,the an upgrade in the Portuguese Republic’s rating to investment grade by credit rating agencies, had Since the first quarter of 2017, the decrease in Portuguese government bond yields, together with period values. Sources: BancodePortugalandThomsonReuters.|Note:Endofthe average portfoliomaturity exposure tosovereigndebtsecuritiesand Chart I.1.5• Percentage By contrast,onlyaround7%ofthisassetclass wasclassifiedas“heldtomaturity”inthepreviousaccountingframework(IAS39). cost”. “amortised at classified are banks Portuguese by held bonds government of 31% approximately 9), (IFRS framework accounting current the In Report, June2017. For more details, see the Special Issue “IFRS 9 – Main changes and impacts anticipated for the banking system and financial stability”, 10 12 14 0 2 4 6 8 Italy Others Maturidade média (esc.dir.) Dec. 11 Dec. 12 Resident bankingsector’s Dec. 13 Dec. 14 Dec. 15 Dec. 16 Portugal Spain Dec. 17 9 andasaresultmakingtheircapitalimmunetotheimpactof Jun. 18 0 1 2 3 4 5 6

Yers average portfoliomaturity exposure tosovereigndebtsecuritiesand Chart I.1.6• period values. Sources: BancodePortugalandThomsonReuters.|Note:Endofthe Percentage 10 20 30 40 50 0 8 Indeed, following the introduction of the Maturidade média (esc.dir.) Italy Outros Dec. 11 Dec. 12 Resident insurancesector’s Dec. 13 Dec. 14 Dec. 15 Dec. Portugal Spain 16 Dec. 17 Financial Stability Jun. 18 0 2 4 6 8

Yers loans grantedtoyoungerenterprises outstanding of one-third still Nevertheless, p.p.). 2.5 (by 2011 since decreased has which 2018), to firms in the construction andgranted real estate activities sector (5% of total assets as at June Another relevantcomponentofbanks’indirectexposurestotherealestatesectoriscredit accounting forapproximately28%ofPortuguesebanks’totalassets(ChartI.1.7). mostly indirect,particularlyviaresidentialrealestateusedascollateralinthemortgagemarket, estate assets (38.9% of total assets, 1.5 p.p. down from the end of 2016). This type of exposure is A sectors; (d)itdoesnotexcludeloansgrantedtoprojectsrelatedtherealestatesector,aspublicworks.Endofperiodvalues. Source: Banco dePortugal. | Notes: (a) Includes loans and shares; (b) gross values; (c) excludes loans to NFCsin the construction and real estate activities Chart I.1.7•Bankingsector’sexposurestotherealestatesector| 11. 10. effects ofadecreaseinborrowers’incomebythetime retirement. and a reduction in real estate asset prices, or in borrowers’ income, and will tend to mitigate the More financing. tackle more to easily household the able potentially adverse be effects of a will of gradual increase banks in short-term Portuguese interest rates sustainability and consumers measure, the this with to complying by specifically, as well as system, banking Portuguese resilient more a to contribute to is agreements) credit consumer and guarantee equivalent or (more specifically, credit related to residential immovable property, credit secured by a mortgage the Recommendation issued by Banco de Portugal de Banco by issued Recommendation the spreads on rate loan agreements), is conducive to a loosening in credit standards. In this respect, the purpose of interest the lower in particularly (reflected market mortgage the in pressure The currenteconomicenvironment,characterisedbylowinterestratesandcompetitive and realestateactivitiessector). sectors (approximately 40% of corporate NPLs is accounted for by enterprises in the construction other to compared greater proportionally is NPLs of volume the NFCs, to granted loans total of activities sector (Section 3.2.2 Non-financial corporations). Although this sector accounts for 24% t the end of the first half of 2018, Portuguese banks continued to be highly exposed to real to exposed highly be to continued banks Portuguese 2018, of half first the of end the t bportugal.pt/en/page/ltv-dsti-and-maturity-limits). (https://www. 2018 July of as force in consumers, for agreements credit new of framework legal the within Portugal de Banco of Recommendation That have startedtheirbusinessasof2013. 15 30 45 0 0921 0121 0321 0521 072018S1 2017 2016 2015 2014 2013 2012 2011 2010 2009 Loans to householdscollateralized by real estate Loans to non-financial corporations collateralized by real estate (c) (a) funds estate real to Exposure 10 isassociatedwiththeconstructionandrealestate 11 for new creditagreementsfor consumers Loans to NFCs of construction and real estate activities sectors (d) sectors activities estate real and construction of NFCs to Loans Real estate owned (b) Percentage oftotalassets 17 Vulnerabilities, risks and macroprudential policy 18 Banco de Portugal • Financial Stability Report • December 2018 update: 16November2018. Latest averages. 2000-18 the represent lines dashed The notation. risk credit by years, ten to one of maturities the for rate interest mid-swap average the and Sources: Thomson Reuters and Banco de Portugal calculations. | Notes: Spread between the average yield of iBoxx Index of private non-financial corporations Chart I.1.8• despite aslightincreasesincethefirstquarterof2018,particularlyinriskierclasses(ChartI.1.8). levels, low historically at remain NFCs area euro by paid premia Risk segments. market financial coming years may lead torisk-aversion behaviour and riskpremiareassessments across several monetary economicgrowthoverthe policy, andabackgroundofexpecteddecelerationinworld partial materialisation of some risks stemming from tradetensions andthenormalisation of theUS the level, European and global at both uncertainty, economic and geopolitical Increased Report. the of issue previous the in presented assessment the to compared intensified risk premia,eithertriggeredbyaglobalreassessment or amoreidiosyncraticevent. This riskhas of reassessment abrupt and significant the still is Portugal in stability financial to risk main The enhance one mutually theymaterialise, another. and,should together interact may herein identified area in the world economy explains the overall extent of the risks listed in this Report. The risks euro the of integration financial and economic of degree high the Furthermore, framework. area euro the by determined largely is economy Portuguese the of environment macrofinancial The 1.2 exposures andtheeconomicperformanceofthoseeconomiesshouldbemonitoredfurther. and creditlinesgrantedtoNFCsmoreexposedtheseeconomies.Assuch,developmentsin loans through mainly indirect, also is exposure This banks. Portuguese some for significant be The exposurestosomedevelopingeconomiesthatdependoncommodityexportscontinue political uncertaintyandpose importantdownsideriskstoeconomicgrowthinthe shortto T rade tensionsbetweenmajor economicblocksarestillamongthemainsources of global intensified amidaless favourable macrofinancial environment The riskofasignificantandabrupt reassessment ofriskpremia 130 180 230 -20 30 80 Risks tofinancialstability Private sectorriskpremia| BBB Basis points A AA Financial Stability scenarios, respectively. In both cases, the more substantial effects result from a decrease in adecrease from exports, duetolowerexternaldemand. result effects substantial more the cases, both In respectively. scenarios, war trade generalised or war trade limited from scenario, baseline the with compared 2.5% to 0.7% of GDP, Portuguese on period three-year a of course the in impact negative cumulative a 14. 13. 12. NBER’s BusinessCycleDatingCommittee( Sources: NBER and Federal Reserve of St. Louis (FRED). | Notes: The grey areas refer to periods of economic cycle contraction in the US and calculated by Chart I.1.9• interest rateduetostructuralfactors,suchaslowerproductivityandpopulationageing. long-term the in decrease a reflecting be may bonds government US on yields long-term that given However, I.1.9). (Chart past evidence suggeststhatthepredictivepowerofthisindicatormayhavedecreased,inparticular the in seen as recession, a of onset the signal may curve yield the of flattening The low. all-time an at is yields bond government two-year and ten-year between spread However, someuncertaintypersistsonthemaintenanceofthismomentuminUSeconomy.The economy, mainlyduetothepro-cyclicalnatureoffiscalpolicy. in theFedFundsRatetolevelsabovelong-terminterestratecontainanoverheating the continued rise in interest rates in 2019. The Fedalsoalluded to the possibility ofanincrease normalisation, with future expectations of a fourth interest rate increase in December 2018 and policy monetary with proceeded (Fed) System Reserve Federal The policy. of fiscal expansionary an effects the to due partly 2018, of half first the in firmly grow to continued economy US The an impactoneconomicsentiment. with already firms, particularly expectations, agent economic on weigh countries, both between tariffs between China and the US, as well as the threat of further trade tariffs on all goods traded and Mexico,theirtermsconditionsremainanopenquestion.Thematerialisationoftrade Despite the trade agreements already in place between the US and the EU, as well as with Canada medium run. -3 -2 -1 See “TheSlopeoftheYieldCurveandNea r-Term Outlook”,publishedbytheSanFrancisco Fed on15October2018. countries imposecustomdutiesontheimports fromothercountries,withanimpactofapproximately10%oninternationalprices. trade all that assumes scenario war trade generalised The imports. US on tariffs 10% imposing by retaliate would economies these Subsequently, US. the to there is an increase across all import tariffs by the US for all goods from third countries, leading to a 10% increase in prices on exports from such countries tensions”, protectionist global in rise a of impact “Macroeconomic 5 Box see details, more For IMF, 0 1 2 3 4 World Economic Outlook 12 Spread between10-yearand2-yearyields–US| A simulation study shows that increased protectionist tensions may bring about , October2018. http://www.nber.org/cycles/cyclesmain.html). Latestavailabledata:1August2018. 13 , June 2018. In the limited war scenario, Economic Bulletin,June2018.Inthelimitedwarscenario, Per cent 14 19 Vulnerabilities, risks and macroprudential policy 20 Banco de Portugal • Financial Stability Report • December 2018 average and/orwhosebanking systemsstillsufferfromvulnerabilities. towards otherMemberStates, mostnotablythosewithindebtednesslevelsabovethe euroarea economic fragmentationinthe euroarea.Thismayleadtothedeteriorationinmarket sentiment and financial and risks, redenomination of resurgence the premium, risk Italy’s of reassessment the following launch particularly of an deteriorates, excessive deficit procedure Italy by the in European Commission, situation there may budgetary be an the additional if However, I.1.12). and I.1.11 (Charts limited relatively been has economies area euro other on yields to contagion date, and uncertainty related to the implementation of economic policies by the new government. To yields rose markedly across maturities. This reflects concerns about sovereign debt sustainability Following the elections in Italyandthe formation of the new government, Italian government bond 16 update: Latest indices. euro) November 2018. (area VSTOXX and (USA) VIX the by on the Euro Stoxx 50 and S&P 500 equity indices, represented respectively Implied volatilityinpricesofoptions Source: ThomsonReuters.|Notes: markets | Chart I.1.10• by politicaluncertaintyinItaly. addition tocontagionfromtheeventsmentionedabove,itsdevelopmentshavebeenimpacted in case, latter the In I.1.10). Chart and markets, Financial 2.2 (Section Europe in extent, lesser a markets. Thesemovementshavepassed through toothermarkets,particularlyinChinaand, financial international in conditions liquidity lower anticipating perspective, investment an from indicated thattheseboutsofriskreassessmentmayhavestemmedfromabroaderchange which have gainedtractionin the market over the past few years. Some market players have strategies, selling and buying automated to due magnified been have may factors These growth. by investors,tradetensions,politicaluncertaintyandexpectationsforadecelerationinworld inter alia, thenormalisationofUSmonetarypolicyatamorerapidpacethaninitiallyexpected reflect, may which sentiment, market the in changes abrupt mirrors This years. few over the past seen trend the valuation interrupting thus firms, technology among mostly markets, equity US in sparked again once was sell-off a 2018, October in However, 2017. in seen those to Following the marked increase in early 2018, equity market volatility fell back again to levels close However, manyeuroareabankingsystemsareconsiderablyexposedtotheseeconomies. muted. relatively were economies other on episodes reassessment premia risk these of effects contagion The Africa). South and Argentina Turkey, US (e.g. financing and external dollar-denominated imbalances macrofinancial greater with those particularly (EMEs), economies emerging market some in conditions financing in deterioration a to contributed also have Fed the by Strong economicgrowthintheUS,appreciationofUSdollarandinterestrateincrease 10 20 30 40 50 0 Per cent Implied volatilityinequity VSTOXX VIX composite indicator| Chart I.1.11• in theeuroarea,WPNo.2185,October2018. the approachdevelopedinBeyondspreads:Measuringsovereignmarketstress using calculated is indicator This Note: | Bank. Central European Source: 0.0 0.2 0.4 0.6 0.8 Portugal Sovereign systemicstress Spain Between 0and1 Greece Italy Euro area

Chart I.1.12• to worsen, even for domestic economic agents with longer-term debt, more diversified sources diversified more debt, longer-term with agents economic domestic for even worsen, to buffers. In the case of persistently deteriorating risk premia, market financing conditions will tend market volatility, with an impact on financing conditions, especially for issuers with lower liquidity The current macrofinancial environment and high uncertainty levels may result in greater financial contracts andtheensuingeconomicimpact. financial concerning particularly relationship, area-UK euro the in interruption an of effects the in risk premia reassessments worldwide. Furthermore, the risk and high uncertainty surrounding “hard Brexit”) is another factor that may bring turmoil to international financial markets and result so-called (the Union European the from withdrawing (UK) Kingdom United the of context the in at European level, given its importance to financial markets, the possibility of a no-deal scenario Still Source: IMF,FiscalMonitorOctober2018.|Note:Dashedlinesrepresentprojectedvalues. Chart I.1.13• different adjustment pace in public debt may help mitigate the materialisation of this risk (Chart I.1.13). Despite thepossibilityofcontagionfromsituationinItalytoothereconomies,expectedly Sources: ThomsonReuters(BancodePortugalcalculations).|Note:Lastupdate:16November2018.

Percentage of GDP 10 12 14 16 18 100 110 120 130 140 0 2 4 6 8 40 50 60 70 80 90 0921 0121 0321 0521 0721 0922 0122 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011 2010 2009 10-year sovereigndebtsecurities–spreadsversusGermany| General governmentgrossdebt| Italy France PT Portugal Percentage ofGDP IT Spain ES 0 1 2 3 4 5 Irlanda IE Basis points Euro area Euro 21 Vulnerabilities, risks and macroprudential policy 22 Banco de Portugal • Financial Stability Report • December 2018 market interest rates are reflected only partly in the deposit component (demand deposits tend deposits (demand component deposit the in partly only reflected are rates interest market relatively shortermaturities. On theotherhand,asregardsinterestexpenses,developments in share of reflects the stock of these loans was granted at customers, a floating interest rate, which is gradually to reset at loans on particularly relatively quickly developments in short-term interest rates, to the extent that a very substantial income, interest hand, one the On operations. margin, given the asymmetric pass-through of these interest rates to borrowing and lending In the banking sector, lower short-term interest rates have a negative impact on net interest of riskpremia. reassessment abrupt an of materialisation the to sensitive more markets financial international riskier from profitability higher seek to assets, thusincreasingtheirexposure.Inturn,theexcessive narrowingofriskpremiarenders investors led has environment rate interest low The contracts tradedintheLondonInternationalFinancialFuturesandOptionsExchange(LIFFE).Latestupdate:16November2018. Source: Thomson Reuters (Banco de Portugal calculations). | Note: 90-day average value of the interest rate implicit in the three-month EURIBOR futures Chart I.1.14• despite thepositiveeffectsonNPLs. has curtailed the improvement of profitabilityenvironment among financialrate institutions ininterest Europe andlow Portugal, The I.1.14). (Chart 2019 October previously, – 2020 June before not territory positive enter to expected rates interest Euribor with downwards, shifted futures Euribor three-month the by implied curve rate interest the issue oftheFinancialStabilityReport, asset 2019 –indicatesaverygradualincreaseinmarketinterestrates.Comparedwiththeprevious net lower of wake the in – ECB purchases asoftheend2018andpossibilityanincreaseinkeyinterestratesmid- the by policy monetary normalising of prospect The and amoreresilientbankingsystem,asthesefactorsinfluenceriskperceptionbyinvestors. that policies pursue promote the sustainability of public finances, potential to output growth of the Portuguese economy essential is it such, As liquidity. available widely more and financing of -0.6 -0.3 stability remain interest rates orapossibledelay inthisrise,risks tofinancial Amid expectations ofavery gradual increase inshort-term 0.0 0.3 0.6 0.9 1.2 Dec. 18 Mar. 19 Jun. 19 Sep. 19 Dec. 19 Mar. 20 Jun. 20 Sep. 20 Dec. 20 Mar. 21 Jun. 21 Sep. 21 Dec. 21 Mar. 22 Jun. 22 Jun. 22 Mar. 21 Dec. 21 Sep. 21 Jun. 21 Mar. 20 Dec. 20 Sep. 20 Jun. 20 Mar. 19 Dec. 19 Sep. 19 Jun. 19 Mar. 18 Dec. Implied interestrateinthethree-monthEURIBORfuturescontracts| Dec. 17 Dec. May. 18 May. Nov. 18 Per cent the levelobservedbefore internationalfinancialcrisis. time, therehasbeenanupturn innewloanstohousepurchase,althoughstillclearly below that same the At I.1.16). (Chart 2015 June since levels area euro the below fallen has which deposits, line with the decrease in the interest rate margin between new loans for house purchase and new reported asdiminishing,duetocompetitivepressurein the creditmarket.Thisindicationisin However, the tightening of other conditions, such as spreads, remained unchanged or was maturities. to and granted amounts to limits stricter ratio, (LTV) loan-to-value the of tightening measure implemented by Banco de Portugal was the main factor behind this. This resulted in the Survey reportedthatcreditstandardshadtightened,and indicatedthatthemacroprudential Looking at the household sector, most institutions participating in the October 2018 Bank Lending that donotcovertheriskinherentinloanswillleadto increasedcreditdefaultinthefuture. low with firms benefit economic sustainability.Infact,attemptingtoincreaselending bysettinginterestratespreads may it risks, implied of remuneration the than cost lower a channelling at the funds with of associated is it that extent the to run, short the in firms better of a performance with coexists spreads of narrowing the Although I.1.15). (Chart stable relatively were spreads havefollowedadownwardpathsince2013,thusapproachingeuroarealevels,which degreeof alower by wasaccompanied ratereduction differentiation of spreads according to NFC risk levels theinterest (Section 4.3. Credit standards). Interest rate of 2018, half first the In enterprises. large and SMEs both to loans medium-risk on spreads the of narrowing a indicated In thecaseofNFCs,somebanksparticipatinginOctober2018BankingLendingSurvey as asimplemean.Half-yearflows.Thedashedlinesrepresentthe2003-18averages. or (NFCs loans business new for rates computed area euro for interest Values NFCs. and households from MFI deposits new of rate average between weighted a and respectively) purchase, house Difference for households Note: | calculations). Portugal de (Banco Bank Central European Source: Corporations | business anddeposits–Non-Financial Chart I.1.15• of spreads(duetocompetitivepressure)orlessstricttermsandconditionsagreements. banking sector,produceincentivestoloosercreditstandards,resulting,interalia,inthenarrowing Consequently, the very low interest rate environment, along with the search for yield by the near-zero annualratesofchange,againstabackgroundstillhighoverallindebtednesslevels. post to continues sector financial the by granted loans of stock the sector, private non-financial the of most for and However, effect. price this offset partly can lending bank of volume greater the existinglag.Furthermore, interest ratesoncustomerdeposits cannot fall belowzero.A reinforces which roll-over, upon only re-priced are deposits time while rate), interest no bear to 0 1 2 3 4 5 T–NFCs PT – Spreads onnewcredit Percentage points A–NFCs EA – house purchase| business anddeposits–Householdsfor Chart I.1.16• -1 0 1 2 3 T–Households (housing) PT – Spreads onnewcredit Percentage points A–Households (housing) – EA 23 Vulnerabilities, risks and macroprudential policy 24 Banco de Portugal • Financial Stability Report • December 2018 of 2013 and the first half of 2018, residential real estate prices rose by approximately 29%, while decrease in the stock of home loans, although at an increasingly slower pace. Between the end main factor behind price developments in the residential real estate market, with the continued However, available evidence suggests that credit granted by resident banks in Portugal is not the of loanstohouseholdsforhousepurchase.Residentialrealestatepricesmeasuredin terms. and 2018Q2, with exception of France (2018Q1). Cyprus and Malta are excluded from the sample due to the lack of data. Cumulative changes of the stock Sources: European Central Bank and Organization for Economic Co-operation and Development (OECD). | Notes: Cumulative changes between 2013Q4 purchase | Chart I.1.17• growth (ChartI.1.17). was broadlybasedacrossmanyeuroareacountries,inafewcasesalongwithrobusthomeloan 2018 of half first the and 2013 of end the between prices estate real residential in acceleration economy, Portuguese which has contributed to an improved perception from domestic and international investors. The the in upturn the from dissociated be not should prices market estate momentum in tourism and direct investment by non-residents. The recovery in residential real regional/local level (Section 2.3. Residential real estate market). This has been linked to the strong estate prices have been overvalued, with possibly more marked overvaluation episodes at In recent quarters, some signals, albeit limited, have emerged that aggregate residential real in theeventofadversescenariosandensuingreductiondebtservicing. economic in deceleration a and pace) activity, it is essential that credit risk assessment and pricing are suitable, thus containing losses gradual a at (albeit rates interest short-term rising of private sector and low savings rates (particularly significant in the household sector), the outlook non-financial indebted highly a of background a against developments, these mind in Bearing levels, inthefirsthalfof2018. with longer maturities.Theinterestrateappliedinthistypeofoperationwasrelativelystable,athigh loans towards shift a with but crisis, financial the to prior recorded volume the to nearer Consumer credit continued to accelerate in the first half of 2018, and the flows of new loans drew

Credit growth – Households (housing) by demandfrom non-residents Real estateprice growth inPortugal continued tobedriven -20 Percent Cumulative changesinresidentialrealestatepricesandloansforhouse -10 GR IT 100 -40 -20 20 40 60 80 0 0 FR BE 10 FI Real housing price growth LV SI AT DE 20 ES NL LU LT EE SK 30 PT 40 50 IE 60 the monitoringoffintechfromafinancialstabilitystandpoint. of complexity the as well as topic, this reviews perspective” stability financial – “Fintech 2, entitled Box risks. systemic of propagation the for channel a or risk of source a be also may fintech and topotentiallycutassociatedcosts,whichshouldallow forgainstheeconomy.However, market, which makes it possible to expand the provision of these services and the customer base and indevelopmentsthebusinessmodelofmostentities directlyorindirectlyactiveinthis in this area. This wave has materialised in greater diversity of entities providing financial services, processes and activities entities, new comprising fintech, so-called the market, the in introduced been has services financial in innovation technological of wave new a years, few past the Over NPLs collateralisedbythistypeofasset,ashasbeenthecasesincemid-2016. reduce to and kind in payment as received estate real sell to ability sector’s banking the affect already made.Ascenariowhererealestatepricesareabruptlycorrectedmayalsonegatively in the value of real estate in the meantime, and also taking into account the loan repayment value, on the back of the valuation initially used when assessing credit and a possible increase real estate collateral, the negative impact of any price correction may be mitigated by a store of loans andrealestateprices.Lookingatthestockofforhousepurchaseorgrantedagainst new credit agreements forhouseholds,thus reducing the risk ofaninteraction between domestic regards as recommendation macroprudential Portugal’s de Banco by mitigated be should effect internalise price dynamics when assessing credit risk on new loans for house purchase. This adjustment inthismarketposesriskstothesector,particularlyifcreditinstitutionsinadequately Given thatthebankingsystemishighlyexposedtoresidentialrealestatemarket,asuddenprice most services, and goods Portuguese notably affectingtourismexports. for demand external on impact adverse an have may materialisation ofgeopoliticaluncertaintyepisodesandtheslowdowninglobaleconomicactivity The volatility. larger experience to tend which investors, non-resident of conditions financing in particularly inthecaseofabruptriskpremiareassessmentsatgloballevel,anddeterioration same trendmayresultinthemarket’sincreasedsensitivitytointernationalenvironment, the However, collateral. estate real against granted loans with associated NPLs in reduction the the sale of real estate received as payment in kind held in banks’ portfolios and contributing to The higher demand for real estate had a positive impact on the domestic banking system, easing by non-residentsorfirms. Lisbon MetropolitanAreaandAlgarve,whichmayberelatedtothegreaterweightofpurchases in total transactions between 2010 and the year that ended in June 2018 was more marked in the information broken down by region, the decrease in the share of bank loans this to households for house purchase at Looking period. same the over 12% by declined purchase house for loans 15. heterogeneity”, EconomicBulletin For moredetails,seeBox5,entitled“Recent developmentsinthesaleoffamilydwellings and loans to households for housepurchase: regional the mainriskfrom afinancialstabilitystandpoint confidence inthefinancial system andhasbeen considered Despite itsadvantages, technologicalinnovation may affect , October2018. 15 25 Vulnerabilities, risks and macroprudential policy 26 Banco de Portugal • Financial Stability Report • December 2018 the deepeningofEMU. in followed be should that priorities of hierarchy ‘proper’ the on differ positions their 2016, June in approved roadmap the a of light only, in Furthermore, liquidity mutualisation). full comprising or coinsurance whether of system (i.e. run long the in shared are losses how EDIS, notably most the of establishment the on proposal Member Stateshaveyettoreachpoliticalunderstanding asregardskeyaspectsofthescheme, Commission’s European the after years Three policy measuresandprudentialsupervision/resolutionmeasures. monetary of influence the by crossed landscape a in and instruments available the given act to financial stability still lies with national authorities, which are now materially limited in their ability on nationalpublicaccounts.Consequently,theultimate responsibilityforthesafeguardingof oninstitutions’ from thesedecisionsarestillbornebynational‘safety nets’, whichcouldpotentialityimpact centres thatdecision-making fact the supervision and resolution matters have been upscaled to European from level, while any costs arising arise chiefly imbalances These incomplete Europeaninstitutionalarchitecture. an of imbalances of perpetuation the to inherent risks stability financial intensify helped has – since (SRM) Mechanism Resolution Single January 2016 –, the lack of the a European Deposit Insurance Scheme (EDIS) – the third and and last pillar 2014 November since (SSM) Mechanism Supervisory Single the – operational fully are Union Banking the of pillars two first the Although urgency of establishing a true Banking Union, through immediate, effective and concerted action. the a on agreement made full in Report, leaders Presidents’ Four European so-called the on banks), based 2012, and in commitment sovereign the between link the breaking (i.e. mind in stability financial area ofa euro the stemming from the correlation between sovereign risk and banking risk. With this key objective to thevulnerabilities risks and –exposed architecture institutional scope European anunprecedented fragmented of – crisis financial recent The supply. comply with the MREL, most notably, deleveraging, which would have a negative impact on credit to order in strategies other pursue to banks force may markets financial international access to and/or the cost of issuing these assets for the Portuguese banking sector. A more limited capacity access of riskpremia for implications significant have may – sovereign domestic ofareassessment the on impacting materialise, risk the should instance, – for environment macrofinancial adverse more A time. of period short relatively a in MREL the meeting for instruments eligible European the to applies requirement banking systeminitsentirety,itwillverypossibleresultasubstantialincreaseissuesof this that of Given sentiment importance. themarket gain will As such, issuers domestic markets. financial international to access need will banks MREL, liabilities eligible and funds own for requirement minimum the with comply to order In evidence ofriskmaterialisationatEuropeanlevel. no is there date, to However, activities. financing activity economic and intermediation financial change a central component of stability, must be safeguarded, irrespective of how and who carries out maysubstantially and the board, system, across financial the in confidence context, this In customers. service financial with relationships system financial the altering is Fintech some risks. more resilient. However, thetransition process may entail The ultimategoalofregulation istomake thebankingsector third pillaroftheBankingUnion shouldnotbedownplayed:botharelikewiseindispensable to Despite the agreement reached on the common fiscal backstop to the SRF, the importance of the national budgets,andthuspromoting financialstability. on impacting potentially without action, resolution a out carrying when act to capacity effective funding schemefortheSRFtransitionperiodisalsokey toenhancetheSRM’scredibilityand on the and SRF the to basis ofanappropriategovernancearchitecture,building aliquiditysupporttoolandaninterim backstop fiscal common the of operationalisation swift the Alongside has yettomaterialisesubstantially(e.g.legislativeinitiativesunderimplementation). Furthermore, aforward-lookinganalysisiscrucialtocapture theprogressthat,albeitongoing, onboth focusing review, acomprehensive quantitative and qualitative factors, will allow for a grounded comparison of the progress made. Only structure). financing models, business size, (e.g. systems banking respective their of and assets) legacy certain of level high the for drivers certain Member State and without taking into of account their particularities (e.g. macroeconomic compliance situation, each strict in departure of the points different to the for providing as without targets, evaluation quantitative predefined mechanicist/rigid a on relies – EDIS the of measures are sufficient – either for the backstop to the SRF or also extended to the establishment However, risks to financial stability lie ahead if the future model to assess whether risk reduction from access tothisbackstop. excluded be will institution financial participating or State Member no that is conditions theseto aspect key A build-up. MREL by gauged capacity loss-absorbing the and reduction NPLs of back the on systems banking among decreased sufficiently have risks whether of assessment prior the on conditional 2024), to prior (i.e. period transition the of end the of ahead backstop the of implementation the include would which President, Council European the to President Eurogroup the by sent letter June 25 the in out set as reform, ESM the of part as reinforced be Stability European Mechanism the (ESM) would provide that ‘safety that net’. Its role in crisis decided management, moreover, should was it SRF, the to backstop fiscal common the to Turning Scheme”. Insurance Deposit European the on negotiations political beginning for roadmap a on dhering to all elements of the 2016 roadmap in the appropriate sequence, work should start “[a] that agreed leaders political summit, 2018 June the in EDIS, the regards as specifically, More backstop mechanism),allotherdecisionswerepostponed. fiscal common resort last a (i.e. (SRF) Fund Resolution Single the to backstop the of exception fell shortofeconomicagents’expectationsabouttheBankingUnionissue,giventhat,with Member States,butfromthefactthat,atleastfornow,theyareirreconcilable.Thesummitresults the political stalemate surrounding the EDIS may not stem solely from diverging positions among the regards as which, – 2018 June Banking Union,mirrortheMesebergDeclaration,aFrench-Germanagreement–suggestthat 29 on Summit Euro the of conclusions the Furthermore, risk sharing,whichisamajorstructuralstepbackwardsfromthe2015draftlegislationonEDIS. increase to leaders European among agreement an securing in difficulties and negotiations of The Communication from the European Commission, of 11 October 2017, exposed the complexity pursue theultimategoalofbreakinglinkbetweenbankingriskandsovereignrisk. call for progress in increased risk sharing (via EDIS), in line with the commitments made, and thus important steps already taken and the risks to financial stability of an incomplete Banking Union, to riskmutualisation.Ontheotherendofspectrum,MemberStatesthat,inview other MemberStates,maintainthatadditionalrisk-reductionmeasuresmustbeinplaceprior the one hand those which, concerned that their banking systems would systematically subsidise As such,politicaldiscussionshaveconvergedtoapolarisedstalemateamongMemberStates.On 27 Vulnerabilities, risks and macroprudential policy 28 Banco de Portugal • Financial Stability Report • December 2018 • • • • carried outbysystemicallyimportantcross-borderbankinggroupsintheirjurisdiction.Assuch: activities the from stemming stability financial to risks mitigate to ability authorities’ competent initiatives and trends in European banking regulations that the may rethink pose to obstacles imperative to the is host it national –, death” in national but life, in global are banks “global that quote relying, however, on the ‘safety nets’ of each Member State – whichbringsus to Mervyn King’s regime management crisis European a from stemming vulnerabilities prevailing amid Therefore, they aresuitablyskilledtoprotecttaxpayersandfinancialstabilityintheirjurisdiction. transition period,MemberStateshavethenecessarynationalinstrumentsinplacetoensurethat key priority in the action taken by European authorities, it is vitally important that, in the course of the – both in the Unionas a whole but also in each Member State– is not seen asan end in itself and a (including the backstop to the SRF and the EDIS), and as long as the safeguarding of financial stability the remaining elements of an institutional architecture for a true Banking Union are not yet in place because namely reaped, fully be can EMU true a of part being from benefits the as time such Until if itcomestobestrippedofitscomponentassociatedwithfullmutualisationlossesinthelongrun. particularly EDIS, the from benefits future possible of view in warranted are sheets, balance banks’ in (either to access the EDIS or as part of the transition to loss sharing), to address legacy issues identified stability stemmingfromthebankingsystembeingsubjecttoanumberoftransitionalrequirements deepening of the EMU, policymakers are faced with a major challenge: assess whether risks to financial However, taking into account the fragile outlook about the sequencing of reforms towards the ultimate goalofatrueBankingUnion,seetheJune2018issueFinancialStabilityReport. the with consistent model EDIS an for need the on details more For crises. with dealing when taxpayers protecting thus act, to capacity actual its in confidence agents’ economic on impact a trulyoperationalandsoundcrisismanagementsystemintheeuroarea,duetotheirex-ante dependence among the group’s subsidiaries. For that purpose, when planning and implementing dependence among the group’s subsidiaries. For that purpose, when planning and implementing multiple-point-of- to opposed and integration fosters and implies approach first the that extent the to –, (MPE) resolution entry as – groups banking cross-border for resolution (SPE) of-entry iswarrantedaboutthedisseminationacrossBankingUnion of thesingle-point- discussion A to carrytheirsupervision. conferred on national competent authorities to refuse the establishment of such branches or business in other Member States – either as a branch ora subsidiary –and the powers It isadvisabletorethink the possibility of banking groups tochoose how tocarryout their Union. Banking individual basis,thisisanationalsafeguardthatshouldbein placeinthetransitiontoacomplete an on requirements liquidity from authority supervisory banking European the by derogation the of effect the curtailing Although exposures. intra-group for limits exposure large apply to entitled It is also to be expected that, with regard to options and discretions, Member States remain financial stabilityinallMemberStateswhereagivenentitycarriesoutitsbusiness. only befeasible in atrulyintegrated market, which providescommon guarantees to safeguard intheEuropean Union andtheresulting emergence ofglobalplayersinasinglejurisdiction.However,thiswill activities withcross-border groups among ofresources allocation efficient IV-CRR: what’s new?”. Underlying this is the argument that it is key to boost circulation and CRD the of “Revision Issue Special the see details, more on For borders. across basis individual an flexible more requirements liquidity from derogation current the making (ii) and groups, from capital requirements, on an individual basis, for subsidiaries of cross-border banking It seems unwise to carry on with the debate about: (i) the proposed introduction of a derogation xoe t rss neet o sil nopee uoen ntttoa acietr, hc are which architecture, partly duetothelackofacross-border‘safetynet’capablewithstandingsystemicshocks. institutional European incomplete still a to inherent risks to exposed maintenance ofadirectlinkbetweenbankingriskandsovereignrisk,thesystemisstill In the absence of a cross-border centralised ‘safety net’ and, consequently, in light of the risk ofsuboptimalsolutions. thinking up decisive and effective solutions may be precipitated by a new crisis, with the increased EMU, the of deepening the for action crucial of implementation the postponing by Furthermore, sustainable fundingbyborrowers,thusminimisingdefault risk. on new lending, to access encouraging by hand, other the on and, resilience sector financial to contributing thus risks unreasonable taking from corporations financial and institutions credit agreements credit new for consumers,withthepurposeoftakingpreventiveaction, ontheonehand,bydiscouraging of framework legal the within Recommendation a issued Portugal de prices areconducivetothefurtherlooseningofcreditstandards. On1February2018,Banco The economicupturn,inalowinterestrateenvironment, andtheupwardtrendinrealestate the bankingsystemmoreresilienttoriskmaterialisation. making at aimed are buffer Institution Important Systemically Other the and buffer conservation capital the (CCyB), buffer capital countercyclical the while risk, systemic of build-up the reduce Borrower-based measures, such as the aforementioned Recommendation, are intended to of Banco dePortugalwithinthelegalframeworkofnewcreditagreementsforconsumers. the Recommendation and (O-SII) buffer Institution Important Systemically Other the (CCB), buffer conservation capital the include Examples risk. systemic of build-up the address to suited of macroprudentialpolicyandtheactivationinstrumentsitdeems,exante, To date, Banco de Portugal has chiefly focused on the development of the conceptual framework system asawhole,orpartthereof,withpotentiallynegativeconsequencesfortherealeconomy. services that may, inter alia, affect the flow of credit, stemming from risk materialisation in the financial financial in disruption of risk the as defined be can risk Systemic resilience. sector financial bolster to and defining with entrusted of systemicrisk,aswellbyproposingandadoptingmeasurestopreventormitigatesuchrisks,so is Portugal de Banco implementing macroprudential policy, most notably by identifying, monitoring and assessing sources authority, macroprudential national the As 1.3 16. website, https://www.bportugal.pt/en/page/ltv-dsti-and-maturity-limits. Portugal’s de Banco and 2018, June Portugal, de Banco of Report Stability Financial the in Policy Macroprudential 1.3 section see agreements, credit consumer new and property immovable residential to relating recommendation, macroprudential Portugal’s de Banco regarding details further For from the resolution plan). strategy actuallyimplementedintheeventofresolutiondiffersfromplan). the when (particularly jurisdiction its in subsidiary each of importance systemic the regards as and level group at both addressed be should concerns stability financial measures, resolution into force on1July framework ofnewcredit agreements for consumers entered The Recommendation ofBanco dePortugalwithinthelegal Macroprudential policy 16

29 Vulnerabilities, risks and macroprudential policy 30 Banco de Portugal • Financial Stability Report • December 2018 ratio. affecting thecalculationofdebt-service-to-income(DSTI) ratioandtheloan-to-value(LTV)ratio. below theminimummonthlywage,whichareexcludedfrom themacroprudentialmeasure,thus consumer credit agreements. Moreover,availabledata for someinstitutionsincludesloans10times the periodbetweencreditworthinessassessmentand thereleaseoffundsislongerthanfor tothe prior particularly noteworthy in credit agreements relating to residential immovable property, for which place took assessment creditworthiness Recommendation’s entry into force, but whose funds were only released after 1 July 2018. This is forwhich operations credit by affected ofinstitutions number ina the limitssetoutinrecommendationwereimplemented onlygradually.Also,theanalysisis that given months, few first the over developments credit on impact According to the data collected, a complete analysis cannot be made of the Recommendation’s with agraceperiodforpaymentofinterestand/orprincipal. with an increase in consumer credit products with a fixed interest rate and a decrease in products entry intoforce,evidencesuggeststhatthesupplyofcreditproductshaschanged,forinstance, Although most consumer credit is already granted at a fixed rate, following the Recommendation’s a meanstomonitorthelimitsandexceptionslaiddownbyBancodePortugal. in theRecommendationisnotmet,loanapplicationmovedupdecision-makingprocess,as capacity, interalia.Furthermore,forthevastmajorityofinstitutions,whereanycriteriasetout supplemented withpreviouslyappliedcriteria,suchasincomenetofexpenditureanddebtservicing credit agreements.Foranumberofinstitutions,thecriteriasetoutinrecommendationare assessment ofborrowersbyinstitutions,giventhatithassetharmonisedminimumcriteriafor Overall, theimplementationofRecommendationseemstohaveimprovedcreditworthiness established intheRecommendation. limits the with accordance in channels these in offer their adapted have to seem institutions but implementation of limits in the digital channels of a number of institutions was more incipient, established in the Recommendation in its retail distribution channels. In turn, at that time, the Compiled informationsuggeststhatasat31Julyallinstitutionsoperatedwithinthelimits specialising inconsumercredit. Banco de Portugal contacted major institutions in the Portuguese financial system and institutions With thepurposeofassessingimplementationaforementionedRecommendation, residential real estate prices and the credit cycle, with positive consequences for financial stability. real estate market prices, setting these limits will tend to mitigate interlinkage risks between residential in growth marked of environment current the in that considers Portugal de Banco trend for prices, which is an undesirable scenario, as it poses risks to financial stability. Therefore, greater pressurefromcredit-backeddemandforhousingmaycontributetoanongoingupward Recent developments in housing prices are out of synch with the credit cycle in Portugal. However, grant thistypeofcreditinPortugal. financial corporations, having their head office or branches in Portuguese territory authorised to immovable property and new consumer credit agreements. It covers all credit institutions and applies tonewcreditagreementsconcludedfrom1July2018onwards,bothrelatingresidential likely reductionintheborrower’sincomeuponretirement.Thismacroprudentialrecommendation ingeneral. lending On theotherhand,thiscalibrationtakesintoaccountexpectedriseininterestratesand affecting without profile risk higher a with borrowers to lending constrain T 17. he limits introduced by the Recommendation were calibrated, on the one hand, so as to at 30June2018. These institutions represent about 94% of the total consumer credit agreements and credit agreements relating to residential immovable property, as 17

the activation of the countercyclical buffer, as discussed in greater detail in Box 3, entitled in detail ingreater “Implementation ofcountercyclicalcapitalbuffersinthe European Union”. discussed as buffer, countercyclical the of activation the At European level, in line with the upswing in the credit cycle, there is an increasing trend towards applied tohomeloansandcorporateloans,whicharestill decreasing. risk, exceptforrealestateassetprices,whichcontinueon anupwardpath,aswellspreads systemic cyclical of build-up a indicate not do buffer capital countercyclical the compute to used Portugal kept the countercyclical capital buffer at 0% for the last quarter of 2018. Most indicators de Banco trend, long-term its to relation in gap credit-to-GDP negative persistent the of view In compliance withthemacroprudentialmeasure,andwillactaccordingly,ifitdeemsnecessary. institutions’ the monitor closely to continue will Portugal de Banco Portugal. de Banco by adopted the mainfactorbehindsuchdevelopmentswascompliancewithmacroprudentialmeasure collateral requirements, the LTV ratio and other limits to volume/maturity. According to respondents, in creditrelatingtoresidentialimmovableproperty,institutionsreportedchangestowardsstricter property and consumer credit agreements. As regards the terms and conditions of agreements, to householdloanshavetightened,bothincreditagreementsrelatingresidentialimmovable In the October 2018 Banking Lending Survey, most institutions indicated that credit standards applied below 10timestheminimummonthlywageorprovision/useofcreditlinesandcards. scope of the Recommendation, there seems to have been no change in the pattern of loans Looking to data on the monitoring of developments in the credit categories excluded from the this willleadtheaverageloanmaturitytowardsrecommendedlimit(30years). been taken yet, institutions expect that, by ceasing to grant loans with a maturity of over 40 years, for credit agreements relating to residential immovable property, although no specific action has amaximum with loans offered maturity dateof50years.Asregardsthegradualconvergencetoanaverage30years institutions of number a property, immovable residential to the before Recommendation of However, Banco de Portugal entered into therein. force, as regards credit agreements out relating set caps the to breaches significant reported have to seem of newcreditagreementslongerthanthoseestablishedintheRecommendationanddonot Turning toloanmaturity,mostinstitutionshadnoupperlimitsinplaceasregardsthematurity residence stoodbetween80%and90%oftheappraisalvalue. was standing practiceamonginstitutions that thecapforLTVratioownandpermanent price is below the appraisal price. For instance, prior to the implementation of this measure, it depends onthelowerofpurchasepriceandappraisalprice.Indeed,overall, H 2.5% ofabank’stotalexposures, risingby0.625percentagepointscomparedwith2018. to correspond and effective fully become will buffer conservation capital the 2019 January 1 On The phase-in of the capital conservation buffer has remained unchanged and is nearing completion. owever, the LTV ratio seems to have become stricter, to the extent that total credit granted now last quarter of2018,at0%totaloutstandingexposureslast quarter The countercyclical capitalbuffer remained unchangedinthe until 1January 2019 The capitalconservation buffer will continue tobephased in 31 Vulnerabilities, risks and macroprudential policy 32 Banco de Portugal • Financial Stability Report • December 2018 necessary for Banco de Portugal, as the macroprudential authority, to consider taking action toaction taking consider to authority, macroprudential the as Portugal, de Banco for necessary or prevent to tools discusses also It Portugal. mitigate suchsourcesofsystemic risk.Theconclusionisthat,atnationallevel,itdoes notseem in funds investment of size the and system, financial the in risks amplify help may entities these how funds, investment of features relevant most the into looks risk“ systemic of source a as funds “Investment entitled Issue Special The tool tolimitleverageinalternativeinvestmentfunds(AIFs). collective for (undertakings UCITS harmonised investment a in transferable securities) reporting framework developing across the EU and a macroprudential at aims it Furthermore, tests. resilience ofinvestmentfundstoliquidityshocks,thereby fosteringthepracticaluseofstress potential address to systemic risksstemmingfrominvestmentfunds.ThisRecommendation aimsatbolsteringthe ESRB/2017/6, Recommendation issued recently has (ESRB) Board Risk Systemic European the However, materialisation. risk upon institutions of resilience the bolster the to directed been banking sector,withthepurposeofpreventingormitigatingbuild-upsystemicrisk have EU the across used instruments policy macroprudential date, To | Table I.1.1• be fullycompletedon1January2021. misaligned incentivesandmoralhazardassociatedwithinstitutionsdeemedtoobigtofail,should macroprudential tool,whosepurposeistomitigatethebuild-upofsystemicrisksstemmingfrom andas such, As unchanged. remained illustrated inTableI.1.1,on1January2019thesecondstageofimplementationwillstart.This institutions these for buffers capital of phase-in the Despite aslightadjustmentinthescoresusedtoidentifysystemicallyimportantinstitutions, helping maintainstablefinancingflowstotherealeconomy. and institutions of resilience the bolstering thus scenario, financial and macroeconomic adverse potentially a in experienced losses absorb to is buffer conservation capital the of purpose The Caixa EconómicaMontepioGeral Banco BPI Santander Totta,SGPS Novo Banco Banco ComercialPortuguês Caixa GeraldeDepósitos Percentage oftotalexposures half ofthetotalrequirement establishedasof2021 InstitutionbufferThe OtherSystemically Important reached and theuseofexcessive leverage ininvestment funds sources ofsystemic riskassociatedwithliquiditymismatches Recommendation ESRB/2017/6 helpsmitigateorprevent Banking group O-SII bufferappliedtoeachbankinggroupfrom1January2019onwards 1 January2019 0.125% 0.250% 0.250% 0.250% 0.375% 0.500% 1 January2020 O-SII buffer 0.188% 0.375% 0.375% 0.375% 0.563% 0.750% 1 January2021 0.250% 0.500% 0.500% 0.500% 0.750% 1.000%

