I was very pleased and honoured to accept the invitation from the PORTO BUSINESS SCHOOL to attend the closing dinner and diploma ceremony of the 9th Post-graduate Course in Financial Analysis. This course has warranted considerable prestige from society, academia and the business world for its students and their employers, as shown by its accreditation by the European Federation of Financial Analysts Societies, the CMVM and especially, because it is the best judge, the market. The quality and reputation of the PORTO BUSINESS SCHOOL's academic staff are sources of great prestige.


Everyone knows that the banking system plays a fundamental role and that the banks' essential function is intermediation. Their primary responsibility is to manage their customers' deposits well and efficiently invest the resources obtained from financing companies, institutions and households in the service of the economy, growth and the people's wellbeing.

The Portuguese banks fulfil their responsibilities scrupulously and have shown a considerable capacity for modernisation in recent decades and remarkable resilience in very tough circumstances, such as the two serious crises in the last five years.


I would first like to recall the huge impact of the sub-prime, toxic asset and sovereign debt crises on the European banking system.

The toxic assets that many banks accumulated, low-quality loans (when granted for profitless projects), led to a need for unprecedented state support for banks in the European Union and tough measures to reinforce bank regulation and supervision to make the financial system more stable and reduce risks.

The Portuguese banks were among the most resilient and those that needed the least state assistance in the European Union in the 2008-2010 crisis. At the time they did not use any facility to increase their capital and recourse to state guarantees was the lowest in the euro area (3% of GDP).

The Portuguese banks were, however, affected more by the sovereign debt crisis. On the one hand, this was due to the country's higher risk and, on the other, their high exposure to domestic public debt, which rose to fund the state before the EAP, as the markets were charging impossibly high interest.

Meanwhile, the financial crisis has put the brake on Europe's financial integration process and there are risks of additional fragmentation as the sovereign debt crisis worsens.

In monetary union, there should be homogeneous, uniform monetary conditions in all members. Where financial integration is concerned, the interest rates charged by banks have gone up by an average of 70% in Europe compared to 1990.

Although it is difficult to quantify, the low interest rates charged to companies helped to increase investment, employment and growth, thereby benefiting all European economic agents.

But the truth is that monetary union is currently fragmented and each Member State is subject to its own monetary conditions – liquidity, interest rates, credit terms – which is much tougher in the countries most affected by the sovereign debt crisis. For example, the interest rate charged to companies in Portugal is much higher than in Germany (between January and November 2012, interest on new loans to non-financial companies in Portugal was, on average, 363 basis points higher than in Germany – Portugal 6.2% vs. Germany 2.57%).

There are growing differences in the cost of wholesale finance and retail interest rates among the Member States. This process has to some extent been exacerbated by the focus that some supervisors have placed on the financial stability of their own countries, which has unbalanced the desired level playing field.

Getting back on track towards financial integration is hard and complex and has been too slow.

The crisis has shown that the institutional framework of the Eurosystem cannot ensure macroeconomic and financial stability or provide appropriate crisis management mechanisms. It has intensified existing divergences between Member States as a result of fiscal maladjustments and loss of competitiveness instead of moving towards one of the fundamental pillars of European construction: convergence.

While it is true that the banking system may have taken excessive risks before the financial crisis, the crisis itself interrupted financial integration and generated unwanted fragmentation. One of the Eurosystem's priorities is to get past this financial fragmentation. The politicians' and regulators' response to this undesirable situation is designed to step up financial stability and governance.

It is in this setting that the European financial system is experiencing a time of deep changes that are leading to a new paradigm for the sector. This is characterised by a veritable regulatory, technological, and behavioural revolution and substantial changes in business models.


Regulatory and accounting changes

I repeat that the financial crisis has shown up the insufficiencies in the way Economic and Monetary Union works and there are countless political, legislative, regulatory and structural initiatives to try and correct the shortcomings preventing its operation and achievement of its goals. Banking union, separation between sovereign and bank risk, tax union, effective coordination of economic policy and a central bank that is lender of last resort are fundamental pieces in normalising the situation, along with countless initiatives to strengthen the solidity of the financial system and its prudential and behavioural supervision.

