Portuguese Banking Reforms Integration into European Union Played Key Role in Reshaping of Banking Sector

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IMF SURVEY: How would you characterize the health of Portugal's banking sector prior to the country's entry into the European Union in 1986?

DECRESSIN: Portugal nationalized its banking system in March 1975, and the sector subsequently developed in an environment characterized by pervasive public intervention in the economy and large macroeconomic imbalances, including public sector borrowing that exceeded 20 percent of GDP in some years.To deal with the deficit, the government resorted to monetization, credit ceilings, and capital controls, which it hoped would enhance its ability to mobilize and channel resources. The expansion in the monetary base helped distort banks' balance sheets: deposits grew much faster than credit to the private sector, and excess reserves werePage 31 channeled to the purchase of government paper, directly or indirectly through low-interest deposits at the central bank.Virtually all of Portugal's interest rates were fixed administratively, with subsidized rates accorded to certain projects. In real terms, interest rates were low or negative. On the eve of Portugal's entry into the European Union, many banks found themselves inadequately capitalized and recording losses.

IMF SURVEY: Portugal subsequently carried out extensive reforms of its banking system. What did this entail?

DECRESSIN:While early banking reforms had already been implemented under a stabilization program supported by an IMF financing arrangement in 1983-85, the reform process was invigorated subsequently,with the result that a system once tightly controlled by the state has, by now, been transformed into a fully liberalized and modern one. The reform encompassed domestic deregulation, privatization, and the opening of Portugal's capital account.

It was essential to first reduce the large macroeconomic imbalances that had prevailed during part of the 1980s. Once that was done, the reforms proceeded gradually and in stages. The liberalization of the legal and operational framework of the banking system as well as the reform of monetary policy instruments were initiated before stateowned banks were reprivatized and capital controls abolished.

Legal and operational reforms allowed private banks to operate alongside public banks, granted the central bank more autonomy, and provided for a shift to universal banking (which allowed banks to participate in both commercial and investment activity). In addition, prudential regulations were...