"Unbearable" risks for local banks, says Bank of Portugal

Government needs to tackle deficit to restore liquidity

The Bank of Portugal on Tuesday warned of "unbearable" liquidity risks for local banks if the government fails to nurse its finances back to health and regain the confidence of the financial markets.

In its Financial Stability Report posted on its website, the central bank said Portuguese lenders could not continue to rely on the European Central Bank for liquidity, and needed to boost funding from other sources. It also warned the new so-called Basel III requirements could put an additional strain on their capital requirements.

Portugal's risk premium has hit a series of new record highs of late as investors question the government's ability to rein in its budget deficit, which actually widened in the first 10 months of the year.

With the government's borrowing costs continuing to rise, the Bank of Portugal noted that no Portuguese bank had managed to successfully tap the international debt markets since April.

"The pursuit of a process of credible budget tightening is essential to help open up the international financial markets to Portuguese banks," the Bank of Portugal said. "The unsustainability of the permanent large-scale use of Eurosystem financing will require a redefinition of Portuguese banks' financing strategy, particularly in a framework of persistent major restrictions on access to financing in the wholesale debt markets," the bank's report added.

The central bank, however, hastened to underscore that the country's banks are currently in good health as witnessed by the outcome of the stress test performed in July, which showed the top four lenders well placed to withstand additional risks. The banks' problems in accessing international financial markets are a product of the sovereign risk premium and the structural imbalances in the local economy rather than "any intrinsic profitability or solvency problems of the Portuguese financial system."

The central bank suggested local lenders should broaden their customer bases and offer more attractive savings products. "The adoption of strategies for taking resources from customers is essential in order to mitigate the liquidity risk of the Portuguese banking system," the report said.

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