As Mario Draghi recently said, the current inconsistency between a single monetary policy followed by the ECB and different tax policies in each member country are weakening the transmission channels for monetary policy and hindering economic recovery in crisis situations. Without effective transmission mechanisms, the links between bank and sovereign risk become more powerful and dangerous and this is what has been happening in Europe.

Banking union, which will start with the formation of a single supervision system, the single prudential supervisor (ECB) and later, for moral hazard reasons, the common deposit guarantee fund, common deposit protection and the bank capitalisation fund, will break the link and restore confidence in the banking sector.

I will only mention the most important directives, regulations and decisions being prepared at European and international level.

First of all, there is the upcoming introduction of Basel 3 and its transposition into European law in the new capital requirements directive and regulation (CRD 4 and CRR). This will bring new challenges to the banking sector in terms of leverage and capital and liquidity ratios.

The most important European Union initiatives from different sources are:

  • The Single Rule Book, i.e. the institutionalisation of common guidelines and standards for all EU countries in terms of implementing the CRR and CRD 4 rules
  • The Crisis Management dossier, including plans for recovering and winding up financial institutions and bail-in mechanisms
  • The Liikanen Report, the European version of the Volker and Vickers reports, which identifies the need for and way to deep restructuring of the European financial system.

In Portugal, new binding prudential and behavioural guidelines were issued by the regulator and consumer protection legislation was introduced. I would also like to mention the measure to protect defaulting debtors. It was for understandable social reasons but is somewhat illogical, as it should not have been determined by law and breaches contractual autonomy. It penalises parties who fulfil their obligations and favours defaulters at the others' expense. Protection should come from the state, but it does not have the capacity, due to the current situation. A code of good practices accepted voluntarily by the banks would have been the right solution.


Technological changes

We are all aware of the extraordinary importance of IT in the banks' modernisation, where new platforms and applications have often helped one to stand out from the others in the market and innovative services have benefited their customers. In other cases, IT has facilitated sharing and cooperation between institutions, resulting in substantial synergies and economies of scale.

This use of telecommunication and information technology is going to increase fast and furiously in terms of means of payment, reporting and the development of products.

Banks will look for important competitive advantages through innovation, anticipation and collaborative investments.


Changes in business model

The banks' business model will also change considerably as a result of adaptation to the new market circumstances.

The banks have to adjust to a period of low return while they are also subject to high capital requirements, lower balance sheets and pressure on their net interest income.

They will therefore have to pursue three main strategies: optimisation of the balance sheet (deleveraging, optimisation of risk-weighted assets, revision of portfolios, etc), cost reduction and commercial refocus.

The banks will first concentrate on funding, quality of assets, control of impairment and capital consumption.

They will strive for operational excellence by increasing earnings and reducing costs.

The banks' managing bodies will be concerned with five main issues: high management, high touch (customer relations), high tech, high service and risk control.

Training and retraining will have to be stepped up, as there will be more specialisation and many employees will change their specialisations (e.g. from private loan to business loan experts).

The trend towards innovation and simpler financial products will continue in this area and in services, though there will also be banks that specialise in complex products in response to market needs.

There is very likely to be a change in branch networks. Their number will be reduced, also because of an increase in multi-channel distribution with more and more use of the internet, mobile phones and electronic payments. There will be a rising demand for call centres.

The banks' organisation will be stepped up and optimised and motivational and talent management will be decisive in increasing efficiency and creating competitive advantages.

The banks' governance will be more closely scrutinised by regulators, shareholders, employees and other stakeholders and greater attention will be paid to good practices and codes of conduct. The banks themselves will be concerned with supporting and protecting their customers.



