The document investigates the role of the Portuguese banking industry in Portugal's economic crisis beginning in 2008. It suggests that Portugal's banking crisis preceded and may have contributed to the broader economic crisis. After joining the Euro, Portuguese banks heavily borrowed from foreign institutions, fueling a credit boom that supported lending and consumption until the bust phase began. Four episodes between 2008-2012 identify Portugal's banking crisis, including bank runs, failures, government guarantees, and recapitalization of major banks, worsening the sovereign debt level and leading to Portugal's bailout request in 2011.
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Role of Portuguese Banks in Economic Crisis
1. Abstract
This case study intends to investigate the role of the Portuguese banking industry in the
great economic crisis that Portugal is currently experiencing. The evidence shows the
existence of a Portuguese banking crisis starting in 2008, and preceding the great
economic crisis, marked by the Portuguese bailout program, initiated in April 2011.
It is suggested that the Portuguese banking crisis may be related with the behavior of the
Portuguese banking industry upon Portugal has joined the Euro Currency, which
eliminated the exchange rate risk within the Euro Area. Though, the credit and liquidity
risks were not completely vanished. In fact, the evidence seems to indicate that upon
joining the Euro, the Portuguese banks started a process of intensive borrowing from
foreign financial institutions, reaching total outstanding liabilities of 82,0% over the
Portuguese nominal GDP, in 2007. This has contributed to a capital flow bonanza,
pumping liquidity into the local economy, and thus sustaining both lending and credit-
driven consumption booms. After the boom, Portugal entered a bust phase, in line with
the published literature and originating a banking and economic crisis. Both crises were
amplified due to the European sovereign debts and the Portuguese bailout program.
Using published indicators referred to study banking crises in other countries, a
Portuguese banking crisis is identified, marked by four episodes. Namely, 1) two bank
runs and a Government takeover of one of the banks in 2008; 2) the bankruptcy of the
other bank in 2010; 3) Government guarantees of approximately 6,9% of the nominal
GDP to the major Portuguese banks, in 2011; and 4) Government recapitalization costs
of approximately 4,0% of the nominal GDP to the major Portuguese banks, in 2012.
During this time period, the Portuguese government increased the level of its sovereign
debt, and has requested for the bailout assistance from Troika, in April 2011.
Keywords: Portuguese banking crisis, financial crisis, boom-bust cycle, capital flow
bonanza, banks, banking performance