20. 19. therefore, itmaystillbechanged. process. legislative and, co-legislators European the ongoing among negotiations from result the will version final the of such, As part as Parliament European the and Council European the by presented proposals other also but proposal, EC initial the only not cover discussions 18. that shouldgoverntherevisionofmacroprudentialpolicyframework. In its response to the EC’s public consultation, Banco de Portugal enumerated several principles mechanisms betweenauthoritiespromotingfinancialstability. cooperation and coordination the out set exactly to need the was consultation public EC’s the in addressed items the of one such, As (SRM). Mechanism Resolution Single the and (ECB/SSM) pre-dates theestablishmentofBankingUnion,includingSingleSupervisoryMechanism before national macroprudential authorities were appointed across Member States, as it also coordination between these authorities. In fact, the current regulatory framework was agreed the institutionalarchitecture,includingmandatesofvariousauthoritiesinvolvedand macroprudential policy framework in the EU, encompassing the banking regulatory package and In 2016 the European Commission (EC) launched a public consultation about the revision of the systemic riskstemmingfromfundactivity. aspotential the necessary, available where mitigate, help instruments will ESRB/2017/6 Recommendation of in suggested set a having that considers Portugal de Banco notwithstanding, address potential risks to the financial system stemming from investment funds. This conclusion banking regulation package (CRD sector, withtheapproachbeingconsistentthatadoptedforothercomponentsof the proposedrevisionsareincludedinadditionalrisk-reducingmeasuresforbanking decided that it was too early to propose a full revision of the regulatory framework. Therefore, EC the EU, the in implementation policy macroprudential of period short the given However, and (iii) sector, thebanking than maintain theirflexibleapproachtosystemicriskmitigation. other sectors financial in action their strengthen and risk systemic monitor and identify to tools and powers sufficient with authorities macroprudential principles aim to: (i) foster a clear allocation of responsibilities and policy instruments, (ii) provide investment firms. Regulation (EU) No. 575/2013 of the European Parliament and of the Council, of 26 June 2013, on prudential requirements for credit institutions and supervision ofcreditinstitutionsandinvestment firms. Directive 2013/36/EU of the European Parliament and of the Council, of 26 June 2013, on access to the activity of credit institutions and the prudential Banco dePortugal’sperspective”,FinancialStabilityReport from priorities main Union: European the in framework policy macroprudential the to “Changes entitled 1, Box in up summed are principles These (CRR/CRD) strengthens(CRR/CRD) the macroprudential policyframework The revision oftheregulatory packagefor thebankingsector 19 /CRR , June2017. 20 ), given that it was not revised in its entirety. At present, 18 Overall,these

33 Vulnerabilities, risks and macroprudential policy 34 Banco de Portugal • Financial Stability Report • December 2018 within thesetofamendmentstoregulatorypackage(CRR/CRD)forbankingsector. into changes to the macroprudential framework that are still under negotiation, duly framed detail greater with looks new?” what’s IV-CRR: CRD the of “Revision entitled 2, Issue Special The for eachauthority. of therevisionframeworkistoaligngoal,mandateandinstrumentsinplace in place to mitigate such risks or be able to make use of existing tools more flexibly. The purpose instruments tomitigatesystemicrisks,macroprudentialauthoritiesshouldhavealternativetools 2 Pillar using of impossibility the Given should. tool macroprudential a as risks, signal properly to used be cannot confidentiality, their to due and, authorities microprudential to assigned were falls under the macroprudential policy remit. Indeed, powers associated with Pillar 2 instruments which profiles, risk similar with institutions to measures supervisory common of application the in use their precluding thus level, institution at risks specific mitigate to exclusively instruments One of the legislative amendments under discussion refers to the possibility of using Pillar 2 Pillar using of possibility the to refers discussion under amendments legislative the of One 21. of supervisorymeasurestoinstitutionswithsimilar riskprofilesand,therefore,isofamacroprudentialnature. to requirements capital additional impose application the alia, addresses 103 Article particular, In 107). to 102 (Articles IV CRD in out set are powers these framework, current inter the In them. mitigate and, institutions of risks specific the assess to authorities supervisory for possible it makes Pillar 2–Supervisorymeasuresand powers –isoneofthethree supervisory architecture components,according to theBasel II agreement,and 21

24. 23. 22. than inthesecondhalfof2017). The p.p. (-1.5 year decelerating. on year 3.4% by grew which services, and goods Portuguese for demand external despite growth, positive post to slowdown recorded in the four largest euro area economies contributed to a deceleration in continued activity economic area Euro slightly tighter, reflecting risks of contagion inherent to a number of emerging market economies. become have overall, favourable still although conditions, financial and Monetary impact. their uncertainties due to the possibility of further protectionist measures in the future have amplified course of 2018 apply to a relatively small share of world trade, but increased trade tensions and the over adopted measures Protectionist down. slowing despite activity, economic above grow in mainadvancedeconomies,withtheexceptionofUnitedStates.Worldtradecontinuedto World economicgrowthremainedrobustbutmoremixedacrossgeographies,slightlydecelerating declinedto rate and theunemployment year on year 7.3%. of 2018 half first the in 2.8% by grew In line with the economic growth path, labour market conditions continued to improve. Employment external surplusfortheyearasawhole. period of2017.Thesedevelopmentsarenonethelesscompatiblewiththemaintenancean net borrowing Theobserved the year. of position ispredominantlyseasonalinnature,buthasneverthelessbeenhigherthanthesame half first the in position borrowing net a recorded public consumption accelerated slightly. Similarly to the past few years, the Portuguese economy and private contrast, By exports. and investment in specifically 2017, in observed been had that deceleration the intra-annual close toeuro of year, on continuation year the reflected developments by 2.3% These growth. grew area economy thePortuguese of 2018, half first the In 25. 2.1 Macroeconomicsituationandshort-termprospects 2 Macroeconomic andmarkets 0.5 p.p.comparedwith2017,to1.1%,reflectinginparticularadecelerationservicesprices. by decreased inflation of rate The growth. wage in pick-up a to contributed year the of start the unemployment. Thedeclineintheunemploymentrateandincreaseminimumwageat unemployment, while the pace of reduction in youth unemployment remained below that of total For amoredetailedanalysisofthePortuguese economyinthefirsthalfof2018,seeBancoEconomicBulletin de Portugal, According toStatisticsPortugal’sPortugueseLabour ForceSurvey. National Accountsdatafor2018arepreliminary. and servicesimportsbyPortugal’smaintrading partners.Eachcountry/regionisweightedaccordingtoitsshareinPortugueseexports. Source: Eurosystem.ExternaldemandforPortuguese goodsandservicesiscalculatedbytheECBasaweightedaverageofgrowthinvolume despite decelerating Economic activityinPortugalcontinued topostpositive growth, 23 The drop in the unemployment rate continued to reflect a sharp decline in long-term in decline sharp a reflect to continued rate unemployment the in drop The environment 25 22 , October2018. 24 35 Macroeconomic and markets environment 36 Banco de Portugal • Financial Stability Report • December 2018 exceeded thelevelrecordedimmediatelybeforeinternationa l financialcrisis. grow markedly (by 8.2% year on year). This was the only investment component to have already and equipmentareofparticularrelevance.Despitedecelerating, thiscomponentcontinuedto overall assessmentofactivityinthesector.AsregardsotherGFCFcomponents,machinery their improved gradually have firms survey, works public and construction the In improve. continued to construction in confidence while 2017, in works public in increase considerable a of effect base the by influenced been have to expected are developments These I.2.2). (Chart reflected a slowdown in most components, in particular GFCF in construction excluding housing Investment continued to grow above economic activity, despite decelerating. These developments Sources: StatisticsPortugalandcalculationsbyBancodePortugal. | Chart I.2.1• household disposableincome,thesavingrateremainedatrecordlowlevels. in consumercredit.Innominalterms,asprivateconsumptioncontinuedtogrowslightlyabove growth marked and income disposable household in increase continued a levels, confidence vehicle motor the component. Themomentuminprivateconsumptionoccursagainstabackgroundofhigh particular in year), on year (5.8% high remained nevertheless which I.2.1), a slight (Chart were consumption goods year durable in the growth lower of and consumption current in half acceleration first the in consumption private in developments Underlying Year-on-year rateofchange,inpercentage,andcontributions,percentagepoints of net exports togrowthof netexports Buoyant domesticdemandmitigatedthesmallercontribution -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 Developments inprivateconsumptionandcontributionsfromitscomponents Current Current consumption Durable g oods Private consumption Private 27. 26. extent, netfinancingflowsfromnon-residents. lesser a to and, entities) resident of liabilities of valuation and non-residents against assets of these developments mainly reflected a negative contribution of value/price changes (devaluation at -106%ofGDPtheendJune.AgainstabackgroundsignificantgrowthinnominalGDP, The international investment position (IIP) deteriorated by 1.1 p.p. from the end of 2017, standing an increaseindividendspaidtonon-residentsandadeclinereceived. continued to increase. In parallel, the deficit in the primary income balance increased, reflecting deteriorate yearonandthesurplusinservicesbalancerelatedtotraveltourism to continued balance goods non-energy and energy the 2018 of half first the in transactions, lending declined by 0.6 p.p., to a slight net borrowing position (0.2% of GDP). Turning to external borrowing of non-financial corporations increased by 0.9 p.p., to 2.1% of GDP, and household net in domesticinvestmentand,toalesserextent,declinesavings.Byinstitutionalsector,net increase an reflected developments of These year. half on year first p.p. 0.7 the of increase in an posting 2018, GDP of 1.8% reached position borrowing net economy’s Portuguese The enterprises decelerated. somewhat. In turn, manufacturing, construction, transportation and storage and services to differentiated less although compared with2017.Thegrowthrateintradeandaccommodationfoodservicesstabilised sectors, economic across based broadly was growth Economic Sources: StatisticsPortugalandcalculationsbyBancodePortugal. Chart I.2.2• rate ofchange,inpercentage,andcontributions,percentagepoints -20 -15 -10 improved by2.9p.p.(to-103.1%ofGDP),reflecting positivecontributionsfromnettransactionsandpricechanges. IIP the 2018, of quarter third the In transactions). net example, (for seasonal markedly are IIP the in developments determining factors of number A caution, asunderlyingthisanalysisisanon-negligible probabilityofrevision. with preliminary orprovisional NationalAccountsdatashouldbeinterpreted on thebasisof activity byeconomic sector The analysiseconomic of 10 15 -5 0 5 Machinery and equipment and Machinery Developments inGFCFandcontributionsfromitscomponents| 26 Cons truction e xc. Housing 27 Housing Transportequipment and other Year-on-year GFCF 37 Macroeconomic and markets environment 38 Banco de Portugal • Financial Stability Report • December 2018 Chart I.2.3• rate declinedto6.7%. However, main confidence indicators remained at high levels (Chart I.2.3) and the unemployment of protectionistmeasuresworldwide. adoption the (v) and tensions, geopolitical of aggravation the (iv) economies, market emerging of Italy, (ii) the upsurge in pressures in international financial markets, (iii) developments in a number in developments particular in reflecting area, euro the in uncertainty political (i) with associated mainly are risks downward Portugal, For months. six past the in intensified have but unchanged, a numberofemergingmarketeconomies, in particular2019. Riskfactorsremainqualitatively and 2018, in particularly economies, area euro main for prospects deteriorating reflecting issue, October the in published Forecasts I.2.1). 2018 (Table 2019 and 2018 for levels 2017 at remain to first half of the year. According to the International Monetary Fund (IMF), world growth is projected main advanced economies in the second half of the year, following the slowdown recorded in the in growth economic of stabilisation a to point 2018 of quarter third the for indicators Economic Source: StatisticsPortugal.|Notes:Balancesofrespondents.Seasonallyadjustedfigures.Quarterlyaverage.Lastobservation:2018Q3. indicators for economic activity and private consumption maintained a trend of gradual decrease. In the third quarter of 2018, economic growth continued to follow a declining path. Coincident and thehouseholdsavingratewasprojectedtoremainathistoricallylowlevels. maintained 2018-19 period. In addition, the net lending position of the Portuguese economy was projected to be to increase in 2018 and investment and exports were expected to be revised downwards for the of expenditurewereparticularlyrelevant.Inparticular,growthinprivateconsumptionwasprojected mentioned inthepreviousissueofthisReport,changesdevelopmentsmaincomponents decelerating, growth over the 2018-20 horizon (Table I.2.1). Compared with the March 2018 projections, although positive, to point to continued June in published economy Portuguese Projectionsthe for 28. -80 -70 -60 -50 -40 -30 -20 -10 Coincident indicatorsarecompositethat captureunderlyingdevelopmentsinyear-on-yearchangestherespectivemacroeconomicaggregate. intensified and inmostadvanced economies, butdownward risks have Economic growth isexpected toremain positive inPortugal 10 0 World Economic Outlook Economic sentimentindicator(ISE)andconfidenceindicators Consumer confidence provide a slightly downward revision compared with the April 2018 Industrial confidence Industrial Construction confidence Construction ISE (rhs) ISE 0 20 40 60 80 100 120 140 28

Russia Brazil China economies Emerging marketanddeveloping United Kingdom Euro area USA Advanced economies World economy Portugal Table I.2.1• the exceptionoffallsseen intheChinesestockmarket. with limited, been have – valuations asset financial in example, for – impacts actual but volatility, of riskpremiaworldwide.OngoingtensionsinUS-China trade relationscontributedtoincrease compression significant a to contributed still behaviours yield for search period, recent the in broadly accommodative,inparticulartheeuroarea.Although riskpremiaincreasedsomewhat global economic The the USwasmuchhigherthanexpectedbymarketparticipants, monetaryconditionsremained inPortugal. agents of economic environment remainedfavourableand,althoughthepace ofmonetarypolicynormalisationin conditions financing the on impact increase in the spreads of Italian sovereign debt. However, these developments had a moderate in thecurrenciesofanumberemergingmarketeconomies againsttheUSdollarandamarked observed weresharpfallsinUSstockexchangesFebruaryandOctober,strongdepreciations in theeuro developments main The markets. stock in volatility withdevelopments increased reflecting mostly I.2.4), (Chart line area in 2017, from increased markets financial Portuguese in financial international in markets andriskaversiontoanumberofmarketsegmentsgeographies.Theleveltension tension heightened of periods were there 2018, of course the Over 2.2 Economic Outlook the note“ProjectionsforPortugueseeconomy:2018 – 2020, March 2018. For theremaindergeographies the projectionshad as reference theWorld Outlook see Banco de Portugal, Sources: Banco de PortugalandIMF.|Notes:p–projected.TheprojectionsforthePortugueseeconomyrefertoJune 2018 update. Formoredetail, Spain Italy France Germany , October2018.** Revisions compared tothatpresentedintheFinancial Stability Report,June 2018. ForPortugaltheprojectionshadasreference Financial markets , IMF,April2018. GDP growth| Economic Bulletin , June 2018. The projectionsfortheremaindergeographies are those published by the IMFin the WorldEconomic Annual rateofchange,inpercentage 2017 4.7 2.4 2.2 3.7 2.8 1.5 1.0 6.9 1.7 3.0 1.6 2.3 2.5 2.3 2018 4.7 2.9 3.7 2.3 1.7 1.4 6.6 1.4 2.7 1.2 1.6 1.9 2.4 2 P 2019 4.7 1.9 2.5 3.7 1.9 1.8 2.4 6.2 1.5 2.2 1.0 1.6 1.9 2.1 P 2020 1.7 ------P 2017 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.0 0.1 0.3 0.0 0.0 0.0 0.0 0.0 Revisions** 2018 -0.2 -0.4 -0.2 -0.9 -0.2 -0.1 -0.3 -0.5 -0.6 -0.1 0.0 0.0 0.0 0.0 P -0.4 -0.1 -0.2 -0.2 -0.1 -0.2 -0.1 -0.4 -0.1 -0.1 2019 0.3 0.2 0.0 0.0 P 39 Macroeconomic and markets environment 40 Banco de Portugal • Financial Stability Report • December 2018 sustained convergence of inflation to levels that are below, but close to, 2% over the over 2% to, close but below, are that levels to inflation of convergence sustained through the summer of 2019, and in any case for as long as necessary to ensure the continued slightly, signalling, since the June meeting, that rates should remain “at their present levels at least changed itscommunication ECB The unchanged. remained rates interest key area, euro the In remains highlyuncertain. that process a Union, European the leaving Kingdom United the with associated developments to a limited extent and to recognise that the economic outlook may be considerably affected by and pace gradual a at be will rate interest the in increases future that signal to continued BoE above the 2% target, justified an increase in the reference rate. In monetary policy decisions, the Kingdom accelerated again United in the second quarter. These developments, together the with inflation remaining in activity economic 2018, of quarter first the in slowdown temporary a The Bank of England (BoE) increased Bank Rate by 25 basis points to 0.75% only in August. After in September2017–continuedtobeimplemented. announced– sheet balance FED’s the reducing gradually of plan the changes, rate interest with with a larger amount of debt denominated in US dollars, such as Argentina and Turkey. In parallel against mostcurrencies,revealing,inparticular,thevulnerabilityofemergingmarketeconomies dollar US the of appreciation an to led rates interest in increases Continued 2020. in 3.4% and by the Federal Open Market Committee points to monetary policy interest rates of 3.1% in 2019 September in published estimate median The year. the of end the by 2.25-2.5%, to rate, funds November, marketparticipantsstillassignedahighprobabilitytofourthincreaseinthefederal to referring longer no September), and the monetarypolicystanceremainingaccommodativesinceSeptembermeeting.Inmid- June March, (in times three funds points federal basis the 25 raised by (FED) rate Reserve Federal US The year. the of start the at participants The normalisationofUSmonetarypolicyproceededatafasterpacethanexpectedbymarket Sources: BancodePortugalandECB.|Notes:Dataonamonthlybasis.Lastobservation:October2018. Chart I.2.4• and Compositeindicatorofsystemicstress(CISS)fortheeuroarea 0.0 0.1 0.2 0.3 0.4 0.5 Monetary conditions remained broadly accommodative Dec. 13 Jun. 14 Dec. 14 Jun. 15 Dec. 15 Jun. 16 Dec. 16 Jun. 17 Dec. 17 Jun. 18 Jun. 17 Dec. 17 Jun. 16 Dec. 16 Jun. 15 Dec. 15 Jun. 14 Dec. 14 Jun. 13 Dec. Composite indicatoroffinancialstressforPortugal(ICSF) CF–Portugal – ICSF CISS – Euro area (rhs) area Euro – CISS

medium 0.0 0.1 0.2 0.3 recorded amorepronounceddownwardshiftatmedium-termmaturities. 12-month maturity. In turn, the euro area yield curve estimated from AAA-rated Treasury bonds rates interest market money euro background, remained negative,withlongermaturitiesincreasingslightlyfromMayonwards,inparticularthe this Against 75%). (around high remained an increasebyJune2019wassmall,whiletheprobabilityofend instruments, In theeuroarea,expectationsofanincreaseindepositfacilityrate,implicitmarket at stabilising 1.7% overthe2018-20horizon. inflation HICP to point 2018 September of exercise projection macroeconomic ECB the underlying projections particular, In 2019. and 2018 for slightly upwards revised been for euro area inflation by international institutions continue to be broadly aligned, to be continue institutions international by inflation area euro for 32. 31. 30. 29. the following pronounced more considerably became which correlations, ES/IT and PT/IT in decline gradual a was there mid-August, from (iii) crisis; the by affected less countries of that to closer came yield Irish the of behaviour the while Spain, and Portugal on effects contagion considerable had Italy in situation deteriorating the mid-August, to mid-May from (ii) Ireland; and Italy Spain, Portugal, of yields the between synchronisation relative a was there mid-May to year the of start the from (i) distinguished: be can periods different Three mixed. more were rates 10-year in developments crisis, debt sovereign the by affected more countries in turn, In less affectedbythesovereigndebtcrisis. volatility led to flight to safety flows, which resulted in a further decline in the yields of countries inUS Treasury todevelopments yields. AtthestartofOctober,deterioratingsituationinItalyandanincreasestockmarket related effects contagion reflecting again, increased yields path. However, declining from mid-August–andalthoughanumberofeuroareaeconomicindicatorsdecelerated ona embarked debt crisis sovereign the by affected less countries Following theincreaseobservedatstartofyear,10-yeargovernmentbondyields term”. f rud .% n h cr piae osmto deflator consumption private core the in 2.0% around of inflation excluding energy and food remained slightly above 1%, compared with a rate of change Prices (HICP) reached 2.1% in September. Despite continued economic growth, underlying HICP the energycomponent.Theyear-on-yearrateofchangeinHarmonisedIndexConsumer from contribution a positive reflecting mostly 2018, throughout accelerated inflation area Euro confirm expectations. in September, with the objective of ending net purchases by the end of the year if inflation data confirmed and June in announced was October from billion €15 to billion €30 from purchases On thebasisofprobabilitiesanincreaseimplied inswapagreementsontheeuroareaovernight interestrate. ECB, OECD, European Commission,IMF,interalia. The officialnameis CorePCE(PersonalConsumption Expenditure) Index. the horizonofnetassetpurchases”. In the April meeting, expectations were that key ECB interest rates would “remain at their present levels for an extended period of time, and well past on theeuro area sovereign debtmarket The deteriorating situation inItalyhadalimitedimpact 29 As regards the Asset Purchase Programme (APP), a reduction of the pace of the net asset 32 were adjusted over the course of the year. In mid-November, the probability of 30 f h Uie Sae. Projections States. United the of

31 having 41 Macroeconomic and markets environment 42 Banco de Portugal • Financial Stability Report • December 2018 stability) – and an improved outlook for the banking sector. Underlying developments in the euro areasovereigndebtmarketwastheongoingpublicsectorpurchaseprogramme(PSPP). in developments Underlying sector. banking the for outlook improved an and – stability) indicators – including government debt developments (Chart I.1.13, Section 1.2 Risks to financial fiscal favourable Portugal, in activity economic buoyant a reflecting year, the of half second the in visible was risk sovereign Italian and risk sovereign Portuguese between differentiation The 34. 33. 2018 there was an increased issuance of euro area non-preferred senior debt securities May, inparticularforsubordinateddebt,whichentailsahigherrisk.Similarlyto2017,throughout Debt issuance costs increased considerably with the worsening situation observed in Italy in Portugal. in than buoyant more be to continues securities debt via funding bank area, euro the In I.2.5). (Chart banks European and banks Portuguese by issued securities between narrowed differential the observed, volatility the despite onwards, July From features. similar with banks European by issued securities of set a of trajectory the accompanied market secondary the in banks Portuguese by issued securities debt on yields year, the of half first the In respectively. Banco Novo and CGD by million €400 and million €500 to amounting issuances 2 Tier notably mostdebt, subordinated issue to continued banks Portuguese turn, In residual. remained debt increased slightly. In Portugal, similarly to the past few years, the issuance of marketable private corporations non-financial area euro by securities debt of issuance gross decelerating, despite after the considerable compression ofthesecondhalf2017.FromJanuaryto September 2018, segments, which may be considered a positive development from a financial stability perspective, Risk premia increased graduallyin the corporate debt market, in particular inlowercredit quality category. investment speculative the from Portugal removed Moody’s and positive to stable grade investment- rating. Revisions its for Portugal went maintains in the Italy opposite direction. three, S&P changed all its outlook In from notch. one by rating its lowered S&P and negative to stable from outlook their changed S&P and Fitch debt. sovereign Italian of risk long-term to From theendofAugust,threemainratingagenciespublisheddecisionsonmedium significantly inItaly(ChartI.1.12,Section1.2Riskstofinancialstability). widened and Spain, and Portugal in considerably change not did Germany, particular in crisis, the by affected less countries the vis-à-vis differential yield bond government 10-year the year, uncertainty surroundingtheItalianStateBudget.Despiteaslightvolatilityovercourseof cost thanAT1andTier2instruments. are eligibleforcompliancewiththesubordinatedcomponent ofMRELrequirements,atalower transposing Directive(EU)2017/2399wasapproved bytheCouncilofMinistersatstartNovember. law draft The liabilities”. senior other below but instruments, funds own as qualify not do that liabilities subordinated and instruments funds own 2017. The Directive requires, for example, that Member States “create a new class of non-preferred senior debt that should rank in insolvency above These instruments were created by Directive (EU) 2017/2399 of the European Parliament and of the Council, which entered into force on 28 December The latestratingdecisiononSpainwasmade in April2018. increased throughout 2018 Risk premia associated withdebtofEuropean firmsandbanks 34 , which 33

with thecontagionofemerging marketeconomies. Chinese the economy and negative effects associated with tensions in US-China in trade relations and slowdown a of signs reflecting mid-November, to January from 19% by dropped Index over thecourseof2018was thesharpdropinChinesestockprices.TheShanghaiComposite passive investment strategies,amplifyingmarketchanges.Oneof themainstockmarketdevelopments follow and/or levels low at remaining volatility on bet which orders products sell in investment increase for an by amplified been have to expected is drop price the February, of economic and financial developments. As was the case with the correction observed at the start to reflect an environment of heightened risk aversion and an overreaction by investors to negative downward revisionoftheIMF’sworldeconomicoutlook, magnitudeofthecorrectionseems support fundamentals economic of these developments, for example the significant number yield increase in the previous week a or the slight Although month. that in 8% by dropping 500 S&P the with markets, financial international in turbulence renewed saw October of start The closely followedthedynamicsofEuropeanmarket. market stock Portuguese the turn, In sovereign. the and companies insurance banks, between with theworseningsituationinItalyandrenewedfearsaboutsystemicimpactoflink associated closely banks, European of performance negative the reflected partly developments accompanied by considerable volatility (Chart I.1.10, Section 1.2 Risks to financial stability). These trend, downward a by followed mid-May, until observed was recovery a economies, European major In I.2.6). (Chart growth economic sound and earnings corporate improved by supported September, to April from gains significant accumulated and path upward an resumed indices in majorstockmarketindiceswererathermixedfortheremainderofyear.MajorUS stock marketvolatilityremainedatlevelsabovethoseobservedin2017.Developments After thesharpfallinUSstockexchangesatstartofFebruary,whichthenspreadworldwide, – December2022,CGDdebtsecuritiesJune2023andNBsecurities-July2023). securities debt (BCP 2022 March – securities debt CGD of that to close date redemption early the to up maturity remaining a with euro, in issued banks, the on yield The 2018. November 16 observation: European of securities debt Last 2) (Tier AT1 (15) 6 of yields, market secondary basis. of average weighted a to corresponds 2) (Tier AT1 of daily sample banks European a on Data Notes: | Portugal. de Banco by calculations and Bloomberg Sources: Chart I.2.5• 10 12 geographies Stock market developments were rather mixed across 0 2 4 6 8 Jan. 17 Yields onAT1andTier2debtsecuritiesinthesecondarymarket| Apr. 17 G Tier 2 CGD – AT1 – CGD Jul. 17 Jul. Oct. 17 Oct. ooBno–Tier 2 Novo Banco – AT1 – banks European Jan. 18 Apr. 18 Jul. 18 uoenbns–Tier2 – banks European Tier2 BCP – Per cent Oct. 18 Oct. 43 Macroeconomic and markets environment 44 Banco de Portugal • Financial Stability Report • December 2018 slightly comparedwiththefirst quarter. down slowing 2018, of quarter second the in terms real in 10.1% by grew prices house 2017, of by 33% in real terms, after dropping by 26% from 2007 to 2013. Compared with the same period in thesecondquarterof2013. Sincethen,anduptothesecondquarterof2018,prices increased In the first half of 2018, house prices in Portugal remained on the recovery path that had started encourage thesupplyofrentalhousing. and tax system or market rules). This would make it safer to invest in this type of asset and might and justice the regards as example, (for stabilised and optimised be to market the of functioning the supply between adjustment Asustained demand intherealestatemarketalsorequiresinstitutionalframeworkwithanimpacton stability. financial to detrimental particularly may mitigatetheriskofinteractionbetweenhousepricesandbankloans,whichtendstobe agreements) credit consumer and guarantee, equivalent or mortgage a by secured agreements credit property, immovable residential to relating agreements credit (specifically, consumers for agreements credit new on Portugal de Banco by issued Recommendation the with Compliance observed beforetheinternationalfinancialcrisis. have purchase for house loans of flows maintained theirrelativeimportanceintotalsalesamounts,butstandmarkedlybelowthelevels gross addition, In I.1.16). (Chart trend downward a Despite thepricedynamics,outstandingamountofloansforhousepurchaseisstillon geographies andmarketsegments. to becontained,buttheremaysituationsofamorepronouncedovervaluationincertain is evidenceofaslightovervaluationinaggregateterms.Atpresent,thisexpected Against the background of an ongoing recovery in residential real estate prices in Portugal, there 2.3 Source: ThomsonReuters.|Notes:Dataonadailybasis.Lastobservation:16November2018. Chart I.2.6• 105 115 125 135 increasing a recovery in thepastfew years, withprices andtransactions In Portugal,theresidential real estatemarket hasexperienced 75 85 95 e.1 a.1 u.1 e.1 e.1 a.1 u.1 Sep.18 Jun. 18 Mar. 18 Dec.17 Sep.17 Jun. 17 Mar. 17 Dec.16 Residential realestatemarket Stock marketindices| PSI-20 Eurostoxx 50 December 2016=100 Eurostoxx Bancos S&P500 Shanghai Composite Index been pickingup,althoughataslowerpacethantransactions inexistingdwellings. this period.Inlinewithanincreaseincompleteddwellings, transactionsinnewdwellingshave of theseries. start the since level highest the reached and amounts) sales in 30% of increase (an earlier year the total of 2018, half number of real estate transactions increased first by around 20%, compared with the same period the a In I.2.8). (Chart transactions housing of amount the and in number increase sharp a of context the in occur to continued growth price house Portugal, In impact ofidiosyncraticdomesticfactors. growth andcontinuedverylowinterestratesforaprotractedperiodoftime,isdominatingthe and scopeofthesedevelopmentssuggestthattheimpactsharedfactors,suchaseconomic Italy, Greece andFinland–postedpositiverealratesofchangeinhouseprices.Thepersistence of exception the with – I.2.7) (Chart analysis under countries all 2016, of start the Since Belgium, France,Finland,GermanyandtheNetherlands.AggregationisbasedonnominalGDP. include Greece, Ireland, Italy, Slovenia and Spain. Cyprus is not considered for lack of data. The countries less afected by the crisis considered are Austria, crisis the by afected more countries other The Note: | Bank. Central European and Development and Cooperation Economic for Organization Sources: Chart I.2.7• was notthecaseinPortugal. by asubstantialovervaluationinthepre-crisisperiod,followedanabruptadjustment,which Ireland and Spain. Indeed, the residential property market in these countries was characterised from developments in other countries that were also affected by the financial crisis, in particular different very were period pre-crisis the in Portugal in prices house in developments However, I.2.7). (Chart countries area euro of number large a across based broadly was 2018 of quarter In Portugal, the acceleration in house prices in real terms observed from mid-2013 to the second 35. 100 120 140 160 180 Statistics Portugalprovidesdatafrom2009onwards. 60 80

1999Q2 1999Q4 2000Q2 35 Real HousePrices| Transactions in existing dwellings accounted for 85% of total transactions during Euro area 2000Q4 2001Q2 2001Q4 2002Q2 2002Q4 2003Q2 Portugal 2003Q4 2004Q2 2004Q4

2005Q2 Index 1999Q1=100 2005Q4

Other countries more afected by the crisis the byafected more countries Other 2006Q2 2006Q4 2007Q2 2007Q4 2008Q2 2008Q4 2009Q2 2009Q4 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 Countries less afected by the crisis by the less afected Countries 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 2016Q2 2016Q4 2017Q2 2017Q4 2018Q2 45 Macroeconomic and markets environment 46 Banco de Portugal • Financial Stability Report • December 2018 Chart I.2.9•HousepricesinPortugal–Existingandnewdwellings| negative andsignificant,asobservedsince2016. remained dwellings existing and new of prices in growth the between differential The dwellings. – which has been observed since mid-2014 – continued in the first half of 2018 (Chart I.2.10). (Chart 2018 of half first the in continued – mid-2014 since observed been has which – Across thecountry,trendofanincreaseinnumber andaveragevalueoftransactions Source: StatisticsPortugal. I.2.9). (Chart 11.2% of the same period of 2017, while prices of new dwellings grew by 6.3%, posting an overall increase with compared 12.6% by increased dwellings existing of prices 2018, of quarter second the In Source: StatisticsPortugal.|Note:six-monthfiguresareannualised. Chart I.2.8• 36. -15 -10 100 120 140 160 180 The housepriceindexpublishedbyStatistics Portugal isachain-linkedLaspeyres-typehedonic price index. 10 15 -5 20 40 60 80 0 5 0

2010 Q1 2017 2016 2015 2014 2013 2012 2011 2010 2009 2010 Q2

2010 Q3 Residential realestatetransactionsbysegment| 2010 Q4 2011 Q1

2011 Q2 36 2011 Q3 new for particular in quarter, first the with compared decelerated Prices 2011 Q4 2012 Q1

All dwellings All 2012 Q2 2012 Q3 2012 Q4

2013 Q1 Existing 2013 Q2 2013 Q3 2013 Q4 2014 Q1

Existing 2014 Q2 2014 Q3 New 2014 Q4 2015 Q1 2015 Q2

2015 Q3 Thousands 2015 Q4 New 2016 Q1

2016 Q2 Annual rateofchange 2016 Q3 2016 Q4

2017 Q1 2018H1 2017H1 2017 Q2 2017 Q3 2017 Q4 2018 Q1 2018 Q2

38. 37. of euroareacountries. set a for measures two publishes and calculates ECB the undervaluation/overvaluation, of signs In ordertoassesswhetherhousepricesareinlinewitheconomic fundamentalsorareshowing which addedtoasearchforyield,specificallynon-financial assets. factors, this contributed to lower risk perceptions among domestic and international investors, declining considerably and consumer confidence rising to record high levels. unemployment Together with other with growth, continued experienced has economy Portuguese the conditions, are similar to those of 2008, and (iii) since mid-2013, together with very accommodative monetary after a significant drop in prices observed from 2007 to 2013, (ii) the levels reached in real terms Within this context, it is important to point out that (i) the recovery seen in the past adequacy ofthelevelsthathavealreadybeenreached,comparedwithunderlyingfundamentals.few years occurs the about questions raises prices estate real residential Portuguese in momentum recent The Portugal inthefirsthalfof2018. mainland in out carried transactions total in region each in transactions of weight the signals circles the of size the Note: | Portugal. Statistics Source: Portugal. in metre square per dwellings family of sales of value median the in 8% of increase year-on-year a with consistent is transactions of value average the in increase This Area. Metropolitan Porto of 2018. The average value of transactions increased overall, in particular in Algarve and the quarter second the in terms quarterly in sales record posted Portugal mainland of regions All prices against economic fundamentals until the first half of 2013 (Chart I.2.11). Since then and then Since I.2.11). (Chart 2013 of half first the until fundamentals economic against prices Chart I.2.10• second quarterof2018,comparedwiththesameperiod2017. and aBayesianinverteddemandmodel.Forfurther details,seetheJune2011andNovember2015issuesofECB The twomeasuresusedarecalculatedfrom:the ratioofhousepricestodisposableincomepercapita;theprice-to-rentratio;anassetpricingmodel dicadores&indOcorrCod=0009490&contexto=bd&selTab=tab2&xlang=en. Data from the first quarter of 2016 onwards available on the Statistics Portugal website at: of houseprices inPortugal inaggregate terms There isevidence ofaslight,althoughcontained, overvaluation Amount of transactions 10 15 20 25 30 35 40 37 10 Lisboa, Porto and Faro stood out in this indicator, growing by more than 20% in the in 20% than more by growing indicator, this in out stood Faro and Porto Lisboa, .ProM .2 ot,ecuigProM .3. A. M. Porto excluding North, 2. A. M. Porto 1. Transactions infamilydwellings–changesfrom2017H1to2018H1| 38 For Portugal, these measures signal an increasing undervaluation of undervaluation increasing an signal measures these Portugal, For 15 3 1 Number of transactions ofNumber Algarve 20 5 4 4. https://www.ine.pt/xportal/xmain?xpid=INE&xpgid=ine_in 6 M. A. M. Lisboa 2 25 5. Centre 6. Alentejo 6. Centre 5. Financial StabilityReview Per cent . 30 47 Macroeconomic and markets environment 48 Banco de Portugal • Financial Stability Report • December 2018 household indebtednessratios. in fall ongoing the to contributing thus 2018, of quarter third the in 1% to close standing trend, outstanding amountofbankloansforhousepurchasehas followedanincreasinglylessnegative and slowed down compared with the end of 2017. In turn, the year-on-year rate of change in the 2017, of period same the from 27% around by increased loans new of flows whole, a as September 2018 in ending quarters four the For I.2.12). (Chart levels pre-crisis below considerably house for loans bank purchase maintainedtheupwardtrendobservedsince mid-2013,althoughtheyremain new of flows gross 2018, of quarters three first the of course the Over determinants ofresidentialrealestatepricesisuncertain. evolved considerably in Portugal in the past few years. However, their treatment as fundamental and theroleplayedbytourismindetermininghousingsupplydemand.Bothfactorshave methodologies mightnotappropriatelycapturetheparticipationofnon-residentsinmarket these particular, In period. recent the in Portugal in overvaluation price house of potential phenomena assess to difficult particularly is it that fact the with together uncertainty, of degree However, theestimatesderivedfrommethodologiesusedarecharacterisedbyacertain demand andsupplyindicatorsassetpricingmodels,positivevaluessignalovervaluation. positive values signal overvaluation. (**) The averagepricedeviationisasyntheticmeasurebasedonfourvaluation methods, puttingtogetherhousing Source: European Central Bank - Statistical Data Warehouse. | Note: (*) Residuals of a valuation model estimated on the basis of economic fundamentals, estate market| Chart I.2.11• fundamentals, whichsuggestsaslightovervaluationinaggregateterms. signal aslight–althoughlimitedmisalignmentofresidentialrealestatepriceswitheconomic trend andhavestartedtofollowanupwardpath.Morerecentdevelopmentsinthesemeasures accompanying theincreaseinhouseprices,thesetwoindicatorshavereverseddownward -20 -18 -16 -14 -12 -10 before theinternationalfinancialcrisis sales amountsbutare considerably below thelevels observed Credit flows have maintainedtheir relative importanceintotal -8 -6 -4 -2 0 2 4 6

2007Q1 2007Q2 2007Q3 2007Q4

2008Q1 Estimates ofpriceover/undervaluationinthePortugueseresidentialreal 2008Q2 Per cent 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 Valuation model residuals* 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 Average pricedeviation** 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2016Q4 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 2018Q2 amount oftransactionsinfamilydwellings Chart I.2.13• households withtheirownequitymayaccountforagreatershareoftransactions. foreign investment,realestatepurchasesbyotherresidentsectorsorpurchased based across regions, but more important in the Lisboa Metropolitan Area and Algarve, where 39. Sources: StatisticsPortugalandBancodePortugal. y on t hueod b bns n Portugal. in banks by households to loans by financed not dwellings of number the in increase an of result a mainly was sales total in loans (Chart 40% to close of 2016 I.2.13). This is clearly of below the level observed in 2010 (around 65%). The end decline in the share of the at reached level the at quarters recent in stabilised dwellings family in transactions of amount the to loans housing new of flows gross of ratio The Source: BancodePortugal. Chart I.2.12•Grossflowsandstocksofhousingloans| 1,000 2,000 3,000 4,000 5,000 6,000 Economic Bulletin For furtherdetails,seeBox5“Recentdevelopments inthesaleoffamilydwellings and loans to households for house purchase: regional heterogeneity, Per cent 0 10 20 30 40 50 60 70 80 0 2003Q3 2009Q1 2004Q1

, BancodePortugal,October2018. 2009Q2

Amount of transactions (right-hand scale) 2004Q3

2009Q3 Amount oftransactionsandratiogrossflowsnewhousingloanstothe 2009Q4 2005Q1 2010Q1 2005Q3

2010Q2 Quarterly flows of credit granted 2006Q1 2010Q3 2010Q4 2006Q3 2011Q1 2007Q1 2011Q2 2007Q3 2011Q3 2008Q1 2011Q4 2012Q1 2008Q3 2012Q2 2009Q1 2012Q3 2009Q3 2012Q4 2013Q1 2010Q1 2013Q2 2010Q3 Ratio of gross flows of new housing loans to the amount of transactions amount to the loans housing new of flows gross of Ratio 2013Q3 39 2011Q1

2013Q4 Comparedwith2010,thisdeclineisbroadly 2011Q3 2014Q1

2014Q2 Stock of housing loans(right-hand scale) 2012Q1 2014Q3 2012Q3

2014Q4 EUR millions 2013Q1 2015Q1 2015Q2 2013Q3 2015Q3 2014Q1 2015Q4 2014Q3 2016Q1 2015Q1 2016Q2 2016Q3 2015Q3 2016Q4 2016Q1 2017Q1 2016Q3 2017Q2 2017Q3 2017Q1 2017Q4 2017Q3 2018Q1 2018Q1 2018Q2 2018Q3 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 0 20,000 40,000 60,000 80,000 100,000 120,000

