LISBON, June 6 (Reuters) - Portuguese banks are still vulnerable to various risks and must avoid easing strict criteria for lending or offering complex financial instruments in the hope of repairing profitability dented by low interest rates, the central bank warned.
The country's banking sector is still recovering after the state had to rescue two lenders in 2014 and 2015, their problems exacerbated by massive bad loans, while many clients lost their life's savings by buying into toxic assets sold to them as safe.
In a financial stability report released on Tuesday, the Bank of Portugal said that despite stronger solvency and loan-to-deposit ratios, the high stock of non-performing loans and assets tends to weigh on investor perception of Portuguese lenders, restricting their access to market financing.
"Although the prospects for the Portuguese economy have improved ... the high public and private sector indebtedness and the low potential growth continue to pose risks to financial stability," it said, adding that record-low interest rates in the euro zone put additional pressure on Portuguese banks.
It warned that in such a setting, banks could be tempted to launch complex financial instruments that allow to recover some of the lost profitability by transferring risks to clients, which could create reputation hazards and undermine confidence in the banking sector.
"This context could also create incentives for excessive risk-taking via search-for-yield behaviours, particularly by being less restrictive in conceding loans... It is fundamental that financial institutions correctly evaluate risks linked to new loan flows," the central bank said.
It said it was important for banks to heed its warning as new consumer and housing loans were on the rise even as the total stock of loans to the non-financial private sector still ebbed last year, continuing the trend that started during the country's financial crisis in 2010. (Reporting By Andrei Khalip, editing by Axel Bugge and Pritha Sarkar)