S&P Global Ratings believes that Portuguese banks face a moderate risk from tech disruption. Although customer preferences are evolving rapidly--and much more following the COVID-19 outbreak--Portuguese banks generally benefit from relatively loyal customer bases, with whom they have developed close relationships over the years. In our view, the bulk of Portuguese bank customers are still traditional and more culturally inclined to have face-to-face interactions, particularly among the older adult population. Dense branch networks in Portugal allow proximity to customers and will remain, in our view, key in banks' omnichannel commercial strategies.

Nevertheless, the speed of change in technology, customer preferences and higher customer expectations on accessibility to financial products cannot be ignored. Similar to other countries and pushed by a younger tech-savvy generation, we expect Portuguese customer preferences will continue shifting toward fast and convenient, mobile, and cheaper banking services. Although generally lagging somewhat their Western European peers, Portuguese banks have started to upgrade and transform their legacy IT infrastructures and processes into newer digital ones, dedicating an increasing amount of human and financial resources to digitization, which is now high on management agendas. Until a few years ago, most of Portugal's major banks were in restructuring mode (including Novo Banco until recently), which likely somewhat detracted management's attention to digitalization. At the same time, the banking system's relatively high and increasing foreign ownership has likely also helped increase awareness of the need to digitize. We generally observe that larger banks are leading and investing more heavily to adapt, while smaller ones, such as Caixa Economica Montepio Geral and EuroBic, might not have the capacity to do as much. Ultimately, embracing technology should allow Portuguese banks to preserve or improve their efficiency. For lagger banks, it could also ultimately help ensure the viability of their business models.

We do not see the entrance of new participants as an imminent threat for the Portuguese banking system. We believe that regulators are not particularly keen to promote the development of fintechs to foster competition. The lack of a regulatory sandbox is an indication of this, in our view, and different from the U.K. or Spain, for example. Portugal's fintech industry remains highly fragmented, and its credit volumes almost immaterial compared to bank credit. For now, we see banks mostly cooperating, rather than competing, with fintechs. Furthermore, open banking is still in early development, while the more traditional population might be concerned with security and data privacy issues relating to information sharing with tech companies. At the same time, a particularly quick digitalization might imply leaving the elderly population partly unattended, with the consequent reputational risk that this could mean for the banking sector.

TRIP Analysis Shows That Portuguese Banks Face A Moderate Risk From Tech Disruption

We base our current views of disruption risk for Portuguese banks on our four-factor analysis of the Portuguese banking system's technology, regulation, industry, and preferences (TRIP).

Industry: Disruption Risk | Moderate

Incumbent banks should preserve their business models as long as they continue advancing their digital offerings

We consider the technological disruption risk for Portugal's banking industry moderate. The Portuguese banking system is highly concentrated, with the five largest banks (listed in order of total assets: government-owned Caixa Geral de Depositos S.A., Millennium bcp S.A., Banco Santander Totta S.A., Novo Banco S.A., and Banco BPI S.A.) constituting close to 80% of the system's consolidated assets. The sector is largely foreign-owned, with more than 50% of domestic bank assets controlled by foreign companies.

We do not believe tech might disrupt incumbents' business models because Portuguese banks generally benefit from relatively loyal customer bases, with whom they have developed close relationships, and their product offering covers most customers' financial needs. Banks typically focus on regular retail and commercial business models, and the degree of financial inclusion is relatively high, similar to that of its closest European peers (92% of Portuguese above the age of 15 had a bank account as of year-end 2017, according to the World Bank). In addition, regulatory barriers to enter are high, and retail banks face limited competition from fintechs so far.

Following the most recent financial crisis, the Portuguese banking system underwent a significant restructuring, reducing the system's branch networks and employees by about 40% and 30%, respectively. This allowed the sector to improve its efficiency, with a cost-to-income ratio of 53% as of year-end 2021, down from the 71% peak in 2013, according to data from Bank of Portugal and the Portuguese Banking Association. While we believe there is room for improvement, the Portuguese banking system's efficiency compares well with the European average.

