BOX 2.1 | INTERCONNECTEDNESS WITHIN THE RESIDENT FINANCIAL
SYSTEM
importance for the system’s stability. Although links within the financial sector are an important element,
as they give some flexibility to the definition of the business model, they require constant monitoring in
order to mitigate possible contagion and regulatory arbitrage risks.
This interconnectedness may have two types of effects. If on the one hand it can be a contagion mechanism,
on the other hand, it may also be useful to absorb shocks, which has been proven by the fall in external
demand for domestic securities, that lead to an increase in investment in those securities by the resident
financial sector. In effect, considering that a significant group of relevant countries for the Portuguese
economy are also conditional on structural adjustment processes at the economic and financial level, and
against the background of a decline in external financing to the Portuguese economy, resident agents
have also reduced their investments abroad. Therefore, similarly to developments at the international
level, the financial sector has adopted a more domestic perspective, enabling resident banking groups
to adjust within their own economic group.
Interconnectedness within the financial system may be due to: (i) bilateral exposures, i.e. the most direct
contagion channel; (ii) exposure to common risks; (iii) reputational risks. In addition, it is important to
mention existing indirect exposures, in particular stakeholder relationships broadly based across the
financial industry. In effect, in many cases, main national banks control major insurance corporations and
pension fund management companies, as well as investment fund management companies operating
in the national financial system, significantly influencing the business models defined by those entities.
In the recent past, exposures among national financial entities have increased considerably. In fact,
exposure to the resident financial sector (measured as a percentage of total assets) grew from 17 per
cent1 at the end of 2007 to 26 per cent in June 2013, which corresponds to an important share of total
assets and illustrates the relevance of existing links, as well as their recent developments.
As expected, due to its weight in the domestic economy, the banking sector concentrates the largest
share of assets on national financial entities. Exposure to this sector rose from around €49 billion in
December 2007 to approximately €117 billion in June 2013, mainly explained by an increase in inter-
Table 1
EXPOSURE TO THE FINANCIAL SECTOR | % OF TOTAL ASSETS
Banks and Money
Market Funds
Insurance C. and Securitisation Funds Investment funds
Pension Funds
Dec. 2007
Jun. 2013
Exposure to the financial sector
Source: Banco de Portugal.
1 For the purpose of this analysis, it has been purged of the effect of claims on the central bank.
Total
2
69
Risks to Financial Stability
The recent financial crisis has highlighted the interdependencies within the financial sector, as well as their
-bank exposures. As a percentage of total assets, there was an increase of 11 percentage points (from 11
per cent to 22 per cent). Moreover, in June 2013, around 62 per cent of debt securities issued by banks
II
BANCO DE PORTUGAL | FINANCIAL STABILITY REPORT • November 2013
70
were held in the portfolio of the resident financial sector, compared with 23 per cent in December 2007.
In addition, considering that, after the financial crisis, the interbank market and in particular non-collateralised financing ceased to be an alternative for bank funding, the physical assets held by the sector
could be expected to increase. In recent years, the amount of loans granted by banks to the financial
sector has declined while funding in the form of securities has increased substantially, which was related
to the purchase of securities held by financial vehicle corporations and the purchase of banks’ securities.
This behaviour is partly explained by the need to obtain collateral for ECB funding. In this respect, repo
and reverse repo operations, intended to obtain collateral for Eurosystem monetary policy operations
within the scope of some financial groups should also be mentioned.
The absolute value of the banking sector claims on OFIs (other than insurance corporations and pension
funds) increased by 81 per cent since late 2007, which was exclusively due to the 237 per cent rise in
securitised assets. Even though the concentration of securitisation corporations and funds’ claims on the
national financial system has remained virtually unchanged, there is a sizeable increase in the absolute
value of these investments (22 per cent), which was due to growth of credit securitisation activity during
this period and also to the fact that these operations cannot be derecognised from the balance sheet.
Although the overall value of the assets held by the insurance and pension funds sector represents a
rather lower amount than in other segments of the financial industry, it is important to highlight the
predominance of the remaining national financial sector in the investment portfolio of these players. In
fact, those investments represented 28 per cent of the total assets of the sector at the end of the first
half of 2013, corresponding to a 9 percentage point increase since December 2007.
The behaviour of investment funds (excluding money market or securitisation funds) has been contrary to
that observed in the other activity segments, as a result of their decreasing exposure to other entities in
the national financial sector, which may be explained by changes in the investment policy of certain funds.
In spite of the risks to the financial system that may emerge from these links, reference should be made
to the recent adoption of a set of measures intended to mitigate any potential systemic risks. For instance,
new regulatory instruments have been introduced which consider, in a more explicit and integrated
manner, the systemic risk resulting from interlinks within the financial system. These instruments shall
materialise in the definition of ceilings to intra-financial sector funding (including banks, credit institutions,
investment corporations, insurance corporations, funds, unregulated financial entities) which will make
it possible to mitigate the concentration and liquidity risk, inter alia. Reference should also be made to
the existence of concentration limits in investment portfolios, or provisions that desincentivate excessive
concentration, which aim at promoting risk diversification.
In short, an increase in the interconnectedness of the national financial system has been apparent in the
recent past. Although this has been more evident at the balance sheet level, it is interesting to stress the
existence of other sources of possible contagion, such as reputational risk or the exposure to common
risk factors. Also in this respect, reference should be made to exposures to other sectors and, in particular,
to sovereign risk, which has shown considerable correlation with securities issued by the financial sector.
Without prejudice to the above, against the background of a sharp reduction in external financing
sources available to national entities, it is interesting to also emphasise the positive role played by these
mechanisms, facilitating the adjustment process of the national economy.