The Portuguese banking crisis of 2016 is ongoing

It was only on Friday that I found myself analysing again the problems and travails of the Italian banking system and this morning we find that its Euro area twin the Portuguese banking system is in further trouble as well. Mind you according to Italy’s Finance Minister Padoan there is no problem at all.

Italian finance minister rejects need for banks bail-in……Pier Carlo Padoan, the Italian finance minister, has denied that Italy’s banks are suffering from systemic problems and rejected a “bail-in” of private investors.

Apparently though there are “a few “contained” critical cases.” As we mull the record of official denials of banking problems we can only wonder how large a number “few”can be and does he mean contained like at Fukushima?

In a familiar tale share trading in Monte Paschi was stopped this morning in Milan as it fell another 5%.

The Portuguese Banks

Let me repeat a summary I used on June 7th and July 6th.

A concentrated banking sector with strong links to the Portuguese establishment and many links to Angola has failed to provide investment for the economy in the good times and led to contraction in the bad times. Whenever the light of media attention is shown on the sector we see cockroaches scuttling for cover. Putting it another way this is the reality of the theory of money velocity falling.

The Portuguese statistics office in its review of 30 years of European Union membership puts it like this.

The second subperiod, from 2001 to date (2014), was marked, by contrast, by an almost stagnant Portuguese economy, while the EU15 and the EU28 on average experienced economic growth (average annual growth rates slightly above 1.0%)……….. In other words, the conditions for this small open economy trying to find its place in the new international environment became much more unfavourable, with the additional aggravating circumstance of having to meet the fiscal targets set out within a financial rescue programme.

Not much of a recommendation of the decision to join the Euro is it? The previous period has been more successful. But the “almost stagnant Portuguese economy” of this century has meant that the banks have got weaker and in fact the economy and the banks have dragged each other lower.

For those unfamiliar with Portugal there has been the issue also of unfavourable demographics which have been made worse by this.

However, the crude rate of net migration has been following a negative trend since 2011, as was already the case with the crude rate of natural increase.

Novo Banco

Let us remind ourselves that this was supposed to be as it name implies as good bank or literally new bank. Back on August 3rd 2014 the Bank of Portugal told us this.

Under Article 153-B of the RGICSF, the Resolution Fund will solely own the equity of the new bank, and will later allow new capital to enter, reestablishing a shareholder base for this bank with the inherent reimbursement of the capital now provided by the fund.

Ah “allow new capital to enter!” Well nearly two years and several abortive attempts later there has been not a penny or cent of new capital but there was this last New Year.

The nominal amount of the bonds retransferred to Banco Espírito Santo, S.A. totals 1,941 million euros and corresponds to a balance-sheet amount of 1,985 million euros.

So the new clean bank turned out to be not so clean which I would imagine explains the shortage of buyers for the equity. This rather leaves the Resolution Fund holding a very expensive baby.

The equity capital of Novo Banco, to the amount of €4.9 billion, is fully underwritten by the Resolution Fund.

What is the make-up of the fund?

The Resolution Fund’s sources of funding are the contributions paid by its member institutions and the proceeds from the levy over the banking sector, which, according to applicable regulations, are collected without jeopardising the solvency ratios.

Why is this a good idea?

The State will bear no costs related to this operation.

Oh really?

Given that the Resolution Fund started its operation only in 2012 and has not available sufficient financial resources to finance the resolution measure applied to Banco Espírito Santo, S.A., the Fund took out a loan from the Portuguese State. The loan granted by the State to the Resolution Fund will be temporary

Eurostat took a somewhat different view.

“other adjustments” that in 2014 includes € 6 186 million (3.6% of GDP) related to the recording of the financing operations of the State to the public enterprises “Carris” and “STCP”, to the write-off of nonperforming loans by BPN Crédito, held by Parvalorem, S.A. and to the capitalization of Novo Banco.

The other banks

In theory they now hold Novo Banco via the Resolution Fund albeit that it had nowhere near the money to pay for it. According to the Financial Times this morning that is not going so well.

Estimates of the potential bill facing banks, which finance the resolution fund that bailed out Novo Banco in 2014, range from €2.9bn to €3.9bn. Some bankers are even doubtful that the rescued lender will attract any acceptable offers, leading to its possible break-up or liquidation.

Has a “good bank” ever destroyed money and capital so quickly? This is a flaw of collective banking insurance which I have pointed out many, many times and here is the present consequence.

Portuguese banks, already undercapitalised and loaded with bad debt, are bracing for heavy losses from Lisbon’s so far unsuccessful attempts to sell Novo Banco, the lender salvaged from the collapse of Banco Espírito Santo.

Caixa Geral de Depósitos

Back on the 6th of July I pointed out that there seemed to be a flurry of departures from the board and that trouble was building. Today the FT puts it like this.

Lisbon and EU authorities are locked in tough negotiations over plans to recapitalise state-owned Caixa Geral de Depósitos, Portugal’s largest bank, with conflicting estimates of its capital needs ranging from about €2bn to €5bn.

