The Bank of Portugal has imposed a capital buffer requirement for mortgages on four of the country’s largest banks, in a move to curb excessive risk-taking and protect financial stability.
What is the capital buffer requirement?
The capital buffer requirement is an additional amount of capital that banks have to hold to cover potential losses from their mortgage portfolios. The buffer is calculated as a percentage of the risk-weighted assets (RWA) of the mortgages, which reflect the probability and severity of default.
The Bank of Portugal said that the buffer will apply to four banks that have a significant market share in mortgage lending: Caixa Geral de Depósitos (CGD), Banco Comercial Português (BCP), Novo Banco and Santander Totta. These banks account for about 80% of the total mortgage market in Portugal.
The buffer will vary depending on the loan-to-value (LTV) ratio of the mortgages, which measures the amount of the loan relative to the value of the property. The higher the LTV ratio, the higher the risk and the buffer. The buffer will range from 0% for mortgages with LTV ratios below 50%, to 1.5% for mortgages with LTV ratios above 90%.
The buffer will be phased in gradually, starting from 0.5% in January 2024 and reaching the full level in January 2026. The buffer will be reviewed annually and adjusted if necessary.
Why did the Bank of Portugal impose the buffer?
The Bank of Portugal said that the buffer is a macroprudential measure, which aims to prevent or mitigate systemic risks that could threaten the stability of the financial system. The buffer is intended to strengthen the resilience of the banks and reduce the likelihood of a credit crunch or a housing bubble.
The Bank of Portugal said that the buffer is justified by the following factors:
- The mortgage market in Portugal has grown significantly in recent years, driven by low interest rates, high demand and limited supply of housing. The mortgage market represents about 60% of the total credit to the private sector and about 40% of the total assets of the banking system.
- The mortgage market in Portugal is highly concentrated, with four banks holding about 80% of the market share. This creates a high degree of interconnectedness and contagion risk among the banks and the economy.
- The mortgage market in Portugal is exposed to several risks, such as a sharp increase in interest rates, a decline in house prices, a deterioration in income and employment conditions, or a change in borrower behavior. These risks could lead to a rise in non-performing loans (NPLs) and impairments, which could erode the capital and profitability of the banks and affect their ability to lend.
- The mortgage market in Portugal has a high share of variable-rate loans, which account for about 90% of the total. This makes the borrowers and the banks more vulnerable to interest rate shocks and increases the volatility of the banks’ net interest income.
- The mortgage market in Portugal has a low share of mortgages with LTV ratios above 80%, which account for about 15% of the total. However, this share has increased in recent years, especially among new loans, reflecting a relaxation of credit standards and an increase in house prices. These mortgages have a higher risk of default and loss given default, and require more capital to cover potential losses.
How will the buffer affect the banks and the borrowers?
The buffer will have different impacts on the banks and the borrowers, depending on their characteristics and behavior.
For the banks, the buffer will increase their capital requirements and reduce their return on equity (ROE). The Bank of Portugal estimated that the buffer will increase the average risk-weighted assets (RWA) of the four banks by about 3.5%, and reduce their average ROE by about 0.4 percentage points. However, the impact will vary across the banks, depending on their market share, portfolio composition, capital position and profitability.
The Bank of Portugal said that the buffer will not affect the solvency or liquidity of the banks, as they have sufficient capital and funding to meet the buffer. The buffer will also not affect the existing mortgages, as it will only apply to new loans or refinanced loans.
For the borrowers, the buffer will increase the cost and reduce the availability of mortgage credit. The Bank of Portugal estimated that the buffer will increase the average interest rate on new mortgages by about 0.1 percentage points, and reduce the average loan amount by about 2.5%. However, the impact will vary across the borrowers, depending on their income, wealth, credit history and LTV ratio.
The Bank of Portugal said that the buffer will not affect the affordability or accessibility of mortgage credit for most borrowers, as they have sufficient income and savings to meet the buffer. The buffer will also not affect the existing mortgages, as it will only apply to new loans or refinanced loans.
What are the expected benefits and challenges of the buffer?
The buffer is expected to have several benefits and challenges for the financial system and the economy.
The benefits include:
- Enhancing the resilience of the banks and the financial system, by increasing their capital buffers and reducing their risk exposure.
- Promoting a more prudent and sustainable mortgage lending, by discouraging excessive risk-taking and encouraging more conservative credit standards.
- Reducing the procyclicality of the mortgage market, by dampening the credit and house price cycles and mitigating the feedback loops between the banks and the economy.
- Aligning the mortgage regulation in Portugal with the international best practices and standards, such as the Basel III framework and the European Systemic Risk Board (ESRB) recommendations.
The challenges include:
- Balancing the trade-off between financial stability and economic growth, by ensuring that the buffer does not unduly constrain the credit supply and demand and hamper the economic recovery.
- Monitoring and evaluating the impact and effectiveness of the buffer, by collecting and analyzing relevant data and indicators and adjusting the buffer if necessary.
- Coordinating and communicating the buffer with other macroprudential and microprudential measures, by ensuring consistency and complementarity among the different tools and authorities.