EUR millions 49 Macroeconomic and markets environment 50 Banco de Portugal • Financial Stability Report • December 2018 residents, non- by purchased were territory Portuguese the in sold properties estate real of 8% 2017, In estate byinvestors,particularlyforlocalaccommodation. the real estate market is also the resultofbuoyanttourism,which has boosted demandforreal regular residentsandtheapprovalin2012ofGoldenVisaregime.Therecoveryobserved developments arelinkedtotheintroductionin2009ofamorefavourabletaxregimefornon- 41. 40. has investment Non-resident grown since2012bothintermsofnumberpropertiesandtransactionamounts. market. estate real Portuguese the in momentum the behind As mentioned,demandforrealestatebynon-residentscontinuedtobeanimportantfactor prices andbankloans,whichtendstobeparticularlydetrimentalfinancialstability. with the macroprudencial recommendation may mitigate the risk of interaction between house compliance addition, In income. borrowers’ and/or assets estate real of prices the on shocks increase inshort-terminterestrates,usuallyusedasreferencerates–andofpotentialadverse a gradual through specifically – normalisation policy monetary a of effects the accommodate more resilientcreditinstitutions.Inparticular,itwillhelpthesetwosectorstoeasily to contribute consequently will and funding will sustainable with theRecommendation obtain households Portuguese help Compliance relevant. isparticularly 2018, July since effect in agreements secured by a mortgage or equivalent guarantee, and consumer credit agreements), for consumers (specifically, credit agreements relating to residential immovable property, credit agreements credit new on Portugal de Banco by issued Recommendation the background, this interest ratespreadsonloansandotherstandardsusedbybanksintheirtransactions.Against of creditstandardsonloanstohouseholdsforhousepurchase.Thisresultsinacompression estate market increase competitive pressure among credit institutions, which leads to an easing The currenteconomicenvironment,thelow levels of interest rates and developments in the real value hasbeengraduallydecliningsince2014(from16%inthatyear). respectively in terms of number and value. However, the share of non-residents in the total sales 23% and 19% by grew investment 2016, with Compared year. that in out carried transactions total of value average the than higher 50% almost was non-residents to sold properties estate The classificationbyStatisticsPortugalasnon- resident takesintoaccountthebuyer’scountry ofresidence. UESmodo=2&xlang=en andrefertothe2012-17 period. on available are Data mixed. and Statistics Portugalwebsiteathttps://www.ine.pt/xportal/xmain?xpid=INE&xpgid=ine_destaques&DESTAQUESdest_boui=344332942&DESTAQ rural urban, categories: three into grouped are and purposes other and manufacturing trade, housing, Statistics Portugalrecentlypublisheddata on thepurchaseofrealestatebynon-residents.Publisheddatacoverp roperty for market inPortugal,althoughataslower pace Demand by non-residents continues toboostthereal estate 41 corresponding to 12% of the sales value (Chart I.2.14). The average value of real of value average The I.2.14). (Chart value sales the of 12% to corresponding 40 These (Golden Visas)grewby18%,specificallyforthepurchase ofrealestate. amount invested in real estate as a result of residence permits granted for investment purposes From theendof2017tothirdquarter2018,number ofpermitsgrantedandthe Source: StatisticsPortugal. Chart I.2.15• Area, whichtogetheraccountedfor78%ofthetotalsalesvaluebynon-residentsinPortugal. highest number of transactions with non-residents were Algarve and the Lisboa Metropolitan the with regions the terms, regional In I.2.15). (Chart amounts transaction of 36% for accounted In 2017non-residentinvestorsmainlycamefromFranceandtheUnitedKingdom,whichtogether Source: StatisticsPortugal. Chart I.2.14• 42.

september18.pdf Statistical dataavailable on thewebsiteof thePortugueseImmigrationandBordersServiceathttps://www.sef.pt/en/Documents/Mapa_ARI_EN_ EUR millions 10,000 15,000 20,000 25,000 5,000 0 . The Netherlands, Country ofresidencenon-residentinvestorsinrealestate–2017| Investment inthePortugueserealestatemarketbyinvestororigin 2012 Belgium,4 Non-resident Others, 25 USA, 3 Sweden, 4 4 2013 Germany, 5 Switzerland, 6 2014 Resident 2015 China, 6 Share of non-resident (right-hand scale) (right-hand non-resident of Share France, 20 Brasil, 7 2016 United Kingdom, 42 2017 16 Per cent 0 2 4 6 8 10 12 14 16 18

Per cent 51 Macroeconomic and markets environment 52 Banco de Portugal • Financial Stability Report • December 2018 October –ofnew,morestringent,rulesonaccesstothisactivity. of end the at force into entry subsequent and – July in approval the by influenced been have to 43. Source: StatisticsPortugal.|Note:six-monthfiguresareannualised. Chart I.2.16• significant most the increase (63%). posted Area Metropolitan Lisboa the 20%, than more by grew Portugal completions grew by 37% year on year in the first half of 2018. Although all regions in mainland since 2016 observed path the on (Chart I.2.16). Following an increase of 25% continuing in 2017 compared with of 2018, 2016, the number of housing half first the in increase to continued reflect developments in the supply of this type of property. The number of housing completions In addition to demand for housing, the price dynamics in the residential real estate market the totalrecordedin2017. exceeding already 2017), of period same the with compared terms aggregate in (42% Faro and in the first three quarters of 2018. Registrations grew considerably in the districts of Lisboa, Porto trend ofanincreaseinthenumberregistrationsforthisactivitythatbegan2014continued main touristareas,isrelatedinparticularwithincreasedactivitylocalaccommodation.The country’s the in particularly Portugal, in market estate real residential the in momentum strong The https://rnt.turismodeportugal.pt/RNAL/ConsultaRegisto.aspx?Origem=CP&FiltroVisivel=True at Portuguese in available accommodation), local of registry (Portuguese Local Alojamento de Nacional Registo of website the on data to According contained inhistoricalterms Housing supplyshowed signsofarecovery, despiteremaining 10 20 30 40 50 60 70 0 0720 0921 0121 0321 0521 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 Completed andlicencedbuildings| 43 However,thedynamicsobservedinthirdquarterareexpected Building permits Building Thousands Completed buildings . 0712018H1 2017H1 more significantovervaluationincertaingeographiesand marketsegments. situations of be may there terms, aggregate in situation market’s the reflect significantly yet not valuations in real estate when taking on exposures to real estate assets. Although this does In addition,creditinstitutionsshouldadequatelyassessrisksarisingfrompronounced the constructionsector. responses onthesupply side toincreasesindemand,relatedthelongproductionprocess This issueisparticularlyrelevantintherealestatemarket,asthereatimegapbetween past few years, household indebtedness ratios in Portugal remain above the euro area average. of demandfromnon-residents.Itshouldbenotedthat,despiteaconsiderabledeclineinthe sustainability the and trends demographic creditworthiness, household as such demand, affect to thecurrentenvironment–visibleinrecentpricedynamicsbutalsostructuralaspectsthat In thisrespect,itisimportantthatfuturerealestatesupplytakesintoaccountaspectsrelating supply ofrentalhousing. or market rules). This would make it safer to invest in this type of asset and might encourage the estate market to be optimised and stabilised (for example, as regards the justice and tax system This would also require the institutional framework with an impact on the functioning of the real stability. financial and economy the in allocation resource of efficiency the about concerns as sustained adjustmentbetweensupplyanddemandthatwouldaddresssocialconcerns,aswell In view of the buoyant residential real estate market, it would be important to promote a buildings. residential new predominantly completions, housing and permits building total of 25% to close stood housing rehabilitated of share the Nevertheless, 31%. reached Area Metropolitan Lisboa the in change of rate the 2017, of period same the from 3% by increased only 2018 of half first the numberofbuildingsinentireterritorywhererehabilitationworkswerecompleted geographies, where pressure is higher on the demand side. Against this background, although of supply,inparticularwherethisresultsincreasedsupplyforcertainqualitysegmentsand In addition, the rehabilitation of existing buildings will tend to contribute to changes in the pattern observed beforethemostrecentfinancialcrisis. levels the below significantly stands permits building and completions housing of level current in the next few quarters, which may dampen the upward pressure on prices. However, the completions, the number of housing completions is expected to continue to increase considerably been positiveandincreasingsince2015.Giventhelagbetweenbuildingpermitshousing has differential This completions. housing of number the and permits building of number the at a similar level to that of housing completions. Consequently, the differential widened between 2018 of half first the in change of rate the with increased, also permits building of number The 44. creating analternativeforinvestingsavings). agents. This may have positive effects on the economy (e.g. by reducing costs associated with geographic mobility, promoting urban regeneration and economic for choice the broaden to potential the has rights, tenant and landlord between balance appropriate an with market, rental functioning A 44 53 Macroeconomic and markets environment 54 Banco de Portugal • Financial Stability Report • December 2018 budget balancewasrevisedupwards,exceptforFrance, whichisprojectedtorecordamore the crisis debt sovereign the by affected less countries In projections. spring the with compared euro area countries in2018 and 2019 are somewhat more heterogeneous across the countries in developments balance budget on Commission European the by projections recent most The value registeredintheStatebudgetfor2019. a deficit of 0.6% of GDP (keeping the spring forecast unchanged), which is 0.4 p.p. higher than the in 2017), mainly reflecting a decrease in interest expenditure. For 2019, the Commission forecasts 46. 45. operations in2017and,althoughtoalesserextent,2018. non-recurrent by affected were p.p.) (-4.2 developments balance half budget first Year-on-year 2018. the of in cent per 1.9 was basis accounts national a on deficit government general The shocks oneconomicactivityandfinancingconditions. trend of adownward general government indebtedness. Such efforts are essential to diminish vulnerability to adverse toensure order in efforts adjustment budget structural maintain must Portugal stability). financial to Risks 1.2 (Section contained relatively were – Portugal including – countries area euro other affecting effects contagion However, Italy. in developments political the reflecting May, since increased markets debt sovereign area euro in stress The conditions. financing favourable of maintenance the from and area, euro the and Portugal in environment economic a favourable from benefit to continued financing government general 2018, During 3.1 3 FinancialpositionoftheGeneral GDP in 2018. The European Commission’s autumn forecasts also point to the budget deficit standing at 0.7% of 2019 for Report Budget State (OE 2019). the in reiterated and 2018-22) (PE Programme Stability the in half of the year was consistent with the official target for the whole year (0.7% of GDP), as defined GDP ratio. Taking into account the intra-annual profile of the last few years, the deficit of the first expenditure to interest and expenditure primary in declines reflecting GDP, of p.p. 1.1 fell deficit autumn 2018. This representsa0.2p.p.improvementon thespringforecast.Forfurtherdetails,seeEuropeanCommission,Economic Forecast, general governmentbalance,seeBancodePortugal, due to their magnitude. For further details on general government financing in the first half of 2018, including the set of non-recurrent factors affecting 2018 in p.p.) (0.4 Banco Novo into and 2017 in GDP) of p.p. (2.0 CGD into injections capital of impact the particular in emphasise to important is It factors Budget balance continued toimprove excluding non-recurrent Non-financial Private Sector Government andofthe General government 46 As for the structural balance, an improvement of 0.4 p.p. is expected (after 0.8 p.p. Economic Bulletin , October2018. 45 Excluding these transactions, the transactions, these Excluding

to 2017| Chart I.3.1• ageing. of pressures to increase expenditure on pensions and healthcare associated with population priority should be given to an effort to contain primary current expenditure, especially in ainvestment over context public of quality the medium term which will not jeopardise the potential growth of the economy. Furthermore, and level a ensure should strategy consolidation fiscal The remaining virtuallyunchangedintherecentpast. On the other hand, since 2013 total revenue as a ratio of GDP has also shown a downward path, levels of public investment, similarly to other countries with high levels of publicindebtedness. for non-recurrent operations,hasbeenoccurring in a context of maintenance of historically low adjusted balance budget the in developments by measured situation, fiscal the on improvement debt with more favourable price conditions than repaid debt. At the same time, the recent market new of issuance the reflecting balance, budget the on improvement an to continuously points ofGDP 48. 47. recurrent measures. non- other and measures support sector financial include transfers Capital Note: | Portugal. de Banco by calculations and Portugal Statistics Sources: negative balancein2018. ah Cat I.3.1). (Chart path and despite slight nominal 2013, growth, the Since ratio of primary current expenditure. expenditure to government GDP shows by restraining a marked downward namely effort, consolidation fiscal remarkable a requiring keeps Portugal in level indebtedness government general high The within theframeworkofpreventivearmStabilityandGrowthPact. continue toshowastructuralbudgetbalancefallingshortofthemedium-termobjectiveset most euro across stance area countries. In this context, a significant number of countries, including Portugal, will policy probably fiscal expansionary an reflecting 2019, in deterioration slight a whole,theprojectionkeepsindicatingvirtualstabilisationofbalancein2018andits mainly for2019,andtoalesserextentinSpain.Instructuralterms,theeuroareaas -4 -3 -2 -1 For furtherdetailsonpublicexpenditureinstructural terms,seeBancodePortugal,EconomicBulletin In Germanytherewas anupwardrevision in2018 (+0.4p.p.)andasmallerdownwardrevision in2019(-0.2p.p.). 0 1 2 3 4 5 6 7 Difference ineachyearvis-à-vistheaveragefigurefor1998-2007period,percentage revenue Total Developments ingeneralgovernmentrevenueandexpenditurefrom2008 48 Also,since2014developmentsininterestexpenditure have contributed 47 Primary current Also,therearedownwardrevisions of the budget balance in Italy, expenditure investment Public transfers Capital , May2018. expenditure Interest 55 Financial position of the General Government and of the Non-financial Private Sector 56 Banco de Portugal • Financial Stability Report • December 2018 Chart I.3.2• of portfolio Portugal’s de Portuguese governmentdebtmaintainedgrowthsimilartothatobservedintherecentpast. Banco (PSPP), programme purchase sector public ECB’s the under considerable increase in 2016. Despite the reduction in the volume of monthly net purchases financing turn, In from insurance corporations and pension funds kept its marked downward path, following a market. secondary the in in securities adecrease debt government from Portuguese benefited on have yields portfolios whose banks, by gains capital of realisation relatedto partly was reduction This securities. debt of form the in financing in particularly 2017, with thesameperiodofpreviousyear.Thiscontrastsafallduringsecondhalf compared sharply less though 2018, of half first the in increased banks resident from Financing first halfoftheyear(ChartI.3.2). 50. 49. ICFP referstoInsurancecorporationsandpensionfunds. Source: Banco de Portugal. | Notes: Households’ deposits in the general government comprise savings certificates and Treasury certificates. The acronym mostly retailinstruments, through financing government general of 2018 placed withhouseholds, half first the In of floating rate bonds. rate floating of certificates. Treasury particular in On the other hand, instruments, there were residual net redemptions retail of savings certificates and no new of issues subscriptions in the new a decrease on reflected remuneration have may This years. to recent in figure compared period same the lower in observed asignificantly that recorded certificates Treasury of subscriptions Net -10000 more diversifiedsetofinvestors,i.e.notexclusively targetedathouseholdsavings. a with placed bonds rate Floating years. seven approximately of maturity a with billion €1 totalling bonds rate floating new issued IGCP) – Pública Dívida da e Tesouraria da Gestão de (Agência Agency Management Debt and Treasury Portuguese the July in However, 2018. June to reference with Report this of publication of date the on available Accounts Financial National the on based is flows financing government general of analysis The In year-on-yeartermsoranalysingtheyearended inthesecondhalf. from resident banks remained high Financing through retail instruments decelerated andfinancing remained atahistoricallylow level Market financingfrom non-residents increased slightly, but it -8000 -6000 -4000 -2000 2000 4000 6000 0 Debt securities Loans Debt securities Deposits Debt securitiesDebt securities Loans Debt securities Debt Loans securities securitiesDebt Debt Deposits securities Debt Loans securities Debt Banco de de Banco Portugal General governmentfinancingbycounterpartyandinstrument| 50 As a whole, financing from households increased only marginally in the in marginally only increased households from financing whole, a As 49 continuedtoincrease,butalowerextentthanin2017and2016. Banks 2017 H1 2017 Households 2017 H2 2017 ICFP 2018 H1 2018 Non-residents Eur millions Other

Chart I.3.3• showing high elasticity against changes in the remuneration of the different savings instruments. resident sectors, especially households. Household demand for Portuguese public debt has been feature of the structure of public debt holders in Portugal has been the increased share of other purchased undertheprogrammeforanextendedperiod.Forlastfewyears,adistinctive should neverthelesscontinuetoreinvesttheprincipalpaymentsfrommaturingsecurities predictable end of monthly net purchases under the PSPP by the end of the year. The Eurosystem regular debt refinancing under favourable price conditions, in particular against a background of a ongoing fiscal consolidation process, maintaining a diversified investor base is important to ensure the with together However, markets. financial international in aversion risk of degree the in and conditions in changes to vulnerable less conditions financing State’s the makes non-residents of 51. refers toother(non-monetary)financialinstitutions.TheacronymEFAPEconomic andFinancialAssistanceProgramme. Sources: Banco de Portugal, ECB and Portuguese Treasury and Debt Management Agency (IGCP). | Notes: Public debt from Maastricht. The acronym OFI continued decreasing. it Portugal in and stable, remained it Italy in while recovered, non-residents by held component the Spain In differentiated. more been have non-residents of share the in developments 2011, Since I.3.3). (Chart crisis debt sovereign the by affected more countries other in extent, lesser a to although and, Portugal in decreased holders debt public of structure the within residents a fairly low level historically. Between 2007 and 2011, the share of public debt held by non- The debt securities component increased slightly, but the share of non-residents remained at unchanged. virtually remained EFAP, the under loans excluding non-residents, from Financing €10 billion. at ahighercost,whichin2017materialisedtheearlyrepaymentofIMFloanabout an additionalrepaymentinDecember.Therefore,theStatecontinueditsstrategytorepaydebt a new repayment of the IMF loan was made (€0.8 billion) and permission was requested to make Concerning the loans under the economic and financial assistance programme (EFAP), in January 100 Recently, there has been a significant disinvestment in Italian public debt by non-residents that was offset by an increase in the weight of Italian banks. 20 40 60 80 0 2007

2011-2017 Germany Structure ofpublicdebtholders|

51 Central Bank AsstatedinthepreviousissueofthisReport,declineshare 07201 2007 France 0720 2011-2017 2007 1-2017 Ban OFI ks Other residents Per cent,end-of-periodfigures Spain 721-0720 2011-2017 2007 2011-2017 2007 EFAP Non-residents (exc.EFAP) Italy ortugal

57 Financial position of the General Government and of the Non-financial Private Sector 58 Banco de Portugal • Financial Stability Report • December 2018 Chart I.3.4• until 2020,withhighervolumesexpectedfor2021and2022. contained relatively are needs refinancing debt long-term and medium Annual years. 30 and 15 of maturity approximate an with securities of placements particular in reflecting 2017, and 2016 The average maturity of issued medium and long-term debt increased significantly compared2017. with in -0.24% with compared 2018, in period same the during conducted tenders for -0.34% partly associated with a differentiated recording of time-lagged operations, have led to a ratio a to led have operations, time-lagged of recording differentiated a with associated partly adjustments, deficit-debt hand, other the On decrease. ratio the to contributed effect) (dynamic growth GDP nominal and debt of cost implicit the between differential negative the and balance compared to the end of 2017 (124.9% of GDP). Similarly to 2017 as a whole, the positive primary At theend of the first half of the year, the public debt-to-GDP ratio remained virtually unchanged and MTNissuedinthecorrespondingyear.**Thecostofdebtoutstandingreferstofirsthalf2018(annualizedfigure). PGB considers issued debt long-term and medium- of maturity average The year. corresponding the in issued MTN and FRN PGB, Tbills, comprises and maturity and amount issuance by weighted is issued debt of cost The Notes: | Portugal. Statistics and IGCP ECB, Portugal, de Banco Sources: than for2017asawhole. approximate maturity of 10 years reached 1.9% for tenders conducted until October, 0.9 p.p. less euro area sovereign debt markets. The average allotment rate in Treasury bond tenders with an in stress increased reflecting year, the throughout fluctuation some with but I.3.4), (Chart stock In thecourseof2018,averagecostissueddebtremainedbelow 52. tenders andamountsassociatedwithsyndicated issuances. Comprising Treasury bond tenderswitharesidual maturity between9and 11 years. Excluding amounts placedduring the non-competitivephase of developments inItaly. relatively favourable, despitetheturbulence duetopolitical Financing conditions insovereign debtmarkets remained 2018 iscompatible withareduction intheyear asawhole The stabilisationofpublicdebt-to-GDPratio inthefirst halfof Per cent 0 2 4 6 8 0121 0321 0521 2017 2016 2015 2014 2013 2012 2011 Cost andmaturityofpublicdebt Average residual maturity of debt outstanding (rhs) outstanding debt of maturity residual Average outstanding debt of Cost 52 Inturn,theaverageallotmentrateinTreasurybilltendersstoodat Average maturity of MLT debt issued(rhs) Cost of debt issued Jan. 2018** to Sep. to 0 5 10 15

Maturity (years) that is less liable to adverse shocks affecting economic activity and financing conditions and conditions and financing compatible withthesustainabilityofpublicfinances. activity economic affecting shocks adverse to liable less is that indebtedness, government general of trend downward a ensure to order in efforts adjustment contagion to Portugal has been relatively limited. However, Portugal must maintain structural far, So fiscal value. market stock their on and yields debt bank Italian on maturities, different at yields of thematerialisationsometheserisks,withanon-negligibleimpactonItalianpublicdebt example recent a are Italy in deteriorating perspectives economic and developments Political debt market,andtheslowdownineconomicactivityaremainrisksmediumterm. level, theabruptreassessmentofriskpremiaatglobalupsurgeintensionssovereign and in most highly indebted countries in the euro area. The increase in the overall interest rate capitalisation effortsinordertopromotetheirresilience in amoresustainablemanner. downturn ineconomicactivity,showshowimportant it isforcompaniestokeepuptheir Uncertainty relatedtointernationaltradedevelopments, whichmaycontributetoasteeper corporate indebtedness,whichisstillhigh. temporary a is decrease inorder not tojeopardisetherecoveryofbusinessinvestmentnorongoing fallin this that key is it However, average. area euro the of those than) lower (but to half of 2018 wasfairly limited, taking into account its strong recoverysince2009 to levelscloser Regarding non-financial corporations (NFC), the decline in the savings rate in 2017 and in the first in economicactivity. value emphasises the vulnerability of this sector, especially given the expectations of a slowdown is stillhigherthaneuroareaaverage,theinterruptionindownwardtrenddebtnominal pace, while the nominal value of debt rose. In a context where the household indebtedness ratio The householdindebtednessratiocontinuedtodecrease,althoughatanincreasinglyslower guarantee, andconsumercreditannouncedbyBancodePortugalinFebruary2018. credit relating to residential immovable property, credit secured by a mortgage or equivalent design of the macroprudential measure on new credit agreements for consumers, in particular long maturitiesthatexceedborrowers’workinglives.Thisisoneofthefactorsconsideredin background inwhichhouseholdsarestillhighlyindebtedand,mostimportantly,withloans system associated with expectations of a considerable fall in income on retirement, against a particularly relevantvulnerabilityinthebackdropofageingpopulationandapublicsocialsecurity a is rate savings household low the Portugal, In average. euro the below clearly and value low In thefirst half of 2018, the household savings rate continued to decrease, reaching a historically sector 3.2 International institutions end oftheyear. ratio included in the State Budget Report for 2019 points to a reduction to 121.2% of GDP by the debt public for estimate The whole. a as year the in mitigated be should that effect an increase, 53. IMF, EuropeanCentralBankandCommission. Financial positionofthenon-financialprivate 53 keep signalling risks to developments in public debt ratios in Portugal in ratios debt public in developments to risks signalling keep 59 Financial position of the General Government and of the Non-financial Private Sector 60 Banco de Portugal • Financial Stability Report • December 2018 the secondhalfofyear(andasawhole). a follows sector institutional this of of those than lower levels presents normally year the of half first the borrowing/lending which in pattern seasonal net that mention to important is It of disposableincome contrasts with a net lending of 0.6% of disposable income in the same period of 2017 (Chart I.3.5). (Chart 2017 of period same the in income disposable of 0.6% of lending net a with contrasts first half of 2018 household net borrowing was approximately 0.3% of disposable income, which the in Portugal, Statistics by published data accounts national available currently to According 3.2.1 57. 56. 55. 54. review) under period the in 3.3% to 2017 of half first the in 3.9% (from rate savings the in decline a reflected developments These non-produced non-financialassets. (a) accounts. national quarterly the from calculated are figures Corresponds to the sum of gross half-year fixed capital formation, changes in inventories, acquisitions less disposals of valuables, and acquisitons lessThe disposals of Notes: | calculations). Portugal de (Banco Portugal Statistics Source: Chart I.3.5• (from 3.7% to 4.1% of disposable income, respectively), income, disposable of 4.1% to 3.7% (from most recentlybyjobandwagerecovery. private significant reflected has rate savings the consumption growth,onaverageabovethatofdisposable income,thelatterbeingsupported in decrease The 2015. of half second the In annual 3.8%to4.0%ofdisposableincomein2017andtheyearendingJune terms,from 2018,respectively. In annual 4.7%in2017to4.4% terms,from theyearending inJune2018. there wasanetlendingof2.2%intheyearas awhole. although income, disposable of 2.4% approximately of 2008, of half first the in was position borrowing net a posted households that time last The in June2018. ending year the in income disposable of 1.1% to 2017 in income disposable of 1.5% from declined lending net household flows, annual of terms In 10 12 historically low level position, albeitslight,withadeclineinthesavings rate toa In thefirst halfof2018,households recorded anetborrowing -2 0 2 4 6 8 Households 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2016 H1 2017 H1 2018 H1 2018 2017H1 H1 2016 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 Net lendingNet / borrowingNet Savings, investmentandnetlending/netborrowingofhouseholds| 56 Gross savings Gross and an increase in household investment in real assets Investment in real assets (a) 57 55 maintainingthetrendobservedsince Net capital transfers capital Net Percentage 54

2018 wouldhaveemphasisedthisweakness. to economic growth and/or financial stability. The decrease in the savings rate in the first half of tend to reflect on a decrease in consumption or increase in default, with potential consequences 58. debt service financial effort, either by an income reduction or the byaffecting shocks a costthat ofindicates financinghouseholds increase, Portuguese of rate savings low the addition, In guarantee, andconsumercreditannouncedbyBancodePortugalinFebruary2018. credit relatingtoresidentialimmovableproperty,securedbyamortgageorequivalent the in considered factors the of one design ofthemacroprudentialmeasurenewcreditagreementsforconsumers,inparticular was This I.3.7). (Chart (35%) 62% was contract-end at (70) 65 over aged borrowers to related loans housing of stock the 2018, June In lives. working highly indebtedand,mostimportantly,withloanslongmaturitiesthatexceedborrowers’ considerable fallinincomeonretirement,againstabackgroundwhichhouseholdsarestill of ageingpopulationandapublicsocialsecuritysystemassociatedwithexpectations In Portugal, the low household savings rate is a particularly relevant vulnerability in the backdrop the secondquarterof2018arethoseyearendinginthatquarter. Source: Eurostat (Banco de Portugal calculations). | Note: The figures for Percentage ofdisposableincome Chart I.3.6•Householdsavingsrate| higher thanPortugal. particularly noteworthy, although, with the exception of Spain, kept their savings rate significantly are declines, significant posted which France, and Italy Spain, I.3.6). (Chart Portugal in case the Since 2011,thehouseholdsavingsratehasdecreasedinsomeeuroareacountries,aswas

to which a significant number of households have a very low or even negative savings rate, making them particularly vulnerable to shocks to vulnerable particularly them making rate, savings negative even impacting ontheirincome(suchasretirement, unemploymentoraninterestraterise). or low very a have households of number significant a which to The financial vulnerability of Portuguese households was analysed in Box 4 of the December 2017 issue of the 2018 Q2 12 16 20 0 4 8 04 Denmark Poland Ireland Portugal Netherlands 21 20 16 12 8 2011 Spain Germany Italy Euro Area Euro France the loanholderatcontract-end| for housepurchaseinJune2018,bytheageof Chart I.3.7•

considered. not are self-employed to Loans Register. Credit Central the of basis the on Source: Banco de Portugal. | Notes: Data on housing loans are calculated Percentage 0 1 2 3 4 5 6 7 04 05 06 07 08 90 85 80 75 70 65 60 55 50 45 40 Age of loan holder at contract-end Distribution ofoutstandingloans Financial StabilityReport,according Percentage 58 will 61 Financial position of the General Government and of the Non-financial Private Sector 62 Banco de Portugal • Financial Stability Report • December 2018 Chart I.3.8•Sourcesandusesoffundsbyhouseholds| 2.2% ofdisposableincome,anamountsimilartothatthesameperiod2017(ChartI.3.8). for accounted assets financial of acquisition net 2018, of half first the in Additionally, income. disposable of 0.4% of flow net positive annual an with 2017, in interrupted been had 2011 in started that debt financial households’ of repayment net for trend the that noted be should it repayment of the same period of 2017, accounting for 0.5% of disposable income. Nevertheless, net the to contrast in income, disposable of 0.6% about of debt financial of flow net positive a In terms of financial savings, financial of terms In 59. and holidaybonusesineffect since2013(ChartI.3.9). Treasury bondsissuesandbythenon-extensionoftwelfth-payment schemeforChristmas no with half-year a in investments alternative of availability the by influenced be may period, this perceived as lower risk. Investment in bank deposits normally has a seasonal pattern and, within usually and assets liquid more for preference a reflected have may households by investment Against a backdrop of particularly low interest rates on deposits, this pattern of the portfolio of floatingrateTreasurybonds(Portugueseacronym:OTRV). though lower than those observed in the same period of 2017, and with negative net transactions to approximately 0.3% of disposable income, with positive net transactions of Treasury bills, even amounted instruments debt government Portuguese in investment net 2018 of half first the In a netincreaseofabout5.3%disposableincome,comparedwith0.1%inthesameperiod2017. to what happened in 2015 and 2016. Thus, in the period under review, households’ bank deposits had In the first half of 2018, the households’ financial asset portfolio saw a shift towards bank deposits, similarly disposals ofnon-producednon-financialassets.(c)Correspondstothesumloansanddebtsecurities. income. (b) Corresponds to the sum of gross fixed capital formation, changes in inventories, acquisitions less disposals of valuables, and acquisitions less Source: Banco de Portugal and Statistics Portugal. | Notes: The half-year figures are calculated from the quarterly national accounts. (a) Gross disposable Financial savingscorrespond tothedifferencebetweennettransactionsinfinancialassetsand nettransactionsinfinancial liabilities. 2015 andinterruptedin2017 investment inbankdeposits,resuming thetrend since observed In thefirst halfof2018there was anincrease inhousehold -20 -15 -10 10 15 20 -5 0 5 0820 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 2009 2008 Financial debt (c) Investment in real assets (b) Gross savings 59 household net borrowing in the first half of 2018 translated into translated 2018 of half first the in borrowing net household Uses Sources Percentage ofdisposableincome Netcapital transfers Net purchases of other financial liabilities(c) Net purchases of financial assets 2016 H1 2017 H1 2018 H1 2018 H1 2017 H1 2016 loans intotalhouseholddebtcontinuestobeveryhigh(around 71%inJune2018). before the financial crisis. Despite the developments in credit for consumption, the share of housing loans in the prior six months. the majority of which were granted to de btors that have not made full early repayments of housing purchase, house for lending bank This new of flows gross in increase progressive a on based is recovery 2017). of end the at -1.7% with (compared 2018 June of end the at -1.3% reaching negative, before the financial crisis (Chart I.3.10). The annual rate of change in housing loans has become less developments, maintainingrisingannualratesofchangethat reachedlevelsclosetothoseof2007, these to contributing increasingly been has consumption for Credit -2.6%. approximately of change average annual an with 2011, June since decrease continuous of period a after 2017), of end the In June 2018, the annual rate of change in loans to households stood at around 0.3% around at stood households to loans in change of rate annual the 2018, June In in mainurbanandtouristcentres(Section2.3Residentialrealestatemarket). especially investments haveloworzeroreturn,andtheopportunitiesrelatedtotourismbuoyancy, same the within assets financial in increase period). This preference may reflect 7% the high return on real assets, in a a context where low risk financial with (compared 2017 and 2014 between 16% approximately by increased has property estate real households’ that indicate Estimates households. R Source: BancodePortugalandStatisticsPortugal. Chart I.3.9• 61. 60. eal estate assets continue to stand out among the assets targeted for investment by Portuguese Portuguese by investment for targeted assets the among out stand to continue assets estate eal -10 10 o mr ifrain n hs ujc, e Bx ”e las o oshls o hue ucae n la rpyet: n nlss with analysis an repayments: loan and purchase house for households to loans ”New 2 microeconomic data”,EconomicBulletin Box see subject, this on information more For Annual rate ofchangeinloans grantedtohouseholds byallotherresidentandnon-residentsectors. -5 those observed beforethose observed thefinancialcrisis acceleration ofcredit for consumption tohighlevels, closeto Loans tohouseholdshadanincrease closetozero, withan 0 5 T Deposit oans reasury bond 2012 to NFC to s

resident b s s Transactions infinancialassetsofhouseholds| 2013 an s Ot Ot 2014 ep her her debt , May2018,andRetailBankingMarketsMonitoringReports , BancodePortugal. 61 osit However, gross flows of new loans are still well below those observed ﬁnancial s

in securit t he generalg asset 2015 ies s overnm 2 016 ent (savingscer 2017 i ﬁcat es andt reasury Percentage ofdisposableincome bills) 06H 2 2016 H1 E Curr a Tot ty uity l ﬁnancial ency andot an 12018H1 017 H1 d i nvestment f asset her s deposit t 60 ransact und (0.0% at at (0.0% s sha ions res

63 Financial position of the General Government and of the Non-financial Private Sector 64 Banco de Portugal • Financial Stability Report • December 2018 looser creditstandardsappliedtothistypeofloans. growth ratesandpercentagepoints 64. 63. 62. the creditmarket In addition,the increase in consumer credit continues to belargelyduenewborrowersentering is only negligibly sensitive to possible interest rates rises as they comprise mostly fixed-rate loans. amounts without involving higher instalments. Unlike housing credit, debt service on these loans economic activity. On the other hand, higher average maturities make it possible to borrow higher deleveraging process ofthisinstitutional sector, especiallygiventheexpectations of aslowdownin and as a percentage of disposable income. For that reason it is important to proceedwiththe within aframework wherethehouseholdindebtednessratioisstillveryhighininternational terms reduction, debt of pace the of rigidity the increase maturities average Higher 2012). in 15% with (compared 2018 of half first the during into entered agreements credit the of 40% for accounted years eight over maturity a with agreements the credit, consumer new of flows volume annual the of half almost for accounting purchase, car for credit of segment the In I.3.11). (Chart agreed agreement characteristics, resulting in higher contractual maturities and higher average amounts Since 2012, credit forconsumption growthhas moved in tandemwithchanges in the respective for consumption path ofthenominalinterestrateoncredit translated intoadownward credit. Yet, competition pressurebetween credit institutions within thismarket segment has decline andhigherwages, despite therelativelyhighinterest rates, in realterms, of thistype unemployment in reflected cycle, business the of upturn the with associated be may acceleration Credit for consumption had an annual growth of 14.2% in June 2018 (12.3% at the end of 2017). This Source: BancodePortugal.|Note:Totaldebtincludesloansforhousepurchase,andconsumptionotherpurposes. Chart I.3.10•Contributionstotheannualrateofchangehouseholds’totalloans| -5 -4 -3 -2 -1 See See theBankLendingSurvey. purposes was7.0%attheendoffirsthalf of2018(9.3%inNovember2008,whenitreachedthehighestlevelcurrentseries). Despite the downward path of interest rates on new consumer credit operations, the interest rate on the balance of loans for consumption and other 0 1 2 3 4 5

Financial Stability Report , June2018. Dec. 09

Jun. 10

64 Dec. 10 andnottogreaterindebtednessofalreadyindebtedhouseholds.

Loans for house purchase house for Loans Jun. 11

Dec. 11

Jun. 12

Dec. 12

Jun. 13

Loans for consumption for Loans Dec. 13 63 Jun. 14

Dec. 14

Jun. 15

Dec. 15

Total debt debt (a.g.r.) Total Jun. 16

Dec. 16

Jun. 17 Annual

Dec. 17 62 and Jun. 18 66. 65. loans, floating-rate are agreements credit housing the of most Furthermore, 21 p.p.,standingat33%and37%respectivelytheend of 2017(ChartI.3.13). and p.p. 16 approximately of decreases posted Ireland and Spain while 2018), of half first the in (unchanged 34% to p.p. 11 by decreased households Portuguese of ratio leverage the 2017, of have reducedtheirleverageratiointhepastfewyears.Betweenendof2011and countries those Portugal, to Similarly countries. area euro in ratio average 33% a with compared (leverage ratio) in the period prior to the financial crisis. assets financial In household Portugal, total this in ratio debt reachedfinancial 47%of share intheir 2008, increased income disposable of Most euroareacountrieswithcurrentlyhighlevelsofhouseholdindebtednessasapercentage of thisinstitutionalsector,especiallygiventheexpectationsaslowdownineconomicactivity. of housing loans, theinterruption in thedecline of thedebt nominal value emphasises the vulnerability euro area average, and the its pace of reduction is expected to be slower due to the high relative weight the than higher still is Portugal in ratio indebtedness household the where context a In I.3.12). (Chart consumption for credit in momentum continued the particular in reflecting rose, also debt household from anincreaseinthenominalvalueofdisposableincomeaperiodwhere reduction inthedebtratiohasgraduallysloweddownand,yearendingJune2018,itresulted of December2017,keepingonthedownwardpathgenerallyobservedsince2009.However, end the at 105% with compared income, disposable of 104% was debt household total 2018, June In cards, creditlines,bankaccountsandoverdraftfacilitiesareexcluded. specified purpose. Onnewconsumercreditconsideredonbothcharts,theamount,maturityand reimbursement schemearesetatcontractorigination, i.e. credit a without granted be also may credit of type This services. health or education equipment, house as such services, and goods of acquisition Source: Banco dePortugal. | Notes:Car loans are granted for thepurchase of cars or othervehicles,new or used.Personal credit isgranted for the Chart I.3.11• are expectedtorisegradually. operations has decreased in the past few years (Chart I.3.14). In any case, short-term interest rates more sensitive to possibleinterestratesrises, Average maturity (in years) As for the credit stock at the end of December 2017, estimates indicate that a 200 b.p. increase in the indexes associated with housing credit housing with associated indexes the in increase b.p. 200 a that indicate agreements wouldleadtoadeclineinhouseholds’ disposableincomeabove1%,ceterisparibus,onlyininterestpayable. estimates 2017, December of end the at stock credit the for As Banking MarketsMonitoringReport by mixed-rate followed agreements – 81%), comprising an initial (approximately fixed-rate period, agreements followed by a credit floating-rate period housing (accounting for 17%). new For further for details, see type interest-rate frequent most the as remained rate floating the 2017, In only 1percentage attheendof2017 pointbelow thatobserved accounted for approximately 104percent ofdisposableincome, At theendoffirst half of 2018,totalhouseholddebt 5 6 7 8 1501,0 2501,0 3501,0 14,500 14,000 13,500 13,000 12,500 12,000 11,500 2012 Average amount (in euros) 2013 New consumerloans Car loans 2014 2011 , BancodePortugal,2017. 2015 2016 2010 2017 2018 H 1

66 although the relative weight of new floating-rate new of weight relative the although

Average maturity (in years) 2 3 4 5 0040 0050 0060 7000 6500 6000 5500 5000 4500 4000 2012 2011 Average amount (in euros) Personal credit Personal 2010 2013 2014 2015 65 andtherefore 2016 2017

2018 Retail H 1

65 Financial position of the General Government and of the Non-financial Private Sector 66 Banco de Portugal • Financial Stability Report • December 2018 of disposableincomeandpercentagepoints to households| Chart I.3.14• Source: ECB and Eurostat (Banco de Portugal calculations). | Note: Leverage ratio calculated as the ratio between financial debt and total financial assets. Chart I.3.13• Source: BancodePortugalandStatistics Chart I.3.12• Source: BancodePortugal.|Note:(a)Yearending inJune2018. -8 -6 -4 -2 10 12 10 20 30 40 50 60 70 80 0 2 4 6 0 2 4 6 8 0 0921 0121 0321 0521 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Jun. (a) Jun. 18 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 131 Change in the indebtedness ratio indebtedness the in Change Write-offs purchase house for Loans 2001 New loansforhousepurchasesbymonetaryfinancialinstitutions Households leverageratio| Households’ indebtednessratioandcontributionstoitschange| Percentage ofdisposableincome 2007 to 128 130 2008

to 20 130 11 of which: with initial rate fixation up to 1 year Indebteness ratio Indebteness Other changes in volumein and price Loans for consumption 125 In percentageoffinancialassets 2012 to 2017 122 115 Portugal (2008) Disposableincome change Othercredits 109 105 2018 Q2 Portugal (2017) Portugal Percentage

104 0 20 40 60 80 100 120 140 69. accounting forapeaksince2006. Investment Surveyincreasedslightlyin2018,afteradecline 2017,thusreturningto2016levelsand Particularly, the share of companies identifying return on investment as the main limiting factor in INE’s by thepreventionofadverseliquidityeventsduetolow opportunitycostofholdingthesefunds. backdrop of low remuneration of bank deposits, accumulation of liquid financial assets may be justified 68. 67. ratios. debt-to-assets lower with companies in significant more was deposits and currency countries. AsmentionedinpreviousissuesofthisReport,duringthe2010-16periodincrease area euro most with tandem in increased have Portugal in NFCs by held deposits and currency fact, In ofGDP). (2.1% (23.1%). 2017 December in level average area euro the to close and series historical the of peak new a deposits in especially further, increased GDP, of 22.7% to approximately corresponded NFCs by held deposits and currency total 2018, June In sector bythis held assets financial time, On the other hand, there was a net repayment of loans and debt securities by NFCs. At the same financial in increase an through essentially liabilities, with emphasis on an equity increase, especially through unlisted shares and other equity. met was sector institutional this of borrowing net The of non-producednon-financialassets. (a) accounts. national quarterly disposals the less acquisitions and valuables, from of disposals less acquisitions inventories, calculated in changes formation, capital are fixed gross of sum figures the to Corresponds half-year The Notes: | calculations). Portugal de (Banco Portugal Statistics Source: Chart I.3.15•Savings,investmentandnetlending/netborrowingofNFCs| (from 13.4%ofGDPto13.6%GDP)largelyexplainthischange. investment in increase slight a and 2017) of half first the with compared p.p., 0.7 of reduction a to corresponds which GDP, of 11% (to from savings in decline The increase I.3.15). (Chart 2017 p.p. of half first the 0.9 a 2018, of half first the in GDP of 2.1% was NFCs of borrowing net The 3.2.2 -12 results oftheInvestmentSurveyareinterim untilthesurveyinJuneoffollowingyearandcomprisecompaniesreportinginvestmentconstraints. The 2017. in 20.6% with compared 2018, in 20.9% was investment limiting factor main the as investments on return identifying companies of share The See destaques&DESTAQUESdest_boui=314609278&DESTAQUESmodo=2&xlang=en in theFSRwererevised.ForinformationconcerningreviewsrefertoINEwebsiteat: https://www.ine.pt/xportal/xmain?xpid=INE&xpgid=ine_ Following INE’s release of the final results of the economic accounts for 2016 and the interim results for 2017, some of the aggregates usually analysed result ofadecrease insavings andaslight increase ininvestment Net borrowing ofNFCs increased inthefirst halfof2018asa 12 16 -8 -4 0 4 8 Financial Stability Report , June2018,especially ChartI.3.20. Non-financial corporations 2008 Net 2009

