Interest rate rises to impact banks

The increase in interest rates by central banks and the subsequent rise in yields on Portuguese sovereigns held by Portugal’s banking sector will have an impact but will “not endanger the sector” say economists.

According to Lusa, the increase in interest rates will mean a loss in the profitability of Portugal’s high level of public debt which Portuguese banks hold, and which will benefit financial margins according to economists contacted by the news agency.
According to economist Paulo Pinho (Nova SBE)(pictured), when referring to the gains the banks will make on financial margins from an increase in interest rates (the difference between the interest paid on deposits and the interest charged on credit) the loss of profitability of Portuguese bonds has to be taken into account even though gains on financial margin make a significant offset.
Portuguese banks have a portfolio with high amounts of Portuguese public debt. When public debt gains value in the markets, banks see a profit (which has been the case in recent years), when they fall in value, it means losses on this investment, which can have an impact on bank capital ratios. (Likely to be seen now)
According to Paulo Pinho, to avoid posting losses, the banks can put these bonds in the column ‘investment assets’ where they will not register the devaluation, but when they mature the bonds will be paid out (even though €100 today will not have the same worth at €100 in 10 years time, because of inflation and interest rates), instead of putting it in the ‘trading securities’ column (where they would have to reflect the market value).
If the banks sell the debt, they would have to register losses, which is not ideal. “The situation would only get really complicated if there was a deterioration in the rating of the Portuguese Republic and the European Central Bank stops accepting Portuguese debt as collateral, which happened in 2011.
But in the medium term, this situation is unlikely, and the minister of Finance has been more concerned about protecting public finances.
Ricardo Cabral (ISEG) points out that in the financial crisis the ECB made the banks indirectly reflect the market values of debt, even that which was under the ‘investment’ column. Moreover, the evaluation of debt held by the banks is part of evaluations made by supervisors in stress tests, and could “force banks to increase their capital requirements if something goes awry with Portugal’s public debt”.
However, he thinks that the ECB will act prudently since other counties could be more affected (Greece, Italy, Spain) and highlights the revenues that the banks can get on margin from the increase in interest rates.
Economist António Nogueira Leite said that the banks might have to post losses on their debt portfolio, but makes it clear that the banks’ situation is much more solid, and has been “much more cautious in managing public debt”.
As for sovereigns being transferred under the heading ‘investment assets’, he said it was possible but would “have to make sense in substance” and would have to be authorised by auditors and regulators. “I don’t see banks doing this because they are more capitalised and are behaving more responsibly”, said the man who was vice-president of Caixa Geral de Depósitos (2011-2013), secretary of State for the Treasury and Finances under the António Guterres government, and an economic advisor for the Passos Coelho government (PSD).