This summer new lending recommendations came into effect for Portuguese credit institutions. The decision to tighten credit lending in Portugal has coincided with a report by the International Monetary Fund (IMF) that highlights the potential risks in pockets of the Portuguese housing market. Although the recommendations are not binding, they demonstrate that Portugal is keen to take both a prudential and proactive approach to overseeing the revitalisation of its credit markets.
Portugal’s new lending rules were drafted by the Board of Directors of Banco de Portugal, the country’s macroprudential regulator. They were initially announced last winter as new data caused the Bank to reconsider its previously sanguine position.
With the economy growing by more than 2 percent and unemployment falling, regulators weren’t concerned over a loosening of credit conditions in Portugal. As the bank previously explained, “The changes in the supply of credit, namely the reduction in spreads applied to medium-risk loans, were mainly justified by competitive pressures and a more favourable risk assessment”. Moreover, the rise in housing prices had helped prop up the construction sector, which had taken a hard tumble as a result of the financial crisis.
However, as more recent data became available, it has become apparent that Portugal’s credit market requires more active oversight. In particular, housing prices rose by 12 percent in the first quarter of 2018 compared to same period last year. This was the sharpest increase in prices since the sector’s recovery began in 2013.
This led the Bank to re-evaluate its assessment of the housing market in its June Financial Stability Report:
“After a period of falling prices in the residential segment, some signs of aggregate price overvaluation began to appear in the second half of 2017. Although indications of aggregate overvaluation are very limited, the duration and speed of the price growth may pose risks to financial stability in case of persistence or reinforcement of this dynamic”.
The IMF has also advised careful oversight of the rebound in Portugal’s housing market. In its 2018 Article IV Consultation released in July, the IMF drew attention to emerging financial vulnerabilities in the Euro Area.
“There are places—for instance, Luxembourg, some German cities, and some areas in Portugal and the Netherlands—where mismatches between demand and supply are driving strong residential or commercial real estate price appreciation”.
The fund also advised policy makers “to remain vigilant to financial stability risks and move decisively where necessary to defuse pockets of vulnerability with targeted macroprudential actions”.
The Bank of Portugal’s recommendations should help reduce some of these vulnerabilities. Specifically, it sets out three limits for the ratio between the loan and the value of the property used as collateral. For those individuals who are permanent residents in Portugal and are seeking a loan for personal use, the ratio shouldn’t exceed 90 percent. However, if a permanent resident applies for a loan to be used for other purposes, the maximum ratio is 80 percent. Finally, when credit is requested for the purchase of property held by a credit institution or a financial leasing agreement, the limit increases to 100 percent.
The Bank of Portugal has also proposed conditions and maturities for these loans. For instance, monthly payments made to cover an individual’s loans should be capped at 50 percent of the borrower’s income. The regulator also recommends that mortgages shouldn’t be extended beyond 40 years. By 2022, the Bank of Portugal would like to see gradual convergence towards an average loan maturity of 30 years. However, consumer loans should not exceed 10 years.
These recommendations apply to all credit and financial institutions that are headquartered or have a branch in Portugal. However, they are still recommendations and are therefore not binding. Those banks that do not comply will need to explain why they should be excluded from these standards. Nevertheless, when speaking to Parliament this spring, Carlos Costa, the Bank’s governor, warned that if too many financial institutions ignore the new lending recommendations, they could be adopted as binding rules.