/ lending

2010 n e t b o rrowing 2011 69 2012

t capital tr Net 2013

2014 ansfers

2015 . 2016 Gross saving 2017 67

2016 Investment in Investment Percentage ofGDP H 1

2017 H 2017 real assets (a) 68 1

Against a Againsta 2018 H1

67 Financial position of the General Government and of the Non-financial Private Sector 68 Banco de Portugal • Financial Stability Report • December 2018 the recoveryofentrepreneurialincome. This I.3.17). enabling goods, of price Chart the on gradually and reflect should input I.3.16 labour the to (Chart related costs in increase added value NFC gross in growth the offset than more which recovery, employment and wage the cycle, business the of stage current the with line in reflecting, (0.6 p.p. of GDP) is noteworthy, and it mainly resulted from an increase in compensation of employees, of GDP and an increase in distributed income. In the first case, the decrease in gross operating surplus 71. 70. income addedtousesfordistributedofcorporationsandreinvestedearningsFDI(entrepreneurialincome)nettax es onincomeandwealth. investment, other investment income and rents), in the absence of detailed quarterly data. (c) Net entrepreneurial income corresponds to the balance of primary income andrents.(b)Correspondstoallcategoriesofproperty(i.e.,interest,distributed incomeofcorporations,reinvestedearningsforeigndirect difference between sources and uses, except for the net entrepreneurial income. (a) Includes reinvested earnings of foreign direct investment, other investment Source: Statistics Portugal (Banco de Portugal calculations). | Notes: The half-year figures are calculated from the quarterly national accounts. ‘Net’ stands for the Chart I.3.17• Source: StatisticsPortugal(Bancodecalculations).|Note:Thehalf-yearfiguresarecalculatedfromthequarterlynationalaccounts. The lower NFC savings rate reflected both a decrease in net entrepreneurial income Chart I.3.16• (EFAP), andmarginallyhigherthantheoneobservedineuroareaDecember2017. netentrepreneurial Programme Assistance Financial and of Economic the of beginning the since level apercentage highest the income) (as reaching significantly, increased corporations of income -40 -30 -20 -10 -15 -10 Portuguese economyin2018 detailed discussion on the projectionsforPortuguese economy, seeEconomicBulletin a For inflation. on pressure wage limit may margins FDI profit corporate and tourism of with associated components earnings volatile some of developments reinvested The and corporations of income distributed for uses to income) netoftaxesonincomeandwealth. added (entrepreneurial income primary of balance the to Corresponding 10 20 30 40 50 60 10 15 20 25 -5 0 0 5 0820 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 2009 2008 0820 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 2009 2008 Gross operating Current taxesonincomeandwealth Other property income (net) Subsidies Gross added value Uses ofNFCs’grossoperatingsurplus| Decomposition ofNFCs’grossoperatingsurplus| surplus . (a) 71 Net Net On the other hand, in the first half of 2018, distributed distributed 2018, of half first the in hand, other the On Gross saving Net propertyincome(b) Gross operating surplus Taxes on production and imports distributed income of corporations Percentage ofGDP , October 2018, particularly Chapter II: Projections for the Percentage ofGDP Compensation of employees of Compensation Net interest Net entrepreneurialincome(c) Net currenttransfers 2016 H 2016 2016 H1 2016 70 1

as a percentage asapercentage 2017 H 2017

2017 H1 2017 1

2018 H1 2018

economic crisis,resultinginanincreasethedistributedincomerateofcorporations exceeded positive changes in net entrepreneurial income in the period prior to the financial and significantly income distributed in changes positive Particularly, developments. rate savings to During those two periods, the contribution of the distributed income of corporations was important Chart I.3.18• rate area euro the than higher between 2005and2011(ChartI.3.20). was corporations of rate income distributed the Portugal, In 73. 72. (entrepreneurial income)netoftaxesonincomeandwealth. FDI of earnings reinvested and corporations of income distributed for uses to entrepreneurial incomecorrespondstothebalanceofprimaryadded income of corporations to netentrepreneurial income. Ontheother hand, net distributed incomerateofcorporationscorrespondsto the ratio of distributed Source: StatisticsPortugal(Bancodecalculations).|Notes:TheNFC Percentage ofnetentrepreneurialincome Chart I.3.19•NFCsdistributedincomerate| financial assets.(b)Includesthestatisticaldiscrepancybetweennetlending/netborrowingcomputedwithinscopeofcapitalandaccount. to Corresponds (a) non- non-produced of disposals less acquisitions and valuables of disposals less acquisitions inventories, in changes formation, capital fixed gross of sum the accounts. national quarterly the from calculated are figures half-year The Notes: | Portugal. Statistics and Portugal de Banco Sources: I.3.18). (Chart limited still is 2017 in started that savings NFC in decrease the crisis, economic and financial the during or to prior either rate, savings average the account into taking fact, In -25 -20 -15 -10 20 40 60 80 10 15 20 25 -5 0 0 5 of FDI(entrepreneurialincome)nettaxeson incomeandwealth. entrepreneurial incomecorrespondstothebalance ofprimaryincomeaddedtousesfordistributedcorporationsandreinvestedearnings On theother hand,net net entrepreneurialincome. corporations to income of the ratioofdistributed income ratecorresponds to The NFCdistributed period 1999-2006andinthe2007-12 respectively. the in 6.4% and 7.2% of rate savings average NFC the with compared GDP, of 10.2% was 2018 of half first the in ending year the for rate savings The 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2016 H12017 H12018 2016H12017H1 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 Change Change in financial assets saving Gross Distributed income rate of corporations of rate income Distributed Sources andusesoffundsbyNFCs| Change in financial debt transfers capital Net Gross saving Percentage ofnetentrepreneurialincome Chart I.3.20• Sources Uses 20 40 60 80 0 (entrepreneurial income)netoftaxesonincomeandwealth. FDI of earnings reinvested and corporations of income distributed for uses to entrepreneurial incomecorrespondstothebalanceofprimaryadded income of corporations to net entrepreneurial income. On the other hand, net distributed incomerateofcorporationscorrespondstotheratio Source: Eurostat(BancodePortugalcalculations).|Notes:TheNFC Percentage ofGDP Italy Portugal NFCs distributedincomerate| Changes in other financial liabilities(b) (a) assets real in Investment Germany Euro area 73 (Chart I.3.19). I.3.19). (Chart France Spain 72

69 Financial position of the General Government and of the Non-financial Private Sector 70 Banco de Portugal • Financial Stability Report • December 2018 otiuin o hne i te ai) n GP rwh a 14 .. otiuin. Write-offs contribution). p.p. -1.4 (a (a -0.6 p.p. growth GDP loans and and ratio) the debtsecurities in both changes of to contribution repayment a net reflecting 90.8%, to p.p. 2.5 December 2017,aftera37p.p.maximumdifferenceatthe endof2012. in GDP of p.p. 13 approximately was which area, euro the of ratio difference indebtedness average the the to narrow to possible it made has NFCs Portuguese of deleveraging The half2017. first of the in recorded that to similar ratio, debt the in changes to p.p. 0.5 with contributed Chart I.3.21•NFCsinvestment,changetoaveragefiguresof1999-2006| of the1999-2006periodandisbeloweuroareagrowth(ChartI.3.21). level ofcorporateindebtedness.Infact,business investment stillfalls short of the average values such thatbusinessinvestmentmaycontinuetorecoverintandemwithadecreasethehigh However, itiscrucialthattherecentdecreaseinNFCsavingsrateatemporaryphenomenon (1999-2017) asapercentageofgrossvalueadded. with thestabilisation ingrossoperatingsurplus,whichremainedaboveitshistoricalaverage line in GDP, of 10.8% and 10.6% between stable relatively remained rate savings NFC the year, savings rate between 2009 and 2014. After a decrease in 2015 that was reversed in the following decrease in distributed income during the EFAP, contributed decisively to an increase in the NFC increase in gross operating surplus. The growth of net entrepreneurial income, as well as the an by supported mainly 2007, in 14.5% with compared 2017, in GDP of 17.5% reaching 2007, since most the grew income entrepreneurial net NFC where countries the of one was Portugal 75. 74. NFCs of ratio debt financial the 2018, of half first the In less acquisitions and formation capital gross of sum disposals ofnon-producednon-financialassets.Forallcountriesdepicted,half-yearvaluesareequaltothesumfirsttwoquarterseachgivenyear. the to corresponds assets real in Investment Notes: | calculations). Portugal de (Banco Eurostat Source: -6 -5 -4 -3 -2 -1 It correspondstocreditwrittenofffromassets inthebalancesheetsofresidentmonetaryfinancialinstitutions. NFC financialdebtcorrespondstothesumof debtsecuritiesandloans. with anincrease inthecapitalisationofcompanies inJune2018 Decrease in the financialdebt ratio occurred simultaneously 0 1 2 3 4 0720 0921 0121 0321 0521 0721 121 12018 H1 2017 H1 2016 H1 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 Portugal Euro area Euro Spain 74 Italy as a percentage of GDP decreased by decreased GDP of percentage a as Germany Percentage pointsofGDP France 75

Chart I.3.22•NFCsfinancingflows,financialliabilities| equity, mainlyduetoretentionofearningsbythecompanies. value of companies (3.5%) was also affected by a valuation of listed and unlisted shares and other equity in increase The I.3.22). (Chart GDP of 1.6% to amounted NFCs by equity other and shares 78. 77. 76. 2006 December of level the exceeded significantly which ratio capitalisation ofsmallandmedium-sizedenterprisesledtoanincreaseintheirequity-to-assets vis-à-vis the figures prior to the economic and financial crisis. Actually, successive increases in the of activity,and indicates structural changes in thecapitalisation of some groups of enterprises N Sources: BancodePortugalandStatisticsPortugal.|Note:Totaldebtcorrespondstothesumofsecurities,loanstradecreditsadvances. 2018. of half first the in into on went and 2013 of half second This deleveragingprocesshascontinuedalongsideasteadyNFCcapitalisationthatbeganinthe companies duringtheperiodunderreview. other all than higher significantly been has ratio whose offices, head for decrease lower it a though was even 2006, December to relation in ratio this reduced offices head and enterprises with emphasis on a more significant increase in the equity ratio in trade, construction and trade,construction in ratio the equity in manufacturing. increase significant more a on emphasis with equity-to-assets ratiolevelandtheoneobservedforeachsectorofactivityinDecember2006, current the between activity economic by differences significant also were There p.p. 1 by ratio their increased offices head period, same the During p.p. 2 approximately of enterprises, large ratio againstthesamemonthin2017wassimilarforsmallandmedium-sizedenterprises FC capitalisation shows some heterogeneity when companies are considered by size and sector 10 12 14 Available asofDecember2006,thewholeseries presentsahigherequity-to-assetsratioofhead officesinrelationtoallothergroupsof NFCs. The setofseriestheCentralBalanceSheet Database hasaquarterlyfrequency, andthefirst data correspondtoDecember2006. the firsthalfof2018. the flows of this financial instrument are positive in recent times, accounting for approximately 40% of the consolidated transactions in NFC equity in during the last few years, the significance of this segment in transactions in NFC shares and other equity has been growing. Yet, that segment excluded, SNA 2008 and §3.182(b) of ESA2010). Given the large amount totalled by transactions by non-residents in real estate located in the national territory by non-residents are considered uses in the equity of resident notional companies purchasing/holding such real estate (on this matter see §11.88 of by theNationalAccounts(SNA2008 and ESA2010), real estate isalways an asset oftheeconomywhereitislocated.Thus, real estatetransactions adopted methodology the to According individuals. non-resident by (FDI) investment direct foreign as Accounts National in for accounted are they Turning to transactions in NFC shares and other equity, the impact of real estate purchases by non-residents must be taken under consideration, since -4 -2 0 2 4 6 8 0820 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 2009 2008 Debt securities Loans Trade credits and advances and Trade credits 78 InJune2018,theincreaseinequity-to-assets Percentage ofGDP 76 77 Total debt Total Duringthisperiod,netissuesof (Chart I.3.23). By contrast, large contrast, By I.3.23). (Chart 2016 H1 2017 H1 2018 H1 2018 H1 2017 H1 2016 Shares and other equity other and Shares 71 Financial position of the General Government and of the Non-financial Private Sector 72 Banco de Portugal • Financial Stability Report • December 2018 time since2011. 79. I.3.24). (Chart 2017) December 2017) and in debt securities held by banks (2.8% in June 2018, from -5% in December in credit granted by banks was 1.7%, due to a rise in loans (1.5% in June 2018 from a nil change in institutions, towhichbanksandothercreditinstitutionscontributed.Theannualrateofchange financial resident by granted credit of flow net positive a was there 2018 of half first the in Yet, loans (-0.5%)andindebtsecurities(-2.3%). indecrease a by caused was 2018 June in change negative The 1.3%. by increased it when 2017, The annual rate of change of total credit to NFCs was -0.6% in June 2018, lower than in December sustainable a in manner. resilience their ensure to order in companies Portuguese deleverage to and slowing downofeconomicactivityshowshowimportantitistostrengthenthecapitalposition Uncertainty aboutinternationaltradedevelopments,monetarypolicynormalisation,andthe and fishing. the centralbalancesheetdataset.ExcludesSectionAofNACERev.2:Agriculture,forestry Information onNFCsfrom Source: BancodePortugal.|Notes: December 2006| Chart I.3.23• Manufacturing, mining and quarrying the annualrateofchangeinloanstoNFCswas 0.7%inJune2018. NFCs adjusted for sales of loan portfolios should be considered, even though this series is not net of tariff deficit transfers. According to that table, institutions. In comparison with the data presented in Table A.9 of the Statistical Bulletin of Banco de Portugal, the timeseries loans grantedto and reclassifications write-offs, financial monetary by other recourse, write-offs without in 53% around sold of increase an credit was there for 2018 June and figures 2017 December Between net transfers. deficit tariff on based estimated are credit in change of rates annual Said first timesince 2011 Positive annualrate ofchangebankcredit toNFCs, for the Small andmedium-sized enterprises Transportation and storage and Transportation Wholesale and retail trade retail and Wholesale Electricity, gas and water and gas Electricity, Private corporations Private Equity-to-assets ratioinJune2018andchangebetween Large enterprises Other services Other Percentage andpercentagepoints Construction Head Head offices 79 Thus, the rate of change in loans granted to NFCs was positive for the first the for positive was NFCs to granted loans in change of rate the Thus, June 2018 1 0 -10 02 04 060 50 40 30 20 10 Change between June 2018 and December 2006 figures to loan and debt securities flows from general government, insurance corporations and pension funds and trade credit and advances flows.(b) advances creditand and inprices,excludingwrite-offsofresidentmonetaryfinancialinstitutions. and trade funds pension and corporations insurance Corresponds to credit written off government, from assets in the balance sheets of resident monetary general financial institutions. (c) Corresponds to other changes in volume from flows securities debt and loan to Sources: Banco de Portugal and Statistics Portugal. | Notes: Half-year contributions consider changes from preceding end-of-year figures. (a) Correspond Chart I.3.25• and debtsecuritiesgrantedbynon-residents(ChartI.3.25). loans by replaced and repaid progressively was institutions financial resident by funding NFCs 2014, of half first the for Except crisis. financial and economic the of onset the since observed the net reduction of loans granted by non-residents are significantly in contrast with the changes with together institutions financial resident by granted loans of increase net The non-residents. and sectors non-financial resident by granted loans of repayment net a was there Conversely, Source: BancodePortugal. Chart I.3.24•AnnualrateofchangeincreditgrantedtoNFCs| -10 10 15 -10 -5 0 5 10 15 -5 0 5 2012 Loans and short-term debt securities held by households by held securities debt short-term and Loans Loans and short-term debt securities held residentby financial intermediaries change GDP Long-term debt securities non-residents by held securities debt short-term and Loans Contributions tochangesinNFCs’totaldebtratio| 2013 2014 Banks 2015 2016 Residentfinancial sector 2017 Percentage Percentage pointsofGDP Other Write-offs ( Other f Changes i 2016 changes in inancial liabilities

H1 n to b) tal Total

debt f inancial liabilities stock 2017H1 ratio flows (a) 2018H1 (c) 73 Financial position of the General Government and of the Non-financial Private Sector 74 Banco de Portugal • Financial Stability Report • December 2018 favourable developmentsin the economy(Section4.3Creditstandards). a decreaseintheidiosyncratic risksofenterprisesandeachactivitysector,as well asby banks participating in the BLS pointed out that bank lending to NFCs has been favoured by 2018, of half first the in overall unchanged remained loans new for standards credit Although Source: BancodePortugal. on newbankloans| Chart I.3.26• marginally for loans both up to and above €1 million, when compared with the first half of 2017. declined year one than more of period fixation rate initial an with granted loans new of share the 2018, of half first the In I.3.26). (Chart million €1 over of loans for particularly 2015, since The share of new business with an initial rate fixation period of more than one year has increased standards. a as consequence ofthenormalisationmonetarypolicyaswelltoapossibletighteningincredit ones, gradual even rises, rate interest potential to exposure limit could periods fixation Indeed, withinacontextoflowinterestrates,newloanagreementswithlongerinitialrate though showinggreaterstabilityintheexpectationsofallloandemandfactorsforenterprises. recent survey,inOctober2018,cameupwithresultssimilartothoseoftheJune2018 level of interest rates also led enterprises to apply to these institutions for loans. The most reinforcement ofdemandfornewloansbyNFCsasawayfundinginvestment.Thegeneral According to banks participating in the Bank Lending Survey (BLS) in June 2018, there was a slight to enterprisesinconstructionandrealestateactivities(Section4.3Creditstandards). loans of flows new of share significant a records class riskier the Conversely, classes. risk lower loans toboththemanufacturingandtradesectorsaremainlyassociatedwithenterprisesin of flows gross New slightly. decreased activities estate real and construction to flows gross and increased trade and manufacturing to loans new of flows gross time, of period this In 2017. in T he gross flow of new loans to NFCs increased by 9% in the first half of 2018 from the same period period same the from 2018 of half first the in 9% by increased NFCs to loans new of flow gross he

Percentage share ofnewloansinthefirst halfof2018 have grown since 2015,despitethemarginal decrease intheir New loanswithaninterest rate fixationperiodof over one year 10 12 14 16 0 2 4 6 8 Transactions up to including and EUR1 million 2008 H1 2008 H2 Weight ofnewbankloanswithinitialratefixationperiodmorethan1year 2009 H1 2009 H2 Percentage 2010 H1 2010 H2 2011 H1 2011 H2 Transactionsover EUR 1 million 2012 H1 2012 H2 2013 H1 2013 H2 2014 H1 2014 H2 Average half-year interest rates on total new bank loans (rhs) loans bank new total on rates interest half-year Average 2015 H1 2015 H2 2016 H1 2016 H2 2017 H1 2017 H2 2018 H1

0 1 2 3 4 5 6 7 8 Percentage sector toenterpriseswhichstartedoperatingsince2013| Chart I.3.27• and 5%inmanufacturing. and food service activities, 9% in consultancy, technical and administrative activities, 8% in trade and real estate activities, against 18% in agriculture, forestry and fishery, 16% in accommodation for agriculture, forestry and fishery and accommodation and food services: 11% in construction loans granted to younger enterprises was higher than in other activity sectors in general, except 80. as topreventlossesfromadownturninthebusinesscycle andanincreaseindefault. so operate, they where sector the of features cyclical the and specifics own their consideration in developments their activities, investment and borrowing decisions made by enterprises should takeinto favourable current follows sectors different the to granted credit Although than thoseoftheindividualsectorsactivitydepictedinchart. Source: Banco de Portugal. | Notes: Loan information obtained from the CCR. None of the sectors of activity included in ‘Other sectors’ held a share larger to sector financial resident end ofJune2018 the by granted loans of enterprises intheconstructionandrealestateactivitiessectorwasofaroundonethirdby amount outstanding the – recovery Considering onlyenterprisesthatstartedoperatingsince2013–i.e.atatimeofeconomic more monthspriortothatyear. or three for CCR the in records no had that enterprises to loans of 68% approximately to corresponds 2013 since operating started that enterprises food services (10%) and a slight increase in consultancy, technical and administrative activities (15%). The amount of outstanding loans associated to and accommodation in decrease slight a was there though reached, be would conclusions same the overall sector) financial resident the from loans enterprises thatneverreceived 2013 (proxyfor months priorto or more Considering loanstoenterprisesthathadno records intheCCRforthree since 2013 a significantshare oftotalloanstoenterprisesincorporated The construction andreal estateactivitiessectorholds Manufacturing, 10 Construction and real real and Construction Outstanding amountinJune2018ofloansgrantedbytheresidentfinancial estate activities, 32 activities, estate 80 (Chart I.3.27). Also in this sector, the share of the outstanding amount of amount outstanding the of share the sector, this in Also I.3.27). (Chart Other sectors,14 Agriculture, Percentage fore food service activities, 12 activities, service food Trade, 14 st Accommodation and ry fi and Consultancy, technical and administrative sher activities, 11 activities, y, 7

75 Financial position of the General Government and of the Non-financial Private Sector 76 Banco de Portugal • Financial Stability Report • December 2018 on provisioning of non-performing loans assets’ credit risk. Also in this regard, the implementation of the addendum to the ECB guidance capital. This standard results in faster recognition of impairment losses, in line with the financial model toanexpectedlossmodel,withimpactonthebanks’recognisedimpairmentsand Finally, theadoptionofIFRS9on1January2018ledtotransitionfromanincurredloss terrorist financing,andthemitigationofcyberrisk. and money-laundering combating to regard in namely risk, operational also but risks, financial activity. Inparticular,institutionsmustensuresuitableassessmentandcontrolnotonlyofthe not compromisetheadoptionofsuitablepoliciesforcontrollingrisksinherenttobanking regard to dividend distribution. On the other hand, the efforts to reduce operational costs must system ontheonehandrequireadoptionofprudentapplicationresults,particularlyin Despite the current improvement in profitability, the challenges still facing the Portuguese banking the shorttomediumterm. in MREL with comply to capital, regulatory for eligible instruments debt subordinated highly of issuance the for need the by and structures cost operational rescale to need firms the by (fintechs), fromspecialised competition the potential by services, financial of digitalisation the by NPL stock, by the need for investment in technology infrastructure to face the challenges posed be constrainedbythelow-interest-rateenvironmentineuroarea,persistenceofhigh which real estate asset prices were rising. However, the Portuguese banking in system continues environment to financial and macroeconomic favourable a in place took developments These capital ratiowasstrengthenedbytheissueofdebtinstrumentseligibleforownfunds. while impairment decline to continued coverage ratiosincreasedagain.Theliquiditypositionremainedatcomfortablelevels.total (NPLs) loans Non-performing increased. efficiency improvement took place as lower credit impairment losses were recorded and operational I 4 Bankingsector 81. banking system. the ingeneral, the within heterogeneity in fall a despite However, adjustment, the in phases different role. at are institutions intermediation financial their out carrying for conditions the im-prove to and shocks, adverse to resilience and profitability future increase to designed were out restructuring processes and followed non-performing asset reduction plans, which together carried have system banking Portuguese the of institutions main the years, few last the Over promptly impairmentlossesincreditagreementswhichbecomenon-performing. n the first half of 2018, banking system profitability continued on a recovery trend.This a recovery on continued profitability system banking of 2018, half first the n eu/ecb/pub/pdf/ssm.npl_addendum_201803.en.pdf For more information on the addendum to the ECB guidance on provisioning of non-performing loans see: https://www.bankingsupervision.europa. . 81 creates a significant incentive for recognising more recognising for incentive significant a creates Table I.4.1• 84. 83. 82. or reverse stagnate could dynamic should theeconomyslowdown. this ofimpairments, the procyclicality to due profitability However, asthereisevidenceofapositiverelationship betweeneconomicgrowthandbank Portugal, with creditdefaultbyborrowersfalling,inparallelincreasing pricesonassociatedcollateral.in recovery economic of context a in place took This it. of two-thirds about – and impairments ROA in provisions flowof lower byasubstantially compared tothesameperiodof2017.Thiscomponentcontributed0.26p.p.increase chiefly driven was Profitability Note: Returnonassets(ROA)iscomputedusingProfitorLossesbeforetaxes,asapercentageofaverageassets. | Source: BancodePortugal (ROE) equity on return and 0.7% was (ROA) assets on Return year. year-on- significantly increased results system’s banking Portuguese the 2018, of half first the In 4.1 supervisory authorities. impairment lossesshouldcontinueinthenextfewyears, inlinewiththeplanssubmittedto reflected agreatercontributionfromthisactivitycomparedtothesameperiodyearbefore. to the main institutions with significant international activity, international significant with institutions main the to Memorandum items: Profit orlossbeforetax 7. Otherresults 6. Provisionsandimpairments 4. Otheroperatingincome 5. Operationalcosts 3. Incomefromfinancialoperations 2. Netfeesandcommissions 1. Netinterestincome Average oftotalassets Impairment oncredit Total operatingincome[=1+2+3+4] Core operatingincome[=1+2-5] and macroeconomicfactors”,FinancialStability Papers,BancodePortugal. banking system – determinants and prospects”, Banco de Portugal, For more details on the influence of the macroeconomic factors on the banking sector’s profitability, see Special Issue “Profitability of the Portu-guese International activityisdeemedsignificantwh en thenon-domesticshareoftotalexposure isabove10%. ROA andannualisedearningsbeforetaxaverage assets ROEcorrespond totheratiosbetween andaverageequityrespectively. provisions andimpairments Banking system profitability increased, mainly reflecting lower Profitability Banking system’sstatementofprofitorloss 385,467 2017 H1 -1,727 -3,010 -5,838 9,644 3,075 1,318 1,087 2,777 6,137 84 -356 362 Given the persistence of high NPL stock, the recognition of recognition the stock, NPL high of persistence the Given (annualized) EUR milion 384,563 10,803 -2,464 -4,255 -5,706 3,256 1,184 1,001 2,853 6,109 2017 260 840 Financial Stability Report, June 2017, and Martinho et al (2017), “Bank profitability 380,293 2018 H1 -1,232 -2,022 -5,498 9,523 3,586 2,746 2,921 6,164 -327 569 767 2017 H1 -0.45 -0.78 -1.51 -0.09 2.50 0.80 0.34 0.09 0.28 0.72 1.59 of averageassets 83 In percentage developments in profitability also profitability in developments 82 -0.64 -1.11 -1.48 was 7.7% (Table I.4.1). In regard regard In I.4.1). (Table 7.7% was 2017 2.81 0.85 0.31 0.07 0.26 0.22 0.74 1.59 2018 H1 -0.32 -0.53 -1.45 -0.09 2.50 0.94 0.72 0.15 0.20 0.77 1.62

change inROA(pp) Contributes to 2018 H1 -0.03 -0.08 0.01 0.13 0.13 0.37 0.05 0.26 0.09 0.04 0.01 0.01 77 Banking sector 78 Banco de Portugal • Financial Stability Report • December 2018 ROA waslowerthantheeuroareamedian. its European counterparts. Importantly, the (negative) contribution made by operational costs to to compared system banking Portuguese the by recorded impairments and provisions of flow larger a by mainly justified be to continues position relative This I.4.3). median (Chart area the euro the below for slightly was ROA system’s banking Portuguese the 2018, of half first the In figures. or Lossesbeforetaxes,asapercentageofaverageassets.Annualized Source: BancodePortugal.|Notes:ReturniscomputedusingProfit on assets(ROEandROA) Chart I.4.1• system’s ROA. banking the in increase the to contributed also 2017 June in BPI by BFA of deconsolidation the negative base effect caused by the recognition of negative foreign exchange reserves arising from the of dissipation the Furthermore, I.4.2). (Chart institutions larger the of some for particular in bya wasaccompanied terms, inaggregate rightward shift in ROA’s distribution, meaning the increase in this indicator was broad-based, system, banking the in profitability greater The levels, whichreflectgreaterequitylevelsperunitofasset(ChartI.4.1). to adverse shocks. This fact is consistent with the current relationship between the ROE and ROA following the international financial crisis that began in 2008, reflected in the increased resilience The lowerleveragelevelsareakeyfeatureofthebankingsystems’overalladjustmentinyears results, particularlyinregardtodividenddistribution. of application prudent the require institutions Portuguese facing still challenges the profitability, profit retention helps strengthen institutions’ solvency. Thus, despite the current improvement in Banking system profitability has important implications for the financial system’s stability level, as 85. As a percentage For moredetails,consultSection“3.4Profitability” oftheFinancialStabilityReport of average equity -20 -16 -12 -8 -4 0 4 8

2010 ROE

2011 85 Return onequityandreturn 2012 2013 2014

ROA (rhs) 2015

2016 3,3

2017 0,3 // 3,9 0,3 7,7

2017 H1 0,7 2018 H1 -2,0 -1,6 -1,2 -0,8 -0,4 0,0 0,4 0,8

As a percentage of average assets assets before taxes,asapercentageofaverageassets.Annualizedfigures. Losses or Profit using computed is (ROA) assets on Return Bandwidth=0.12. assets. their to according institutions weights that kernel Gaussian a using Source: Banco dePortugal.|Notes:Empiricaldistributionobtained Empirical distribution| Chart I.4.2• 18-, , , , , 3,6 2,7 1,8 0,9 0,0 -0,9 -1,8 , December2017. Return onassets(ROA)– 2017 H1 Percentage ofaverage 2018 H1 2018 contributions tochange| Chart I.4.4• Therefore, heterogeneitybetweeninstitutionsdeclinedinthefirsthalfof2018. operating resultstabilisedatvaluessimilartothoseobservedforthesameperiodyearbefore. recurring higher a with institutions the 2018, of half first the In I.4.5). (Chart result operating ring observed wasdrivenbyanimprovementinthisindicatortheinstitutionswithalowerrecur- increase The costs. operational in reduction the significantly, most and, commissions and fees in-creased by 0.13 p.p. (Chart I.4.4). This followed the increases in net interest income and in net assets andpercentagepoints 86. bars correspondtocontributionsmadechanges intheratio.Annualizedfigures. correspond torecurringoperatingresultasapercentageofaverageassets.Theother interest incomeandnetfeescommissionslessoperationalcosts.Thebluebars Source: BancodePortugal.|Notes:Recurringoperatingresultisaggregatenet operatingresult recurring bythe made ROA to thecontribution of 2018, half first the In items areunavailableforcertaincountries.However,thisshouldnotaffecttheanalysissubstantially.Annualizedfigures. from income of appropriation goodwill, negative includes item ‘Other’ subsidiaries, joint ventures The and associates, and income Notes: from non-current assets held for sale | and not qualifying as discontinued operations. Data Data). for some Banking (Consolidated Bank Central European Source: Chart I.4.3• average assets 0,5 0,6 0,7 0,8 0,9 1,0 Recurring lessoperationalcosts. operatingresultisdefinedbyaggregate netinterestincomeandfeescommissions heterogeneity between institutions Operating result improved inacontext ofdeclining Other operating income operating Other and commissions (net) commissions and 2017 H1 Net interest Net H1 2017 Incomefrom services Income from financial from Income 0,80 Net interest income interest Net Impairments and operations Operating costs Operating provisions income Operating result–Leveland ROA –Internationalcomparisonofcontributions(2018H1)| 0,01 Other commissions ROA 0,04 Net 25-, 15-, 050005101520253,0 2,5 2,0 1,5 1,0 0,5 0,0 -0,5 -1,0 -1,5 -2,0 -2,5 Operational Percentage ofaverage costs 0,09 Portugal Average assets 0,01 2018 H1 0,94 distribution | Chart I.4.5• EA median 0400040812162,0 1,6 1,2 0,8 0,4 0,0 -0,4 sn a asin enl ht egt isiuin acrig o their to assets. Bandwidth=0.07.Annualizedfigures. according institutions weights that kernel Gaussian a using Source: Banco de Portugal.|Notes:Empirical distribution obtained Operating result–Empirical Percentage ofaverageassets 2017 H1 2017 [min;max] Percentage of 2018 H1 2018 86

79 Banking sector 80 Banco de Portugal • Financial Stability Report • December 2018 will facilitatetheentryofnewenterprisesintomarket. However,thereisstillnoevidenceof with the transposing of the Revised Payment Services Directive (PSD 2) into Portuguese law Portuguese into 2) (PSD Directive Services Payment Revised the of transposing the with hand, bechallengedbyadditionalcompetitivepressures, mainlyonpaymentservicesprovision, The currentfavourabledevelopmentsinincomefromservices andcommissionsmay,ontheone of allcommissionsreceived. 41% around represented which services payment from commissions the in increase the to due heterogeneity inthebankingsystemfalling.Theincrease incommissionsreceivedwasmainly institutions thathadlowerincomefromcommissionsin the sameperiodyearbefore,with in feesreceivedbeinggreaterthantheincreasepaid.Thiswasdrivenby increase the to due year-on-year, 5.2% increased (net) commissions and services from Income amounts (leftpanel)andnewtimedeposits(rightforloansdeposits. outstanding by weighted rates average Half-yearly individuals. and corporations non-financial to loans Includes Notes: | Portugal. de Banco Source: financial privatesector–Domesticactivity| Chart I.4.6• between thisspreadandthatofbalances(ChartI.4.6). new loans and deposits with the non-financial private sector continued to narrow, closing the gap interest rateoncustomerdeposits.Indomesticactivity,thespreadbetweenrates in implicit the in thereduction reduction the by to offset partly was effect due This rate. interest and implicit associated the sector, private non-financial the to granted portfolio loan the in reduction the through both received, interest in fall the to due was This 2018. of half first the in As regards lending to and deposits from customers, net interest income declined year-on-year interest received. in reduction a in re-sulting rate, interest implicit portfolio’s this as well as sector, private financial for trading.Intheoppositedirectionwasareductioninloanportfoliograntedtonon- held derivatives finan-cial and securities of detriment the to and deposits customer of favour in years, few last the over observed structure financing the of recomposition the from benefit to through customer depositsandsecurities.Additionally,developmentsinnetinterestincomecontinued financing of cost implicit the of reduction the from principally arose liabilities on rate on liabilitiesfallingmorethantheimplicitinterestrateassets.Thefallin This wastheresultofanincreaseinimplicitinterestratespread,with increased marginally year-on-year, increasing its contribution paid, to ROA to interest 1.62% of average total as-sets. and received interest total between difference the i.e. income, interest Net 87. 0 2 4 6 8 Gazette on12November2018,enteringintoforce thedayafteritspublication. Decree-Law No. 91/2018, which transposes PSD 2 into the Legal Framework for Payment Services and Electronic Money, was published in the Official

2010 H1 2010 H2 2011 H1 2011 H2 Interest ratesonoutstandingamountsandnewtimedepositswiththenon- 2012 H1 2012 H2

2013 H1 Stocks 2013 H2 2014 H1 2014 H2 2015 H1 Loans 2015 H2 2016 H1 2016 H2 2017 H1 2017 H2

2018 H1 Per cent Deposits 0 2 4 6 8

2010 H1 2010 H2 2011 H1 2011 H2

Spread 2012 H1 New business 2012 H2 2013 H1 2013 H2 2014 H1 2014 H2 2015 H1 2015 H2 2016 H1 2016 H2 87

which which 2017 H1 2017 H2 2018 H1 the cost-to-income ratio to increase. reduction in total operating income. slight In the first the half of 2017, given various non-recurrent costs, events caused operational falling of result the was This I.4.7). (Chart efficiency system’s 89. 88. the institutionswithgreateroperationalcostsperasset. operational costsmadea0.09p.p.contributiontotheincrease inROA,stemmingmainlyfrom other The administrative expensesanddepreciationamortisation alsofellyear-on-year.Thefallin costs. operational system’s banking the of 57% around represents item This staffcosts. in fall the to due mainly year-on-year, 5.8% fell costs operational 2018, of half first the In capitalisation schemeuponthesaleofNovoBanco. ratio withadjustmentBwasonlyadjustedbythetriggeringofcontingent Novo Banco,andthelossarisingfromdeconsolidationofBFAbyBPI.The revision, thetriggeringofcontingentcapitalisationschemeuponsale was adjusted by the restructuring processes, collective labour agreement (CLA) Source: BancodePortugal.|Note:Thecost-to-incomeratiowithadjustmentA The cost-to-incomeratio operational efficiency. providers throughdigitalmeansmayalsocontributetotheincreaseinbankingsystem’s hand, the building of synergies between the incumbent institutions and the new financial service significant competition by fintechs, as the Directive only entered into force recently. On the other costs andtotaloperatingincome Chart I.4.7• efficiency asmentionedabove,andthedeteriorationofthisratioinothergeographies. system’s banking Portuguese the in improvement the to due was This I.4.8). (Chart 2018 of half The Portuguese banking system’s cost-to-income ratio was below the euro area median in the first similar adjustments. applying after 2018 of half first the of end the at observed that than lower slightly is which 56%, EUR billion deconsolidation ofBFAbyBPI,withanegative impactonthe‘Otheroperatingincome’item(2017H1). an (with costs operational reduced which (CLAs), agreements impact in 2017 H1 and 2018 H1); (ii) restructuring processes, which raised operational costs (2017 H1and 2018 H1); (iii) the lossarising from the labour collective of revisions (i) were: adjustments the in considered events The Ratio betweenoperationalcostsandtotaloperating income. -10 ratio, continued toimprove inthefirst halfof2018. Banking system efficiency, measured by the cost-to-income 10 15 -5 0 5

CtI w/ adjustment B (rhs)CtIw/adjustment (rhs) ratio CtI Income Operating Total 2010 2011

2012 Cost-to-income (CtI),operational 2013 2014

2015 88 fell 2.8 p.p. in the first half of 2018, indicating an increase in the banking 2016 2017 CtI w/ adjustment A (rhs) CtIadjustmentw/ costs Operational //

2017 H1 89 Correcting for these events, this indicator stands at about 2018 H1 52 57 62 67 72

Per cent 38 43 48 53 58 63 68 73 78 cent International comparison(2018H1)| Chart I.4.8• Source: EuropeanCentralBank(ConsolidatedBankingData). DE FR CY CtI 2017 H1 2017 CtI LV BE MT Cost-to-income (CtI)– AT IT FI CtI 2018 H1 2018 CtI IE SI LU PT NL SK EA Median GR ES Per LT EE 81 Banking sector 82 Banco de Portugal • Financial Stability Report • December 2018 portfolio andtherecordingofimpairmentsonthoseassets. tions (Chart I.4.10). Indeed, a negative correlation was observed between the quality of the credit The recording of credit impairments was heterogeneous across the banking system’s institu- around 29%(ChartI.4.9). by impairments credit of reduction the by driven mainly was This 2008. of half first the of that to the flow of impairment losses (net of reversals) declined in the first half of 2018. On the one the On 2018. NPLs, new of flow lower a from i.e. risk, credit of of materialisation lower a from resulted this hand, half first the in declined reversals) of (net losses impairment of flow the In thecurrentcontextofeconomicrecovery,increasingreal estatepricesandlowinterestrates, granted tocustomers.Annualizedfigures. of creditimpair-mentsandprovisionsasapercentagetotalaveragegross flow the to corresponds charge loss loan The Notes: | Portugal. de Banco Source: charge loss loan the 2018, of half first the In improving their operational efficiency and mitigating effects of potential competition from fintechs. the banking system should follow an investment policy in digitalising its structures, with a view to Finally, risk. cyber of mitigation the and financing, terrorist and money-laundering combating to regard in namely risk, operational also but risks, financial the of only not control and assessment adequate notundermine must control of the risks inherent to banking activity. In particular, the institutions must ensure suita-ble costs operational reduce to efforts institutions’ the However, system’s futureprofitability. added costs at thetimeoftheirimplementation,theyareexpectedtohelpincreasebanking involve to continue may revisions (CLA) agreement labour collective and retirements voluntary to increase their operational efficiency. In particular, although the early retirement pro-grammes, system’s institutionshavebeendrivenmainlybytherestructuringprocessesunderway,de-signed Over 91. 90. loan losscharge Chart I.4.9•Impairments,provisionsand more sharplyamongtheinstitutionsforwhichthisindicatorwashigherinfirsthalfof2017. As a percentage For moredetails,seeSection4.1“Profitability”, FinancialStabilityReport The loan loss charge corresponds to the flow of credit impairments and provisions as a percentage of total average gross credit granted to customers. of average assets The loanlosscharge reached itslowest value since June2008 0,0 0,5 1,0 1,5 2,0 2,5 the last few years, the changes in operational costs for most of the Portuguese banking Portuguese the of most for costs operational in changes the years, few last the Credit i Other pr 2010 mpairments

ovisions and 2011 2012 2013

impairment 2014 2015 2016

2017 //

Loan 2008 S1

loss c 2017 S1 2018 S1 harge (rhs) 0,0 0,5 1,0 1,5 2,0 2,5 90

As a percentage similar level a 0.5%, to year-on-year, p.p. 0.2 fell , June2018. of average gross credit distribution | Chart I.4.10• 10-, , , , , 2,0 1,5 1,0 0,5 0,0 -0,5 -1,0 granted tocustomers.Annualizedfigures. of creditimpairmentsasapercentagetotalaverage gross credit assets. Bandwidth=0.06. The loan loss charge corresponds to the flow their to according institutions weights that kernel Gaussian a using Empirical distributionobtained Source: Banco dePortugal.|Notes: 91 However,theloanlosschargefell Percentage ofaverageassets Loan losscharge–Empirical 2017 H1 2017 2018 H1 2018 Chart I.4.11•NPL (net of impairments) to total assets ratio – International comparison | levels, improvingtheconditionsforfurtherreducinghighlevelofNPLs. capital increase to retention profit promote must institutions the profitability, system banking of 93. 92. Source: EuropeanCentralBank(ConsolidatedBankingData).|Notes:NPLsaccordingtotheEBAdefinition.Certaincountriesa re notrepresentedduetolackofdata. countries. European other to unfavourably compares and significant be to continues level NPL the However, I.4.11). (Chart Italy and Ireland in that to identical less or more is Portugal in assets total in impairments of net NPLs of share The (cures). performing to non-performing from transitioning loans and write-offs, and sales to due portfolio credit the of quality average the in progress remarkable made has system banking Portuguese The 4.2 Letter Circular a published Portugal With aviewtoapplyingtheaccountingprincipleslaiddowninIFRS9consistently,Bancode of effortstoreducethestockNPLsand,incertaincases,therecordingimpairments. convergence of asset quality indicators towards international stand-ards requires the continuation the Finally, impairments. higher to lead may loans non-performing of provisioning on guidance ECB should the economy slow down. Furthermore, the effects of applying IFRS 9 and the addendum to the and the reduction in the flow of impairments. Hence, the current dynamics may flatten out or reverse However, asmentionedabove,therearesignsofapositiverelationshipbetweeneconomicgrowth Thus therewillpossiblyberoomforreversingpartoftheimpairmentsrecordedpreviously. context has facilitated the increase in value of real estate collateral, reducing the expected loss. current the Similar-ly, position. financial debtors’ the in improvement the to due ‘cures’), (termed more favourableeconomicsituationwilltendtoswitchloansfromnon-performingperforming resulting in a lower need for recording impairments on the credit portfolio. On the other hand, the credit forinstitutionsunderitssupervision. principles supportingtheassessmentofcalculationmethodologiesforexpectedlosseson 10 15 20 25 However, implementation of the NPL definition proposed by the EBA is not yet fully harmonised across euro area countries, whichmaybias countries, euroarea Report, December2017and“Conceptsusedintheanalysis ofcreditquality”, ”, (NPLs) across loans non-performing of stock fullyharmonised the address yet to “Strategy not Issues Special is see details, EBA more For comparisons. the international by proposed definition NPL the of implementation However, issuedCircular Letter No.CC/2018/00000062, on15 November 2018. The NPLratio continued todecline 0 5 RC EP VI IL SM EN KA EF ILU FI FR BE AT SK NL EE MT ES LT SI IT LV PT IE CY GR Asset quali ty Jun. 16 92 givingitsunderstandingofthebenchmarkcriteriaand Jun. 18 Financial StabilityReport 93 Thus, in the current con-text of recovery , November2016. EA Median Financial Stability Per cent 83 Banking sector 84 Banco de Portugal • Financial Stability Report • December 2018 Around 60% of the fall in the NPL ratio was due to the flow of write-offs and cures (Chart I.4.14). I.4.14). (Chart andcures write-offs of flow the to The cumulativedeclineofNPLstockamongNFCssinceJune 2016cameto€12billion. due was ratio NPL the in fall the of 60% Around of around €3 stock billion in this segment, which accounts for around 65% of NPL total NPLs in the banking system. in decline a to due was ratio NPL the in reduction This 2017. falling December since 2018, p.p. June 2.9 of end the at 22.3% at stood (NFCs) corporations non-financial for ratio NPL The are estimated to have accounted for around 90% of the change in the NPL ratio since June 2016. together factors three These NPLs. of cures (net) and sales by extent, lesser a to and, write-offs around of decline a to corresponding p.p., €18 billion of NPL 6.2 stock (-36%). Over this fell period, the change in NPL ratio stock was explained chiefly NPL by the 2016, June in peak its From and cashbalancesatcentralbanksothercreditinstitutions;(2)–correspondstothesumofNPLsinrelationtotalloans. cash includes customers, to loans as well – as (1) definition. EBA the to according NPLs figures. End-of-period Notes: | Portugal de Banco Source: Table I.4.2• ratio NPL the 2018, June In performing, allowingaswifterexitoftheseassetsfrominstitutions’balancesheets. for recognising more promptly impairment losses in credit agreements which become non- on provisioning of non-performing loans and the adoption of IFRS 9 create a significant incentive guidance ECB the to addendum the of implementation the regard, this in Also institutions. the asset reductionplanssubmittedtothesupervisoryauthoritieswhicharebeimplementedby assets on losses with little chance of recovery continue to be recognised, in accordance with the non-performing and maintained is trend reduction NPL current the that important is it Thus 94. in the NPL ratio in the first half of 2018. The public information availa-ble for some of the principal principal the institutions indicatethecontinuationofNPLstockreductiontrendinsecondhalf2018 of some for availa-ble information public The 2018. of half first the in ratio NPL the in non- becoming performing) new loans (Chart I.4.12). These of two factors are estimated to (net account for and cures over two-thirds of the decline of write-offs flows significant from all above benefited ratio NPL the of reduction The billion. €4.6 around by stock NPL of reduction the by principally driven All sectors Households Non-financial corporations Ratio betweenthegrossvalueofNPLsand thetotalgrossvalueofloans. NPL NPL ratio NPL ratio NPL ratio NPL NPL Housing o.w. Past-due o.w. Unlikely-to-pay Consumption andother Housing Consumption andother Loan portfolioquality 94 stood at 11.7%, 1.6 p.p. down on December 2017 (Table I.4.2). This was was This I.4.2). (Table 2017 December on down p.p. 1.6 11.7%, at stood Notes (1) (2) (2) (2) (2) (2) 10 10 10 10 10 10 10 Unit % % % % % 6 6 6 6 6 6 6 € € € € € € € 12,865 33,151 31,713 18,747 50,459 2016 Jun. Jun. 4,568 8,297 19.0 30.3 17.9 9.2 7.2

12,030 30,160 28,315 18,046 46,361 2016 Dec. Dec. 4,101 7,929 16.2 29.5 17.2 8.7 7.0

11,154 27,232 26,615 15,661 42,276 2017 Jun. Jun. 3,922 7,232 15.0 27.5 15.4 8.1 6.5

24,184 22,558 14,443 37,001 2017 Dec. Dec. 9,824 3,527 6,297 13.1 25.2 13.3 7.1 5.7

21,123 20,522 11,946 32,468 2018 Jun. Jun. 8,722 3,393 5,329 12.6 22.3 11.7 6.4 4.9

Δ Jun. 2016 Δ Jun.2016 Jun. 2018 -12,028 -11,191 -17,992 -6.4 pp -8.0 pp -6.2 pp -2.8 pp -2.3 pp -4,142 -1,175 -2,967 -6,801 Δ Dec. 2017 Δ Dec.2017 Jun. 2018 -0.5 pp -2.9 pp -1.6 pp -0.7 pp -0.8 pp -1,102 -3,061 -2,036 -2,497 -4,533 -134 -968 .

for morethanhalfofthischange (ChartI.4.14). accounting cures, (net) was households to loans in ratio NPL the in reduction the of driver main The 2017. De-cember since purposes, other and consumption for loans on million €134 around essentially the result of a reduction of around €1 billion euros in NPL stock on hous-ing loans and purposes stood respectively at 4.9% and 12.6%. The decline in NPL ratios in these seg-ments was In turn, the NPL ratios on loans to households for house purchase and for consumption and other Other denom-inatoreffectsreflectchangesinthestockofloansthatarenotrelatedwith the NPLstock(e.g.netflowofperformingloans). foreclosures. and amortisations of cures, net NPLs new namely securitisations, and sales write-offs, than other reasons for outflows and inflows NPL the Source: Banco de Portugal. | Notes: NPLs according to the EBA definition. NPL sales include securitisations. The ‘New NPLs, net of cures’ item reflects all Chart I.4.13• the firsthalfof2018,toalevelabovethatobservedinotherindustries. in increased, ratio coverage the manufacturing, In I.4.13). (Chart ratio coverage impairment the in increase an as well as ratio, NPL the in decline generalised a also was there sector, activity By enterprises. larger among greater was ratio coverage impairment the in increase the However, I.4.13). (Chart enterprises larger and SMEs across based broadly was ratio, coverage impairment NPL the of strengthening the with combined ratio, NPL NFCs’ the in reduction the 2018, of half first the In denom-inator effectsreflectchangesinthestockofloansthatarenotrelatedwithNPL(e.g.netflowperformingloans). reflects all the NPL inflows and outflows for reasons other than write-offs, sales and securitisations, namely new NPLs item net cures’ ofcures, of amortisations net NPLs, ‘New and foreclosures. The Other securitisations. include sales NPL definition. EBA the to according NPLs Notes: | calculations). (internal Portugal de Banco Source: Chart I.4.12• NPL ratio (%) 10 15 20 25 30 35 40 45 50 17,9

05 45 86 26 66 64 62 60 58 56 54 52 50 Jun. 16 SME NPLcoverage by impairments ratio (%) F Total – NFC

NFCs’ NPLratioandimpairmentcoverage–bysizeactivity| Write-offs NPL ratio–Contributionstodevelopments|

By size NPL sales entreprises Large

New NPL net of cures

Other denominator

Dec. 17 Dec. effects 13,3 Dec. 17 NPL ratio (%) Jun. 18 10 15 20 25 30 35 40 45 50 55 56 57 75 70 65 60 55 50 45 Write-offs NPLcoverage by impairments ratio (%) Per centandpercentagepoints Manufacturing Real estate activities NPL sales Other By activity New NPL net of cures C

onstruction Other denominator effects Trade Percent 11,7 Jun. 18 85 Banking sector 86 Banco de Portugal • Financial Stability Report • December 2018 in theloanstohouseholdsforconsumptionandotherpurposes segmentfell(-1.7p.p.). households for house purchase (3.2 p.p.) segments, while the to impairment loans coverage and ratio on p.p.) NPLs (4.0 NFCs to loans the in ratio this in increase the reflected This I.4.3). (Table In the first half of 2018, the impairment coverage ratio on NPLs on ratio coverage impairment the 2018, of half first the In assets. their to according institutions weights that kernel Gaussian a using obtained distribution Bandwidth=0.7 (NFCs)andBandwidth=0.04(households).NPLsaccordingtotheEBAdefinition. Empirical Notes: | Portugal. de Banco Source: Chart I.4.15• institutions. banking system’s institutions (Chart I.4.15). However, there was still high heterogeneity be-tween the of most for ratios NPL the in decline a was there 2018, June and 2017 of end the Between performing loans). of flow net (e.g. stock NPL the with related not are that loans of stock the in changes reflect effects denom-inator Other ofcures, foreclosures. and amortisations net new NPLs namely and securitisations, sales write-offs, than other reasons for NPLs, outflows and ‘New inflows The NPL the securitisations. all include reflects item sales cures’ NPL of net definition. EBA the to according NPLs Notes: | calculations). (internal Portugal de Banco Source: half of2018| Chart I.4.14• 95. 02 04 50 40 30 20 10 0 2 Ratio between impairments recorded for NPLs andtheirgrossvalue. Ratio betweenimpairmentsrecordedforNPLs sharply The impairmentcoverage ratio intheNFC segmentincreased 5 , Dec. 17 2 Non-financial corporations

Write-offs Non-financial corporations Per centandpercentagepoints NFC andhouseholdNPLratios–Empiricaldistribution| NFC andhouseholdNPLratios–Contributionstodevelopmentsinthefirst Dec. 17 Dec.

