Portugal
Financial Sector Assessment Program: Detailed Assessment of Observance of the Basel Core Principles for Effective Banking Supervision

This Detailed Assessment of Observance of the Basel Core Principles for Effective Banking Supervision for Portugal discusses the country's market structure. Portugal’s regulatory framework is modern and sound, and highly compliant with international standards. Organic Law (OL) of Banco de Portugal (BdP) provides a clear framework, objectives, and responsibilities for carrying out the supervision of credit institutions, financial companies, and other entities legally subject to the BdP’s regulation. The regulatory framework allows the authorities to undertake globally consolidated supervision over internationally active banking groups.

Abstract

This Detailed Assessment of Observance of the Basel Core Principles for Effective Banking Supervision for Portugal discusses the country's market structure. Portugal’s regulatory framework is modern and sound, and highly compliant with international standards. Organic Law (OL) of Banco de Portugal (BdP) provides a clear framework, objectives, and responsibilities for carrying out the supervision of credit institutions, financial companies, and other entities legally subject to the BdP’s regulation. The regulatory framework allows the authorities to undertake globally consolidated supervision over internationally active banking groups.

I. General

1. The assessment of the Basel Core Principles (BCPs) for Effective Banking Supervision1 was undertaken as part of the Financial Sector Assessment Program exercise that the IMF has conducted at the request of the Portuguese authorities. The assessment was conducted December 6–20, 2005, onsite in Portugal by Marcel Maes (formerly Belgian Banking Commission and IMF) and Alvir Hoffman (IMF-MCM).

II. Information and Methodology Used for the Assessment

2. The assessment is based on several sources. These include: (i) a self-assessment by the Portuguese central bank (Banco de Portugal—BdP); (ii) detailed interviews with staff from the BdP; (iii) a review of legislation, regulations and other documentation on the supervisory framework and on the structure and development of the Portuguese financial sector; (iv) meetings with other authorities and independent bodies, and the accounting and auditing profession; (v) meetings with the banking industry, the Associagao Portuguesa de Bancos (Portuguese Bank Association - APB) and individual institutions representing different categories of banks; and (vi) numerous publications available from BdP and background material from various industry sources.

3. The assessment was performed in accordance with the guidelines set out in the BCPs Methodology.2 For instance, the guidelines require that the assessment be based on the legal and other documentary evidence in combination with the work of the supervisory authority as well as the implementation of the regulation in the banking sector. Full compliance requires that all these three prerequisites are met. The guidelines allow that a country may fulfill the compliance criteria in a different manner from the ones suggested as long as it can prove that the overriding objectives of each BCP are reached. Conversely, countries may sometimes be required to fulfill more than the minimum standards, e.g., due to structural weaknesses in that country. The BCPs guidelines also state that the assessment is to be made on the factual situation as of the date when the assessment is completed. However, changes, which are clearly underway, e.g., in laws or practices, which will alter compliance with the principles, will be mentioned in the assessment.

4. The assessors have had full cooperation from the Portuguese authorities and have received all information necessary for the assessment.

III. Overview of the Institutional and Macroprudential Setting and Market Structure

5. In Portugal, financial intermediation is dominated by banking institutions, the larger of which are organized as financial conglomerates. As of end 2005, there were 61 banks, including 22 branches of institutions authorized in other EU member states, 168 other credit institutions, and 105 financial institutions under the BdP’s supervision. The Portuguese state continues to hold a significant stake in the banking sector through the fully state-owned Caixa Geral de Depositos, one of the two largest banks in the country.

6. Notwithstanding the difficult operating environment of the last few years, marked by slow economic growth and narrowing interest rate margins, Portuguese banks have maintained a solid profitability and strengthened their capital position. As of end-2005, the capital adequacy ratio has reached 11.3 percent; nonperforming loans (NPLs) have fallen to a historically low level of 1.6 percent of total loans while provisions, applying International Financial Reporting Standards (IFRS), stood at 63 percent of NPLs. However, potential vulnerabilities remain, mainly associated with the high level of household and corporate debt as well as the significant concentration of banks’ exposure across sectors (especially real estate) and borrowers.

7. The supervisory framework is organized as a combination of a traditional sectoral approach with a partially integrated functional approach. While prudential supervision is entrusted to the BdP (in the case of credit institutions, investment firms and other financial companies) and to the Instituto de Seguros de Portugal (ISP) (in the case of insurance and re-insurance intermediaries and pension funds), cross sectoral supervision of the market rules of conduct of financial intermediaries in the securities market rests in the hands of the Comissão do Mercado de Valores Mobiliarios (CMVM). The three Portuguese supervisory agencies coordinate their activities within an overarching high-level committee, the Conselho Nacional de Supervisores Financeiros (CNSF). Bilateral memoranda of understanding (MoU) provide the framework for day-to-day coordination.

IV. General Preconditions for Effective Banking Supervision

8. The BdP, which is an integral part of the European System of Central Banks (ESCB), is a public legal entity with administrative and financial autonomy and its own property. The members of the Board of Directors are nominated for renewable terms of five years, and they can only be removed from office under circumstances envisaged by the European Central Bank (ECB) statute. As a result, in performing its tasks, including that of supervisory authority, the BdP enjoys a high degree of independence from government institutions or other forms of political influence. Portugal’s framework of laws, accounting, payments, transparency, and financial sector oversight practices is in line with international standards and EU Directives. The law provides a comprehensive and flexible framework to deal with financial institutions in distress and the overall financial safety net is adequate, albeit untested in a major case to date.

V. Summary of Main Findings

9. Portugal’s regulatory framework is modern and sound, and highly compliant with international standards. The supervision of Portuguese financial institutions by the BdP is active, professional, and well organized. In particular, the supervision of banks’ loan classification and provisioning policies—an area that raised some controversy a few years ago—was assessed to be in full compliance with international best practices, following some regulatory changes in 2002–03. However, there is still room for improvement in the institutions’ risk assessment processes and in supervisory risk management and planning, although important progress has been recently made.