If we wished to copy the Beatles and set about “fixing a hole” what might it cost?

In a recent report, Barclays estimated that Portuguese lenders could need up to €7.5bn to resolve a “systemic banking crisis” that was bringing the country under “close market scrutiny”.


Portugal is far from alone in seeing the share prices and values of its banks fall in 2016. However there are specific problems here based on the Portuguese system and the way that it has tried to play the parlour game “pass the parcel” without the music ever stopping. If we look back a corrupt banking system with links to Angola has lived through 15 years of  overall economic stagnation which of course it has contributed to. There is a growing list of problems which the Portguese state has looked away from.

However as time has progressed it has successively been forced to face up to them one by one. Usually not by itself as it has invariably used accountancy chicanery to avoid that but after a period Eurostat catches up with it. This means that its deficit problems ( 12.4 billion Euros in 2014 , 7.9 billion in 2015) have continued which have meant that the national debt (129% of GDP) has grown too. The can has been kicked not into a future full of sunshine but one with more clouds and rain. More Euro area punishment for breaking the fiscal rules is of course part of that.

In current conditions a rising national debt means much less than it did simply because Mario Draghi and the ECB are hoovering up so much of it  So far the purchase of 19.1 billion Euros of Portuguese government debt has meant that it can continue to borrow relatively cheaply ( ten-year yield 3.06%). But as to repaying any of it well that looks ever further away and without ECB support then Portugal looks on its way to insolvency unless it can finally find some sustained economic growth. A great shame for what is a lovely country.


28 thoughts on “The Portuguese banking crisis of 2016 is ongoing

  1. Hello Shaun ,

    “More Euro area punishment for breaking the fiscal rules is of course part of that. …”

    for Portugal or the German tax payer ?


  2. I hadn’t thought about the velocity of money in Fisher’s equation, which is always assumed to be fairly steady in Friedmantite economics. If money becomes locked up in property, which has been at the heart of many problems in Iberia and Ireland, the velocity will slow quite significantly. Given MV=PT (quantity of money x velocity = price level x numbers of transactions), the assumption is that V approx = T, so that as economist Henry Thornton observed in 1802 an increase in money supply does not necessarily mean an increase in economic output, just an increase in inflation as M becomes P (from – which is of course, the one thing Carney and Draghi have overlooked. However, given the infrequency of property T, that slows the V through the economy and thus means that “Portugal (cannot) find some sustained economic growth.”

    • It’s a topic I’ve seen covered fairly consistently here by both Shaun and commenters over the past year or two David.

      There appears to me an inherent assumption in many CBers that velocity is a constant which might explain there obsession with printing=inflation.Clearly,recent history tells us that repeated and excessive printing results mainly in declining velocity.That’s about all.Meaningful inflation of the sort that can keep bank balance sheets solvent and erode national debt problems is still a pipe dream.

      Having said that the Brits may have stumbled on a solution although it wasn’t the solution Carney wanted.

      Unfortunately,for me,there is only one way out of this mess and that is for banks to eat their losses and by extension that means equity and bond holders too.

      Distortions in risk pricing have led to asset bubbles that have killed real economic activity and replaced it with financial engineering in the hope noone will notice.

      Unfortunately,people tend to notice declining real incomes in a way that CBers would never understand.

      Hope isn’t a strategy.

      • I think money velocity, whilst having slowed since 2008, remains an indicator to directionality although is no longer a predictor of rate of growth/shrinkage.

  3. Hello Shaun,
    Good blog yet again!
    So we have the Portugese banks in worst trouble, and the Italians, don’t forget the Greeks. The Austrian banks still have vast East European non performing loans and mortgages on their books. Even German banks aren’t immune. Holland?
    Mario ” whatever it takes” Draghi – you don’t have enough cash to sort this lot out!

  4. Hi Shaun, not exactly on topic but I was reviewing some IMF speeches and country reports from March and noticed them complaining about excessive leverage and impaired balance sheets globally, presenting risks to the future of which your chosen subject today is a part. I couldn’t help comparing to their “stories” over the last few years, that excellent progress was being made with de – leveraging, then there were their own “Selected Issues” papers alongside “Financial Stability” reports over the last 2 years (prior to March 2016) saying leverage was under control and balance sheets were healthy!!

    So what happened? Has leverage rocketed in the last year? Cos if it has they certainly didn’t mention anything building or have they forgotten what they were saying over the preceding 2 years?

  5. Great blog, Shaun.
    I am confident that the model for Portuguese recovery is Greece and that soon Portugal, like Greece, will be enjoying untold wealth created by its membership of the Euro.
    Even with my most pro-EU hat on, I cannot see how Portugal has benefited from being in the Euro. How many countries have to have their economies trashed before someone spots a link here?

    • And if the EU authorities really do play hardball in the Brexit negotiations, there is a chance that they may trash even the German economy.
      No paymaster, no discipline; no discipline, no €uro.

      • “And if the EU authorities really do play hardball in the Brexit negotiations, there is a chance that they may trash even the German economy.”