NPL sales

Net NPL net of cures Jun. 18 Jun.

Other denominator effects 2 2 , Jun. 18 3 024681012 0 . Dec. 17 7

Write-offs 95 Dec. 17 Dec. increased 3.5 p.p. to 52.8% to p.p. 3.5 increased H ouseholds H NPL sales ouseholds Per cent

Net NPL net of cures Jun. 18

Other denominator effects 0 . Jun. 18 6 96. Source: BancodePortugal Table I.4.4• new model for calculating impairment by financial institutions. The implementation of accounting standard IFRS 9 from January 2018, led to the introduction of a (3) –correspondstothesumofaccumulatedimpairments,collateralandguaranteesassociatedwithNPLsinrelationtotalNPLs. NPLs total to relation in NPLs on impairments accumulated of sum the to corresponds – (2) institutions; credit other and banks central at balances cash and cash includes customers, to loans as well – as (1) definition. EBA the to according NPLs figures. End-of-period Notes: | Portugal. de Banco Source: Table I.4.3• Table I.4.4). asset classes:performing,underperformingandnon-performing(TableI.4.4). prior model (IAS 39). This approach introduces three stages, correspond-ing to the following financial of impairmentlossesonanexpectedlossbasis,asopposedtotheincurredconceptusedby Classification calculation Time horizonusedinimpairment Probability ofdefault(PD) Loss givendefault(LGD) or loss(interestrateincidence) Recognition ofinterestinprofit All sectors Non-financial corporations Households ratio NPL impairmentcoverage NPL totalcoverageratio ratio NPL impairmentcoverage NPL totalcoverageratio Special Issue2“IFRS 9 –Mainchangesandimpacts anticipatedforthebankingsystemandfinancialstability”,FinancialStabilityReport ratio NPL impairmentcoverage NPL totalcoverageratio Housing Consumption andother Expected lossimpairmentmodelofIFRS9 Coverage ofNPLsbyimpairments,collateralandguarantees Notes (1) (2) (1) (3)

(2) (2) (3) (2) (2) (3) Unit Performing 12 months Point-in-time" "PD 12months Point-in-time Gross value % % % % % % % % Stage 1 2016 Jun. 43.2 85.9 46.4 36.7 60.0 97.9 84.1 23.9

2016 Dec. 45.3 87.2 48.9 35.4 63.2 96.3 85.0 21.0 increase sincerecognition)" (Operations withsignificantrisk "Underperforming Remaining termtomaturity Point-in-time" "PD lifetime Point-in-time Gross value 2017 Jun. 45.9 88.5 49.1 36.5 63.5 96.3 87.0 21.9 Stage 2 96

This new model involves recognition Thisnewmodelinvolvesrecognition

2017 Dec. 49.4 90.5 53.9 37.1 62.6 95.8 89.0 22.8

2018 Jun. 52.8 92.2 57.9 39.6 60.9 91.6 92.9 26.0

Δ Jun.2016 11.5 p.p. Jun. 2018 -6.3 p.p. 9.7 p.p. 6.3 p.p. 2.9 p.p. 0.9 p.p. 8.8 p.p. 2.1 p.p. (credit-impaired)" "Non-performing to maturity Remaining term Point-in-time" "100% Point-in-time (of impairments) Net value Stage 3

Δ Dec.2017 Jun. 2018 , June2017. -1.7 p.p. -4.2 p.p.

3.5 p.p. 1.7 p.p. 4.0 p.p. 2.5 p.p. 3.9 p.p. 3.2 p.p.

87 Banking sector 88 Banco de Portugal • Financial Stability Report • December 2018 Chart I.4.16•ClassificationoftheloansaccordingtoIFRS9impairmentmodel–June2018 2018, onlyslightlybelowtheNPLratiosinthesesegments(ChartI.4.16). classified in stage 3 represented 21.6% and 6.2% of the total of their respec-tive portfolios in June households and NFCs to granted loans the fact, In 3. stage in are NPL as classified assets the of in prudentialterms.InthecaseofinstitutionsapplyingIFRS9,itmaybeex-pectedthatmost cial assets according to the applicable accounting standard must be classified as non-performing has been increasing (Chart I.4.17). These developments began in the loans to households for consumption andotherpurposessegmentand,morerecently, intheNFCssegmentalso. households to loans the in began developments These I.4.17). (Chart increasing been has the banks’ drive to reduce the high NPL stock, as the performing to component of the loan due portfolio partly is sector private non-financial the to loans of portfolio the of value the in decline The 2%. pur-poses other for households to loans and 5% consumption for households to loans NFC segment representing around 21% of assets, loans to households for house pur-chase 28%, the with started), series time the (when 2008 since value lowest the assets, of 59% represented port-folio this 2018, June In households. and NFCs to loans of reduction the of result the chiefly that began in 2011, decreasing 1.6% between December 2017 and June 2018. This behaviour was trend falling the continued impairments) credit of (net portfolio loan customer the of value The 4.3 Source: BancodePortugal. exposures, non-performing on regulation European with accordance In 97. No. 680/2014of16April2014,subsequently altered byCommissionImplementingRegulation(EU)No.295/227of9January2015. under article 99(4) of Regulation (EU) No. 575/2013 of 24 July 2014, adopted by the Commission through Commission Implementing Regu-lation (EU) TechnicalStandardsonsupervisoryreportingforbearanceandnon-performing expo-sures EBA/ITS/2013/03/rev1: EBAFinaldraftImplementing change increased to NFCs was positive, whileconsumer credit’s annualrate of In thefirst halfof2018,theannual rate ofchangebankcredit Credit standards 21,6 Non-financial corporations Non-financial 13,3 Performing ( stage 1 )

65,1 Underperforming (stage Underperforming 2) 9,0 Non-performing ( 6,2 Households stage 3) 97 credit-impaired finan- credit-impaired 84,8 change | financial privatesector–Year-on-yearrateof Chart I.4.17• period ofdecreasingbalancesloanstothesesectors. prolonged a after observed was fact This I.4.18). (Chart 2018 June in positive slightly were NFCs continues todecline,althoughataslowingpace. buoyant realestatemarket.Inturn,creditgrantedtoenterprisesintheconstructionindustry has postedarapidrecovery,althoughwithslowdowninJune2018,likelytobeduethe 100. 99. 98. Manufacturing sectors, bankcredittoNFCscontinuedpostpositiveannualratesofchangeinJune2018 Bank credit to NFCs (loans and debt securities) increased 1.7% year-on-year. In terms of activity tions aregrantedbyinstitutionsownedinternationalgroups. opera- credit consumer new of proportion significant a Additionally, segments. other in 90% around to compared consumption, for households to operations credit new of 50% around for accounted institutions largest seven The corporations). Non-financial 3.2.2 (Section (-1.1%) rate consumer loans,withhousingloanscontinuingtodecline,althoughatanincreasinglyslower in increase 11.8% the by driven was (0.4%) households to granted loans of growth slight The EBA definition. the to according NPLs Note: | Portugal. de Banco Source: In domestic activity, the adjusted annual rates of change -25 -20 -15 -10 -5 0 5 Includes wholesaleand retailtrade;repairofmotorvehiclesand motorcycles,aswellaccommodation,foodservicesandthelike. Includes manufacturing,miningandquarrying. for theeffectsofcreditportfoliosales. Adjusted for securitisation operations, reclassifications, write-offs and exchange rate and price revaluations. Where relevant, the values are ad-justed Dec. 15 Jun. 16 Dec. 16 Jun. 17 Dec. 17 Jun. 18 Jun. 17 Dec. 17 Jun. 16 Dec. 16 Jun. 15 Dec. Per cent 99 Performing Loans grantedtothenon- andTrade 100 (Chart I.4.19). Total credit granted to real estate sector enterprises Non-performing of change| financial privatesector–Annualrate Chart I.4.18• resident inPortugaltoresidentstheeuroarea.Solobasisactivity. securities held by banks. Credit granted by monetary financial institutions debt includes corporations non-financial to credit Bank sales. portfolio credit of effects the for relevant, where and, revaluations price and rate and exchange write-offs reclassifications, operations, securitisation for Source: BancodePortugal.|Notes:Annualratesofchangeadjusted -12 12 -8 -4 0 4 8 e.1 e.1 e.1 e.1 e.1 e.1 e.1 Dec. 17 Dec. 16 Dec. 15 Dec. 14 Dec. 13 Dec. 12 Dec. 11 Dec. 10 Non-financial corporations Non-financial Households – House purchase House – Households 98 for bank credit to households and Per cent Bank creditgrantedtothenon- oshls–Consumption Households – oshls–Total Households –

89 Banking sector 90 Banco de Portugal • Financial Stability Report • December 2018 bank) withresidentsintheeuroarea.Solobasisactivity. central (excluding Portugal in resident institutions financial monetary Source: Banco dePortugal. | Notes:Newoperationsperformedby Cumulative flows| Chart I.4.20• that ofbeforethefinancialcrisis(ChartI.4.21). to simi-lar was level spread the 2018, of quarter third the of end the At Risks). 1.2 (Section area new loansanddepositswithNFCscontinuedtonarrow,approachingthoseobservedintheeuro on rates interest the between spreads the Additionally, I.4.20). (Chart crisis financial the before nine first the for months of the years 2015 to 2017. However, these values are substantially lower than those of average the for observed that with line in are NFCs to loans bank new Total granted bymonetaryfinancialinstitutionsresidentinPortugaltoresidentstheeuroarea.Solobasisactivity. revaluations and, where relevant, for the effects of credit portfolio sales. Bank credit to non-financial corporations includes debt securities held price by and banks. rate Credit exchange and write-offs reclassifications, operations, securitisation for adjusted change of rates Annual Notes: | Portugal. de Banco Source: of change| Chart I.4.19• 10 20 30 40 50 60 70 0 -12 -10 classes Spreads onnew bankloanstoNFCs narrowed across alltherisk -8 -6 -4 -2 0 2 4 6 8 a.Fb a.Ar a u.Jl u.Sp c.Nv Dec. Nov. Oct. Sep. Aug. Jul. Jun. May Apr. Mar. Feb. Jan. 2015-2017 2003-2007 Dec. 10 Per cent

New bankloanstoNFCs– Jun. 11 Bank creditgrantedtonon-financialcorporationsbyactivity–Annualrate Manufacturing

EUR billions Dec. 11 2018 2008-2010 Jun. 12

Dec. 12

Jun. 13 Trade 2011-2014

Dec. 13 loans anddeposits–NFCs| Chart I.4.21• with residentsintheeuroarea.Solobasisactivity.“ bank) central (excluding Portugal in resident institutions financial monetary by rates onnewoperationsperformed amounts ofnewoperations.Interest Source: Banco de Portugal. | Notes: Quarterly average rates weighted by the Jun. 14 0 2 4 6 8

Construction Dec. 14 2007 Q1 2007 Q3 2008 Q1 Jun. 15

Loans 2008 Q3

2009 Q1 Interest ratesonnewbank 2009 Q3 Dec. 15 2010 Q1 2010 Q3 2011 Q1 Jun. 16 2011 Q3 Real estate activities

Deposits 2012 Q1 2012 Q3 Dec. 16 2013 Q1 Per cent 2013 Q3 2014 Q1 2014 Q3 Jun. 17 2015 Q1 2015 Q3 2016 Q1 Dec. 17 Spread 2016 Q3 2017 Q1 2017 Q3 Jun. 18 2018 Q1 2018 Q3 In the first half of 2018, the spreads on lending interest rates to NFCs continued tobeseg- continued toNFCs rates mented accordingtocreditrisk.However,therewasa general narrowingoftheinterestrate interest onlending thespreads of 2018, half first the In and realestatesectorsareingeneralassociatedwithhigher-risk classes. is associatedwiththemanufacturingandtradesectors. In contrast,newloansinthebuild-ing concession. Inparticular,thegreaterallocationofnewloans toenterprisesinthelowerriskclass As mentioned above, heterogeneity between activity sectors continued in regard to new loan (excluding centralbank)withresidentsintheeuroarea.Solobasisactivity. management of new loan concession by monetary financial institutions. New operations performed by monetary financial institutions resident in Portugal of half 2018. first The amounts the relating to in enterprises that 34% improved and their risk 2017 class in in each 33% year are 2016, relatively constant, in with no 30% evidence 2015, suggesting exclusively in passive 30% 2014, in 40% approximately totalled which considered, not were information risk without enterprises regarding operations New 5%. above of year one in PD a with enterprises the to corresponds 3) class a (risk class risk higher with the and enterprises the to corresponds 1) class (risk class risk Lower 5% to equal or below and 1% above of year one in PD series. a with enterprises to corresponds 2 class risk less; or 1% of year one in (PD) operations default of probability new total the and class risk each of weights the calculate to default probabilities revisit-ed”, Economic Studies, Banco de Portugal. “Firm (2016), New al. operations et regarding A. enterprises Antunes, are used, of with methodology the the risk follows information enterprise available, each to information risk of attribution The Notes: | Portugal. de Banco Source: Chart I.4.22• According to the various editions of the Bank Lending Survey (BLS) of 2018, 102. 101. the firsthalfof2013. enterprises inthebestriskclassesduringperiodunderreview,ashasbeenobservedsince the total change in loan stock granted by the resident financial sector continued to come from the Also, I.4.22). (Chart enterprises those to loans new in increases more and reductions fewer both risk enterprises.Since2016lower-riskenterpriseshaveincreasedtheirshareofnewloans,dueto In the first half of 2018, the sum of new bank loans to NFCs continued to be higher among low-er- was change significant no mentioned bytheinstitutionssurveyed. credit, for demand enterprises’ of terms In enterprises. higher-risk degree lesser a to and enterprises medium-risk to applied spread the principally affected have competition between institutions are likely to have made credit policy looser. This is thought to However, factors such as the improvement in general and sectoraleconomic condi-tions and and terms and conditions on credit agreements for enterprises remained largely un-changed. 100 For furtherdetailsseeEconomicBulletin Bank LendingSurveys ofApril,JulyandOctober 2018,Banco dePortugal. 10 20 30 40 50 60 70 80 90 0 2014 H1 2014 H2 2015 H1 2015 H2 2016 H1 2016 H2 2017 H1 2017 H2 2018 H1 2018 H2 2017 H1 2017 H2 2016 H1 2016 H2 2015 H1 2015 H2 2014 H1 2014 Risk class 1 (lower risk) New loansgrantedtoNFCsbyriskclass| 102 , October2018,inparticularChartI.3.18. Risk classRisk 2 (intermediate risk) Per cent Risk class 3 (higher risk) 101 the credit stand-ards 91 Banking sector 92 Banco de Portugal • Financial Stability Report • December 2018 Chart I.4.23• narrowing ofspreadsformedium-riskenterprises,andtoalesserextenthigher-riskenterprises. broadly consistent with the results of the October BLS, in which the institutions indicated a slight is behaviour This environment. financial and macroeconomic favourable more the from arising distributions is likely to be associated with the improvement in the enterprises’ finan-cial position, rowed by 10 p.b. and that of risk class 3 (higher risk) by 13 p.b.. The leftward shift of the spreads’ nar- risk) (intermediate 2 class risk of that p.b., 8 by narrowed risk) (lower 1 class risk of spread for householdsinthethirdquarter.Mostinstitutions Octobersurveysaidthatthefactor quarter. IntheJulysurvey,bankswerealreadyreporting atight-eningincreditstandards loans for house purchase and, to a lesser extent, to consumer loans, became tighter in the third However, intheOctoberBLS,banksindicatedthat termsandcondi-tionsapplyingtonew factor to the squeezing of spreads on housing loans and, to a lesser degree, on consumer credit. households remainedstable,despitecompetitivepressure beingcitedintheBLSasacontributing In the first half of 2018, credit standards and the terms and conditions on credit agreements with (excluding centralbank)withresidentsintheeuroarea.Solobasisactivity. in 2016, 33% in 2017 and 34% in the first half of 2018. Interest rates on new operations performed by monetary financial institutions resident in Portugal 30% 2015, in 30% 2014, in 40% approximately totalled which considered, not were information risk without enterprises regarding operations New 5%. above of year one in PD a with enterprises the to corresponds 3) class (risk class risk higher the and 5% to equal or below and 1% above of year one in PD a with enterprises to corresponds 2 class risk less; or 1% of year one in (PD) default of probability a with enterprises the to corresponds 1) class (risk class risk Lower series. operations new total the and class risk each of shares the regarding calculate to available, operations information risk New the with Portugal. used, are de enterprises Banco Studies, Economic revisited”, probabilities default “Firm (2016), al. et A. Antunes, of methodology the follows enterprise each to information risk of attribution The amounts. loan by weighted Spreads Portugal. in operating groups banking largest seven the by granted Loans 10%. above and 0% below truncated Distribution 0.3. = bandwidth Epanechnikov, = Kernel Notes: | Portugal. de Banco Source: Percentage points I.4.23). (Chart classes risk higher the for especially NFCs, to loans on spreads 103. 0,1 0,2 0,3 0,4 0,5 0,6 new consumer lendingisatarecord high With theeconomy recovering andunemployment falling, loans tonon-financialcorporations”, default risk and those in risk class 3 the highest. For more information, see Special Issue “Risk segmentation on the interest rate spreads of new bank lowest the presenting 1 class risk in those with risk, default their to according classes, risk credit three into divided subsequently were Enterprises (2016). al. et Antunes in out set methodology the to according estimated Z-score the by measured is corporations non-financial of risk credit The 0 012345678910 Risk class 2 (intermediate risk) - 2018 H1 Risk class 1 (lower risk) - 2017 Spreads onnewbankloanstoprivateNFCs–Empiricaldistribution| Financial StabilityReport Risk class 3 (higher risk) - 2017 Risk class 1 (lower risk) - 2018 H1 , December2017. Risk class 3 (higher risk) - 2018 H1 Risk class 2 (intermediate risk) - 2017 103 The median

Cumulative flows| Chart I.4.26• hold depositsremainedstablefromthefirsthalfof2017(ChartI.4.27). spread betweentheinterestratesonnewconsumerloanstohouseholdsandthosehouse- The I.4.26). (Chart crisis financial the before found those above slightly levels at are op-erations In regard tothe loan segment tohouseholds for consumption, the cumulative total of new bank) withresidentsintheeuroarea.Solobasisactivity. central (excluding inPortugal resident institutions financial monetary Source: BancodePortugal.|Notes:Newoperationsperformedby Cumulative flows| Chart I.4.24• This narrowinghasbroughtspreadstobelowthosefoundintheeuroarea(Section1.2Risks). households and those on household deposits have narrowed since the end of 2015 (Chart I.4.25). to loans housing new on rates interest the between spreads the addition, In I.4.24). (Chart crisis new credit in this segment, new business is at levels far below those observed before the financial of volumes the of recovery rapid the Despite (EFAP). Programme Assistance Financial the of start was on average significantly above that observed for the first nine months of the years following the In the first nine months of 2018, the cumulative total of new housing loans granted to house-holds rate levelcontinuedtocontributehouseholds’increaseddemandforcredit. interest general the and market housing the for outlook the confidence, consumer in boost The Recommendation onnewhousingandconsumerloans,inforcesinceJuly2018. Portugal’s de Banco with compliance was standards of tightening the to most the contributing bank) withresidentsintheeuroarea.Solobasis activity. central (excluding inPortugal resident institutions financial monetary Source: Banco de Portugal.|Notes:Newoperationsperformedby 10 15 20 0 1 2 3 4 5 0 5 a.Fb a.Ar a u.Jl u.Sp c.Nv Dec. Nov. Oct. Sep. Aug. Jul. Jun. May Apr. Mar. Feb. Jan. a.Fb a.Ar a u.Jl u.Sp c.Nv Dec. Nov. Oct. Sep. Aug. Jul. Jun. May Apr. Mar. Feb. Jan. 2015-2017 2003-2007 2015-2017 2003-2007 New consumerloans– New housingloans– EUR billions EUR billions 2018 2008-2010 2018 2008-2010 2011-2014 2011-2014 purposes | loans anddeposits–Households,housing Chart I.4.25• purposes | and deposits–Households,consumption Chart I.4.27• with residentsintheeuroarea.Solobasisactivity. monetary financial institutions resident in Portugal (excluding central bank) by amounts ofnewoperations.Interestratesonoperationsperformed Source: Banco de Portugal. | Notes: Quarterly average rates weighted by the central bank)withresidentsintheeuroarea. Solo basisactivity. (excluding Portugal in resident institutions financial monetary by performed by theamountsofnewoperations.Interest ratesonnewoperations Source: Banco de Portugal. | Notes: Quarterly average rates weighted 10 12 0 2 4 6 8 0 1 2 3 4 5 6 7

2007 Q1 2007 Q1 2007 Q3 2007 Q3 2008 Q1 2008 Q1 Per cent Per cent Loans 2008 Q3 Loans 2008 Q3 2009 Q1 2009 Q1 Interest ratesonnewbank 2009 Q3 Interest ratesonnewloans 2009 Q3 2010 Q1 2010 Q1 2010 Q3 2010 Q3 2011 Q1 2011 Q1 2011 Q3 2011 Q3 De 2012 Q1 Deposits 2012 Q1

p 2012 Q3 2012 Q3 osits 2013 Q1 2013 Q1 2013 Q3 2013 Q3 2014 Q1 2014 Q1 2014 Q3 2014 Q3 2015 Q1 2015 Q1 2015 Q3 2015 Q3 2016 Q1 2016 Q1 Spread S p

read 2016 Q3 2016 Q3 2017 Q1 2017 Q1 2017 Q3 2017 Q3 2018 Q1 2018 Q1 2018 Q3 2018 Q3 93 Banking sector 94 Banco de Portugal • Financial Stability Report • December 2018 01010202020303040440 400 360 320 280 240 200 160 120 80 105. 104. Source: BancodePortugal. (LCR) ratio coverage liquidity the with levels, comfortable at stayed liquidity system 2018,first thebanking half of In 4.4 Empirical distribution| Chart I.4.28• considered ofextremelyhighliquidityandcreditquality. are they as calculation, buffer liquidity the in weighting a given not are EU, the of governments the liquidity buffer increase (9 p.p.). Level 1 liquid assets, such as debt securities issued by general of driver main the was component debt public The I.4.29). (Chart banks central in reserves and debt public mainly 2018, of half first the in 10% approximately by increased buffer liquidity The the euroarea(ChartI.4.30). liquidity buffer. liquidity the in increase the to due essentially were LCR the in Developments I.4.28). (Chart institutions institutions withalowerratio,therebycontributingtothereductionofheterogeneitybetween due totheincrease inliquidassets The bankingsystem’s liquiditypositionimproved 2015/61 of10October2014. The liquidity buffer comprises the liquid assets held by credit institutions that satisfy requirements set in the Commission Delegated Regulation (EU) The LCRcorrespondstotheratioofavailableliquidassetsandnetcashoutflowscalculated under a30-daystressscenario. Liquidity andfunding 105 Liquidity coverageratio– In June 2018, the Portuguese banking system’s LCR was above the median for median the above was LCR system’s banking Portuguese the 2018, June In Dec. 17 Dec. 104 growing by 16 p.p., to 190%. The increase was observed principally in the in principally observed was increase The 190%. to p.p., 16 by growing Per cent Jun. 18 | Chart I.4.29• Source: BancodePortugal. Per cent Level 2 Level 1 Level Coins 1 assets – a a ssets – ssets 2,8 1,8 Central government 3,5 Liquidity buffer–Structure and banknotes assets

Level 1 including Level 1 a a 25,8 – ssets – ssets 66,1 withdrawable reserves % O assets, Central bank ther

operations alsoincreased. markets. Inthesamevein,percentageofassetsavailableascollateralformonetarypolicy financial the in liquidity obtain to collateral as use for available assets of percentage greater a 107. 106. Source: BancodePortugal. Contributions Chart I.4.31• falling 4.7p.p.(ChartI.4.32). value median the with left, shifted distribution ratio’s loan-to-deposit The (-1.1%). NFCs and customer deposits.Thisdecreaseintheloanportfoliowassimilarsizeforbothhouse-holds The decline observed was due to a fall in the loans to customers, following an increase in The loan-to-deposit ratio declined steadily, falling 3.4 p.p. from December 2017 to 89% (Chart I.4.31). I Source: EuropeanCentralBank(ConsolidatedBankingData).|Notes:Certaincountriesarenotrepresentedduetolackofdata. Chart I.4.30•Liquiditycoverageratio–Internationalcomparison| n the first half of 2018, the asset encumbrance ratio Percentage points 100 150 200 250 300 350 system –someindicators”,FinancialStabilityReport banking Portuguese the in risk liquidity systemic “Monitoring Issue Special see risk, liquidity systemic assess to indicators on information more For The assetencumbranceratiomeasurestheshareoftotalassets(andcollateralreceived)that isusedascollateraltoobtainliquidity. -9 -6 -3 0 3 Δ Δ Dec. Credit Deposits from 10 SI to customerscontribution Dec. 11 LV customers contribution Dec. 12 Loan-to-deposit ratio– Dec. CY 13 Dec. 17 Dec. 14 LT 107 Dec. 15 MT Dec. Loan-to-deposit 16 PT , June2018. Dec. 17 SK ratio 80 100 120 140 160 (rhs) EE Percentage Source: BancodePortugal. Empirical distribution| Chart I.4.32• Jun. 18 Jun. ES 60 106 IE declined by 1.5 p.p. to 18.8%, indicating FI Loan-to-deposit ratio– 80 IT Dec. 17 Dec. Per cent LU Per cent EA Median EA 100 AT NL Jun. 18 BE 120 FR

95 Banking sector 96 Banco de Portugal • Financial Stability Report • December 2018 billions 108. operations (TLTROs). June In refinancing longer-term assets). targeted comprised mainly banks central from obtained financing 2018, total of p.p. 7 around of fall (cumulative 2012 June in Programme, Assistance such, this Financial the As under reached high record the totalassets. from decline its of continued has financing 4.7% of source reaching of 2018, half first the in fell funding bank Central in cashbalancesatothercreditinstitutions. institutions. This increase reflects growth in deposits of other credit institutions and a stabilisation institutions) credit other increased 14.2%, at to €23.4 billion, balances representing 6.3% of assets cash net of cash balances of at other credit (net financing interbank 2018, of half first the In positions andderivatives. short includes item liabilities’ ‘Other The Notes: | Portugal. de Banco Source: I.4.34). (Chart fell also deposits new with associated cost the Additionally, half. In domestic activity, total new NFC and household deposit operations fell year-on-year in the first low opportunitycostofholdingliquidityinacontextveryinterestrates. time, demand deposits continued to increase, and time deposits continued to fall, reflect-ing the NFCs’ deposits,witheachsectorcontributing1p.p.tocustomerdepositbehaviour.Atthesame and households’ in evident more was increase This equity). and liabilities total of (66% structure Customer deposits increased 2.2% from December 2017, increasing their share in the financ-ing financing fromcentralbanksanddebtsecurities(ChartI.4.33). in decline a and institutions, credit other and customers from deposits 2017. in growth December reflected This from 1.5% increased liabilities system’s banking the 2018, of half first the In Chart I.4.33• low, evennegative,marketinterestrates,reflectingtheECB’saccommodativemonetarypolicy. 6 b.p..Thereductionofinterestratesonnewdepositoperationstookplaceinacontextrecord half-yearly interestrateonNFCs’depositsfell7b.p.andtheforhouseholds’ 110 220 330 440 550 NFCs’ andhouseholds’ depositsincreased, whiledebtsecuritiesfell 0 on interestratesandamountsofnewdeposits. which 15/2012, doubled the No. penalty on Portugal own funds and de increased the Banco penalty on of short-term and Instruction demand deposits by (April 2012). reinforced Both measures subsequently had a was sizeable impact regime This 2011). November in force into entered which own fundsfromnewdepositoperationswith interestratesofmorethan300b.p.aboveEuribor (Instruction ofBanco de PortugalNo.28/2011, of deductions of introduction the specifically more Portugal, de Banco by taken measures reflected also onwards 2011 from seen adjustment The O eposits D 1 e t e h posits 0 c e r .

lia bilit

Dec from f 1 r om 1 i e . s

cus c e n Financing structure| D t t 1 o r e a m 2 l c

e bans .

r s Dec. 1 3

D 1 e 4 c E Securit . e

uit p o Dec. y sit 1 i e s 5

s from

1 other e 6 c.

cred EUR D 1 e 7 it c i . n

s t itut J un. 1 i 8 ons by monetary financial institutions resident in Portugal (excluding central central bank) withresidentsintheeuroarea.Solobasisactivity.“ (excluding inPortugal resident institutions financial monetary by the amountsofnewoperations.Interestratesonoperationsperformed Source: BancodePortugal.|Notes:Half-yearlyaverageratesweightedby operations appliedtotimedeposits| Chart I.4.34• 0 1 2 3 4 5

2010 H2 2011 H1 Non-financial corporationsNon-financial 2011 H2 2012 H1 Interest ratesonnew 2012 H2 2013 H1 2013 H2 2014 H1 2014 H2 2015 H1 108 Households

2015 H2 Theaver-age 2016 H1 2016 H2 Per cent 2017 H1 2017 H2 2018 H1

egtd ses RA dciig agnly blne he dnmc ad ik weight). risk and dynamics sheet (balance marginally declining (RWA) assets weighted risk- the with CET1, in reduction the to chiefly due was This I.4.35). (Chart 2017 December from cent andpercentagepoints Chart I.4.35•CET1ratio–Contributions| banking across dispersion its in increase system institutions(ChartI.4.36). the by accompanied was ratio CET1 the in decline standard. gradual recognition theover five years of thefor negative impact on CET 1allowing due to the application of575/2013, this No. (EU) Regulation in for provided arrangements transitional of the institutions some by adoption the by mitigated was capital 1 CET system’s banking the on in impairmentsontheseassets,byvirtueoftheincrease in expectedloss.However,theim-pact standard resulted in the reclassification of financial assets between categories and the increase enced bytheapplicationofIFRS9from1January2018. Theadoptionofthisnewaccounting influ- were capital system’s banking Portuguese the in developments 2018, of half first the In Source: BancodePortugal. The Common Equity Tier 1 capital (CET1) ratio 4.5 the insolvencyhierarchy.ThistypeofinstrumentiseligibleforMRELbutnotforownfunds. in instruments debt unsecured of position the regarding 2017/2399, (EU) Directive transposing respectively. Additionally,on8NovemberadraftlawwasapprovedbytheCouncilofMinisters capital 2 Tier for eligible instruments in million €400 and million €500 issued Banco Novo and institutions issued instruments eligible for both own funds and MREL. In the first half of 2018, CGD prin-cipal system’s banking the of some while place took This bonds. covered in decline 19% the Debt securities as a percentage of assets fell 0.5 p.p. to 4.2% from December 2017, as a result of 110. 109. 13 The totalcapitalratio was strengthened inthefirst halfof2018 . 9 The (average)riskweight correspondstotheratiobetweenrisk-weightedassetsandtotalassets. Ratio betweenCommonEquityTier1capitalandrisk-weightedassets. Dec. 17 0 Capital Capital and . 11 results

Other 0.41 comprehensive 0 .

Transitional 36 adjustments

Prudential 0.08 filters 0 .

Other CET 1 29 changes

Balance sheet 0.14 dynamics 0 .

Risk 15 weight Per 13 . 4

Jun. 18 109 stood at 13.4% in June 2018, decreasing 0.5 p.p. distribution | Chart I.4.36• Source: BancodePortugal. 111213141516 Per cent CET1 ratio–Empirical Dec. 17 Dec. Jun. 18 110 The

97 Banking sector 98 Banco de Portugal • Financial Stability Report • December 2018 The totalcapitalratio triggering ofthatmechanismwasrecordedinprofitorlossfortheyear. the to linked value the year, financial 2017 the In million. €726 around totalling contracts, sale Banco Novo the in down laid mechanism capital contingent the of triggering the by in-fluenced was item this in increase the 2018, of half first with the In ratio, reserves’. ‘Other CET1 from coming that the of half to contribution positive p.p. 0.29 a made item changes’ CET1 ‘Other The impact ontheCET1ratio. negative p.p. 0.36 a had 2018, January 1 on ended which IV), CRD – Directive Requirements tal tion (EU) No. 575/2013 (Capital Requirements Regulation – CRR) and Directive 2013/36/EU (Capi- The eliminationofmostthetransitionalprovisionsonownfunds,establishedunderRegula- cation offinancialinstrumentsunderIFRS9. reclassifi- the by explained partly ratio, CET1 system’s banking the on impact negative p.p. 0.41 The increase in fair value losses accumulated in the ‘Other comprehensive income’ item had a 111. 2 Tier instruments haveamaturityof10years. aforementioned the since requirements, MREL future the of context the in relevant could be markets financial the in instruments these of issue The million. 130 USD totalling 1 Tier 2 on the market worth €400 million. Also, Haitong Bank issued instruments eligible for Addi-tional instruments, concludingtheirrecapitalisationplan.Novo Banco putinstrumentseligibleforTier debt of million €500 issued Depósitos de Geral Caixa made. were 2 Tier for eligible instruments of issues two 2018, of half first the In I.4.5). (Table capital 2 Tier all above and capital 1 Tier tional Addi- in increase the to due is ratio CET1 the and ratio capital total the between divergence The Source: EuropeanCentralBank(ConsolidatedBankingData). Chart I.4.37•Totalcapitalratio–Internationalcomparison| the lowestcapitalratiosineuroarea(ChartI.4.37). as the RWA stayed stable. However, the Portuguese banking system continues to pre-sent one of funds, own total in increase the to due chiefly was 2018 of half first the in ratio this of behaviour 10 15 20 25 30 35 Ratio between total ownfunds andrisk-weightedRatio betweentotal assets. 0 5 EI IL UN TL ID TB KF RI YP ES PT CY IT GR FR SK BE AT DE SI LT MT NL LU LV FI IE EE CommonEquity Tier 1 111 stood at 15.2% in June 2018, increasing 0.1 p.p. from the end of 2017. The Additional1 Tier Per cent Tier 2 Tier Risk weightedassets fell fromDecember2017(ChartI.4.38). central banks, which carry a 0% risk weight in the RWA calculation. Thus, the average risk weight assets, as this derived from the change in the publicdebt securities portfolio and the cash in change in the capital ratios. This fact occurred despite the increase in the banking system’s total the to contribution nil practically a making stable, remained RWA the 2018, of half first the In an increaseinthetotalexposure,aswellslightfallbankingsystem’sTier1capital. reflected mainly behaviour This (3%). Supervision Banking on Committee Basel the by defined In the first half of 2018, the leverage ratio fell 0.1 p.p. to 7.7%, far above the minimum requirement must beimplementedbytheendof2020. promote standardisationinthenationalcompetentauthorities’prudentialassessment,which to designed standards technical regulatory the of draft final the published EBA the 2016, July In requirements macroprudential institutions. between requirements different prudential 2 Pillar the different the and by jurisdictions between undermined is systems banking between into accountinthecomparisonofinstitutions’capitalratios.Additionally, IRB models to measure the exposures’ risk and thereby to determine the RWA should be taken 0% in Malta, with Portugal at 29.1%. Due to their high level of flexibility and discretion, the use of international affect used to calculate risk, banking system exposures at risk varied between 81% in the Netherlands and credit for (IRB) approaches comparisons. In June 2018, thepercentage of original exposures for which IRB models were based rating internal of importance However, theidiosyncraticfactors of thevariousbankingsystems, most notablythevarying structure isatthemedian. (88%). At euro area partlevel, the prevalence of CET most 1 in the Portuguese the banking system’s own funds for 1 CET comprise to continues structure) system’s the (and institutions main D Source: BancodePortugal. Own funds 112. Memorandum item: Table I.4.5• Common equitytier1–fullyphasedin Tier 2capital Tier 1capital espite theaforementionedAdditionalTier1and2issues,ownfundsstructureof Additional tier1 Common equitytier1 The bankingsystem’s average riskweight declined e te B Dsuso Ppr n h ftr o te R Apoc (http://www.eba.europa.eu/documents/10180/1003460/EBA-DP-2015- Approach IRB documents/10180/1525916/Final+Draft+RTS+on+Assessment+Methodology+for+IRB.pdf/e8373cbc-cc4b-4dd9-83b5-93c9657a39f0 the of future the on 01+DP+on+the+future+of+IRB+approach.pdf Paper Discussion EBA the See Composition ofbankingsystemownfunds ) and the final draft of the Regulatory Technical Standards (https://www.eba.europa.eu/ Standards Technical the Regulatory of draft final the and ) 240,564 2014 Dec. 19,506 27,150 27,421 29,480 2,060 270 112 233,242 24,896 28,966 29,371 31,083 2015 Dec. 1,712 405 215,502 2016 20,778 24,583 Dec. 25,230 26,449 1,220 647 202,265 2017 26,305 28,062 Dec. 29,193 30,641 1,448 1,131 202,208 25,950 2018 27,143 28,509 30,756 Jun. 2,247 1,367 Δ Dec.2014 Jun. 2018 -38,355 6,444 1,097 1,089 1,276 187 -8 Δ Dec.2017 Jun. 2018 ). -355 -919 -683 799 236 116 -57 99 Banking sector 100 Banco de Portugal • Financial Stability Report • December 2018 to theratiobetweenrisk-weightedassetsandtotalassets. Source: Banco de Portugal. | Note: The average risk weight corresponds Contributions | Chart I.4.38• discretion. and flexibility of degree high a involves requirement, capital the determine to thereby and risk, I.4.39). However, it is important to note that the application of IRB models to measure exposures’ (Chart requirements capital their defining in banks Portuguese by models IRB of use lower the Portuguese the 2018 banking system June still had in one internationally, of the position highest RWA relative ratios its per unit in of assets improvement in the the euro Despite area, re-flecting Percentage points -3.0 -1.5 0.0 1.5 Average risk weight risk Average Δ Asset without risk contribution without Asset Dec. 14 Jun. 15 Average riskweight– Dec. 15 Per cent Jun. 16 Dec. 16 Jun. Δ 17 RWA contributionRWA Dec. 17 Jun. 18 55 58 61 64

Percentage Source: EuropeanCentralBank(ConsolidatedBankingData). International comparison| Chart I.4.39• 25 35 45 55 65 75 GR SI LV Dec. 17 Dec. CY PT Average riskweight– SK MT IE AT Jun. 18 LT Per cent EE IT ES DE BE EA Median LU FR FI NL Chart C1.1•REIFunit-holders| maintenance andrenovationcosts. namely building/land, a to exposure direct a of cost addingfull the REIFs, bearing not of of possibility advantages the to main the of one is risk estate real to exposure diversifying of banks receiveinlieuofpayment. REIFs have also proved to play a role in a more dedicated management of real estate assets that REIF activity financed through bank loans. also Furthermore, as a result groups of an increase of banking non-performing loans, some period, same the During sectors. both between channels potential reputational risk involved (indirect exposure). This trend broadened the interconnection the and devaluation price higher a avoid to order in C1.2) (Chart households by redeemed were the 2012-13 during period when, due to the low moreevident return on REIFs, banks and insurance companies acquired units that became link This groups. financial to belonging companies estate investment real and funds, where sector about 50% the banking of total REIF assets as between at December 2017 link were managed significant by management a is there Portugal, In may furtherpromotethedownwardtrendofbanksasREIFunit-holders. estate real the of rates,interest market of level low still the and recovery market, rental the of as well as Portugal, in market The 2018. main June in the units are of these 40% around banks, holding resident REIFs, in by investors held share the of decrease the Despite C1.1). (Chart 20% than less hold they currently units, fund investment of 60% than more average on holding REIFs, in investors main the were households crisis, financial international the to prior Although Source: BancodePortugal. market. estate real commercial Portuguese have beengainingdecisiveimportanceintermsofthetotalnumbertransactions country. As mentioned in previous issues of this Report, non-resident investment funds Likewise, theassetportfoliomayalsobediverseasregardsexposurebygeographyand portfolio, mainly buildings and land, but which can comprise holdings in real estate companies. asset estate real a managing of consists (REIFs) funds investment estate real of activity The Box 1• 114. 113. 100 20 40 60 80 General Government Banks 0 See Section 3 of the June2018 See Section3ofthe real estatefunds.Althoughthisanalysisdoes not includesuchfunds,theyhaveaveryresidualsignificanceinthePortuguesemarket. other in predominantly investing funds of funds includes class fund estate real the level, Union European the at harmonised definition the Under Dec. 00 Dec. 02 Real estateinvestmentfundsresidentinPortugal Dec. 04 NFC Ins. Corp.Pens.Funds Dec 06

. Dec. 08 Financial Stability Reportonrealestatedevelopments. Dec. 10 Households inter. Other Dec. 12 Per cent Dec. 14

Non-residents Dec. 16 Jun. 18 114 From the investors’ perspective, the possibility and percentagepoints change andhalf-yearlycontributions| Chart C1.2• Source: BancodePortugal. 10 12 -6 -4 -2 0 2 4 6 8 Jun. 08 Jun. 09 Transactions Jun. 10 Investment Fundunits–Rateof Jun. 11 113 Jun. 12 Jun. Changes in price in Changes 13 Jun. 14 Jun. 15 Jun. 16 Per cent Jun. 17 NAV Jun. 18 101 Real estate investment funds resident in Portugal Closed-end REIFs have determined the overall REIF activity in Portugal. REIF activity in Portugal gained some momentum up to the end of 2013, when these funds’ assets reached a peak of 10% of GDP. Similarly to REIFs in the euro area, the momentum of national REIFs was mainly determined by closed-end funds115 which from 2006 onwards account for the majority of assets under management (67% in June 2018) and 54% of the net asset value116 (64% in June 2018). Although following the international financial crisis open-end funds stabilised somewhat, it was only as of 2013 that there was a decrease of the assets under management of national REIFs, which was driven by a devaluation of real estate holdings and by the redemption of fund units (Chart C1.3).