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In general, we do not see the entrance of new participants as an imminent threat to the Portuguese banking system. The fintech industry continues emerging in the country, but so far it remains highly fragmented and does not represent a strong threat for incumbent banks, in our view. Fintechs operating in the country include long-established foreign-based Revolut and Ebury, as well as other domestic and recently created ones. Neither do we see a specific threat from other Portuguese-speaking native fintechs (such as Brazilian ones). Most fintechs in Portugal are business-to-business rather than business-to-customer, with their focus generally being on commissions generation rather than financial margins. Emerging fintechs usually lack sufficient resources and investments, and they often seek to partner with incumbent banks to complement their products and services. In addition, we believe Portugal might be less of a target for European fintechs because the cost-to-benefit is lower, given the smaller market size and potential lower absolute returns. Nevertheless, in relative terms, fees and commissions account for about 30% of Portuguese banks' operating revenues, a level very much aligned with the EU average (while net interest income accounts for a greater percentage, of about 63% of operating revenues as of end-2020, versus about 56% for the EU average). This suggests that banks in the country could face similar losses, in relative terms, as their European peers. Similarly, challenger banks generally encounter difficulties in terms of monetization and in becoming fully competitive. Big tech companies like Google and Amazon might represent the largest threat to banks, given their widely-known brands and financial resources, as well as large customer bases. However, we see this more as a long-term, rather than short-term, risk, because Big Techs' entrance into the market is still unclear and they could face regulatory barriers to traditional banking activities. Big Techs have not yet started granting credit in Portugal.

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In fact, the volume of credit provided by fintechs in Portugal is almost immaterial compared to bank credit. However, it cannot be ignored because it has strong growth potential, particularly among segments of the economy not typically served by incumbent banks, or undergoing specific difficulties, such as certain small and midsize enterprises.

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Despite the inevitable risk from tech disruption and increasing competition, we believe that Portuguese banks are generally well equipped to retain their loyal customer bases and client relationships as long as they continue adapting with a competitive digital offer. Banks are generally embarked in multiyear digital transformation plans, usually with the help of third parties, and they offer different products digitally, including investment and insurance products, instant consumer loans, and different payment and transfers options, as well as the possibility of combining customer accounts from other--mostly domestic--banks. Other products, such as fully online mortgage and auto loans, are generally not yet available, though. With a few exceptions, and in line with those of other countries, we generally see the scope and depth of technology investment by Portuguese banks directly associated with their size.

Preferences: Disruption Risk | Moderate

COVID-19 has changed customer preferences, but Portugal's banking clientele remains more traditional than more advanced European economies, in our view

Similar to other economies, customer preferences in Portugal are evolving rapidly and have been adapting because of the pandemic, with an increasing demand for technology-driven banking. Still, we believe that Portuguese banking clients are more traditional than more advanced northern European countries, and more culturally inclined for face-to-face interactions, particularly among older adults (about 22% of the country's population was above 65 at end-2020). In our view, this buys Portuguese banks some time to upgrade their IT solutions and adapt to clients' changes, so we do not see a particular high pressure on banks.

In our view, a large part of the Portuguese population is used to and still prefers interactions with banks through branches, receiving face-to-face attention. This is seen with the sector's still very dense branch networks, despite the significant restructuring in which the system embarked following the financial crisis. As of year-end 2020, Portugal had 33 branches per 100,000 adults on average, compared with the EU average of 24. The country's rural population has declined substantially over the past three decades but is still larger than that of many other EU economies. We anticipate that banks will continue shrinking their branch networks (for instance, Santander Totta and Millennium bcp announced restructuring plans in 2021), but branches will remain a key reference point for the Portuguese to do banking, at least until millennials start to represent the bulk of banks' customer bases.

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Until the pandemic, Portuguese banks were lagging somewhat behind their European peers in their digital offering and transformation, in our view. We partly attribute this to banks' modest profitability--mostly driven by still-high credit losses--and a less tech-savvy population, impeding Portuguese banks' investment in technology and digitalization as much as with their more advanced European peers. Positively, Portugal's ATM system is highly developed in terms of network, range, and quality of allowed operations. The number of ATMs per 100,000 adults in the country is roughly double that of the EU average. The pandemic has led to some changes in consumer behavior, such as an increase of contactless payments and e-transfers. We believe most of these changes, if not all, are here to stay. Unlike in the financial crisis, banks have provided the services the population required during the pandemic, which generally has translated into improved customers' net promoters scores over the past two years.

