PORTUGAL: An Introduction to Banking & Finance

Banking and Finance Overview 

Portuguese market in 2020 

The COVID-19 outbreak inescapably marked the year 2020. Besides the catastrophic public health crisis, the pandemic significantly affected the world economy. Both the spread of the virus itself and the efforts to halt it caused serious disruptions to businesses in virtually every country. In 2020, most economies registered levels of recession, unprecedented in recent decades. Portugal was no exception. The state of emergency was declared on March 19, and renewed until May 2. Recent surges of cases led to additional limitations on economic activity, as well as the imposition of an additional lockdown period.

It is worth noting that, before the virus outbreak, the Portuguese economy was on a positive track. Since the end of 2013, GDP, employment and wages were slowly but constantly increasing. The levels of public debt were decreasing (although still structurally high), and the Government registered, for the first time in democracy, a budget surplus in 2019.

However, the economic impacts of the COVID-19 crisis were strongly felt. The Bank of Portugal (BoP) estimates a decrease in GDP by 8% and an increase in unemployment rate by 7%. Nevertheless, these figures reflect a slight upturn registered in the third quarter, in comparison with the first semester of 2020. As a European Union (EU) Member State, Portugal will continue to benefit from initiatives at the EU level that are helping Member States to weather the impact of this pandemic, providing support, among others, to the economy and its recovery.

The Portuguese banking sector in 2020 

Portugal has recently come out of an unprecedented restructuring of its banking sector. In the previous decade, following the global financial crisis and subsequent sovereign debt crisis, great energy has been put to ensure that Portuguese banks are more resilient. Pursuant to a similar EU agenda, banks are today stronger in terms of leverage, and capital and liquidity levels, to deal with economic challenges. For instance, Tier I capital ratios have doubled since 2010, non-performing loans ratios have decreased to around 5%, and coverage ratios increased to 55%. In 2020, credit granted by banks to the private non-financial sector totalled around EUR235 billion (100% of the GDP), with a slight increase compared to 2019 figures. In addition, Portuguese banks registered a small increase in deposits, attributed to a reduction in household consumption. Interest rates continued their downward trajectory, converging to Eurozone averages. The cost of credit for private non-financial businesses averaged 2% in 2020. However, the returns of the banking sector decreased, mostly given to increases in provisioning requirements. ROE in the Portuguese banking sector averaged between 1% and 2%, and cost-to-income ratio was at 58% to 60%, in 2020.

In light of the above, it is safe to say that Portuguese banks are today more resistant to economic shocks than they were two years ago, and overall gave a positive response to the challenges of 2020. However, 2021 is expected to pose new ones, such as the likely increase in NPLs due to the end of the legislative moratorium regime. The response to the further challenges of 2021 will presumably depend on the development of the pandemic crisis (specifically, the effectiveness of the vaccination plan) but also on the economic recovery. The increase of banks' resilience and capability to absorb losses related to the COVID-19 pandemic and finding attractive secondary markets for NPLs will continue to be key drivers for 2021.

Whilst it is true that the low interest rates, along with the impact of COVID-19, is reducing the core banking profitability, financial institutions are now leaning more towards commission-based income.

The bank’s digitization plans (on the banking system and on the bank-customer relationship) have been accelerated by several years during 2020 as the pandemic motivated customers to seek online only models.

Also worth mentioning is the recent incorporation, in November 2020, of a new Portuguese State owned bank – the Banco Português de Fomento (BPF). The BPF will be Portugal’s national development bank, similar to the German KfW, focused on promoting the growth of the Portuguese economy and providing financing to companies in the event of lack of available financing. It will be interesting to see how this new bank will compete with existing banks and other types of alternative lending.

What was new in the banking sector in 2020? 

1. Economic response to COVID-19 

At the EU level 

To counterbalance the economic effects of the COVID-19 pandemic, the EU institutions prepared a twofold recovery plan.

From a public investment standpoint, Portugal has already begun receiving a significant amount of funds to finance its economic recovery. The EU funds will be channelled essentially through three packages, (i) the Multiannual Financial Framework for 2014-20, (ii) the Multiannual Financial Framework for 2021-27, and (iii) Next Generation EU package, which was announced last May. In total, Portugal is expected to secure over EUR45 billion, in the form of subsidies, loans, and guarantees.

From a financial and monetary standpoint, the European Central Bank (ECB) likewise participated in the recovery plan. First, it kept refinancing interest rates close to zero, and deposit interest rates negative. More importantly, the ECB launched a temporary asset purchase programme of private and public sector securities, known as the Pandemic Emergency Purchase Programme (PEPP). The ECB increased the amounts under the PEPP throughout 2020, to a total of EUR1.85 trillion. Additionally, the ECB approved a package of temporary collateral easing measures to kick-start the European financial markets.

At the national level 

On the other hand, the Portuguese Government approved countless measures to mitigate the tightening of economic conditions in Portugal, from broad financial supports to sectorial ones. In general, it is worth noting that the Government approved several credit lines to support economic activity, of up to EUR13 billion (6.8% GDP), which are being introduced mainly through the banking system.

As early as March 2020, the Government introduced a wide-ranging legislative moratorium on bank loan repayments for families and companies affected by the pandemic crisis. One of the moratorium effects was the extension of the deadlines for capital and interest (re)payments. Subsequently, the Government extended the moratorium to loan payments due until end-September 2021 and the possibility to adhere to the regime until 31 March 2021.