At the European level, REIFs have been gaining importance with an upward trend for the last 10 years, accounting for about 27.4% of GDP in the euro area as a whole in June 2018.117 However, despite the significance gained at the euro area level, it reflects a high geographical concentration, with 90% of total REIF assets in the euro area belonging to resident REIFs of 5 countries: Germany, the Netherlands, France, Luxembourg and Italy.118

Chart C1.3 • REIF assets – positions | As a percentage of GDP

0 Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Jun. 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 REIFs REIFs – open-end REIFs – closed-end

Source: Banco de Portugal.

At the height of the financial crisis, a higher exposure to liquidity and leverage risk increased the vulnerability of open-end funds REIFs are mainly exposed to real estate market risk by holding real estate assets and shares in real estate companies representing 83% and 4% of total assets, respectively, in June 2018. This differs from the euro area reality where real estate assets represent almost half of total REIF assets, which is justified by the buoyancy of the equity market and by a greater portfolio of liquid assets (deposits, public debt and quoted shares).

115. Investment funds with a fixed number of fund units. Closed-end fund subscription is possible only for a predefined period, and redemption may only occur on the date of the fund winding-up. 116. The net asset value of a fund correspond to its asset value (duly evaluated) less actual and outstanding charges. 117. The following countries were excluded due to lack of information: Belgium, Cyprus, Malta and Slovenia.

2018 • December Report • Financial Stability de Portugal Banco 118. For further information, refer to EU Shadow Banking Monitor No. 3/September 2018. 102 aig no con te aue f h ast cnend RIs r epce t so some show to expected are REIFs concerned, dependence on bank lending. However, although assets the financial leverage ratio the of nature the account into Taking Source: BancodePortugal. may posean ratio liquidity the although context, this In funds. open-end for risk) (liquidity risk additional redemptions non-expected toaddress assets liquid sufficiently of absence The 120. 119. Chart C1.4• mentioned euroareaREIFshavelessrealestateintheirportfolios. area euro units/shares), REIFs reach liquidity fund ratios (about 30%) much higher investment than those of national and funds since as already shares banks, by issued securities debt, public the euro area. However, taking a broader concept of liquid assets under consideration (deposits, crisis, reaching levels of around 2%. These ratios are slightly below those of all open-end REIFs in open-ended funds was 12% in June 2018 (Chart C1.4), it deteriorated at the height of the financial (Chart C1.6). assets estate real of 21% about representing portfolios, REIF closed-end in relevant also is Land REIFs). closed-end for 52% and REIFs open-end for (74% 2018 June in assets estate real of 60% about represents estate real rented as constraints market rental by affected also is return REIF March 2018(accordingtotheAPFIPP/IPDIndexforPortuguese realestateinvestmentfunds). and 2017 June in return total to compared 2018 June in improvement an showed which REIFs, national of performance the in visible also is Portugal in market estate real the of recovery The the of financial system:Mappingtheregulatoryframework). parts other and banks shadow between interconnectedness The on Paper Occasional ESRB forthcoming the (see contagion to related matters limiting at aiming measures than rather measures preventive generally are measures such Nevertheless, risk). systemic of source a as funds Investment on Issue Special (see funds investment of activity the in involved risk systemic the mitigate to applied were measures legislative several crisis, financial international the After at 16%duringthefirsthalfof2018(ChartC1.5). (14% in June 2018). This ratio is mainly determined by the leverage of closed-end REIFs which was 20% in 2011, it is now at far lower levels (11% in June 2018) and below the level of euro area REIFs Most REIFrealestateassetsarerented 10 12 14 16 18 0 2 4 6 8 The financialleverage ratioisdefinedastheofloanstoassetsfund. The liquidityratioisdefinedastheofde posits toassetsofthefund. Dec. 00 REIFs Dec. 02 Dec. 04 Liquidity ratio| EF –open-end – REIFs Dec. 06 Dec. 08 Dec. 10 Dec. Per cent 12 EF –closed-end REIFs – Dec. 14 Dec. 16 Jun. 18 Chart C1.5• Source: BancodePortugal. 10 15 20 25 30 0 5 Dec. 00 REIFs Dec. 02 Dec. 04 Financial leverageratio| EF –open-end – REIFs Dec. 06 Dec. 08 Dec. 10 120 reachedapeakof Dec. 12 EF –closed-end – REIFs Dec. 14 Dec. 16 Per cent 119 Jun. 18 of of 103 Real estate investment funds resident in Portugal Chart C1.6 • Real estate characteristics Chart C1.7 • Real estate according to purpose | EUR billion – Composition in June 2028 | Per cent 5,0

4,0 Non-rented Land

3,0 40% 30% Housing real 2,0 Others 20% estate 1,0 10% 0% 0,0 Commercial Other real estate real estate Open-end Open-end Open-end Open-end Closed-end Closed-end Closed-end Closed-end Land Building Finished real Finished Service projects & estate – rented real estate – real estate Rights non-rented

Dec. 13 Jun. 17 Jun. 18 Total Open-end Closed-end Source: Banco de Portugal. Source: Banco de Portugal.

Taking into account that REIF total return is determined by the value of real estate asset portfolios, as well as of the rents it generates, the rise of rented real estate between June 2007 and June 2018 shows an increase in the relative importance of rents as a source of income, reflecting nevertheless a higher exposure to default risk resulting from rent arrears. Although a considerable share of real estate is located in the Lisbon municipality (30% of real estate holdings, followed by Oeiras and Oporto municipalities with 7% and 6 respectively), the increase is dispersed across other regions. Regarding the purpose of real estate assets (Chart C1.7), in June 2018 these were related to services (29%), however with a greater concentration in the case of open-end REIFs (39%).121 To a lesser extent, real estate for commercial purposes accounted for 21% and 16% of open-end and closed-end REIF portfolios respectively. Unlike open-end funds, non-rented land and housing real estate have a significant weight in closed-end funds, 19% and 16% respectively. In June 2018 rented real estate assets were mainly for service and commercial purposes, accounting for 42% and 25% of the total respectively, with the share of real estate for commercial purposes increasing on a year-on-year basis (Chart C1.8). Housing real estate kept their relevance to closed-end funds, as observed at the analysis by purpose.

Chart C1.8 • Purpose of rented real estate Chart C1.9 • Duration of real estate asset assets| Per cent portfolio – Empirical distribution | Years

100 10 21 20 13 80 18 16 60 23 24 22 25 40

20 47 44 39 40 0 Jun. 17 Jun. 18 Jun. 17 Jun. 18 Open-end Closed-end Services Commercial Housing -11 3 5 7 9 11131517192123252729 Industry and Logistics Tourism Others Jun. 17 Jun. 18

Source: Banco de Portugal. Source: Banco de Portugal. | Note: The duration of real estate is the difference between the acquisition period and the reference period for the holdings. For the comparability of the two periods, one year was added to the duration of real estate holdings in June 2017. The empirical distribution was obtained using an Epanechnikov kernel that weights real estate by its value.

2018 • December Report • Financial Stability de Portugal Banco 121. It is not possible to present the characteristics of other types of property. 104 124. 123. 122. adjusting the effect of passing of time between these two periods, using an empirical distribution (Chart C1.9) for two periods in time (June 2017 and June 2018) and a with longer existence in the portfolio. Indeed, based on the average duration those particular in portfolio, REIF the in remained assets estate real year, last the Over Over thelastyear,realestateassetportfolioremainedrelativestable also presentspecificrisks,particularlytheriskofinterconnectionwithfinancialsector. vulnerable toadverse developments thatmayoccurinthefuture. Furthermore, investmentfunds them makes market this to exposure their developments, market estate real of result a as REIFs with associated indicators profitability and risk in improvement recent the despite nutshell, a In observed inopen-endREIFs. the in longer remained portfolio. However,inthemostrecentperiod,latterisconvergingtoasimilarlevelone assets estate real REIFs open-end in REIFs, closed-end to Compared that theREIFportfolioismostlycomposedofrentedrealestateassets. purchase and sale is evident, lower than1. The acquisition and sale effect corresponds to the difference between lines, and the acquisition of real estate accounts for the values of the duration One yearwasadded tothepropertyduration inJune2017. Duration measuredasthedifferencebetweenacquisitionperiodandreference fortheholdings. 124 as distributions almost overlap. This is consistent with the fact 123 the low impact of real estate 122 of real estate assets 105 Real estate investment funds resident in Portugal Box 2 • Fintech – financial stability perspective125

Fintech (acronym for financial technology) is Figure C2.1 • Technological innovation in financial services defined as technology-enabled innovation in financial services which may result in new business models, applications, processes or products, with an associated material effect on the provision of financial services.126 The evolution of the financial system has been accompanied by several significant technological development episodes, such as the introduction and use of credit cards (Figure C2.1). The term ‘fintech’ refers to the current wave of technological innovation, which differs from previous episodes because of the speed at which innovation is occurring and the perception of the broad potential impact on business models, including the provision of and access to financial services (of which the evolution of the so-called fintech127 credit is an example) (Chart C2.1).

Accelerated innovation in financial activity has been enabled by the widespread use of information technologies and data processing (e.g. internet, artificial intelligence, big data) and driven by financial services consumer demands, especially those associated with the banking sector, by inefficiencies of the financial services market and by the new regulatory and supervisory framework.128

This box develops a conceptual approach to fintechs, focusing on the implications to financial intermediation and the main risks for financial stability.

Source: IMF (2007).

125. This box uses fintech-related terms. For further support, refer to the Financial Stability Committee (2017) glossary. 126. Definition pursuant to the Financial Stability Committee (2017). The term ‘fintech’ may refer to entities that develop and provide financial services based on innovative technologies, or to the technologies used by those entities, banks or other entities within the financial system. 127. Fintech credit comprises credit facilitated by electronic platforms promoting direct contact between debtors and creditors. Usually, it includes the so-called ‘crowdfunding’ and ‘peer-to-peer’ (P2P) activities. 128. In particular, the CRR/CRD IV legislative package, which reflects more demanding regulatory requirements on the banking sector and may trigger business opportunities in different areas, as well as the new European Payment Services Directive (PSD 2, acronym for the Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, applicable as from 13 January 2018,

2018 • December Report • Financial Stability de Portugal Banco and transposed into the Portuguese legal framework by Decree-Law No. 91/2018 of 12 November 2018) that endows greater access to this segment. 106 f oe iaca srie ad tu, rdcin f ares o h ety f new playersand of entry the to services. such of provision the in diversification and decentralisation greater of promotion the ofbarriers areduction thus, and, services financial some of hand, the effect most often referred to has been one a the reduction On in structure. costs market associated sector’s with financial the the provision on impact fintechs’ on certainty no is There • financial institutions. actual materialisationwilldepend,interalia,onthecharacteristicsofsystemitselfand wave oftechnological new structure and functioning. These are potential changes and the may take different forms, where their reason that for its on consequences have necessarily will market services financial the in players and innovation and fintechs, several of establishment the Exploring opportunities to improve market efficiencies has been one of the motives underpinning and processing. benefitted from the progress made in artificial intelligence applications and big data management This isthecaseofbusinessareassuchascredit-grantingorassetmanagement,whichhave fintechs, andincumbents). (authorities, players different the of role the reflecting segment, market services financial the to with bank customers, where the boundaries and materialisation of such progress differs according developments, both in terms of back-office and support functions and in terms of technological its relationship from benefit to system financial the of evolution the be may scenario possible A customer baseandthecapacitytoabsorbremainingcompetition. 132. 131. 130. 129. ‘bigtech’) so-called (the companies technology big how on depending concentration higher a observe to possible be might it contrary, the on case, this In power. market greater from benefit institutions financial where areas business in competition increased to lead also may development Fintechs Source: BIS(2017).|Note:EMEAincludesEurope,MiddleEastandAfrica. Chart C2.1• Impact offintechsonfinancialintermediation 100 200 300 Market structure 0 See WEF(2017). GAFA(acronym In thiscontext,theso-called for Google,Apple,Facebook,eAmazon)playakeyrole. One examplewouldbetheprogressmadein creditriskassessmentmodels. Financial StabilityCommittee (2017)andIMF(2018). 131 0321 052016 2015 2014 2013 Volume of new fintech credit | USD billion USD | credit fintech new of Volume participate in the financial services market, as such companies have asignificant have companies assuch market, services financial the in participate Asia-Pacific Fintech creditevolution 130 Americas 132 EMEA 100 200 300 400 0 2016 Q12016 Europe (excl GB) (excl Europe Fintech creditvolumes|2016Q1=100 United States United 2017 Q12017 China 2018 Q12018 United Kingdom United 129

107 Fintech – financial stability perspective • Efficiency There are several fintechs focused on the provision of services to financial system institutions and applying technological innovation to optimise back-office and support functions.133 The so called ‘regtech’134 entities and activities are one example, and so are fintechs that develop credit risk assessment models or fraud detection models based on big data, allowing financial institutions to benefit from significant efficiency and effectiveness gains.

• Wider access to financial services Fintechs may promote easier and widespread access to financial services, whether by reducing the costs related to those services or by diversifying the means of access to such services. These gains will be proportionate to the barriers which existed before the introduction of the various innovations and probably the greatest benefits will occur in regions with less accessibility to banking services provided in a traditional way or for customers with a lower level of financial sophistication. An example is the impact of the use of mobile banking services in sub-Saharan African countries. Within the context of developed countries, a recent example is wealth management apps relying on artificial intelligence, allowing more households and small-sized enterprises to benefit from this service, which was previously inaccessible due to heavy initial investments and/or high fees. Crowd-based loan and investment platforms may have a similar effect.

Fintech as a potential risk and a shock amplifier The impacts mentioned above are usually associated with an increased offer of financial services135 to a wider customer base at a lower cost, which should result in gains for the economy. In terms of financial stability, however, the assessment of fintechs’ potential impact is more complex due to the interaction with other exogenous factors such as: (i) blurring boundaries between intermediaries, markets and providers of financial services, as promoted by fintechs; (ii) characteristics of financial institutions (e.g. governance, strategic planning, attitude towards innovation), (iii) characteristics of the financial system (e.g. interconnections, concentration, levels of competition),136 and, related to these two latter factors, (iv) risk dissemination channels. Thus, it is essential to take all these dimensions under consideration, as well as the interconnections between the potential risks and benefits related to each fintech in order to understand how to promote innovation without undermining the stability of the financial system. Systemic risk sources (and amplifiers of the impact of pre-existing sources) that could potentially emerge from the transformation of the financial system triggered by fintechs are described below.

• Reputational and contagion risk Trust between providers of financial services and their customers is crucial for financial stability. Fintechs may influence this relationship through several channels. Firstly, to the extent that fintechs may be unregulated or covered by less demanding regulatory and supervisory schemes, and thus not subject to the same scrutiny.137 This may result in inefficient and less conservative

133. These are part of a larger group of fintech entities and activities which are not offered directly to financial service customers (usually called B2B – business to business – or B2B2C – business to business to customer), as opposed to the B2C (business to customer) segment, in which fintechs engage directly with customers. 134. Fintechs applied to meet regulatory and compliance requirements. 135. This extension reflects on the type of financial service and the potentially higher diversity of providers. 136. See Financial Stability Committee (2017) for a further analysis of the characteristics of the financial system and institutions, and their relation to potential benefits and risks to financial stability. 137. According to the survey presented by EBA (2017), only 9% of the fintechs surveyed are credit institutions under the CRD, 18% are payment institutions under the Payment Services Directive, and 11% are investment institutions under the Markets in Financial Instruments Directive. 39% are not subject

2018 • December Report • Financial Stability de Portugal Banco to any regime or are subject to unidentified regimes. 108 cases, showagreater–sometimes total–dependenceoncertaintechnologicalinfrastructures. customers. This relevance is emphasised by new business models of fintech entities that, in many service financial or institutions financial by use widespread their to due fintechs of context the in important institutions as defined by macroprudential policy, but which may have systemic relevance There are certain providers of financial services or market infrastructures that are not systemically • stress onfinancialmarketsandliquidityshortage. system, and thatcanincrease the volatilityofdeposits,inparticularsituations of increased operating in the payments area facilitate and accelerate the movement of funds within the banking that on algorithms react quickly to changes in market conditions, thus increasing price volatility. Additionally, fintechs based fintechs trading electronic for true particularly be may This volatility. One characteristic shared by many fintechs is speed, which makes them prone to increase market • mitigate excessivecreditgrowthdonotcoverthemajorityoffintechcredit. indebtedness levels. Furthermore, macroprudential policyinstruments currently envisaged to customer non-sustainable to contributing thereby volumes, substantial reaches credit fintech if vulnerability significant a be could that and capacity, professional a in credit grant to authorised fintech framework, this Within stability. credit represents a new business model that can be developedoutside the group of institutions financial to risk of source a is growth credit Excessive the economicagentsorsectorsaffectedbysuchmovements. exposureto orindirect investors. Thefinancialsystem couldbeaffectedtotheextentofitsdirect the factthatmanyappsarebasedonsimilaralgorithms, generating correlatedreactionsfromthe apps maybeautonomous to initiate market orders. The dynamics could beheightened due to the pro-cyclical dynamics of financial markets and sectors. In extreme situations, some investment enhance to contribute may fintechs Apps, and platforms investment by conveyed information to way same the in react to likely more is fintechs through investing entities of behaviour the as far so In risk. higher a with associated assets financial other and shares in directly invest to agents non-qualified encourage may that apps and platforms management asset are example Another capacity. non-professional a in credit grant to sector financial the outside entities allow they areoneexample, as creditactivities fintech andother platforms Lending institutions. financial by fornon-financial easier make it they as institutions to have access to or provide financial services previously largely provided orintermediated procyclicality enhance potentially can fintechs Some • have integratedthemintotheirbusinessmodel. or fintechs such of clients also are institutions financial regulated several as far so in indirectly, system financial the undermine also may fintechs by management risk inefficient possible The and fintechcompanieswhichareintermediatingorfacilitatingtheservice. institutions supervised and regulated by provided services financial between distinction a make nor invest, they which in assets financial the with associated risk the of perception clear a have mightnot Thesecustomers corporations). andsmall-sized (households customers losses retail such affect when especially sector, financial the of part large a in even or similar as perceived information). Losses incurred by customers of one fintech can undermine the trust in every fintech control appropriate the mechanisms) or misconduct without (e.g. in the relationship with processes customers or the handling of automatic confidential on over-reliance (e.g. management risk Systemic relevance Volatility Procyclicality andexcessivecreditgrowth 109 Fintech – financial stability perspective This could be the case of cloud computing technologies, with an increasingly widespread use and a relatively limited number of suppliers. This potential dependence of the provision of financial services on a limited number of suppliers makes them systematically relevant. The risk associated with these situations is heightened by the possibility that the interconnection between financial institutions is not identified and safeguarded, and that the suppliers of such services are outside the scope of prudential regulation.

in turn, fintechs may contribute to the widespread use of certain alternative technological infrastructures that challenge more traditional options (e.g. distributed ledger technology (DLT) that can be applied for clearing securities), which may pose a systemic risk depending on (i) the capacity of the financial system to resist to a disruption of that infrastructure, and (ii) the existence of mechanisms to regulate and monitor those infrastructures.

It is also important to emphasise the growing relevance of big databases and unstructured data sources (e.g. social media, news websites) in the framework of fintechs. In so far as it is not possible to control or validate some of such data at source and as they are more prone to disruptions and errors, they may pose a systemic risk.

• Cyber-risk and operational risk The financial system’s increasing dependence on technology has emphasised the relevance of cyber-risk, which is particularly relevant due inter alia to: (i) the diversity of points vulnerable to a cyber-attack; (ii) the existence of several direct and indirect channels through which a cyber- attack can impact on the financial system and economic activity; and (iii) the high frequency of attacks, not limited by geographical barriers.

In addition, information systems may fail for other reasons, and the disruption caused by such failure may have a greater impact in a context where fintechs promote information systems’ dependence and interconnection and a greater dependence on third-party service providers.

Final considerations

It is of particular importance to reach a balance that allows taking advantage of technological innovation without hampering the stability of the financial system. Within this balance it is essential to safeguard confidence in the financial system, a key element for preserving its stability, regardless of the channel, form and players that ensure the financial intermediation activity and economic activity funding. Thus, fintechs must be assessed and monitored from a financial stability perspective, which is a challenge given the diversity of interconnected dimensions that have to be considered.

To the extent that fintechs blur the boundaries between institutions and jurisdictions, it is necessary to ensure adequate articulation between different national and international authorities. Nonetheless, given the fast pace of innovation and the scarcity of quantitative information on these entities and activities, measuring their relevance and quantifying the associated risks is a complex task.138

Furthermore, the assessment of such risks must be carried out against the backdrop of a conceptual framework focused on the type of financial service provided, bearing in mind the underlying technology, and reducing the relevance of the type of institution providing the service.139

138. In most situations information is obtained using non-periodic surveys with higher costs and a greater time lag in the release of results.

2018 • December Report • Financial Stability de Portugal Banco 139. See Financial Stability Committee (2017) and IMF (2018) for concrete proposals for classifying technological innovations according to this rationale. 110 Council onFinancialandMonetarySystems. (2018), Forum Economic World White paper. (2017), Forum Economic World KPMG (2018),Thepulseoffintech2018. discussion note,June2017. (2017), Fund Monetary International stability�, OverviewofFinancialStability,January2016. financialfor innovation technological of implications �The (2016), Bank Nederlandsche De DNB, regulatory issuesthatmeritauthorities’attention. Financial Stability Committee (2017), Committee Stability Financial Bank forInternationalSettlements(2018),QuarterlyReview,September2018. institutions fromfintech,3July2018. European Banking Authority (2018), (FinTech), EBA/DP/2017/02,4August2017. services’ segment where fintechs relate directly with final customers, final with directly relate fintechs where segment services’ and it may even benefit from this interaction in terms of the cost structure. Thus, even in the financial current developments, both as an investor in fintechs in investor an as both developments, current that occurredmainlyinternallyinbanks.However,thebankingsystemhasbeenanactiveplayer stability deriving from fintechs. from deriving stability 144. 143. 142. 141. 140. system, financial European the by technologies sophisticated particularly of scale) significant a (on adoption the of indication no is there Currently relevance andgrowthofthenewmarketplayers, of the financial institutions in Europe were still recovering from the crisis). This may be related to the almost concurrently with the economic and financial crisis (or during a period where a large number to maintainandstrengthenitscustomerbase.However,thecurrentinnovationwavehappened order in it internalising services, financial in innovation technological to adapt to ability the shown European Banking Authority (2017), context, thepositioningofbigtechnologycompaniesinthismarketisalsorelevant. the this way Within customers. service financial with interacts the traditional more as perceived system banking as well as models, business of adjustment and evolution fintechs the However, accelerate) sector. (or require banking traditional more the of viability the undermine would growth References: According totheEuropeanBankingAuthority (2017),themajorityoffintechstargetfinalcustomers. KPMG (2018),WEF (2017). in fintechs investment of 2018, surpassed theresultsrecordedin2017. months six first the during that, mentions (2018) KPMG services. financial of range wide a in operating fintechs of number increasing and significant a is there Europe in currently (2017), Authority Banking European the by conducted survey the to According See FinancialStability Committee (2017)andWEF(2017). See EuropeanBanking Authority(2018). 141 In addition, from a historical perspective, the banking sector has Inaddition,fromahistoricalperspective,thebankingsectorhas The global financial and monetary system in 2030, Global Future Global 2030, in system monetary and financial global The Balancing financial stability, innovation, and economic growth, and economic innovation, stability, financial Balancing Discussion Paper on the EBA’s approach to financial technology EBA Report on the prudential risks and opportunities arising for Financial stability implications from FinTech: Supervisory and Supervisory FinTech: from implications stability Financial fintech and financial services: initial considerations, IMF Staff IMF considerations, initial services: financial and fintech 140 142 nor of the materialisation of risks to financial financial to risks of materialisation the of nor differently from previous innovation episodes episodes innovation previous from differently 143 and as a partner or client of those entities, and as a partner or client of those entities, 144 it seems unlikely that their it seems unlikely that their

111 Fintech – financial stability perspective Box 3 • Implementation of countercyclical capital buffers in the European Union The current economic setting, featuring an expansion of the business and credit cycles, particularly the increase of real estate prices, has been the reason given by a larger number of macroprudential authorities for recently deciding to apply countercyclical capital buffers.145 This situation has led various countries to adopt capital-based measures. These differ from those that target credit standards, the so-called borrower-based measures.

The countercyclical capital buffer and changes to risk weights applied to assets of credit institutions for calculating minimum capital requirements are one of the most relevant capital- based tools used to mitigate cyclical systemic risk.146

Considering the signs of inversion of the financial/credit cycle, a set of EU countries have chosen, as a capital-based measure, to activate the countercyclical capital buffer (hereinafter the countercyclical buffer). The use of this capital buffer takes into account its well known part in mitigating systemic risk associated to excessive credit growth, which is one of the intermediate goals of macroprudential policies identified by the European Systemic Risk Board (ESRB). Thus, the growing use of this instrument by the national macroprudential authorities of the various Member States justifies its analysis, as was done in the previousFinancial Stability Report regarding macroprudential measures targeting credit standards for household loans.147

These are standardised tools applied to all credit exposures. They contrast with those that target only some types of credit, discriminating between different exposures, and that are not harmonised across the different countries, for instance, measures that are based on the loan- to-value ratio (LTV), and the debt-service-to-income ratio (DSTI).

The countercyclical buffer aims to strengthen the resilience of the banking sector to losses during economic downturns following periods of excessive growth of credit to the private non- financial sector. In addition, as an indirect effect, additional capital requirements throughout the financial/credit cycle may also contribute to mitigate the procyclicality of the banks’ lending criteria, common in economic and financial expansion cycles. Finally, this buffer is to be reduced when the risks materialise, thus contributing to an adequate and steady flow of funds into the economy.148 It falls to each national macroprudential authority to define and announce every quarter the countercyclical buffer rate for credit exposures to the domestic private non-financial sector. This rate is set at a range between 0% and 2.5% of the total risk exposure amount and may exceed 2.5% when duly justified, in which case the mandatory recognition by other EU macroprudential authorities is not required. This buffer is calibrated in multiples of 0.25 percentage points.

145. For further details see the Financial Stability Review of the European Central Bank, https://www.ecb.europa.eu/pub/pdf/fsr/ecb.fsr201805. en.pdf. 146. “Strategy and instruments of macro-prudential policy”, article published in the Financial Stability Report of May 2014. 147. For further details on these measures, in a European context, see Box 1 “Implementation, at European level, of macroprudential tools targeting credit standards for loans to households“ in the Financial Stability Report of Banco de Portugal, June 2018, https://www.bportugal.pt/sites/default/files/ anexos/pdf-boletim/ref_06_2018_en.pdf. 148. For further details on all the capital buffers introduced after the 2008 financial crisis, part of the legislative package called CRD IV and CRR, see Box 4 “Initiatives to strengthen capital buffers“ published in the Financial Stability Report of Banco de Portugal, November 2015, as well as the

2018 • December Report • Financial Stability de Portugal Banco methodological documents available on Banco de Portugal’s website, at https://www.bportugal.pt/en/page/countercyclical-capital-buffer. 112 gap reaches10percentagepoints. ratio exceedsitslong-termtrendby2percentagepoints, reachingitsmaximumlevelwhenthis credit-to-GDP the when exposures of value the of 2.5% to 0% from linearly increase to is rate calibrate the countercyclical buffer. In accordance with BCBS guidance, the countercyclical buffer subsequently and risk systemic cyclical identify to measurement main the as gap) Basel the as known (also gap credit-to-GDP the using recommend which ESRB/2014/1), (Recommendation ESRB the by and (BCBS) Supervision Banking on Committee Basel the by issued guidelines followthe authorities most buffer, countercyclical the implement to methodology the Regarding on thebasisofexceptionalcircumstances. when the increased buffer setting is announced. A shorter period can be set if properly justified the pattern set forth in the CRD IV (Capital Requirements Directive), i.e. 12 months after the date Presently, all the countries have set the date from which countercyclical buffers apply, following national half of2017wasnotfullyappliedandthebufferreducedbeforeend12-monthperiodcountingfromincreaseannouncement. respective the by announced rates the are 2019 first the for rate The of (1) applied. were they moment the to half refer rates Other applied. yet not but second question, in period the for authorities and macroprudential first the for rates The Notes: | Board Risk Systemic European Source: C.3.1). (Chart Lithuania) and Ireland Denmark, France, (Bulgaria, cent per zero the Czech Republic and Sweden) or the application, for the first time, of a buffer rate other than Kingdom, United the (Slovakia, buffer countercyclical the in increase an announced authorities States’ Member EU nine 2018, November and 2017 of beginning the Between country. that in sector observed non-financial the private of indebtedness significant and growth credit high to due 2015, in buffer, countercyclical a activate to countries EU first the of one was Sweden 149. | Percentageoftotalriskexposureamount Chart C3.1•DevelopmentsincountercyclicalcapitalbuffersasetofEUcountries macroprudential authority. to reachthisthresholdinthesecondhalfof2019,asannouncedlastquarterbyitsnational expected is Sweden though 2.5%, of rate buffer countercyclical the surpassed has country EU 0.0 0.5 1.0 1.5 2.0 2.5 3.0 at theESRBwebsitehttps://www.esrb.europa.eu/national_policy/ccb/all_rates/html/index.en.html authorities macroprudential European the by announced rates of list the see countries, various the in application buffer’s the on details further For 05H 05H 06H 06H 07H 07H 08H 08H 09H 2019H2 H1 2019 H2 2018 2018H1 2017H2 H1 2017 2016 H2 2016H1 H2 2015 H1 2015 Sweden Republic Czech United Kingdom (1) France Bulgaria Lithuania Denmark Ireland . 149 Untilnow,no Slovakia

113 Implementation of countercyclical capital buffers in the European Union However, so as to capture the specificities of each Member State, the ESRB Recommendation states that the authorities responsible for setting the rate may exercise their discretionary powers, using quantitative and qualitative information, in what the ESRB calls ‘guided discretion’. In fact, Chart C.3.2 shows that the economies of most authorities that activated the countercyclical buffer exhibited a Basel gap that was negative or below the lower threshold of 2 percentage points, the threshold used as a reference for signalling the need to activate the countercyclical buffer.

The credit-to-GDP gap may in some cases underestimate the signalling of a build-up of cyclical systemic risks, particularly after long periods of excessive credit growth. This is due to the fact that these cycles, especially if long-lasting, contaminate the long-term trend that is used to calculate the measurement above. In addition, the most recent figures of the credit-to-GDP gap are substantially revised whenever additional data become available and this may lead to less precise policy decisions.150 In fact, for instance, Lithuania’s decision to increase the buffer rate was made even though the credit-to-GDP gap was not significantly closer to the activation range than the initial value for the first decision. This effect can also be seen in decisions to activate the buffer made by the authorities of Bulgaria, Denmark and Ireland, which took into account parameters other than the credit-to-GDP gap.

Chart C3.2 • Relationship between countercyclical buffer rates announced and the credit-to- GDP gap

3.0 20

Upper threshold 10 p.p. 2.5 10 Lower threshold 2 p.p. 0 2.0 -10 1.5 -20 1.0 Percentage -30 Percentagepoints

0.5 -40

0.0 -50 Czech France Lithuania Ireland Slovakia Sweden United Bulgaria Denmark (1) Republic Kingdom First countercyclical buffer announced Last countercyclical buffer announced Credit-to-GDP gap (first buffer) (right-hand scale) Credit-to-GDP gap (last buffer) (right-hand scale)

Sources: European Systemic Risk Board and Bank for International Settlements | Notes: The first countercyclical buffer announced corresponds to the first rise in this capital buffer rate to figures above 0%. Horizontal lines correspond to the thresholds recommended by the BCBS and the ESRB for activating the buffer, between 2 p.p. and 10 p.p. Figures for the credit-to-GDP gap are those reported/published by the macroprudential authorities of each country. (1) Data on the credit-to-GDP gap for the last buffer rate decision were not available.

Therefore, below are the methodologies and indicators used by some macroprudential authorities to guide their decisions to activate and deactivate the countercyclical buffer.

Regarding the indicators used to activate and deactivate this buffer, most national authorities follow the ESRB recommendation (ESRB/2014/1)151 which provides, in addition to the credit-to-

150. For further details see the Financial Stability Review of the European Central Bank, May 2017. 151. Banco de Portugal, in its role as national authority responsible for macroprudential policy, follows and applies the recommendation issued by the ESRB, using the indicators recommended, as well as exercising the discretionary powers for the use of additional indicators. For further details on the methodology and indicators used by Banco de Portugal see “Countercyclical capital buffer in Portugal: how will it work?“, published in December

2018 • December Report • Financial Stability de Portugal Banco 2015 on Banco de Portugal’s website, https://www.bportugal.pt/sites/default/files/anexos/ccb_portugal_en_0.pdf. 114 154. 153. 152. risks lateron. of materialisation the from resulting losses absorb to enough resilient it make that buffers capital with system financial the endow to as so appropriate, more considered are instruments based capital- stage, this At cycle. credit the of stage later a at implemented if effectiveness loosing risk, borrower-based of effectiveness instruments may beachieved if they are implemented at an initial stage of build-upsystemic optimal C.3.1), (Table experience international to According since itcontributestomakingeachinstrumentmoreorlesseffectiveinmitigatingsystemicrisk. instruments should beactivated,i.e.capital-basedinstruments orborrower-basedinstruments, Lastly, the stage of the credit cycleshould be taken into consideration when choosing which losses inanadversescenario.TheUnitedKingdom Other countries use stress tests to set the countercyclical buffer rate, so that it is enough to absorb as apercentageofGDP. deficit account current aggregate the and prices asset estate real This and financial indebtedness, corporations methodology. BCBS/ESRB the unlike series non-financial conditions, credit-granting growth, credit are which indicators, six includes indicator time shorter on based is which economy, Czech the of characteristics the to adjusted gap credit-to-GDP the on cycle and financial indicator’, ‘aggregate called indicator, composite a on based also is authority Czech the by used methodology The corporations. non-financial and households of burden indicators. debt on and indicators dynamics ofsupplementary loans’ non-performing set growth, credit a gap, credit-to-GDP the and are indicators indicators Core financial and macroeconomic core of set buffer countercyclical their base Republic, decisions on a composite indicator. In Slovakia this is called ‘cyclogram’ and it aggregates a Czech the and Slovakia as such authorities, Some with associated risk system-wide of build-up periods ofexcessivecreditgrowth. the signal that variables of sets seven gap, GDP Kingdom (November2017)andtheCzechRepublic(May2017). United the 2018), (June Lithuania countries, three all in 1% to increase the backed argument This 0%. not 1%, be should risk moderate of context a in buffer countercyclical the Republic, Czech the and Kingdom United the Lithuania, of authorities the For sector. non-financial private the to up of cyclical systemic risk, or at a later stage of the cycle, associated to fast growth of loans build- of signs moderate only are there when cycle, credit the of stage recovery the at buffer: the Another matterthatmeritsattention ismacroprudentialauthorities’ timingfordecidingtoactivate 155. policy, availableatBanquedeFrance’swebsite, at macroprudential calibrate to framework analytical A detailedanalysis of themacroprudentialpolicystrategycanbefoundin WorkingPaperAn 7B1. at “, buffer countercyclical financial-policy-committees-approach-to-setting-the-countercyclical-capital-buffer.pdf?la=en&hash=DE1BDDDA9A8628694A5881D6559DE782AFF3A the setting to approach Committee’s Policy Financial “The Statement Policy the in website, England’s of Bank at found be can strategy policy macroprudential the of analysis detailed A measures derivedfrommodelsthatcombinethecredit-to-GDPgapandaselectionofabove measures. (g) and risk, of mispricing potential (f) burden, debt sector private (e) sheets, balance bank of strength (d) imbalances, external (c) developments, The setsofvariables mentioned arelistedinRecommendationC(2)and regard measuresof:(a)potentialovervaluation of propertyprices,(b)credit esrb.europa.eu/pub/pdf/reports/esrb.report180425_review_of_macroprudential_policy.en.pdf?4b6e5f604e78b7d772b788f2f81fc0c8 cross-country a – buffer countercyclical the of “Use B Feature comparative analysis“ in A Review of Special Macroprudential Policy in the EU “, published by the ESRB in the April 2018, available on its website: see authorities the by used methodologies the on detail further For 152 https://publications.banque-france.fr/sites/default/files/medias/documents/wp648.pdf https://www.bankofengland.co.uk/-/media/boe/files/statement/2016/the- 153 andFrance 155 154 aretwoofthesecountries. https://www. . . 115 Implementation of countercyclical capital buffers in the European Union Table C3.1 • Borrower-based instruments used by the different national macroprudential authorities that activated the countercyclical buffer

Income Countercyclical LTV Maturity measures (1) buffer Czech Republic √ √ √ √ France √ Lithuania √ √ √ √ Ireland √ √ √ Slovakia √ √ √ √ Sweden √ √ √ United Kingdom √ √ Bulgaria √ √ √ √ Denmark √ √ √

Source: European Systemic Risk Board | Notes: The borrower-based measures in the table can be analysed in greater detail in the Financial Stability Report published in June 2018 (see footnote 147.). (1) These include DSTI (debt-service-to-income), DTI (debt-to-income), LSTI (loan-service-to-income) and LTI (loan-to-income).

In fact, most of the authorities that activated the countercyclical buffer had, at an earlier stage of the credit cycle, activated borrower-based instruments targeting mainly loans granted to households. This could indicate that such instruments, which act only on borrowers with higher risk profiles, may not have been sufficient to mitigate the build-up of systemic risk associated with the excessive increase in loans to the private non-financial sector. Thus, it was necessary to enhance the financial system’s resilience, so that it may absorb the shocks that could arise from the materialisation of risks, particularly from the losses caused by excessive credit growth. While borrower-based instruments target only certain credit segments and usually new loans, the countercyclical buffer applies to all exposures to the private non-financial sector. Therefore, their simultaneous activation could be justified by the fact that the two instruments complement each other.

To conclude, the credit-to-GDP gap, in the present European context and for most EU countries, remains under the lower threshold of 2 percentage points, which may suggest not activating the countercyclical buffer. Yet, bearing in mind the apparent inversion of the credit cycle in some of the EU Member States, this indicator has not been a major factor for the various macroprudential authorities when making decisions on the countercyclical buffer. Thus, for precautionary reasons and considering the positive stage of the business and financial cycles, there is a growing trend to use this macroprudential policy instrument. As recommended by the ESRB, decisions are based on different indicators related to credit growth, overvaluation of assets, external imbalances, indebtedness of the non-financial private sector, among other, as well as on qualitative criteria.

