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Western EuropeJune 14 2021

Pandemic won't derail Portugal, says central banker

Mário Centeno, governor of Portugal’s central bank, was on the resilience of the country’s economy and the likelihood of bank consolidation.
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Pandemic won't derail Portugal, says central banker

Mário Centeno, governor of Portugal’s central bank, was formerly both finance minister in the Socialist government and president of the Eurogroup of EU finance ministers. 

Q: Do you fear that the impact of the coronavirus pandemic will reverse the economic gains Portugal has achieved in recent years?

A: Portugal has made remarkable progress over the past decade: from a double-digit budget deficit in 2010 to the country’s first budget surplus in 45 years of democracy in 2019. Moreover — and this is often overlooked — since 2016 Portugal has consistently delivered on its commitments. In that year, the initial forecast was for a budget deficit of 2.2% of gross domestic product (GDP) and Portugal delivered a remarkable 1.9%. As a consequence, in 2017, the European Commission took Portugal out of its excessive deficit procedure.

Polls showed that the Portuguese saw this as the event that most increased the country’s self-esteem, more than winning the [UEFA Euro] football championship in 2016 — even among a subset of men. Portugal upheld this commitment in the following years, resulting in the budget surplus in 2019. In 2020, the deficit was 5.7% of GDP, lower than the 6.3% forecast in the supplementary budget approved early in the pandemic. 

The digital transition of the banking sector is well advanced across Europe. Portugal is no exception

As long as this commitment is ingrained in Portugal’s political landscape, and I see no reason why it should not be, the pandemic — a temporary and external shock — will not reverse this extraordinary progress. 

The credibility of budgetary policy in Portugal has changed remarkably, to the point where the International Monetary Fund is forecasting a return to a budget surplus in 2024. This would make Portugal the fastest European country to return to its pre-pandemic fiscal position. There are no objective reasons to fear that the pandemic will reverse recent achievements.

Q: You have said mergers and acquisitions (M&As) are the “natural next step” for Portuguese banks. For what reasons?

A: Portuguese banks went through a deep restructuring process in recent years, focused on strengthening their capital positions, liquidity and operational structures. This resulted in more robust capital ratios, balanced funding profiles and a reduction in branch and employee numbers. Mergers were not a priority for the market as banks focused on internal restructuring and resizing operations to improve operational efficiency.

In today’s environment of prolonged low or negative interest rates, fintech competition and subdued credit demand, banks need to tackle their low profitability. Cost-cutting programmes are one lever for improving profitability, but there is a limit to how much banks can benefit from them. M&As are, therefore, a natural next step for improving profitability through economies of scale and synergies. It is important, however, to distinguish domestic consolidation from cross-border consolidation, as the former would probably generate more benefits than the latter. In Europe, some of the most recent consolidation operations have been domestic mergers. 

The environment is currently more favourable for consolidation. To provide clarity and facilitate sound consolidation within the European banking sector, the Single Supervisory Mechanism and the Single Resolution Board have published guidelines and expectations concerning consolidation.

Completing the banking union is a key condition for achieving a more sustainable process of cross-border bank consolidation in Europe. It will also improve the attractiveness of the banking industry to investors, and the overall confidence and trust of customers.

Q: How do you see Portugal’s banking sector evolving? 

A: Despite positive developments over the past decade, certain vulnerabilities and risks remain for the Portuguese banking sector. Going forward, profitability will continue to be conditioned by the low interest rate environment, expectations of credit risk and the challenges posed by new financial intermediation players. 

Climate and environmental degradation are sources of structural change that affect economic activity and, in turn, the financial system. Acting now is crucial to ensure that the financial sector adopts mitigation strategies that will promote a more environment-friendly economy and preserve the sector’s resilience throughout this process. It is very important to improve the quantity and quality of the data available, and to adjust analytical, regulatory and supervisory frameworks.

The digital transition of the banking sector is well advanced across Europe. Portugal is no exception. A significant investment in IT infrastructure, people and transformation was made by banks over the past two years to achieve significant efficiency gains while keeping revenues stable. 

This means banks should be in a better position to cope with the main trends of the next few years: the introduction of central bank digital currencies; increased competition from large tech companies, which will increase pressure on profitability; and the need to absorb losses from the operational risks stemming from this transition. 

The regulatory environment will have to keep pace with these trends to ensure there are no negative impacts on financial stability. I am confident that this will be the case. 

Q: What impact will relaxing the financial support measures introduced during the pandemic have on the Portuguese economy? Are you concerned about the asset quality of banks?

A: This is a crucial issue for us over the near term. The measures to support both households and companies implemented since March 2020, namely credit moratoria and state-guaranteed loans, have been very important in mitigating liquidity difficulties and defaults. But more targeted measures will be needed going forward.

The criteria for accessing state moratoria in Portugal were not heavily restrictive. Unlike during the previous crisis, when companies decreased their saving rates and households increased them only slightly, we have also observed significant precautionary moves, reflected in a large increase in family and company deposits. 

In the coming quarters, we expect a further deterioration in the asset quality of banks

The legal moratorium expires on September 30, 2021. Any extension — and I don’t expect any — will not benefit from the framework underlying the European Banking Authority’s guidelines. As a result, the general regulatory framework will apply, according to which the classification of exposures (performing or non-performing), must be made on a case-by-case basis.

The impact of the pandemic has not yet led to an increase in non-performing loans (NPLs). According to the latest data, the NPL ratio decreased to 4.9% in the fourth quarter of 2020, driven by a contraction in NPLs. However, the proportion of stage 2 loans is increasing more quickly for loans under moratoria.

In the coming quarters, we expect a further deterioration in the asset quality of banks. Banks need to be prepared for that, not only in terms of dealing with distressed debtors, but also in regard to the prompt identification and measurement of credit risk in the context of the pandemic. Bank balance sheets need to reflect, in an accurate and transparent way, the credit risk of borrowers.

Economic recovery will also play a key role in the materialisation of risks. Hitherto, the economy has outperformed all forecasts. The signals from the US and China are positive and should lead to a recovery of previously sound economies. It is important to remember that this was not a structural crisis.

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