As we all know, Portugal's Economic Adjustment Programme involves four main aspects – fiscal consolidation, rebalancing public finances, structural reforms, reinforcement of the financial system and promotion of economic growth.

We also know that we are going through extraordinarily difficult times involving a need to change our way of life, reassess priorities and values and face up to challenging problems and do everything to solve them. In the current circumstances, the adjustment that we have to make must be as quick as possible so as not to prolong the period of austerity and a lower standard of living. Economic recovery is fundamental, but is likely to be slow.

The crucial question in Portugal is how to speed up the creation of wealth that will lead to sustainable growth. Growth in GDP is fundamental to rebalancing public finances (it's the denominator of all the ratios), creating jobs, increasing people's and companies' earnings and boosting spending and saving.

We need an economic strategy that combines austerity and growth. It's not enough just to have a financial strategy.

As Professor Augusto Mateus said, a coherent, integrated economic strategy must be successful on both battle fronts: on the one hand the sovereign debt crisis, with the closure of the financial markets and the state's fiscal crisis, with excessive deficits, and on the other the loss of competitiveness, with insufficient value and productivity and the crisis of inclusion into globalisation, which generates unsustainable external deficits.

 This means that we not only have to complete and maintain fiscal consolidation and undertake an overall reform of the state and its economic and social functions (competition, transparency, territorial cohesion and solidarity) but also reform the collapsing markets and use structural funds to foster productive investment and value-added exports.

I would like to make a comment.

Since we joined the European Union, the solutions have not only been national, they have also been European and in the interest of the EU and the other Member States.

Imposition of the Economic Adjustment Programme on an EU Member State should, in my opinion, be complemented by an extraordinary package of measures to stimulate investment and recapitalisation of companies, economic growth and employment, as is fitting for a union whose founding pillars are cohesion, convergence and solidarity. Everyone knows that austerity and recession increase divergence and may jeopardise cohesion. That's when solidarity is needed most. This extraordinary programme would make the difference between a country subject to an adjustment programme and another belonging to an economic and monetary union. If this is not possible, then the use of the funds should be made more flexible in order to pursue a priority goal.

What determines economic growth? It is not just capital and work. Growth requires knowledge (a national knowledge system comprising education, innovation, R&D and training), a favourable institutional framework (based on values, relationships of trust and social capital open to dialogue on the rules of economic activity) and especially entrepreneurship and business acumen partly stimulated by a favourable context.

We know that economic growth is the ultimate goal of adjustment programmes but we assume that it is structural reforms and corrective measures that will improve economies' competitiveness. But what is really essential is funding of the economy in its different forms, especially investment and recapitalisation of companies.

Indeed, it is essential to attract foreign and Portuguese investment. We know that we are going through a very bad moment in terms of new investment and even in the growth and strengthening of companies. Countries with adjustment programmes have substantial competitive disadvantages compared to other Member States: restricted financial and capital markets, greater tax burdens, shortage of capital, more expensive and sometimes scarce credit and depressed domestic markets.

A negative perception of the Portuguese economy due to the recession and losses of wealth for Portuguese investors do not help.

The latest developments in issues seem to show that the markets are beginning to look at Portugal more favourably. But we have to create attractive conditions and a strategy to stimulate productive investment aimed essentially at context costs and financial and tax incentives.

At medium and long term, we can take advantage of an improvement in competitiveness resulting from structural reforms and greater efficiency in companies.

Over the short term, however, the focus should be on strengthening and making the most of the existing production infrastructure, which requires companies' efforts at capitalisation and in many cases restructuring, consolidation and internationalisation.

It is often said that credit does not reach the economy. The banks are not facing liquidity problems, as their liquidity is comfortable, and their deleveraging has been fast. The truth is that there is little demand for credit and in most cases companies have weak balance sheets, unsatisfactory levels of self-financing, insufficient capital and no possibility of offering sufficient guarantees. They are therefore unable to pass the risk assessment. In correct management and in view of supervisory and regulatory demands, this assessment must be tough and (slightly) more restrictive, especially over the long run.


