Portugal's banks may face an "intolerable risk" if the country fails to consolidate its public finances, the Bank of Portugal warned on Tuesday, urging the sector to reinforce its capital in the years to come.
The Socialist government has adopted painful austerity measures in next year's budget to slash the fiscal deficit and soothe investor concerns that Portugal may become the next euro zone member to require a bailout, after Greece and Ireland.
But budget execution has been poor so far this year, with core state sector deficit widening 1.8 percent in the first 10 months.
In its financial stability report, the Bank of Portugal said failure to consolidate public finances in Portugal would put the banking sector in jeopardy, especially if the sovereign debt crisis continued in Europe.
"The risk will become intolerable if we do not see the implementation of measures that consolidate public finances in a credible and sustainable way," it said.
The Bank of Portugal reiterated that the austerity measures, including higher taxes and wage cuts in the public sector, would have a recessive impact on the economy next year, although it said the impact could be mitigated by external demand for Portuguese products.
An economic downturn would affect the quality of banks' assets, with less credit for companies and households, whose incomes are expected to drop.
"Given the prospects of the Portuguese economy, reinforcing ... provisions for losses in credit portfolios, and, above all, reinforcing the capital of the banking system are essential to assuring that it remains resistant to adverse shocks," the document said.
It also said the banks needed to find new strategies to tap clients' resources in order to dampen liquidity risks as Portuguese banks had been shut out of the interbank funding market amid jitters over the euro zone periphery.
As a result, the banks had become reliant on European Central Bank funding.
The Bank of Portugal said that, although the borrowing had ebbed of late, it was still of "very significant magnitude" and Portuguese banks were "strongly dependent" on it.
© 2016 Thomson/Reuters. All rights reserved.