        • £400bn is the value of goods and services imported from the EU.
          We are Germany’s third biggest market, taking €98bn in goods alone; €60bn more than they take from us.
          Goods alone, not services.
          That’s a lot of manufacturing jobs.

      • Consider the percentages as it this value that demonstrates the scale of impact. Germany exports 7% of it’s GDP to the UK , an already sluggish economy with a growth rate of circa 2% pa currently. Germany also exports 6% of it’s GDP to China, a strong growth economy with a growth rate of circa 6.5% pa currently –, although I expect Chinese growth to moderate to circa 5.5% pa over the next 2 years.

        Rightly or wrongly German products carry a “Made in Germany” kudos leading to inelasticity of demand, which means those Brits who are buying BMW’s Mercedes, Miele etc already have extensive buying power (because these products are already expensive) and will have the capability and be prepared to pay more via greater tariffs whilst the Brits buying VW and Bosch etc will try their best to pay higher prices for the German goods they respect and want.

        Then there’s China and other ASEAN countries with a steadily growing rich class and middle class who also covet German products. It is my view that in the event of the EU relying on WTO rules in relation to the UK and of course the UK retaliating, Germany may lose about 2% of it’s GDP in exports to the UK which it will replace with moderate difficulty with increased exports to China et al.

        There are more countries in the world than the UK and the EU has trade deals with 60 odd of them, in the case of Germany they will be relatively unaffected by the scenario you describe.

        If you want to talk about EU countries seriously negatively affected by UK retaliation you need to think about a country the UK has historical close links with and is supposedly an ally –

    • “I cannot see how Portugal has benefited from being in the Euro.”

      I can’t see how Portugal benefited from using the escudo – similar growth pattern. Euro membership has nothing to do with it. It’s all about the banks as usual.

      • Well, if you’re saying that EU membership has given no benefit to even the poorer countries, WTF IS it for?
        Why give it any say in your domestic policy?
        Why pay for its bureaucracy, its parliament, its institutions?
        Why allow it supervisory status over your budget?
        Why be a member?

        • Wow, that’s a big question the full answer to which I haven’t got time to give but I’ll attempt a synopsis of the main points:

          First you have confused Euro membership (as in the Euro unit of monetary currency used in the Eurozone) which is what I think James was talking about when he spoke of “being in the Euro” with membership of the European Union of which e.g. the UK has been and still is a member with it’s own sovereign currency.

          I agree that in hindsight Portugal should not have joined the Euro Zone as the Euro has not benefited it, but they thought it would at the time of joining. So why remain a member of the Eurozone?

          First I don’t know if they could leave and simply become a member of the European Union re adopting the Escudo but if they could, they are now in so deep that they would become another Greece as their Euro denominated EZ debt would be re-denominated into a very weak Escudo which they could not service especially whilst trying to deal with the consequent hyperinflation of such a move. Tourism alone (due to stupidly cheap holidays given a weak escudo) cannot save the economy. If you’re thinking companies would move to Portugal because of the exchange rate on Escudos think again because it’s workers are relatively unskilled and companies would likely be unable to recruit staff with the minimum requisite skills.

          If Portugal left the EZ it would in fact be worse than Greece as no one would lend to it due to the debt overhang owed to the EZ.

          If, at this point you are still asking why not leave the European Union too preventing all it’s institutions from having any influence over Portugal? Well, besides the problems outlined above, because Portugal would automatically lose free trade agreements with 80 odd countries (20 odd of which would be EZ/EU countries) and would have to commence negotiations for new trade agreements with those countries in addition to other countries around the world as it searched for new markets which would take years given it’s size, as countries group together negotiating as blocs – European Union, United States of America, Association of South Eastern Asian Nations, Trans Pacific Partnership etc. This method of negotiation automatically pushes individual countries to the back of the queue as the blocs look for large scale agreements rather than small scale ones. Moreover, blocs of nations negotiate better deals than those acting individually simply because of the size of the trade deals they are discussing.

          There is so much more to cover in answer to your question but time is pressing so I end with the following:

          As I said earlier in reply to James, it’s all about the banks! Indeed even Shaun admits that in his title, alluding to Euro membership later as a point scoring exercise as he clearly disagrees with the Euro per se. In Portugal’s case Euro membership simply gave a further downward push on a weak economy, weakened by the banks as usual. It is the banks behaviour which needs to be addressed world wide as Portugal would be OK had it not been for it’s mis-managed banks, I fear the same may be said about most countries. As Expat points out, the entire world should copy Iceland in relation to the banks, following a period of harsh adjustment of about 5 years everything financially speaking would become much better than it is now.

  6. Bail outs have a track record of failure. It is just the thin edge of a large wedge rorting taxpayers. Bail ins have the advantage that the bank directors do not want to ask twice. Letting struggling banks go under is a solution that will not have the Goldman Sachs begging bowls reappearing in another few months. The Icelandic bank insolvencies were not the end of the world, they led to a genuine recovery.

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