Therefore, should the current stage of the credit cycle continue in the future, an even larger number of European countries may decide to activate the countercyclical buffer, with such decisions being grounded on a broad set of macroeconomic and financial indicators as well as on other qualitative information reflecting national specificities. 2018 • December Report • Financial Stability de Portugal Banco 116 II Special issues

Investment funds as a source of systemic risk Amendment of the CRD IV-CRR: what is new?

involved in Shadow Banking, as well as the potential risks they pose to financial stability and stability financial to pose respective transmissionchannels: they risks potential the as well as Banking, Shadow in involved systemic risk. The Financial Stability Board (FSB) lists the following entities as some of the entities non-bank in growth indicates 2009) financial intermediation as Commission, one of the main factors behind the (European 2007 crisis and possibly enhancing Report Larosière de 2009 The process inthebankingsector(InternationalMonetaryFund(IMF),2015). III, interalia,whichledtoconstraintsingrowthbankingactivityoreventriggeredadeleveraging a resultofheightenedregulatoryrequirementstobanksandcompliancecostsrelatedBasel 3. 2. 1. representing about one-third (European Systemic Risk Board (ESRB), 2018). funds investment with 2010, since size in doubled having system, financial the in assets financial of 40% approximately for accounted (EU) Union European the in Banking Shadow 2017, of end the At • • • fromthe intermediation offinancial thetransfer Banking) (Shadow intermediaries financial non-bank to sector banking of 2007-08, crisis financial global the After 1 Introduction of systemic risk Investment funds as asource companies, leasingfactoring specialinvestmentvehiclesandfinancialcreditinstitutions. holding financial are: Banking Shadow of concept the in included be may that participants market financial other funds, investment to addition In However, thesector’scharacterisationbyFSB alsoincludesanactivityperspective(http://www.fsb.org/wp-content/uploads/r_130829c.pdf)(FSB,2013). Portugal’s de Banco of issue 2014 May the in perspective)” entity the (from perimeter banking shadow the of “Delimitation entitled box the This analysisfocusesontheentityperspectivealready mentionedinpreviousissuesoftheFinancialStabilityReport(see money marketfunds),andOtherFinancialIntermediariesAuxiliaries(OFI)(other thaninvestmentfunds). terminologies will be used interchangeably. Using a broader measure, Shadow Banking comprises money market funds, investment funds (other than both Issue, Special this Throughout intermediaries’. (http://www.fsb. financial ‘non-bank system term the uses banking currently FSB regular The org/wp-content/uploads/r_110412a.pdf). the outside activities) (or entities involving intermediation credit to refer to used was Banking Shadow tend toincrease,potentiallyleadingasuddenportfoliodeleveragingthroughassetfiresales. will transactions financing securities on margins and decrease to tend will collateral the of value instruments that may expose entities to significant losses. Under stressed market conditions, the the of some are transactions financing Securities 2018). al, et (Singh capital invested on returns maximise to investments their for funding of source a as leverage on relying repeatedly Entities assets beforematuritynormallyoccursatadiscount,generatinglosses(maturityrisk); asset maturities tend to be longer than the required advance notice of redemption, the sale of very short notice. Disinvestment/redemption on short notice relies on asset sales. However, as a on disinvestment/redemption allowing entities by liquidity low with assets in investment to refers transformation) (or risk liquidity transformation: maturity or liquidity promoting Entities such redemptions,negativelyaffectingthepriceoftheseassets; meet to portfolios asset fund investment in sales fire trigger may turn in which units, these of A devaluation in units not anticipated by market participants may give rise to large redemptions entities, namely investmentfunds,areoftenperceivedasdemanddepositsbytheirholders. these in Units deposits. bank of those to similar features with funds raising Entities 2 ), Banco de Portugal (2014a). Financial Stability Report ), BancodePortugal(2014a). 1 increased significantly as significantly increased 3 In Portugal, Shadow

119 Investment funds as a source of systemic risk 120 Banco de Portugal • Financial Stability Report • December 2018 obligations. Each end-investor is the holder of a part of the investment fund corresponding the to representing equityheldbythefund’sinvestors,grantingeachinvestorsamerightsand of managing assets, generating value for theirunit-holders. Investment fund units are securities Investment funds are collective investment undertakings, Investment 2 Whatisaninvestment fund? countries, EU several in significantly grew funds investment in management under assets decade, last the In financial assetsintheshadowbankingsystemPortugaldecreasedbyaround27%. of value the EU, the to contrast in and review under period the In 13%. around for accounting Banking only represented about 20% of financial assets at the end of 2017, with investment funds 6. 5. 4. or mitigatesuchsourcesofsystemicrisk,aslaiddowninRecommendationESRB/2017/6. size of investment funds in the EU and Portugal. Finally, it identifies a number of tools to prevent entities may contribute to amplify risks in the financial system, and provides an assessment of the This Special Issue describes the most relevant features of investment funds and how these case scenario,affecttheresilienceoffinancialsystemasawhole. worst a in or, system financial the in risk systemic amplify to contribute may funds investment by intermediation financial in increase an whether understand to important is it sector, private Consequently, although investment funds help diversify the sources of funding for the non-financial for transmittingshockstootherinstitutions. funds mayspreadriskthroughtheirinvestors’behaviour,andarethereforeapotentialchannel investment channels, transmission risk these to addition In leverage. high and/or liquidity low with assets financial of share large a hold funds investment if system financial the of resilience assetswith holding the those affect significantly may but also movement This assets. fund’s the with assets, correlated closely price same their the hold that participants market financial only not affecting uncertainty, market financial of periods during particular in prices, asset on impact significant a have may sales These volume. sales funds’ the increase may investors their of profile redemption the and assets fund investment open-ended of maturity and liquidity the that thissourceoffundingismoresensitivetoinvestors’riskperception.Mismatchesbetween securities inthefunds’portfoliosmayleadinvestorstoredeemtheirunits,whichmightimply an abruptandsharpreversioninriskpremiaorsimplyasuddenmaterialisationoflosses However, sector. private non-financial the for funding of source important an became therefore and particular, in market income fixed the in and general, in market financial the in participants higher returnsbutpotentiallywithlessmarketliquidity.Investmentfundsthusbecameimportant are notincludedintheShadowBankingcategory, andthereforearenotincludedinwhatisdesignatedasinvestmentSpecialIssue. fundinth to reference investment funds in this Special Issue comprises mutual funds, real estate funds, venture capital funds and alternative investment funds. Pension funds any classification, statistical different a to owing Nevertheless, fund. investment of type specific a are funds market Money undertakings. In Portugal,mutualfunds,realestateventure capitalfunds,alternativeinvestmentfundsandpensionareexamplesofcollective In addition, the impact of deleveraging by investment funds on the financing of the non-financial private sector is not addressed in this Special Issue. This Special Issue does not analyse potential effects arising from changes in the volume of investment by non-residents in resident investment funds. the mainfocusofthisanalysis.However,theyareformallycollectiveinvestmentundertakings,i.e.aspecifictypemutual fund. (as they invest in short-term assets and are consequently very liquid) and although they are covered by the FSB classification, money market funds are not low is risk maturity and liquidity their considering Thus, 2013). Portugal, de (Banco transmission policy monetary in and deposits bank to characteristics similar with funds raising in role their account into taking Institutions, Financial Monetary Other in funds market money includes classification statistical Portugal’s de Banco of issue 2013 November the in approach”, prudential the to classification statistical the Investment funds mainly differ from money market funds from a statistical point of view. According to the box entitled “Portuguese financial system: from 4 inacontextofverylowinterestrates,associatedwithdemandforsecurities 6 i.e. entities created with the purpose , Banco de Portugal’s Portugal’s de Banco Financial StabilityReport, 5 Table 1containsanon-exhaustivelistofthemostrepresentative fundfeatures. of thistrade-offforinvestorsareincludedinthefeescharged bythemanagementcompany. and, in exchange, investors are provided with a diversified and professional investment. The costs funds: the decision on the fund’s composition is transferred to the asset management company implicit trade-off between information and portfolio diversification for investors investing through (e.g. equity, type bonds, real specifically estate), maturity fund, and issuer. the It is in therefore possible be to conclude may that there that is an assets the of features the investors potential to subscription, before taking an investment decision. The prospectus serves to disclose beforehand given time,theyhavetheopportunitytoreviewfund’sprospectus,namelyattimeofinitial company. However,althoughinvestorscannotascertaintheassetportfolio’sconstitutionatany an investment fund transfers the discretion in investment decisions to the asset management complete informationontheexactmakeupoffund’sportfolio.Indirectinvestmentthrough that choosetoinvestthroughaninvestmentfundformatarenotprovidedwithindividualand normally on short notice. amount investments; and (v) easy accessto withdrawing of invested capital in the (ii) form of unit redemptions, assets; pool of fund-related fees; (iv) investment in markets or securities that would inabroader not be pay available for only low cashwill investors as costs, custody and trading lower (iii) investment management; asset professional allow they as diversification, risk (i) From the point of view of the end-investor (unit-holder), investment funds have some advantages: Source: BancodePortugal,adaptedfromIMF(2015). may manage several funds. autonomously andrunbyamanagementcompanycalled‘assetcompany’,which in proportion to their investment in the fund’s units. Investment funds are thus constituted investment made. Fund investors therefore own the assets and the income those assets generate 8. 7. Figure 1•Relationshipbetweeninvestmentfundsandtheassetmanagementcompany compliance, interalia(Figure1). the portfolios of thefunds: asset management, risk management, liquiditymanagement and In thecaseofopen-endedfunds. asset an to task management the delegating and self-management between management company. choose may (SICAV) Variable Capital à d’investissement Société Assets Investment Other Units Fund liabilities 1 Asset ManagementCompany 8 However, there is an asymmetry of information, as end-investors 7 This company independently manages the various dimensions of Assets Investment Other Units Fund liabilities 2 Assets F ees Investment Other Units Fund managemen liabilities In agr vestmen eemen X t t t Units Cash End pr ospectus Fund investor 121 Investment funds as a source of systemic risk 122 Banco de Portugal • Financial Stability Report • December 2018 shown herewasbasedonthesourcesmentioned aboveandmaynotdirectlycorrespondtothestatisticalclassificationdePortugal. ofBanco from the transposition of Directive 2009/65/EC. Specific rules on investment and leverage limits are described in Chapter VII of this Directive. The classification within the EU once they traded are freely approved by be the supervisory may authority funds of their These country of protection. origin. investor The legal ensure framework would currently applicable which to OICVM funds, generally investment results retail for market European single a establish to was Directive this of purpose main The OICVM. some to relating provisions administrative and regulations laws, the combines 1985 December 20 of 85/611/EEC Directive Sources: Portuguese Securities Market Commission and Portuguese Association of Investment Funds, Pension Funds and Asset Management. | Notes: Council Table 1• 9. accumulation sharetype Non-harmonised funds On thelegalframeworkregulatingthem On theinvestmentpolicyortypeofportfolioassets On incomedistribution On redemptionability Retirement/education Funds with an income Funds withanincome Money marketfunds without limitingtheirstrategy. strategy market any on relying risk, of level given a for return possible highest the generating of purpose the with assets different in investing Funds Equity savingsfunds Closed-ended funds Open-ended funds Harmonised funds Real estatefunds Short-term funds Funds offunds Funds with an Funds withan Equity funds Mixed funds Index funds Bond funds Features ofmaininvestmentfunds share type funds assets), bearingsomesimilaritiestohedgefunds. collective investmentinsecuritiesorotherfinancialassets(withtheexceptionofrealestate Investimento orOrganismosEspeciaisde.Ingeneral,thesefunds'purposeisthe funds (AIFs)oralternativeinvestmentundertakingswereinitiallycalledFundosEspeciaisde alternative investmentfunds.UnderthePortugueselegalframework, funds comprisenon-harmonisedmutualfunds,realestateventure capitalfundsand the PortugueselegislationthattransposedDirective85/611/EEC.Non-harmonisedinvestment Non-harmonised investmentfundsarewhichnotconstitutedin accordancewith denominated asOrganismosdeInvestimentoColetivoemValoresMobiliários(OICVM). (Undertakings forCollectiveInvestmentinTransferableSecurities).InPortugal,thesefundsare Directive 85/611/EECof20December1985,thefirstversiontheso-calledUCITS These areinvestmentfundsregulatedbythePortugueselegislationthattransposedCouncil Funds thatfundtheinvestmentofend-investorsinequitysavingplans(PPA). Funds thatfinanceretirement/educationplans(PPR/E). Funds investingessentiallyinrealestateassets. asset class. Funds investinginequitysharesandbonds,whichmayinvestpredominantlyoneortheother and subsequentprofitability. Funds tryingtoreplicate,inwholeorpart,asecuritiesindextermsofportfoliocomposition Funds withaportfoliocomposedmainlyofunitsinotherfunds. Funds withaportfoliocomposedmainlyofequityshares. rate bondfunds,whichinvestmainlyinbondswithacouponlinkedtofixedatissuedate. fixed- or rate, floating a to linked coupon a with bonds in invest mainly which funds, bond rate floating maturities ofthedebtsecuritiescomprisingportfolio.Bondfundsmayalsobecharacterisedinto: funds generallyhavemoreriskthanmoneymarketorshort-termbondfunds,duetothelonger These bonds). (so-called securities debt private or public of comprised mainly portfolio a with Funds market orinsecuritieswithfeaturessimilartoequityshares. redemption, asisnormallythecasewithmoneymarketfunds.Thesefundsmaynotinvestinequity redemptions arenormallygrantedonafewdays’noticeandnotthesamedateofrequestfor portfolio normally have a longer duration than the assets in money market funds. In open-ended funds, Funds mainly investing in highly liquid assets, similarly to money market funds. However, assets in the similar tobankdeposits. features some with funds low-risk as classified be may these account, into factors these Taking Funds investinginshort-termdebtsecurities,which,assuch,areexpectedtobehighlyliquid. a certainperiodspecifiedbeforehandintheprospectusregulatingfund. within redeem or subscribe may investors which units, of number fixed a issue funds Closed-ended Funds thatdonotdistributeincomegeneratedbytheassetsinportfolio,reinvestingit. Funds periodicallydistributinggeneratedincomeamongend-investorsinthefund. very redeemed and subscribed be may units Normally, frequently. Theportfolioisusuallycomprisedoffairlyliquidsecurities. demand). on depend units of and value number (the time any at units redeem and subscribe may investors funds, open-ended In

9 or are leveraged, thereby amplifying the contagion effects, with material consequences for the for consequences material with effects, contagion the amplifying thereby leveraged, are or and/ assets illiquid in invest funds the if exacerbated be may dynamics price the on effects The This type of behaviour also encourages asset fire sales, putting negative pressure on asset prices. encouraged toredeemtheirunitsinopen-endedfundsand thuswithdrawthecapitalinvested. funds operate with maturity mismatches between assets and liabilities, investors may be in market liquidity or increased volatility in the asset market, and considering that investment 10. value of their investment is declining (so-called ‘first-mover advantage’). In addition,investorswillhaveanincentivetoredeemassoonpossiblewhenevertheyfearthe of marketprices(a‘negativefeedbackloop’). of investment fund assets at increasingly lower prices, which might generate a downward spiral triggering asset fire sales. The use of leverage consequently enhances the probability of fire sales generate pro-cyclical movements, amplifying asset valuation movements and, as such, potentially margin callsandtheadditionaldiscountrelatedtoassetsusedleverageportfoliomay These transactions. financing securities of calls margin additional as well as collateral, as used have toabsorbnotonlytheirownvaluationchanges,butalsochangesinthevalueofassets In astressedmarketcondition,ifthefundusesleverage,assetsininvestmentwill meet anunexpectedlyhighlevelofredemptions. to difficulty greater have will fund investment the redemption, of notice required the of those trade-off implicit an is There strategies. between yieldandliquidity:byinvestinginassetswithhigheryieldslongermaturitiesthan leverage using by or redemption of notice required aretherefore Fundmanagers yields. encouraged toseektheseyieldseitherbyinvestinginassetswithlongermaturitiesthanthe generating products savings offering undertakings as funds investment regard end-investors that fact the to related is risk systemic of source first The investment inportfolioswithlessliquidassetsandworsecreditquality(searchforyield). of very lowinterest rates characterised by a search for higher yields, even when these result from context aglobal in –especially individually of them one of each effects the evaluate to difficult it The potential risks and vulnerabilities listed in the table above show significant interactions, making Source: AdaptedfromtheEuropeanSystemicRiskBoard. intermediaries Table 2• non-bank financialintermediaries(ESRB,2016b)(seeTable2). through financing to related risk systemic of sources several are there ESRB, the to According 3 Sources ofsystemic riskassociatedwithnon-bankfinancial III. Excessivegrowthincredittothenon-financialprivatesectorwithuseofexcessiveleverage II. Interconnectednessoffinancialsystementitiesandrelatedriskcontagion I. Excessivematurityandliquiditymismatches further information,seeIOSCO(2012)andHannam (2013). leaving in the fund assets with higher liquidity risk – and consequently with a higher potential for declining in value – for the remaining investors. For value for investors) is constant. Funds with a variable net asset value also have this advantage, as fund managers tend tosell more liquid assets first, generate liquidity to meet will the redemption will which be borne by assets all other investors the remaining in the liquidating fund, assuming that of the net asset costs value (representing the the fund’s as turbulence, market financial of stages early the in redeem to incentive an have Investors intermediaries Potential risksandvulnerabilitiesfromfinancingbynon-bankfinancial 10 Incaseofaseveredrop 123 Investment funds as a source of systemic risk 124 Banco de Portugal • Financial Stability Report • December 2018 financial and non-financial institutions. As a result, the high sensitivity of fund investors to financial unexpected high level of redemptions byinvestors, thereby propagatingthis shock to other an to lead can markets financial in volatility increased of event an or premia risk in increase An premia associatedwithaprotractedperiodoflowinterest ratesshouldbeanalysed. As such,fromafinancialstabilityperspective,theimpacts thatmayarisefromanincreaseinrisk other financial intermediaries have replaced banks in granting credit to non-financial corporations. consequence of the financial crisis and, possibly, stricter regulatory requirements. Consequently, corporations increased, owing to low financing costs and non-financial deleveraging by by banking issued institutions, market as bond a the in supply the Additionally, corporations. non-financial of low interestrateshasbeenpromotingincreaseddemand fordebtsecuritiesissuedbyriskier period protracted A sector. private non-financial the to particular in credit, granting in play The thirdsourceofsystemicriskmentionedinTable2is relatedtotheroleinvestmentfunds above (IMF,2015). more attractive to potential fund investors, and thus worsening the pro-cyclical effects mentioned of fundmanagers,encouragingthemtoinvestinhigher-yieldingassets,ordermake returns (Baranova et al, 2017). In turn, the behaviour of investors has an impact on the behaviour units when investment funds have low returns and to subscribe units when these have high behaviours byfundinvestorsisalsomentionedintheliterature,astheytendtoredeemtheir pro-cyclical of existence The 2015). (IMF, factors quantifiable on based not and investors other herding behaviourmeansthatinvestorsmakedecisionsbasedontheinvestmentof In addition,thereisevidencethatinvestorsininvestmentfundsshowaherdingbehaviour.This bank, havinganindirectimpactonitssecuritiesportfolio. demand for liquidity byredeemingunitsinanotherfundorevensellsecuritiesalsohelda mainly wheninvestorsarenotabletoredeemtheirunits:thesemayreactthisunmet fund and bank portfolios; and (iii) the behaviour investment of fund investors. The latter becomes noticeable in exposures common (ii) funds; investment by banks of shares or securities debt of holdings (i) through indirectly occur also can contagion hand, other the On redemptions. unit conditions, wheninvestmentfundswillhavetomobilisedepositsinordercopewithpotential market stressed under apparent become to tends which stability, financial to risks of number a investment funds, which may often play a relevant role in bank financing, their volatility may pose in terms of capital requirements, discouraging such holdings. In the case of deposits in banks by funds andbank loans to investmentfunds,asholding units ininvestmentfunds is costlyfor banks investment between transactions funds andbanks.Ofthesechannels,themostfrequentaredepositsinbanksbyinvestment financing securities and loans instruments, derivative with of units in investment funds by banks, (ii) deposits in banks by investment funds, (iii) transactions holdings (i) through directly hand, one the On channels. different through occur can banks and funds investment between Contagion contagion. of risk related the and entities system financial The second source of systemic risk identified by the ESRB is related to the interlinkages between portfolio isthereforerecommended,especiallythehigherleverageinfund. liquidity position of the fund. The existence of an appropriate ratio of liquid assets in the fund’s overall fragile a against mitigate potentially will assets liquid costs, leverage in fluctuations are fund isrequiredtosellassetsatadiscountinordercopewithsuddenredemptionsandthere the which in condition, market stressed a in Even transactions. financing security or instruments quick adjustmentstotheirportfolioiftheyhaveadditionalmargincallsassociatedwithderivative correlated withthese assets. Indeed,leveragedinvestmentfundsholdingliquidassetsmaymake portfolios ofinstitutionsholdingthesameassetsorthathavetheirreturnclosely 13. 12. 11. financial assets total system’s banking the while doubling, than more management under assets financial with a context of very low interest rates, ordisinvest the importance of EU investment funds toinvest increased considerably, way at a relatively low cost. In the 2010-17 period, characterised by a search-for-yield phenomenon, in easy an offering funds, raise (redemption) and the to possibility of investing in vehicle a diversified portfolio a with specialised management are funds Investment 4 Investment fundsinPortugal funds regard tomarketliquiditymismatchesbetweenassetsandliabilities–thesecuritiesinvestment of funds, as there is potentially a maturity mismatch between assets and liabilities – specifically in Investment fundshavebeeninvestingandparticipatinginthegrowthofdebtsecurities.Incase a drop in the prices of these debt issues, which may spill over to other financial market participants. several financial intermediaries to sell debt securities issued by these corporations, thus leading to lead may which corporations, these of assessment profitability future and risk thismighthave the on impact an Presumably, debt. service to corporations ofnon-financial ability the on effect funds. ininvestment andredemption) Simultaneously, an increase in riskpremia–andconsequently in interest rates – may have an forsubscription (both flows amplifies volatility market From 2010 to 2017, Shadow Banking Portugal therefore held around 20% of total financial assets in the system, corresponding to corresponding the system, around 73%ofPortugueseGDP(Chart2). in assets financial total of 20% around held therefore Portugal in Banking Shadow 2017, of end the At 27%. around by declined Banking Shadow Portuguese the in assets financial of value the 2017, to 2010 From EU. the in institution of type this in seen those from different rather been have Portugal in Banking Shadow in developments However, 2018) andaround89%ofGDPgeneratedin2017. (ESRB, EU the in Banking Shadow overall of one-third around for accounted funds investment EU over€42 period, same the with during comparison, By 1). system, (Chart GDP of 273% around i.e. assets, in EUfinancial trillion the in assets financial total of 40% to close for Banking accounted Shadow 2017, of end the At 50%. around by growing assets financial its with system, over-the-counter market,wheredebtsecuritiesaretypicallytraded. they invest in equity shares, which are normally traded in more liquid and larger markets than the as risk, liquidity lower a have will funds mixed and funds Equity 2017). IOSCO, 2016; England, of crisis, which increased even more the sensitivity of bond funds to liquidity risk (ESRB, 2016a; financial Bank the after size in decreased and liquid less became debt) corporation non-financial for (particularly level global a at market debt the that evidence collected have authors Several risk. most of their portfolio in debt securities, are the funds most susceptible to maturity and credit affected be may by liquidityriskbecausetheyallowdailyredemptions.Inturn,bondfunds,asentitiesinvesting funds market Money 2018). (ESRB, risk liquidity to susceptible most are that funds the are funds, market money extent certain a to and, funds mixed and funds bond ESRB, See footnote 1. See footnote Also includingcentral bankbalancesheets. about 10%,alevelclosetothatobservedprior tothefinancialcrisis(seeBox1,“RealestateinvestmentfundsresidentinPortugal”). and Markets Authority (ESMA) is expected to confirm or refute this assumption. In addition, in June 2018, real estate funds showed a liquidity ratio of Real estate funds invest in assets traditionally classified as illiquid. However, a list of less liquid assets at the European level by the European Securities 11 which may be more susceptible to liquidity risk should be identified. According to the to According identified. be should risk liquidity to susceptible more be may which 12 increasedbyonly8.4%. 13 played an increasingly relevant role in the EU’s financial EU’s the in role relevant increasingly an played 125 Investment funds as a source of systemic risk 126 Banco de Portugal • Financial Stability Report • December 2018 growing by104%duringthe 2010-17 period. units of value the with 2017, of end the at GDP of 24% for accounting category, largest third the are funds Mixed 27%. for accounting each 2017, of end the at – GDP of percentage a as units of value the by measured – EU the in funds of type main the were These 3). (Chart respectively 87% and 80% around by increasing growth, relative lower recorded funds equity and bond by significant growth, more than doubling the value of units issued. In turn, the value of units issued recorded also funds mixed and funds estate real period, this During 2017. to 2010 from 218% by grew 2017), in GDP of (3.1% size small their despite units, fund hedge of value the EU, the In Central BankandexcludesMoneyMarketFunds. the includes MMF excluding Institutions Financial Monetary Funds. Market Money for stands MMF Auxiliaries. Financial and Intermediaries Financial Source: Banco de Portugal.|Notes:Financial assets mainly correspond toinvestmentsinassetsotherthan real estateassets.OFIstandsforOther Chart 2•TotalfinancialassetsinthePortuguesesystem|AsapercentageofGDP Institutions, andexcludesMoneyMarketFunds. Financial Intermediaries and Financial Auxiliaries. Monetary Financial Institutions excluding MMF includes central banks, in addition to Monetary Financial was 2017 for GDP Annual review. under estimated for period Bulgaria, Poland and Romania. Annual GDP for the 2013 was estimated for Croatia. MMF stands for over Money Market Funds. OFI stands for Other varies countries area euro of composition The Kingdom. United the and Sweden Romania, Poland, Denmark, Republic, Czech Croatia, Bulgaria, and countries area euro includes sample The assets. estate real than other assets in investments to correspond mainly assets Financial Notes: | calculations. Portugal de Banco and Board Risk Systemic European and Bank Central European Sources: Chart 1• 100 150 200 250 300 350 400 450 100 150 200 250 300 350 50 50 - 0 ex Institutions Monetary F Institutions exMMF Monetary Financial Monetary Total financialassetsintheEUsystem|AsapercentageofGDP 2010 inancial MMF

2011 2010 MMF 2011 MMF 2012 2012 2013 Investment Investment Funds Investment 2013 Funds 2014 2014 2015 O OFI exInvestment FI ex 2015 F Funds Investment unds 2016 2016 2017 Insurance Insurance Corporations Insurance andPensions Funds and Pensionfunds and Corporations 2017 14. of fundsareclassifiedtogetherwiththetypeinwhichtheyprimarilyinvest.MMFstandsformoneymarketfunds. classified under the category of the assets in which they primarily invest. In Portugal, venture capital funds are classified under the category “Other funds” and funds less loans and other liabilities. This classification is carried out in accordance with the ECB’s Manual on investment fund statistics, harmonised at EU level. Funds are Source: BancodePortugal.|Notes:Thevalueofunitscorrespondstonetassetandincludes thevalueofinvestmentsbyinvestmentfundplusotherassets in GDP, of Portugal this growth percentage was not a observed in the as 2010-17 period. In funds Portugal, “Other funds” investment in trend upward clear a is there EU the in While are classifiedunder“Otherfunds”andfundsofclassifiedtogetherwiththetypeinwhichtheyprimarilyinvest.MMFstandsformoneymarketfunds. funds capital venture Portugal, For invest. primarily they which in assets the of category the under classified are Funds level. EU at harmonised statistics, fund investment on Manual ECB’s the with accordance in out carried is classification This funds”. “Other as reclassified were funds hedge of number a 2016, In Kingdom. United the and Sweden Denmark, Croatia, Bulgaria, for data Excluding liabilities. other and loans less assets other plus fund investment the by value investments asset of value net the to includes and corresponds units of value The Notes: | calculations. Portugal de Banco and Board Risk Systemic European and Bank Central European Sources: As apercentageofGDP Chart 3• by typeoffund|AsapercentageGDP Chart 4• size comparedtoGDPwererealestatefundsandbondfunds. relative of terms in Portugal in resident funds investment largest the 2017, of end the At p.p. 1 funds”. However, the increase observed in this category as a percentage of GDP stands at around During this period, growth in venture capital funds partly explains the increase of 108% in “Other 4). (Chart period 2010-17 the in issued units of value the in increase an recording category only 100 120 subscription documentsorinvestmentcontracts, marketingdocuments,oranyotherstatementwithsimilareffect. statutes, rules, fund prospectus, public the from derived are funds investment classifying for criteria the that specifies further glossary The funds). hedge or funds estate real funds, mixed funds, equity funds, bond than other funds investment (i.e. category residual a as funds” “Other defines ec.europa.eu/eurostat/ramon/statmanuals/files/ECB_investment_fund_statistics_2017_en.pdf statistics: fund investment on Manual ECB’s the with accordance in out carried is Portugal de Banco by funds investment of classification The 10 12 14 16 18 20 40 60 80 0 2 4 6 8 - MMF MMF 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 Value ofunitsEUinvestmentfundsandmoneymarketbytypefund| Value ofunitsinvestmentfundsandmoneymarketresidentinPortugal 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 Funds Equity Equity F unds Bond Funds Bond Bond Funds Mixed Funds Mixed MixedFunds Real estate funds Real estate funds . Generally, the manual on investment fund statistics Hedge Funds Hedge Funds Other funds Other Other funds 14 wasthe http:// 127 Investment funds as a source of systemic risk 128 Banco de Portugal • Financial Stability Report • December 2018 may arisefromthesefundsisexpectedtohavedecreased. particular, is lower than in 2010, the potential mismatch between maturity and liquidity risk that given Therefore, that these funds’ exposure to debt securities, in general, and to longer-term debt securities, in 2017. of end the at increase sharp a recording only years) 2 (over securities debt longer-term to exposure with year), 1 to (up securities debt short-term to exposure their a maturity and a liquidity risk. At the end of 2017, bond funds incur simultaneously funds these Consequently, 2016). England, of (Bank market this in liquidity assets and liabilities – invest in the debt securities market, against a background of reduced In turn, bond funds – in addition to traditionally operating with a maturity mismatch between financial system. Portuguese the for risk systemic of source a itself in not is therefore and mismatch maturity a of regard, despitethelowliquidityofrealestateassets,thistypefundisnotsubjecttorisk to realestatefunds,whichexplainswhytheseare,forthemostpart,closed-endedfunds.Inthis the realestatetransferredinlieuofpayment.Banksparttheseassets were forcedtoexecutethecollateralassociatedwithsomeoftheseloans,therebyincreasing and loanstoenterprisesinconstructionrealestatedevelopment.Followingthecrisis,banks Portuguese Indeed, activities. banks hadsubstantialexposuretotherealestatesectorthroughloansguaranteedby estate real and construction in enterprises non-performing of This Portugal. in issued units fund investment total importance is not dissociated from of the economic and financial crisis, which 41% resulted in high levels held funds end estate the real At 2017, estate). (real of assets illiquid relatively of percentage high a have funds estate Real risk identifiedbefore. of sources the and funds) bond and funds estate (real Portugal in funds of types relevant most the with associated dynamics the on out carried is analysis an parallel, In Portugal. in evolved have 2) Table in (described funds investment with associated risk systemic of sources the how units issued in the 2010-17 period – it is important to assess, of from value a the financial stabilityin perspective, growth of lack the and GDP to relative size small their considering particularly – Given that developments in investment funds in Portugal were rather different to those in Europe 16. 15. to the debt market. funds’ units decreased by around 7.5%, which may indicate a reduction in these funds’ exposure these of value the comparison, By 27%. around at stood securities debt to funds bond ended partly reversingthistrenduntil2017.From2010to2017,thedeclineinexposureofopen- 5), (Chart securities debt to exposure their in trend downward a followed Portugal in resident risk, asexpectedinasearch-for-yieldmovement.From2010to2015,open-endedbondfunds term debt securities in the period under review, thereby increasing the funds’ potential liquidity It is important to establish whetheropen-ended bond funds increased their exposureto longer- of thisyear. end the at open-ended were Portugal in resident funds bond most 1), (Table ability redemption of terms in addition, In funds. investment by management under assets total of 32% around for affect theanalysis.Notconsideringthisfund, thevalueofopen-endedbondfundunitswouldhavedecreasedbyaround19%. partly may which fund, bond a as reclassification statistical its to led fund market money a of policy investment the to changes 2017, of start the At not 1.6% oftotalunitsissued,attheend2017. may which for accounted redemptions, only units daily fund market money to Portugal, in established subject fund of are type by However, they term. short the because in assets to risk correspond completely liquidity a incur may funds market Money funds. market money Excluding 16 In terms of maturity, from 2010 to 2012, open-ended bond funds increased 15 resident in Portugal accounted Portugal in resident 18. 17. were households crisis, financial the preceding period the In funds. investment to exposed of systemic risk. From 2010 to 2017, banks and households continued to be the sectors most The interlinkages and the risk of contagion between financial system entities are a second source proxy fortotalleverage,asitexcludesderivativeinstruments.Onlyincludesinvestmentfunds, excludingmoneymarketfunds. Source: Banco de Portugal. | Notes:Theleverage ratio is calculated as the ratioofloans granted to thefund to thevalue of units issued. This ratio is a concentrated in realestate funds. significantly higher than those of open-ended funds. The leverage of closed-ended funds is mostly has followed a downward trajectory. The leverage levels of closed-ended funds were always ratio the then, Since 6). (Chart respectively funds open-ended and funds closed-ended for 4.5% and 28% around reaching 2011, in observed was ratio leverage highest the 2017, to 2010 From Source: BancodePortugal. original maturity|EURmillions Chart 5• Chart 6• this leverageisconcentratedinclosed-endedfunds. a From Portugal”). that fact the in by mitigated is leverage excessive from resident arising risk the perspective, stability financial funds investment estate “Real 1, Box (see 2018 June in 2% only 10 15 20 25 30 35 The leverageratioiscalculatedastheof loans tothevalueofunitsissued. In 2017,64%ofclosed-endedfundswerereal estatefunds. 1000 2000 3000 4000 5000 6000 7000 0 5 0 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 Investments ofopen-endedbondfundsresidentinPortugaldebtsecuritiesby Leverage ratioofinvestmentfundsresidentinPortugal|Percent 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 Up to 1 year 1 to Up Open-ended funds 17 Open-ended real estate funds posted aleverage ratio 1 year to 2years Closed-ended funds Over2 years Totalof debt securities All funds All 18 of 129 Investment funds as a source of systemic risk 130 Banco de Portugal • Financial Stability Report • December 2018 sector |AsapercentageofGDP Chart 7• funds attheendofperiodconsidered(2017),althoughaccountingforonly1%GDP. investment funds. Conversely, non-residents and the general government were more exposed to resident to exposure their in trend downward a followed corporations non-financial and funds pension and companies insurance review, under period the In crisis. financial the before than the In effects. side more recent period, the exposure of banks reputational to funds has declined, remaining nevertheless higher in resulted have could Portugal, in asset companies and management groups banking Portuguese between link close the considering which, recognition, investment fund units – particularly open-ended fund units – in order to avoid fire sales and loss toacquire needed depreciation,banks period offinancial asset in a turn, In investment funds. to – suchasamountsininvestmentfundswhichledtoadeclinetheexposureofhouseholds including inthebalancesheetcustomerresourcesthatwereoutsideconsolidationperimeter by namely customers, from funds raise to need subsequent the and markets financial wholesale international to sector banking Portuguese the of access of lack the by crisis, sovereign the of households asthelargestholdersofinvestmentfundunits.Thismaybeexplained,incontext considerably (to around 6% of GDP in 2011 and around 4.8% of GDP in 2014), with declinedbanks funds investment replacing in investment household crisis, financial and economic the Following debt securities, and, to a lesser extent, shares and other equity – was partly offset by an increase particular in – sector financial resident the to exposure the in reduction The 8). (Chart rebalance decline/ a recorded which residents, by issued securities to exposure to opposed as start, the some variation,remainedhighandrelativelyunchangedat theendofperiodcomparedwith From 2010to2017,theexposureoffundsassetsissued bynon-residents,althoughwith analysed ingreaterdetail,giventhepotentialinterlinkages and contagionbetweentheirportfolios. In addition, the relationship between investment funds andothereconomic sectors shouldbe exposure byinstitutionalsectorstoinvestmentfunds,excludingmoneymarketfunds. only Including funds. investment Financial notably most Other auxiliaries, funds. and market intermediaries money financial other as comprises well (OFI) as Auxiliaries Financial general, and in Intermediaries banks, comprises Institutions Financial Monetary Notes: | Portugal. de Banco Source: 7). (Chart Portugal in resident funds investment in most the investing sector institutional the 19. 0 1 2 3 4 5 6 7 8 9 Although Chart 7 identifies Monetary Financial Institutions, which also includes money market funds, owing to their small size in Portugal, the Portugal, in size small their to owing funds, movement showninthisitemismostlydueto banks. market money includes also which Institutions, Financial Monetary identifies 7 Chart Although 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 Non residents Non-financial c Insurance Corporations and Pensions Funds Monetary F Value ofunitsinvestedininvestmentfundsresidentPortugalbyinstitutional inancial Institutions orporations

Households General Government Other Financial Intermediariesand Financial Auxiliaries 19

Securities and Markets Authority (ESMA) may additionally determine whether the leverage used leverage the whether determine additionally may (ESMA) Authority Markets and Securities European the Consequently, discretion. of level higher a is there leverage, excessive on actions for alternative investment funds, although microprudencial authorities may impose corrective concluded that limits to mitigate excessive leverage are already in place for UCITS. However, work ESRB’s the leverage, of terms In conditions. liquidity exceptional and normal under tests stress conduct regularly to and strategy investment the of profile liquidity the with compatible investment funds, it was concluded that these should adopt redemption policies that are liquidity requirements.Inparallel,UCITSmustregularlyconduct stresstests.Asforalternative in UCITS, that concluded was it liquidity, regulatory legislation, were subject to detailed eligibility rules on assets, in addition to minimum of terms In 2016b). (ESRB, risk systemic of sources identified mitigate or prevent may which tools several are there perspective, ESRB’s the From 5 Macroprudential policyaction ininvestment funds between investmentfundsandotherresidentsectorsalsoseemscontained. lower relativeholdingsofdebtsecuritiesintheperiodunderreview.Finally,riskcontagion bond fundshaveincreasedtheirexposuretolonger-termsecurities,despitefollowingatrendof all open-ended Inaddition, 2015, Since leverage. of levels low have alia) inter funds, estate market. (real categories fund investment less liquid a in sales fire in engaging these of probability closed-ended, mostly are first The funds. and thereforearenotsubjecttounanticipatedredemptionsbyinvestors,whichmitigatesthe bond and terms funds in estate Portugal real in was resident value fund asset of net type of relevant most the 2017 of end the at up, sum To only investmentfunds,excludingmoneymarketfunds. and Intermediaries Financial Financial Other Auxiliaries. The and non-financial private Institutions sector comprises Financial non-financial corporations Monetary and households. comprises GG stands for sector General Government.financial Including resident The Notes: | Portugal. de Banco Source: Chart 8•InvestmentofinvestmentfundsresidentinPortugal|AsapercentageGDP and review under period the remained atverylowlevelsoverthereviewperiod. of start the at than lower was debt public Portuguese to funds end of2015,andanincreaseinthepasttwoyears.However,2017exposureinvestment the until decline a by followed 2013, until increase an periods: different three into down broken be can debt public Portuguese to funds investment of exposure The equity. other and shares of format the in particular in sector, private non-financial the by issued securities to exposure in 0 1 2 3 4 5 6 Securities other than shares of the resident financial sector Securities other than shares of the resident non-financial private sector Securities other than shares of non residents (Total) Securities other than shares of residentGG 0021 0221 0421 062017 2016 2015 2014 2013 2012 2011 2010 Shares and other equity of the resident financial sector Shares and other equity of the resident non-financial private sector Shares and other equity of non residents (Total) . 131 Investment funds as a source of systemic risk 132 Banco de Portugal • Financial Stability Report • December 2018 23. 22. of frequency and data reported. Consequently, the European Commission should make legislative of Member States have reporting obligations for UCITS, reporting practices differ widely in terms A harmonised reporting framework for these funds does not currently exist. Although a number Recommendation D intends to establish a harmonised UCITS reporting framework across the EU. appropriate timingandfrequencytoconductthestresstests. scenarios to be used in the liquidity stress tests, the internal use of stress test results and the the define should ESMA Thus, testing. stress of sophistication and frequency parameters, the a requirementforUCITSandAIFs, parameters ofliquiditystresstestingatinvestmentfundlevel.Althoughisalready Recommendation C is aimed at ESMA, following the development of harmonised guidance on the NCA theircapacitytomaintaininvestmentstrategyunderforeseeablemarketconditions. requirement forthemanagersofopen-endedalternativeinvestmentfundstodemonstrate a on legislate and assets liquid less inherently of list a update to and prepare to ability the ESMA 21. 20. their assetportfolioinlessliquidassets, their investmentstrategyonanongoingbasis.GiventhatsomeAIFsholdalargeproportionof In particular, it establishes the need for such funds to demonstrate their capacity to maintain Recommendation Bisdesignedtopreventpotentialliquiditymismatchesinopen-endedAIFs. suspension ofredemptions. conditions. Inaddition,RecommendationAcallsforNCAstofurtherclarifythepotentialuseofa specific and additional of range liquidity managementtoolswhichcouldbeactivated,inparticularunderstressedmarket wide a ensure to framework legal EU common a formulates Commission European the that requested was It conditions. market stressed of consequence for fundsinallMemberStates,particularwhenfaceconsiderableredemptionsasa Recommendation A addresses the need to create a diversified set of liquidity management tools role inrelationtonationalcompetentauthorities(NCAs)–andtheEuropeanCommission. In this context, in 2017 the ESRB published five recommendations to ESMA – given its coordinating measures ofleveragetohelpenabledirectcomparisonsbetweenfunds. consistent develop to need the addressed FSB the Lastly, generally. more system financial the could capture effects of collective selling by funds and test the resilience of financial markets and effect. In addition, the FSB addressed the need to develop more comprehensive stress tests that “first-mover” mitigate to volatility increased of periods in particularly tools, management liquidity transparency on fund liquidity, both for authorities and investors, and the development of In thisrespect,theFSBrecommendedincreasingamountofinformationavailableand prevention ormitigationofpotentialliquiditymismatchesandonhowtoimproveitsmanagement. management sector (FSB, 2017). As regards investment funds, recommendations focused on the asset the in vulnerabilities identified previously on authorities relevant to recommendations 14 Subsequently, in 2017, following its work on the definition of Shadow Banking, the FSB published authorities, specifyingthecorrectiveactionthatshouldbetaken,includingleveragelimits. competent to recommendations issue may and system financial the of integrity and stability the to risk significant a poses AIFMs of group a or (AIFM) manager fund investment alternative an by Except forunleveraged closed-endedAIFs orforUCITSwhichitisdeemedinappropriate. The ESRB Recommendationspecifiesthefollowingaslessliquidassets:real estate, unlistedsecurities, loansandotheralternativeassets. https://www.esrb.europa.eu/mppa/recommendations/html/index.en.html Directive 2009/65/EC (andsubsequentrevisions) andDirective2011/61/EU. 23 thereisatpresentconsiderableheterogeneityintermsof 22 it is requested that the European Commission grants Commission European the that requested is it . 20 21 signals ofriskstothefinancialsystemand,ultimately, financial stabilityinPortugal. of harmonisationstressteststobecarriedoutbyfunds, therebycontributingtoearly-warning and C,whichwillhelpexplicitlyidentifylistsofinherentlyless liquidassetsandincreasethelevel B Recommendations and implemented, been has it once Portugal), in resident funds of majority (the reporting data UCITS harmonise help will it as highlighted, be should particular, D Recommendation In funds. investment from arising system financial the to risks potential address to can beconcludedthatatpresentthereisnoneedthe nationalleveltoconsidermeasures it However, activities. funds’ from arising risk systemic potential the mitigate will (ESRB/2017/6) recommendations recent ESRB’s the from arising tools of set the of use the that recognised is It remain contained. contagion of channels indirect and direct that shows analysis this system, financial the of parts potential liquidityrisks. With respect to the potential linkages and transmission of risks to other leverage, itismostlyconcentratedinclosed-endedrealestatefunds,andthuslesslikelytospread regards what In mismatches). maturity or liquidity cause to potential greater with such, as (and, not showincreasing exposures to debt markets or to longer-term securities in thedebt market do system, financial Portuguese the in risk systemic generate to likelihood higher a have which and financial crisis and they are yet to rebound to their pre-crisis level. Open-ended bond funds, the in size small economic the following declined importance their as system, financial Portuguese the of context a have funds investment particular, In level. European at the observed accompany increase not did it that shows Portugal in Banking Shadow on out carried analysis The to thestrongincreaseinassetsundermanagementEUpastdecade. macroprudential policy not only due to their specific characteristics in spreading risk but also due the financial system (Banco de Portugal, 2014b). Investment funds deserve special attention from of resilience the enhancing by stability financial promote to is policy macroprudential of aim The 6 Conclusions alternative investmentfunds. enabling thedesign,calibrationandimplementationofamacroprudentialtooltolimitleveragein risks leverage on framework a of establishment the on guidance provides E Recommendation NCAs ofotherMemberStates,ESMAandtheESRB. recommended toproducearegulatoryframeworkthatallowsfortheavailabilityofdata also is Commission European The risks. stability financial to UCITS of contribution potential the changes that enable comparisons between funds, given the need for assessing and monitoring 24. asset managers,inordertomitigatepotentialrisksarisingfrominvestmentfunds. circumstances andimprovethequalityofinformationavailabletocompetentauthorities funds, predict the most appropriate courseof action in adverse macroeconomic scenarios or mitigate the effects of adverse liquidity scenarios and excessive leverage by alternative investment particular in might which 2021, by developed be to expected are tools macroprudential Specific a commonapproachforcompetentauthoritiestousethistool. Generally, Article25ofDirective2011/61/EU. 24 Specifically, this Recommendation proposes the development of development the proposes Recommendation this Specifically, 133 Investment funds as a source of systemic risk 134 Banco de Portugal • Financial Stability Report • December 2018 7 Bibliography Banco de Portugal (2014b), Portugal de Banco Banco dePortugal(2014a),FinancialStabilityReport,May2014. Banco dePortugal(2013),FinancialStabilityReport,November2013. Singh M.,AlamZ.,(2018),“Leverage–ABroaderView”,IMFWorkingPaper . Transparency intheSecondaryCorporateBondMarkets. (2017), Commissions Securities of Organisation International Market Funds. (2012), Commissions Securities of Organisation International Challenges andManagingRisks(Chapter3),pp93-135. (2015), Fund Monetary International Money MarketFundAssociation. (2013), M., Hannam Asset ManagementActivities. (2017), Board Stability Financial Framework forStrengtheningOversightandRegulationofShadowBankingEntities. (2013), Board Stability Financial European SystemicRiskBoard(2018),EUShadowBankingMonitor,No.3/September2018. liquidity andleveragerisksininvestmentfunds. (2017), Board Risk Systemic European paper. (2016b), Board Risk Systemic European European SystemicRiskBoard(2016a),Marketliquidityandmarketmaking. chaired byJacquesdeLarosière. (2009), Commission European England, FinancialStabilityPaperNo.42. system: the resilience of the corporate bond market and the role of investment funds”, Bank of financial the across stress “Simulating (2017), L. Silvestri, J.; Noss, P.; Lowe, J.; Coen, Y.; Baranova, direction”, leverage Report of review and liquidity ”Market (2016), England of Bank www.bportugal.pt/sites/default/files/anexos/politicamacroprudencialemportugal_2.pdf. No. 39(Box2). Money Market Funds, Bank Runs and the First-Mover Advantage, Institutional First-Mover the and Runs Bank Funds, Market Money Macro-prudential policy in Portugal: objectives and instruments, and objectives Portugal: in policy Macro-prudential Report of the High-Level Group on Financial Supervision in the EU the in Supervision Financial on Group High-Level the of Report Policy Recommendations to Address Structural Vulnerabilities from Vulnerabilities Structural Address to Recommendations Policy Strengthening Oversight and Regulation of Shadow Banking-Policy Shadow of Regulation and Oversight Strengthening Global Financial Stability Report: Navigating Monetary Policy Monetary Navigating Report: Stability Financial Global Recommendation of the European Systemic Risk Board on Board Risk Systemic European the of Recommendation Macroprudential policy beyond banking: an ESRB strategy ESRB an banking: beyond policy Macroprudential Policy Recommendations for Money for Recommendations Policy euaoy eotn ad Public and Reporting Regulatory Financial Stability https:// announced by the Commission component’), reduction (‘risk entities sovereign respective their and banks the between link to developandadopt further measurestoreduceriskinthebankingsectorandweaken the The EuropeanCommission’soriginallegislativeproposalfeaturesthreemainsubjects: taking intoaccountthedevelopmentsininternationalstandardsthisfield. participants, market various the of confidence the boosting while system, banking European The risk reduction measures aim to improve the institutions’ resilience and strengthen the following theactiontakeninresponsetofinancialcrisisthatbegan2007-2008. the European Deposit Insurance Scheme (EDIS, the ‘risk-sharing’ component). ‘risk-sharing’ the (EDIS, Scheme Insurance Deposit European the 9. 10. 8. 7. 6. 5. 4. 3. 2. 1. proposals legislative the published Commission European the 2016, November 23 On 1 Overview what isnew? Amendment oftheCRDIV-CRR: 11. legislative initiativesinthatareawiththeultimategoalofcompletingBankingUnion, present to (ECOFIN) Council Affairs Financial and Economic the from calls the address also amending the CRD IV, See thelegislativeproposalhere:https://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1539251888511&uri=CELEX:52015PC0586 m=EN (seespecificallyPart5). e te oni’ cnlsos n h ramp o opeig h Bnig Union: Banking the completing to roadmap the on conclusions releases/2016/06/17/conclusions-on-banking-union/pdf Council’s the See Communication “Towards the completion of the Banking Union”: See thelegislativeproposalhere:https://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1491993170238&uri=CELEX%3A52016PC0851 Single ResolutionFund. a and Mechanism Resolution Single a of framework the uniformin firms a investment certain and and rules institutions credit uniform of resolution establishing the for 2014 procedure July 15 of Council the of and Parliament European the of 806/2014 No. (EU) Regulation See thelegislativeproposalhere:https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM%3A2016%3A0852%3AFIN credit institutionsandinvestmentfirms. of resolution and recovery the for framework a establishing 2014 May 15 of Council the of and Parliament European the of 2014/59/EU Directive investment firms. and institutions credit for requirements prudential on 2013 June 26 of Council the of and Parliament European the of 575/2013 No. (EU) Regulation supervision ofcreditinstitutionsandinvestmentfirms. Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential See thelegislativeproposalhere:https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM%3A2016%3A0850%3AFIN on theoptionsfollowedinjurisdictionswhich adoptthem. regulation and supervision of large, internationally active banks, due to which their application to other smaller or different institutions depends legally binding,butareappliedbydecision ofthelegislatorsrespectivejurisdictions.Furthermore,standardsaredesignedfor not are accords These Supervision. Banking on Committee Basel the by issued supervision and regulation on accords are standards’ ‘Basel The a) Updatingtheprudential regulatory framework byadoptingseveralstandards of the Basel Committee on Banking Supervision (BCBS), buffer based on the leverage ratio and applicable to global systemically important globalsystemically to andapplicable ratio the leverage on based buffer in December2017areexcludedfromthisrevision,aparttheadditionalcapital agreement known as Basel III. However, most of the amendments agreed by the BCBS 2 CRR, 3 BRRD 8 atthetimeofpresentationlegislative proposal for 4 , 5 and SRMR. . http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52015DC0587&fro 6 , 7 These proposals address the objectives 11 finalised in the meantime under the https://www.consilium.europa.eu/en/press/press- . . 9 Theproposals . . 1 for 10

