Banking stability in Portugal: early warning indicators

The Great Recession highlighted the need for a cautious and precise assessment of the stability of the banking sector as banks act as liquidity intermediaries. Indeed, a solid banking system is required for a good allocation of capital and subsequently for the well-functioning of the economy. Over the past decade, in addition to price stability, the maintenance of financial stability has become one of the main objectives of the Eurosystem. In fact, banking system regulations have suffered alterations over time to address that objective.

In response to the 2008 crisis, the Basel III agreement, which was published in 2010, introduced more restricted minimum capital requirements, a new composition of Tier I equity, and requirements on new financial ratios (e.g., the Liquidity Coverage Ratio and the Net Stable Funding Ratio).

The paper constructs an index of banking stability, the aggregate banking stability index (ABSI), using data from financial statements of Portuguese banks during the 2010–2019 period. Second, the paper assesses the impact of macroprudential indicators on the ABSI using time-series regressions, in accordance with the empirical literature on early warning indicators. Several macroeconomic and financial variables are used as determinants of ABSI. The findings suggest an improvement in stability since 2017, and point to several early warning indicators including: the growth rate of the consumer price index, and the ratio of the second money multiplier to gross domestic product.

Click here to go to the paper by Maria Teresa Medeiros Garcia & Simão Rodrigues Abreu.