Objectives, Autonomy, Powers, and Resources (CP 1)

10. BdP’s Organic Law (OL) provides a clear framework, objectives, and responsibilities for carrying out the supervision of credit institutions, financial companies and other entities legally subject to the BdP’s regulation. The principle of BdP’s independence is enshrined in the ESCB’s by-laws and OL provisions. The OL also ensures that the BdP has administrative and financial autonomy and its own property, and is not subject to the financial rules governing the public sector. The BdP derives its income basically from its central bank operations with no fees being levied on supervised institutions.

11. The BdP has the exclusive power to authorize, refuse or withdraw banking licenses. In the cases of branches or subsidiaries of banks authorized in non-EU countries, the BdP examines the proposal and submits its recommendation for the approval of the Minister of Finance (MoF). The OL enables the BdP to take appropriate action to ensure compliance with the laws and maintain the safety and soundness of banking activities. To this end, the BdP can impose, at its discretion, a range of sanctions and remedial actions on a case-by-case basis, depending on the severity of a situation. Legal protection of the BdP staff is ensured by the Legal Framework of Credit Institutions and Financial Companies (LFCIFC). The CNSF and bilateral memoranda of understanding promote cooperation and information sharing with other domestic supervisory agencies.

Licensing and Structure (CPs 2—5)

12. The permissible activities of financial institutions are established in the LFCIFC. The standards for evaluating applications to license establishments, and the criteria for changes in ownership and investments are adequate and strictly applied by the BdP.

Prudential Regulations and Requirements (CPs 6—15)

13. Portuguese banks comply with capital requirements established by Basel I. Risk management techniques used by credit institutions vary considerably in terms of sophistication and complexity, and different risk management tools are used by the same institution to address different risks or portfolios. While banks generally use advanced techniques, including value-at-risk models, to manage trading book risks, they apply less sophisticated tools to assess banking book risks. The BdP has recently issued a regulation that allows banks to use internal models for market risk and, to date, no bank has submitted its own model to the BdP for validation. However, it is expected that major banks will soon submit credit risk models for BdP’s validation. All credit institutions will be also required to implement an internal process for overall capital adequacy assessment. Given these developments, the BdP has to further bolster its internal expertise on model validation and corporate governance evaluation.

14. Banks’ loan classification and provisioning policies comply with the BCPs. However, the planned migration from the current dual system of calculating provisions (economic and regulatory provisions; the former is subject to a specific external audit review) to a more comprehensive risk based approach should be accelerated.

Methods of Ongoing Supervision (CPs 16—20)

15. The BdP carries out its supervisory function through an effective mix of off-site and on-site supervision. The information provided by credit institutions to the BdP is comprehensive and timely so as to provide a basis for effective surveillance and early detection of financial weaknesses. Thorough off-site monitoring is conducted on a continuous basis and it is integrated with regular on-site inspections. At the time of the assessment, a comprehensive framework for assessing the risk profile of supervised institutions was still in the process of being finalized. In early 2006, a manual was completed and a pilot test was successfully carried out by applying the methodology to the assessment of a medium-sized bank. The credit risk register, which is managed by the BdP, is a complementary tool for off-site supervision. The electronic platform supporting the register could be improved and better integrated with other available tools for off-site monitoring.

Accounting Standards (CP 21)

16. Accounting rules and regulations are in line with EU Directives, and hence with the IFRS, and financial statements are prepared in accordance with those standards. Implementation of the IFRS rules has brought to the financial statements greater sensitivity to market risk, and has highlighted the relative importance of contingencies for banks’ employee pension funds. The BdP is empowered to (i) require all financial information deemed necessary for supervisory purposes, (ii) demand from external auditors specific extensive assessments, and (iii) perform on-site inspections in order to assess the quality of information.

Formal Powers of Supervisors (CP 22)

17. The BdP has broad enforcement powers ranging from moral suasion to imposing penalties upon banks and their management, restricting a bank’s current activities, replacing management or restricting their powers, and ultimately revoking the banking license. In the case of financially distressed institutions, the BdP may require a number of financial recovery and reorganization measures; it may also appoint one or more interim board members with veto powers over shareholders’ decisions.

Cross-Border Banking (CPs 23—25)

18. The regulatory framework allows the authorities to undertake globally consolidated supervision over internationally active banking groups. Supervision over the activities abroad of Portuguese banking groups is conducted mainly through on-site inspections at the headquarters and information sharing with host-country authorities. Similarly, at the group level, the overall risk assessment of the foreign institutions operating in Portugal is left to the home supervisor.

VI. Principle-by-Principle Assessment

19. The assessment of each principle is made on a qualitative judgment basis using five categories: compliant, largely compliant, materially non-compliant, non-compliant, and not applicable.

20. A principle will be considered compliant whenever all essential criteria are generally met without any significant deficiencies. A principle will be considered largely compliant whenever only minor shortcomings are observed, which do not raise any concerns about the authority’s ability and intent to achieve full compliance within a prescribed period of time. A principle will be considered materially non-compliant whenever, despite progress, the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. A principle will be considered non-compliant whenever no substantive progress toward compliance has been achieved. Principles will be considered not applicable whenever the BCP does not apply given the legal, structural or institutional features of a country.

21. For each principle there is a descriptive part, which sets out the pertinent laws, regulations, policies and practices. Based on this, and on its implementation, the assessment is concluded. There is also a comment section, specifying the character of any deficiency and providing guidance on how it might be remedied in order to improve compliance with the principle.

Table 1.

Detailed Assessment of Compliance with the Basel Core Principles

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