135 Amendment of the CRD IV-CRR: what is new? 136 Banco de Portugal • Financial Stability Report • December 2018 negotiation processand,assuch,itmaystillchange. the from result will package legislative the of text final The framework. macroprudential the to amendments the as such Parliament, European the and Council European the co-legislators, the Commission’s initial proposal but also additional proposals, introduced by the two European The negotiationofthislegislativeproposalultimatelycoverednotonlythetopicscontainedin 12. information thebanksmustdisclose,commonly knownasthemarketdisciplinepillar. risk, market risk and operational risk. Pillar II relates to the supervisory review and evaluation process (SREP). Lastly, Pillar III covers rules on the credit for requirements capital the covers I Pillar pillars. mutually-reinforcing three on based is II Basel in defined architecture supervisory The Amendment of various other topics of the current regulatory framework such as: (i) as: such framework regulatory current the of topics other various of c) Amendment b) Adoption of the Financial Stability Board standard on Total Loss-Absorbing Capacity, of amendments to the Pillar 2 legal framework; a undertakings, but establish with subsidiaries established in the European to Union; (iv) introduction requirement parent a country third with groups certain for (iii) Union European the in company holding companies; investment or institutions credit in for holdingcompaniesthatareparentundertakingswhoseholdingspredominantly the bank regulation package (CRD-CRR); (ii) imposition of an authorisation requirement revision ofthelistinstitutionsexemptedfromcompliancewithrequirements framework. Requirements forOwnFundsandEligibleLiabilities(MREL),withinthebankresolution which appliestoG-SII,anditsarticulationwiththeBRRDrequirementforMinimum proposed netstablefundingratio). (e.g. subject same ensuring coherencebetweentheliquiditycoverageratioalreadyimplementedand the on Union European the in adopted already standards other with alignment (iii) and requirements) certain with compliance from models business credit riskandmarketrisk,forsmallerinstitutions,orevenexclusionofparticular (e.g. models business simpler calculationapproachesforcertaincapitalrequirements,namelycounterparty or institutions of types certain for proportionality additional (ii) standards; BCBS the original the to sector, adjustments (i) area: banking this in proposed is Union following European the of characteristics certain Acknowledging institutions (G-SIIs). expected creditlossesfrom1January2018. calculation ofownfunds,phasingintheimpactapplyingIFRS9onprovisionsfor the on provisions transitional of introduction (vii) Union; European the in structural deemed essential activities economic financing of encourage to financing way a as the projects, infrastructure concerning and enterprises medium-sized and small to to theadjustmentfactorforcreditriskcapitalrequirementsregardingexposures concession on a cross-border basis (which is currently not permitted); (vi) amendments to subsidiaries from capital requirements on an individual basis, in order to allow its 12 (v) amendments to the waiver granted 15. 14. 13. created aretechnicallycoherentandsuitableundertheSingleRuleBook. safeguarded, as analysed by the European Banking Authority (EBA), to be ensure that to the solutions expected are specificities European Some crisis. financial the after developed package Union European the by adopted be in this revision, in the context of the Basel III standards, which arekey to the risk reduction to subjects main the summarises table following The 3 FinalisingtheadoptionofBaselIIIstandards and requirements,inordertoensurethattheywillbereadycomply. into perspectiveorbydevelopingthemethodologiesneededforapplyingnewconcepts introduction of the new requirements, either through impact studies that put the new rules The perioduntilentryintoforceisimportantfortheinstitutionstostartpreparing will be2021. datethis that expected is it 2019, early into continue negotiations the should However, force). into entry respective and publication after years two to half a and (one 2020-2021 in be will Should these thenegotiations. of negotiations endby2018,itisexpectedthatthedateforapplyingmajorityofprovisions finalisation upon clarified completely be only will frame and thecomplexityofcalendarisachallengeforallpartiesinvolved.However,time both oftheinstitutionssupervisedandsupervisors.Uncertaintyoverdatesinquestion from therevisionofCRDIVandCRR,iscrucialforallowinganappropriatepreparation The definition of the time frame for applying the new CRD V and the new CRR II, which will result 2 Entryintoforce entities sector denominated innon-domesticcurrency). sovereigns/public to exposures certain for risks large to limits the regarding legislationand 9 IFRS introducing of impact the for frameworks transitional (the adopted been already has legislation which for topics the and MREL) and (TLAC framework resolution the to changes the cover not does it However, system. banking Portuguese the for relevance their of This SpecialIssuepresentsandanalysessomeoftheamendmentstoCRDCRRinview lgl rmwr ivlig uiu sse o sadrie pueta rls wih pl t al rdt ntttos n ivsmn firms investment and institutions credit all to apply which rules, prudential authorised tooperateintheEuropeanUnion. standardised of system unique a involving framework legal A texts enteringintoforce20daysaftertheirpublication. legal the with necessary, be still will process revision language and translation subsequent the 2019, of half first the in reached is agreement If the EuropeanParliamentandofCouncil12December2017,applyingfrom1January2018. of 2017/2395 (EU) Regulation to rise giving proposal, original the from separated were frameworks transitional these to relating proposals The 14 13 15 137 Amendment of the CRD IV-CRR: what is new? 138 Banco de Portugal • Financial Stability Report • December 2018 imposing areportingrequirementonthistopic,untilthe finalisation oftheBCBS’swork. the legislative review in progress may include providing for longer transitional periods or simply date forapplyingtherespectivereformproposals.Thus, solutionstobeconsideredaspartof eomn te akt ik tnad Fnaetl eiw f h Taig ok b proposing some revisionstothe2016standard by Book) Trading the of Review (Fundamental standard risk market the reforming on work of continuation the announced BCBS the 2018, March and 2017 June in Significantly, 16. Market risk Pillar III(disclosurerequirements) Net StableFundingRatio(NSFR) Framework forlargeexposures counterparties (CCPs) Requirements forexposurestocentralclearing Counterparty creditrisk Leverage ratio(LR) Credit risk(equityinvestmentfunds) Table 1• Trading Book for marketrisk,arisingfromtheFundamentalReviewof Proposal foramendingtheCRRoncapitalrequirements by creditinstitutionsandinvestmentfirms Proposal foramendingtheCRRondisclosurerequirements requirement witha100%minimumlevel Proposal forintroducingtheNSFRintoCRRasaPillar1 the variousexemptionslaiddowninCRR exposures, specificallyregardingthebenchmarkcapitaland Proposal foramendingtheCRRonlimitstolarge exposures toCCPs Proposal foramendingtheCRRoncapitalrequirements standard approach counterparty creditriskdeterminedinaccordancewiththe Proposal foramendingtheCRRoncapitalrequirements requirement witha3%minimum Proposal forintroducingtheLRintoCRRasaPillar1 through funds requirement calculationforexposuresheldindirectly Proposal foramendingtheCRRoncreditriskcapital Consultation documentsavailablehere: Scope oftheCRDIV-CRRamendment Subject https://www.bis.org/bcbs/publ/d408.pdf and https://www.bis.org/bcbs/publ/d436.pdf. 16 inapublicconsultation,whichraiseddoubtsoverthe (November 2016) Requirements forMarketRisk,EBA-Op-2016-19 for CounterpartyCreditRiskandOwnFunds Commission’s CfAonStandardisedApproach EBA Report:ResponsetotheEuropean BCBS standard(January2016) BCBS standard(JanuaryandJune2015) (December 2015) under Article510oftheCRR,EBA-Op-2015-22 EBA ReportonNetStableFundingRequirements BCBS standard(October2014) Call forAdvice,EBA-Op-2016-17(October2016) the EBA’sresponsetoEuropeanCommission’s EBA Report:Reviewofthelargeexposuresregime: BCBS standard(April2014) BCBS standard(April2014) (November 2016) Requirements forMarketRisk,EBA-Op-2016-19 for CounterpartyCreditRiskandOwnFunds Commission’s CfAonStandardisedApproach EBA Report:ResponsetotheEuropean BCBS standard(March2014) (August 2016) under Article511oftheCRR,EBA-Op-2016-13 EBA Reportontheleverageratiorequirements BCBS standard(January2014) BCBS standard(December2013) Bases fortheLegislativeProposal 18. 17. institutions to hold on to liquidity, which harmed the financial condition of other institutions in reality, these In crisis. thefinancial fragilities stretched over a long time, creating uncertainty in the markets and leading many during affected seriously being financing and liquidity which proved mismatched to the assets’ average duration, which led to the institutions’ structures funding and scenarios adverse in buffers liquidity the of inadequacy the address respectively. These new regulatory measures were designed for liquidity risk management, to 2018and 2015 in implemented be to standards, its into (NSFR) ratio funding stable net a and (LCR) ratio coverage liquidity a of introduction the announced BCBS the 2010, December In minimum level 3.2 Netstablefundingratio:Pillar1requirementwitha100% capital requirements. 1 capital, irrespective of the applicable risk weights for the purposes of calculating the current Thus, an upper limit would be imposed on the institution’s balance sheet according to its Tier and derivatives). assets off-balance-sheet and on- (including exposures relevant its of total the of 3% least at to correspondsthat level capital 1 Tier minimum a keep must institution an that means which 3%, legislative aforementioned the package. Currently, there is a consensus that the compulsory minimum for this ratio should be by covered institutions all for measure 1 Pillar compulsory a CRR follows the discussion over calibrating the leverage ratio with a view to introducing it as Basel, wasincludedasareportinganddisclosurerequirement.Thecurrentamendmentofthe ratio was included in the version in force of the CRD IV-CRR package and, as was the case with that isnotrisk-sensitive,tocomplementtheexistingcapitaladequacyratiosystem.Theleverage The BCBS then developed the leverage ratio, presented as a simple and transparent measure crisis showedtheneedforregulatorymeasurestopreventexcessiveleverage. Although the financial institutions’ intermediation activity justifies a significant leverage level, the that use risk-based approaches. This weakened those institutions and the financial system itself. financial institutions’ in increase leverage which was not always captured adequately by the existing regulatory ageneral requirements was there crisis, financial the before years the In 3.1 standards. The next section presents the amendments following the adoption of some of the Basel Stability Report,BancodePortugal(December2017). case”. Portuguese the – Ratio Leverage “Banks’ Issue Special the see ratio, the in comprised components the on information more For and Yesiltas(2011):“Leverageacrossfirms, banks,andcountries”,NBERWorkingPaperNo.17354. Sorensen Kalemli-Ozcan, 11(3); Volume Banking, Working Central of Journal BIS International regulation”, “Multi-polar Requirements”, (2015): A Capital Haldane, 586; No. Weighted Papers and Risk and “Leverage (2016): Karmakar and Gambacorta 2012/2; Journal: Trends OECD Market distance-to-default”, Financial the and leverage banks, of models “Business (2012): Roulet and Blundell-Wignall 1-17; 105, Economics Financial of Journal better?”, perform banks some did Why globe: the around crisis credit “The (2012): Stulz and Beltratti III; volume 4, Studies, Economic Portugal, de Banco Requirement”, Ratio ECBLeverage III Basel matter?”, the “Understanding (2017) models Karmakar and business Batista 1394; Working PaperNo. Do crisis: financial the during risk “Bank (2011): Marquez-Ibanez and Manganelli Altunbas, example for See Leverage ratio:Pillar1requirementwitha3%minimumlevel 18 Leverage ratio=

T Tier 1 capital capital 1 Tier otal exposure ≥ 3%

17 Financial 139 Amendment of the CRD IV-CRR: what is new? 140 Banco de Portugal • Financial Stability Report • December 2018 22. 21. 20. 19. The proposals 4 Waivers from prudentialrequirements onanindividualbasis an individualbasis(inlinewiththeEBA’sproposal). on requirement NSFR the from waiver a from benefit to authority supervisory respective the by institutions already benefiting from the LCR waiver on an individual basis may also be authorised the NSFR, the of introduction the with Thus, subgroups. liquidity specific for basis, individual an Currently theCRRprovidesforawaiver,oncross-borderbasis,fromliquidityrequirements reflect thestabilityandliquiditylevelofthosecomponents. to order in CRR, the in defined factors by components individual of multiplication the through their assets and off-balance-sheet items. The ratio’s numerator and denominator are calculated the institutionsretainastablefundingstructureinlongterm,givencompositionof to horizon) time (one-year requirement structural mitigate the lags in liquidity that crop up naturally in banking activity. The NSFR requires that longer-term a as works which 100%, of As mentionedabove,theamendmentofCRRintroducesNSFR,withaminimumlevel guarantees on the issuance of debt, or lines liquidity specific providing intervene, to had State the cases, certain In liquidity. of need activity. economic of financing the and stability financial for particular in entails, that costs the all with would only be justified in the scope of a ’complete‘ Banking Union. Thus, most Member States Member most Thus, Union. Banking ’complete‘ a of scope the in justified be only would consistent withalogicofriskreductionmeasuresatthe currentBankingUnionjunctureand of the institutions at the level of the group to which they belong. However, this proposal is not management efficient the on emphasis strong a place SSM the asunder supervisor consolidating responsibilities whose ECB, the by received well particularly was It jurisdiction. single a as Union Banking the of concept the to corollary a is and level Union European at activity border cross- with groups among liquidity and capital of allocation efficient more a of of principle possibility the the on warranted is proposal This country). (host subsidiary a through operates (home country) undertaking and the powers parent awarded to the group’s supervisory authorities the of the country of where that group origin of country the in authorities supervisory the were controversial,restartingthediscussiononbalancebetweenpowersattributedto on anindividualbasisandforbroadeningthecurrentwaiverfromLCR individual basiscannotbewaivedshouldthe parentundertakingofthatsubsidiarybeinanotherMemberState. is located in another Member State. This option does not now exist in the CRR in regard to capital adequacy ratios, compliance with which on an requirement on an individual basis, it may be met at subconsolidated level or at the consolidated parent undertaking level, even where the latter by formed subgroups liquidity through met entities from be the same group established to in different Member States.(LCR) For example, where aratio subsidiary in a Membercoverage State does not meetliquidity the LCR the for allows CRR the Currently, CRR. the of 8 and 7 Articles https://www.eba.europa.eu/-/eba-recommends-introducing-the-nsfr-in-the-eu Liability StructureandMortgageLendingDuringtheFinancialCrisis”;LallourMio(2015):“TheimpactofliquidityRegula tion onBanks”. the Global Financial Crisis” (2012); Huang and Ratnovski (2011): “The dark side of bank wholesale funding”; Dagher and Kazimov (2013): “Banks’ from Evidence Risk: and Structures Funding “Bank Federico: Pablo and Vazquez Francisco (IMF), Fund Monetary International example for See allowed thoseinstitutionstocarryoutcertainfinancingoperations. which 2014, to 2009 from groups, banking the of favour in guarantees personal issued State Portuguese the countries, other in case the was As 20 22 forintroducingawaiver,oncross-borderbasis,fromcapitalrequirements 19 to prevent defaults and possible bankruptcies as a result, Required stablefunding 21

≥ 1 ≥ 00% 24. 23. purpose behind the current legislative proposal. running State, contrary tothecreationofriskreductionmeasures,which,ashasbeenmentioned,was Member each of level the at also but level European at only not for, provided also are stability financial safeguard to tools right the unless level, European at contagion risk current contextofanincompleteBankingUnionwouldalsocreatenewchannelssystemic The decision to waive on a cross-border basis individual-basis capital requirements in the national financialsystems. objectives andinterestsleadtoasymmetricsituationswithseriousconsequencesforthe level, potentially influencing national public finances. This disconnect can give rise to misaligned resolution and supervision the although regard, decisions are primarily European, the this ultimate Europeanguarantee of financial stability the In remains at national namely (EDIS). concluded, Scheme be to Insurance yet Deposit is Union Banking the of pillar third the Indeed, at EuropeanlevelstillaccruetotheMemberStates’‘safetynets’. still incomplete,inwhichthecostsarisingfromsupervisionandresolutiondecisionstaken the parent undertaking of collateral at 50%) to mitigate the risks in play, with the Banking Union by provision (e.g. insufficient as seen is waivers these to conditions adding Indeed, incomplete. waiver fromliquidityrequirementsonacross-borderbasis,giventhattheBankingUnionis reject theproposaltointroducewaiversfromcapitalrequirementsandbroadencurrent powers overthisinstitution. resolution nor supervisory neither had having authorities Portuguese the despite Portugal, in Portuguese deposit guarantee fund would have had to reimburse the deposits in the subsidiary the liquidated, been actually had Español Popular Banco If undertaking. parent its by granted and management; and decision (iv) the acceptance of a risk reduction of the risk the position by means of guarantees of integration of level the (iii) financing; group centralising of possibility the (ii) management; liquidity and capital centralised of policies of acceptance the (i) to regard the concessionofcross-borderwaiversfromprudentialrequirementsonanindividualbasisin rules tosubsidiariesscrupulouslyandjudiciously.Itisparticularlyimportantassesscarefully apply to need the highlights Español Popular Banco of resolution the of example recent The and externally,ensuringfaircompetition. of individual theapplication Thus, domestically both stability, financial preserving to key is level subsidiary at requirements capital its continuity. of supporting their jeopardises capable this nolonger financially, is subsidiaries and financially deteriorates undertaking parent the the through centralisation of capital and liquidity management at banking group level, when, for example,are available gains efficiency structural circumstances, normal under Although, measures ofanationalnaturewarrantedinthecurrentcontext,seeSection1.2“Risks”. 2018. Conference International Annual CIRSF crossroads” a at Union “Banking (2018). Ferreira Elisa vein, similar a In costa-na-international-finance. Conference 2018.PortoBusinessSchool. https://www.bportugal.pt/intervencoes/intervencao-de-abertura-do-governador-carlos-da-silva- Society Banking and Finance International now?” heading we are where – crisis financial 2008 the after years “Ten (2018). Costa Silva da Carlos ECB, WorkingPaperSeries,No.2130,February2018,p.14.. Also inregard to the needtocompletetheBanking Union toallow cross-border activityin the banking system, seeLorenzE.,Schmitz,M.,Tirpák, https://www.bportugal.pt/intervencoes/intervencao-da-vice-governadora-elisa-ferreira-na-cirsf-annual-international-conference. 24 23 For more information on this and other 141 Amendment of the CRD IV-CRR: what is new? 142 Banco de Portugal • Financial Stability Report • December 2018 aspect), andfinallythePillar2Guidance(P2G)conceptisformallyintroduced. P2R as a single requirement for sets of institutions with similar risk profiles (the macroprudential the impose to possibility the of removal the with specified, is nature microprudential its Second, 2. Pillar of application the on proposed are clarifications First, transparency. its increase to and Amendments at Pillar 2 level aim to address discrepancies in its application in the European Union necessary, includingadditionalcapitalrequirements. where measures institution-specific impose assessment, that on based and, implemented, as mechanisms control institutions’ the and risk institution-specific assess authorities supervisory case, (iii) ad hoc information requests and (iv) the possibility of defining the composition of composition the defining of possibility the additional ownfundsimposed,includingcompliancesolelythroughCET1. (iv) and requests information hoc ad (iii) case, each in measures appropriate most the of imposition the (ii) situation, specific institution’s each considering while taking risk of assessment the (i) things): other (among for providing SREP, the package, changes to the initial proposal have arisen, preserving flexibility for the supervisor within legislative the negotiating of process the in However, 2. Pillar of context the in supervisor the by above, for drafting legislative acts and an exhaustive, closed list of measures that couldbe taken mentioned as proposals, containing flexibility’), (‘constrained framework 2 Pillar the of flexibility the reduce to aimed Commission European the from proposal revision initial the regard, this In Commission proposingtomovetowardsacommonlegalframework,basedonlegislativeacts. that were complemented by EBA Guidance EBA by complemented were that institutions. The rules laid down in CRD IV for applying Pillar 2 measures constitute basic principles on measures these of imposition the behind reasoning more produce to required justifiably are Given the concerns arising over supervisors’ accountability on this topic, supervisory authorities capital requirements. the and evaluation process (SREP), and the establishing between of rules for its definition, including additional balance a review supervisory the strike of part as to measures these applying aimed in supervisors to (P2R) awarded flexibility requirements 2 Pillar the on discussions The 5.1 ClarificationsofthePillar2requirements:flexibilityandtransparency II, Basel in defined architecture supervisory the of components three the of one comprise powers’ and measures ‘supervisory as known (P2R) requirements 2 Pillar The 26. 25. of 103 Article the of eliminating creation the and framework (by regulatory macroprudential a of revoke development The IV). CRD to proposes thelegislative Commission the which a provision by presented profile, risk proposal similar a with institutions of set 2 a Pillar single for a measure determine to supervisor the allows IV CRD of wording each current the However, of assessment the in applied being generally institution’s idiosyncraticrisks. nature, by microprudential is 2 Pillar 5.2 MicroprudentialnatureofPillar2 5 Pillar2 methodologies-for-the-supervisory-review-and-evaluation-process-srep-and-supervisory-stress-testing https://www.eba.europa.eu/regulation-and-policy/supervisory-review-and-evaluation-srep-and-pillar-2/guidelines-for-common-procedures-and- 12. See footnote 26 providing specifics and details, with the European the with details, and specifics providing . 25 throughwhichthe 28. 27. use to participants market allow to disclosure that of nature compulsory the specifically, – P2G of As this legislative process progressed, one topic under discussion related to the public disclosure had noformaldraftinginalegislativetext. the supervisoryauthoritiescommunicatetoinstitutions werealreadystandardpractice,they comparable application of the rules.Indeed,althoughtheadditionalcapitalexpectations that of thesupervisorymechanismstowhichinstitutionsare subject,includingconsistentand predictability and transparency the increasing of objective the has P2G drafting, formal its In Note: Nottoscale.MREL/TLACrequirementsnotconsideredinthisdiagram. example in the context of dividend distribution. institutions, the by met but importantly,non-compliancedoesnotinlegaltermsautomaticallyleadtorestrictions,for be to objective an therefore is P2G below). image (see requirement buffer combined the and (P2R) requirements 2 Pillar under increases capital requirements, 1 supervisory Pillar to additional the is guidance This them. underlying scenarios that plausible but improbable have expectations capital additional establishes authorities maycommunicatetoeachinstitution,estimatedlargelythroughstressteststhat (P2G) guidance 2 Pillar 5.3 Pillar2guidance using Pillar2measuresformacroprudentialpurposes(seepoint6). of impossibility the offset to order in framework, macroprudential the improve to aims rightly approach to the individual assessment of each institution. As such, this revision of the CRD-CRR certain issues, in particular in Member States with a stronger tradition of adopting a systemic macroprudential authorities does not raise doubts in conceptual terms, in practice, it leads to the microprudentialsupervisoryauthoritiesandregulatoryinstrumentsattributedto Although thegeneralprincipleofseparationbetweenregulatoryinstrumentsattributedto authorities. Therefore,endingtheuseofPillar2measurestoaddresssystemicrisksisjustified. the regulatory instruments available to the macroprudential and microprudential supervisory between boundaries the of clarification better for need the brings it implementing authorities Figure 1• guidance onanadditionalcapitalrequirementunderP2R. comply with P2G, the supervisor may adopt additional measures, including the conversion of the force andintermsofrevisionproposals,see point6ofthisSpecialIssue. framework in legal the in both requirement, buffer combined the of calculation the and buffers capital various the of description a For additive. become requirements two the case which in risk, at positions domestic to only applied is buffer risk systemic the where for except buffer), risk systemic buffer; (G-SII/O-SII +Max buffer capital + countercyclical buffer conservation capital the comprises requirement buffer combined The amount(MDA)thattheinstitutionsmaydistributetoholdersofequityanddebt. I.e. theydonotreducethemaximumdistributable Capital conservationmeasures Combined buﬀer Pilar 2G Pillar 1 Ranking ofcapitalconservationmeasur P2R re quire ment 28 27 However, if the institution repeatedly fails to MD Activation point A Restriction es 143 Amendment of the CRD IV-CRR: what is new? 144 Banco de Portugal • Financial Stability Report • December 2018 Pillar 2requirements,tosethigher ownfundsrequirements,wherenecessary. or (SRB) buffer risk systemic the as such instruments, other used have authorities macroprudential same Member State, solely on the basis of the origin of their capital. Consequently, a number of the caponsubsidiariesmay jeopardise theequaltreatmentofallinstitutionsestablished inthe if they are lower than the requirement found appropriate by those authorities. Furthermore, making by national macroprudential authorities regarding the optimal calibration of the instrument, where theyareestablishedortheiractivitieslocated. However,theymayrestrictdecision- ensuring thatinstitutionsaresubjecttosimilarrequirements acrossMemberStates,irrespectiveof These caps were established in order to maintain the integrity of the European single market, thereby group atconsolidatedlevel,and(ii)1%ofthesubsidiary’sto tal riskexposureamount. the to applicable rate buffer O-SII or G-SII the (i) of: higher the exceed cannot Union, European the in established group, banking European a of subsidiary the to applies that buffer the Furthermore, the totalriskexposureamount,calibratedaccordingtosystemic riskpresentedbytheinstitution. In compliance with the current framework at European level, the buffer is set between 0% and 2% of and mitigatestheirincentivestotakerisks. their loss-absorbingcapacity,thisadditionalrequirementreducesO-SIIs’probabilityofdefault strengthening By sectors. non-financial and financial the of rest the to contagion potential their failure, of case in and, institutions financial other to interconnectedness or complexity State, financial system, due to their size, importance for the economy of the EU or respective Member The purpose of the O-SII buffer is to compensate for the higher risk that O-SIIs represent for the 6.1 Bufferforothersystemicallyimportantinstitutions(O-SIIs) risk-based bufferrequirement. G-SII the of 50% to corresponds which G-SIIs, to only applicable buffer, 1 Tier Equity Common in linewithBaseldevelopments,therevisedlegislativepackageprovidesforanaccompanying Still as regards G-SIIs, following the introduction of a minimum leverage ratio of 3% and to keep remains incomplete,thisoptionappearstobepremature. change hascomeaboutfromtheprogressalreadymadeonBankingUnion,butgiventhatit This G-SII. a as declassified be to group a for grounds constitute cannot assessment alternative thereby reducingthesystemicimportanceofanumbertheseinstitutions.However,this consider exposures to other Member States participating in the SSM as cross-border exposures, An alternative assessment method has been introduced to identify G-SIIs, which does not not beexaminedseparately. Some review. under package legislative macroprudential instrumentswerenotsubjecttomajorconceptualrevisionsand,assuch,will the in Parliament European the was proposed and as Council the by efficiency, and effectiveness their ensuring some to instruments, flexibility greater macroprudential add to need the brought have 2 Pillar to introduced changes The 6 Macroprudential policyframework that thedisclosuremaybeperceivedincorrectlybymarketasacompulsoryrequirement. communicated to each institution by the supervisor may compromise that purpose, tothe extent lead tothisinstrument losing itsnature as ‘Guidance’.Indeed,thedisclosureofcapitalguidance on principle. In this regard, it is important to ensure that the formal drafting of the P2G should not relevant information, or, onthecontrary,whetherthisdisclosureshouldbeforbiddenoroptional n of Pillar 2 measures. the capitalrequirementsonmortgageloansorimplementationofPillar2measures. Following thecurrentrevision,SRBmaybeusedwithoutpriorconsiderationoftightening 31. 30. 29. amount. exposure risk total the to applicable SRB the and rate buffer Under current law, each institution is required to comply with the higher of the applicable G-SII/O-SII of institutions. to 3% is to stop the SRB from being used to mitigate risks stemming from the systemic significance cap buffer O-SII the raising of purpose the such, As overlaps. any avoiding while up, set were they The various macroprudential instruments should be used to effectively mitigate the risks for which 6.3 Calculationofthecombinedcapitalbufferrequirement(CBR) capital requirements on mortgage loans, used tomitigaterisksthatcannotbeaddressedthroughotherinstruments,suchasthetighteningof Pursuant to the legislation in force, which establishes a pecking order of instruments, the SRB must be G-SII/O-SII bufferorthecountercyclicalcapital(CCyB). through targeted measures. In turn, the SRB shall not be applied to risks mitigated by the this change in the SRB, systemic risks stemming from a particular sub-sector may be mitigated in this given such, As sub-sectors. exposure domestic of set predefined a to applied be also may buffer inherent flexibility the framework, macroprudential instrument wasenhanced:thereferencetolong-termnon-cyclicalrisksremovedand revised the for proposal the In and appliedtototalexposuresordomesticonly. cyclical systemic or macroprudential risks. This buffer may be specific to a sub-group of institutions Under the current legislative framework, the purpose of the SRB is to mitigate long-term non- 6.2 subsidiary’s totalriskexposureamount. subsidiaries the G-SII or O-SII buffer rate(i) applicable to the regards group at consolidatedof level, plus 1%, and (ii) 3%lower of the As the exceed cannot Union. requirement O-SII European the Union, European the the in of established authorisation upon rate, higher a setting risk exposureamounthasbeenagreed,includingthepossibilityofmacroprudentialauthorities As part of the ongoing negotiation process, an increase in the O-SII buffer cap to 3% of the total financial institution are not conclusive. On the one hand, most of these studies these of most hand, one the On conclusive. not are institution financial monetary a Empiricalof capital optimal studiesthe establishing of carried purpose the out with the with exceeded authorisation oftheEuropeanCommission. be only can which amount), exposure risk total the of 5% (of requirements two the of value aggregate the on cap a of establishment the by accompanied the be will (CBR) requirement buffer combined the calculating for rule the to change This apply. would buffers two such that the rule of the higher of the buffer rates would no longer be justified and the sum of the the macroprudential framework, the two instruments are expected to cover different sets of risks, economic impactofstrongercapitalandliquidity requirements,BIS,2010. long-term the of assessment An and 2013; March 1–37, pp. 123, Vol. Journal, Economic The capital”, bank “Optimal G., Marcheggiano, and J., costs and benefits of higher UK bank capital requirements”, Bank of England, Financial Stability Paper No. 35 – December 2015; Miles, D., Yang, See, for instance, Brooke, M., Bush, O., Edwards, R., Ellis, J., Francis, B., Harimohan, R., Neiss, K. and Siegert, C., “Measuring the macroeconomic Except inthecaseswhereSRBonlyapplies withtheotherbuffer. todomesticexposures. Inthosecasesitiscumulative Articles 124and164 of theCRR. Systemic riskbuffer(SRB) 29 Pillar 2 measures or other macroprudential capital buffers. 30 Following the revision of 31 concludethat,

145 Amendment of the CRD IV-CRR: what is new? 146 Banco de Portugal • Financial Stability Report • December 2018 due tothecontinuousproliferation ofnew,interconnectedrules. stem fromthegreatercomplexity inregulationsduetomorecomplexbusinessesbut arealso challenges these that indicate sector financial the from representatives of number a Indeed, pointed outincreasedchallenges inreading,understandingandimplementingregulations. data where their business model is simpler or their activity is lower). However, institutions have simpler approaches to calculate capital requirements and of reporting a smaller amount of specific matters, according to function or complexity (for instance, the possibility of employing in distinctively treated be to activities and institutions of types different for possible it makes proportionality isimplicitlycoveredinanumberofareas inthecurrentregulations,which The conceptofproportionalityisnotnewineithersupervision orbankingregulation.Indeed, proportional andstreamlined. more sector financial the of segments specific to requirements make to text legislative new the CRDIV-CRRpackage.Inresponsetothis,additionalmeasureswillbeintroducedin existing regulations, which has been one of the most debated matters under this revision of of complexity the acknowledged have Parliament, European the notably most Co-legislators, 7 Proportionality out differentrequirementsforthevariousgeographicalareasinajurisdiction. The new wording clarifies that the authority responsible for activating these measures may set The proposed revisionalsoprovidesforthecoordinationbetweenbothauthorities. authority. macroprudential the national notably, most effect, this to authority another these measures to the microprudential supervisory authority, as is now the case, or to nominate In the proposed revision,thenational legislator has the option to attributetheactivation of may alsobesubstantiatedsolelyonthebasisoffinancialstabilityconcerns. informed by loss experience or forward-looking developments in the real estate market, but internal ratings-based approach. The use of this instrument by the supervisory authority may be the for opting institutions by applied values (LGD) default given loss minimum the standardised approachorrestricttheconditionsforapplyingsuchweights,aswelltoraise applicable tomortgageloanscalculateminimumcapitalrequirementsunderthe Under currentlaw,themicroprudentialsupervisoryauthoritymaytightenriskweights 6.4 Tighteningofcapitalrequirementsonmortgageloans rates andtheSRB. be appropriate to introduce a cap on the capital requirement that sums the O-SII/G-SII buffer the riskstheymitigate.Asaresult,theserequirementsmayoverlap.Consequently,itwould and requirements capital between link a direct establish to difficult is it practice, in Moreover, ratio. leverage the as well as requirements, minimum MREL/TLAC the and regimes resolution andof changes regulatory those stilltobeimplementedinfullshouldtakenintoaccount,suchastheintroductionof recent most the of effects the capital, optimal the establishing in themediumtolongterm,whilecostswillbefeltshortrun.Onotherhand,when role. Furthermore, the benefits from higher minimum capital requirements will only be reaped intermediation financial their of weakening possible the to due GDP, on impact its and credit decreased probability of bank failure by bolstering resilience, outweigh the costs of lower the in resulting requirements, capital minimum higher of benefits the level, certain a to up on thefigurebelow. exemptions. This entails the cumulative fulfilment of a set of criteria, including those presented 33. 32. non-complex institution”, and “small a of definition a of introduction the for provides revision legislative ongoing The regards requirementsforvariableremunerationandthereductionincompliancecosts. to rulesonremunerationareunderdiscussion,allowforincreasedproportionalityas capital requirementsforcounterpartycreditriskandmarketrisk.Furthermore,amendments requirements under Pillar 3. It also provides for more streamlined methodologies to calculate the thresholds, revised belowspecific CRR is provides for activity the simplification orwhose of reporting criteria to certain supervisory fulfil authorities and that disclosure institutions For for institutionsdeemedlesssystemicallyimportantand/orwithlower-riskbusinessmodels. rulessimplified of case the in even met, be and precedence take always should depositors of protection the and system banking State, the of soundness the stability, financial of Member objectives the each in Indeed, ineffective. become not do institutions rules prudential that ensuring while proportional more it diverse and EU the co-legislators are trying to streamline the implementation of the CRD IV-CRR package, making in systems banking national or proportionality simplification greater introduced fostering in the amendments CRD from IV-CRR package. benefit Against may this background their activity, of to of heterogeneous type due or which, size institutions, Portuguese to importance particular of is discussion This requirements areundulycomplex,costlyanddisproportionate. disclosure and authorities supervisory to reporting that agree to seem all sector financial the and, assuch,maygrowinsystemicimportancetheirhomejurisdiction.Representativesof institutions other with interconnected often is level, European at small and domestic only if institutions, and not only for thoseconsideredsmallerorlesscomplex.Any institution, even of types all across simplified be must rules the that argue banks active internationally Large, which to understand requirements mustbemetandwhichareoptional,thusshiftingthefocustocompliancecosts. difficulty the in more and requirements, regulatory with compliance models, orthosecombiningthesetypes.Ontheotherhand,problemmaylielessin types, particularly small, not systemically important institutions, those with simple business developed forlarge,internationallyactivebanks,isunsuitableanumberofinstitution On the one hand, it was noted that the implementation of the Basel principles, which were for “largeinstitutions”,“small,non-complex institutions” andotherinstitutionsnotfallingintoeithercategory. the total value of their assets on an individual or consolidated basis (where applicable) is at least €30 billion. As a result, applicable rules will vary following the of one criteria: (i) least has been identified as at G-SII or O-SII; (ii) fulfilling is one the three institution largest institutions, in terms any of total of assets, be in its home Member may State; (iii) which institution”, “large a of definition the into looks also revision ongoing The which increasedmarkedlyinsizetheperiod followingtheglobalfinancialcrisisthatstartedin2007-08. banking), (shadow intermediaries financial non-bank to sector banking the from intermediation financial of transfer the to lead may entry, to It has also been argued (see, for instance, International Monetary Fund, 2015) that the complexity of banking regulations, which creates a barrier 33 which may be subject to simplified requirements and benefit from benefit and requirements simplified to subject be may which 32 147 Amendment of the CRD IV-CRR: what is new? 148 Banco de Portugal • Financial Stability Report • December 2018 35. new revisionhasalreadybeenreferredtoas‘BaselIV’. U euain. h proe f hs sadrs te ocle “ae II Fnlsn post-crisis Finalising III: “Basel so-called reforms”, the standards, these of purpose The regulations. EU that the BCBSstandards released inDecember2017 will besubsequently incorporated inthe The implementation of the new rules does not cover the ongoing process of reforms, given accommodate them. new rules,byassessing their impactandplanningdecisionsingoodtimetoreasonably attention to thesechanges, beginning theirinternalpreparationsfortheimplementation of the to institutions and, assuch, should besuitablyaddressed.Management bodies must pay close and operating costs, inherent to the proper implementation of these reforms, pose challenges capital short-term However, term. long to medium the in benefits expected with system, financial The ongoing legislative reform is primarily intended to bolster the resilience of institutions and the 8 Conclusion results, whichshouldbeoffsetbycloserscrutinyofcompliancewithcapitalrequirements. lessrisk-sensitive could deliver and methodologies calculations of simplification the However, Figure 2• 34. is farfrom negligible, given their importanceandexpectedimpact. amendments future of extent the Therefore, buffer. ratio leverage additional an of incorporation applicable toG-SIIs. only providesforthe As outlinedabove,thecurrentrevisionofCRDIV-CRR the (iii) latter); the of 72.5% than lower revision of the definition of the leverage exposure ratio, be and (iv) an additional leverage ratio buffer not shall former the that means (which approach using the internal ratings-based approach andrequirements calculated using the standardised calculated requirements capital between ratio the i.e. floor, output 72.5% a of introduction the (ii) risk; adjustment valuation credit and risk operational risk, credit for approaches the of revision Lyons, G. J., Ahmad, A., and Xu, C., “Prudential Regulation in an Age of Protectionism”. Banking & Financial Services Policy Report, Vol. 36, No. 1, No. 36, Vol. Report, January 2017,p.8. Policy Services Financial & Banking Protectionism”. of Age an in Regulation “Prudential C., Xu, and A., Ahmad, J., G. Lyons, See: https://www.bis.org/bcbs/publ/d424.pdf. 34 is to adequately balance simplicity, comparability and risk sensitivity and include: (i) the Classification requirementsfor“small,non-complexinstitutions” Simpliﬁed obligations Other Small, in additional r elation T Small Not otal non-comple a assets to tr large criteria/National ading r eco institution < very EUR portfolio x institution and 5b n r esolution options 35 planning Indeed,insome literature the (CRD IV) www.bportugal.pt