Winning back confidence

Just like the banks, Portuguese companies, whose borrowing reached 138% of GDP, have to reduce it by recapitalising.

There are a number of alternatives, if the shareholders are unable to do it:

  • Admission of new shareholders
  • Partnerships with other companies – which may be for consolidation
  • Use of different forms of venture capital
  • Use of innovative instruments and less common forms of capital increase, e.g. recapitalisation and restructuring funds
  • Loan restructuring with possible conversion of part of the debt into capital, thereby strengthening governance
  • Greater use of the capital market


The Portuguese banking sector will have to be in the front line in providing support for economic growth and will seek to be one of its driving forces by funding companies' current operation, investments in their modernisation and new investments, especially in the tradable goods sector. Granting loans to companies with healthy balance sheets, competitive, innovative companies, those with good projects, is one of the banks' main functions. Their contribution to the creation recapitalisation of instruments for companies, venture capital (seed, mezzanine or development), stimulation of access to and use of the capital market (e.g. bond issues) and especially financial restructuring mechanisms for companies will be of great importance in the development of a new, healthy economic growth model. This depends on business capacity, innovation and efficiency to generate greater competitiveness.

For there to be investment there must be saving. I often recall that the savings rate in 1995 was 22% of GDP. Today it is half that.

Low interest rates contributed to borrowing and discouraged households from saving. However, since Portugal began its adjustment programme, the savings rate has begun to rise.


In the current scenario of financial fragmentation, the Portuguese banks have been working in a highly unfavourable context with considerable competitive disadvantages in relation to the banks in most euro area countries.

  • The banks' ratings have been severely penalised by the sovereign debt crisis.
  • They have no access to the IMM
  • In spite of recourse to the ECB, which represents 12.3% of funding, the overall cost of funding for Portuguese banks is much higher than for those in other countries
  • Net interest income is under high pressure, given the weight of loans at very low interest rates.
  • The economic recession and the EAP austerity measures resulted in significant rise in defaults and the need to record impairments and increase provisions.
  • The new EAP capital requirements obliged the banks to follow stricter, more selective criteria in granting loans, with the burden of an image of not granting credit to the economy.
  • The performance of the capital market, mostly resulting from the sovereign debt crisis, has penalised shareholders and does not encourage new ones, hindering their participation in capital increases.
  • The state levied an extraordinary tax on the banks and may impose a financial transaction tax that may not be levied in other Member States.
  • The Portuguese banks had to replace international banks in funding state companies.
  • Banks recorded actuarial losses due to the transfer of their pension funds to the state.
  • Legislation to protect defaulting mortgagees for extraordinary reasons is found in hardly any other European country.
  • Due to literal interpretation of the rules of competition by DGCom, the cost to banks of using the recapitalisation line set out in the Economic Adjustment Programme is extremely high (the interest rate on CoCos is at least 8.5%).

These reasons show that the main problem for banks today is return. Pressure on net interest income, impairments, the tax burden and the impact on costs of new requirements mean that the banks' domestic activity has recorded losses or very small profits.

But the banks' solvency has achieved the highest ever capital ratios and, as I said, liquidity is comfortable.

In short, the Portuguese banks have fulfilled their responsibilities scrupulously. In recent decades they have showed a remarkable capacity for modernisation and outstanding resilience in the face of very difficult circumstances that are now in their fifth consecutive year.

The Portuguese banks will continue to contribute to financial stability and fulfil their irreplaceable mission of funding the economy while also improving their proximity services, optimising their diversified, segmented range of products constantly innovating their services and putting a stake in their social role.

Finally, I would like to congratulate the university and those who took this course on the quality of the knowledge passed on and the contribution to providing the financial sector with competent, highly trained managers.

Fernando Faria de Oliveira

President of the Portuguese Banking Association

Porto, 29 de Janeiro de 2013