Since then, the moratorium regime covered around EUR46 billion in credit, which amounts to around 22% of the total (net) bank credit, in the Portuguese market. Although company loans represented just 30% of the moratoriums approved, these amount to EUR24 billion, which corresponds to approximately 30% of the total credit to non-financial enterprises. According to the EBA, Portugal is the fifth largest EU Member State by total volume of financial and commercial debt under legislative moratoria.

In addition, several banks in Portugal offered innovative solutions to their customers in light of the economic context, such as the suspension of commissions for electronic payments, the availability of lines of credit through digital platforms and special refinancing conditions in certain cases.

2. Beyond COVID-19 

Digital finance 

In 2020, the topic of digital financial services continued to be a central one, particularly at the EU level. In September, the Commission adopted a new legislative package on Digital Financial Services, in order to promote digital innovation in the financial sector, and to address specific risks associated to it.

On the one hand, the strategy aims to strengthen the digital single market in finance, allowing consumers to access services offered digitally across member states' borders. Another objective of the initiative is to build an EU financial data space to promote innovation, based on principles of data-sharing and open finance. In the long run, the strategy proposes a passporting regime to the Fintech sector, allowing players to operate in the EU area, based on a national licence or authorization. Soon, a pilot phase is expected to test these rules.

On the other hand, the proposals show concern for dealing with the specific challenges posed by digital innovation in the financial sector. In particular, the proposal for a Digital Operational Resilience Act (DORA) strengthens both ICT risk requirements (especially, governance and management requirements, and outsourcing risk), as well as ICT incident reporting (including rules on information sharing).

Finally, the EC proposed a harmonized regime for the provision of services related to crypto assets in the EU. In short, the proposal introduces requirements for “stablecoins”, while leaving out assets that qualify as financial instruments or deposits under the EU financial services legislation.

ESG and Sustainable Finance 

Another relevant topic on the agenda of 2020 (and which will certainly keep pace in 2021) was Environmental, Social and Governance (ESG). In the past year, the EU has stressed the importance of climate and social-related aspects of investment policies, in order to achieve the sustainability goals set out in the European Green Deal.

As part of the action plan on sustainable finance, the Taxonomy Regulation was approved by Regulation (EU) 2020/852 of the European Parliament and of the Council of June 18, 2020. It establishes the framework for the EU taxonomy by setting out four overarching conditions that an economic activity has to meet in order to qualify as environmentally sustainable.

Additionally, the European Green Deal Investment Plan of January 14, 2020 announced that the Commission will establish an EU Green Bond Standard (GBS).

At the national level, BoP published in March 2020 its commitment to sustainability and sustainable finance, defining key areas such as the reporting of climate-related risks and the implementation of internal sustainability practices. Likewise, the Portuguese Securities and Exchange Commission (CMVM) announced the creation of an online platform for the disclosure of ESG information to the market. Furthermore, BPF will also play a relevant role as its activities include improving access to finance for projects in research and innovation, sustainable infrastructure and social investment.

For financial players, the meaning of the ESG policies is twofold. On one side, it expands transparency and disclosure requirements regarding non-financial aspects of their investments. On the other, it creates incentives and market opportunities for future green investments in Portugal.

It is expected that the sustainability trend will continue on the Portuguese and EU agenda for 2021.

Shareholder Rights 

In 2020, Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 as regards the encouragement of long-term shareholder engagement (SRD II) was finally transposed in Portugal (Law nº 50/2020, of August 25).

The new rules affect mainly companies issuing shares admitted to trading on regulated markets (listed companies), institutional investors, financial intermediaries, portfolio managers, and proxy advisors. The transposition has a particular impact on matters such as remuneration policy, transactions with related parties, and shareholder participation, especially through the establishment of rules on procedure, and on disclosure and reporting. From the financial sector point of view, the transposition promotes the engagement of institutional investors and financial intermediaries that perform portfolio management services, particularly through rules on transparency and disclosure by portfolio managers.

Anti-Money Laundering (AML) 

On a different note, Portugal also transposed Directive (EU) 2018/843 of the European Parliament and of the Council of May 30, 2018 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing (AML V) (Law n.º 58/2020).

Amongst the changes introduced by the transposition, regarding the combating of money laundering and of financing of terrorism, the adoption of a regime for a harmonized concept of virtual assets (including crypto-currencies) and the expansion of the concept of beneficial owner are noteworthy. Any entity carrying out any of the virtual assets' activities, including virtual currency exchanges and custodial wallet providers, are now required to register with the BoP.

Generally speaking, the transposition of the AML V Directive is expected to increase the need for financial players to perform further AML assessments, particularly regarding transactions with countries outside the EU.

A new Banking Activity Code 

Lastly, the BoP endorsed a draft for a new Banking Activity Code (BAC), which is expected to be approved in 2021. The BAC will revoke the current banking legislation compilation, and regulate, in a single legislative act, the bulk of the banking activity in Portugal.

Besides the consolidation, the BAC draft proposes the introduction of several changes resulting from recent developments in the Portuguese banking sector, and transposes EU directives on the so-called ‘banking package’, particularly CRD V and BRRD.

The main novelties introduced by the BAC include (1) the adoption of a single type of financial firm, (2) a more stringent regime for cross-border transactions with countries outside the EU, (3) new rules on transparency, conflict of interests and transactions with related parties, (4) new standards for subcontracting by financial firms, and (5) an expansion of the BoP’s regulatory and supervisory powers, especially in regards to qualified holdings.