Internet banking penetration in Portugal is lower than average. We partly attribute it to the country's less technologically advanced society vs. other countries. Digital literacy in Portugal is somewhat behind the EU average, after improving significantly over the past few years. In fact, the human dimension is one of the factors driving down Portugal's ranking in the Digital Economy and Society Index (DESI) 2021--ranking 18th of the 27 EU Member States in the human capital dimension, improving from 21 in 2020 and 23 in 2019. As of year-end 2019, 48% of the Portuguese population lacked basic digital skills--and about 26% had no digital skills at all.

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The pandemic has led to a change in consumer habits, with more convenient electronic payment methods expanding to the detriment of cash and check transactions. Although we do not anticipate these trends reversing, the figures of digital payments in Portugal lag in the European context and we expect the use of cash to remain significant and above the EU average, both in terms of number of transactions and value. According to the ECB's 2020 Study on the Payment Attitudes of Consumers in the euro area, cash was used for 81% of payments in point-of-sale and peer-to-peer transactions in Portugal, versus the 73% euro area average; similarly, cash represented 54% of the payments' value, versus the 48% euro area average.

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Furthermore, the role of financial intermediaries in Portugal is not as developed as in other countries such as Anglo-Saxon ones. Banks usually not only offer traditional banking services, but also concentrate on all parabanking activities--including insurance, mutual funds, and pension funds--and generally have long and well-established relations with their customers. Arguably, the pandemic has strengthened Portuguese clients' relationship with incumbent banks--or at least partly--as banks extensively supported a part of their customers by extending moratoriums actively (loans under moratoria reached about 22% of the system's total loans at their 2020' peak, one of the highest in Europe) as well as other support measures which fostered trust and confidence into the banking system, in our view.

In addition, open banking is in early development, with banks starting to explore ways to leverage on the EU's Payment Services Directive 2 and developing their application programming interfaces. We also believe that the more traditional population may be concerned around data privacy issues relating to information sharing with tech companies. While it cannot be ignored, we believe that security and privacy concerns lower the disruption risk of open banking.

Overall, Portuguese banks are taking steps to adapt to customers' evolving preferences. We believe they still have time but, as technology evolves and millennials become their main customers, those that do not invest sufficiently might see their business models particularly threatened.

Technology: Disruption Risk | Moderate

Adapting to new technology and further digitization will remain high on Portuguese banks' agendas

Portugal ranked 16th of the 27 EU member states in the DESI 2021, up from 19th in the 2020 edition. It performed behind the European average in terms of connectivity, integration of digital technology, and human capital, but it performed better in digital public services. Positively, Portugal displays better-than-European-average deployment of very high capacity networks and take-up of broadband connections of at least 100 megabits per second. However, it lags behind the EU in the assignment of radio spectrum for 5G, as none of the pioneer bands have yet been allocated. At the same time, further work is required to ensure that high-capacity networks coverage and mobile broadband take-up reaches all households, including those in rural areas.

We expect the EU Next Generation Funds, through its Digital transition component, should help Portugal reduce the gap with Europe in the journey of adapting to new technologies. In the case of Portugal, the digital dimension entails spending around €3.7 billion spread across 14 components, accounting for 22% of Portugal's Recovery and Resilience plan (RRP), slightly above the 20% threshold defined by regulators. Portugal's plan focuses on prioritizing digital inclusion and training, as well as the digitization of businesses, public administration, and education.

Portuguese banks have generally started to upgrade and transform their legacy IT structures and processes into newer digital ones. Five years ago, many banks usually considered the investment an upfront cost. However, management teams have now placed digitalization high in their agendas, realizing that it will be a continuous evolution, requiring consistent investment and efforts. In fact, the process of adapting and evolving is lengthy, timely, and costly, often involving complex planning and external advisory. Like in other banking systems, we generally observe larger banks leading and investing more heavily to adapt, while smaller ones may not have the capacity to do so as much. According to S&P Global Market Intelligence, a division of S&P Global, the top 5 Portuguese banks' technology and communication expense has increased, but only very slightly, over the past four years, with the upward trend somewhat interrupted by the pandemic in 2020. This is relatively in line with the trend we observe for our top 50 globally rated banks.

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Portuguese banks have also started or are gradually starting to operate in the public cloud. So far, banks are generally adopting a hybrid cloud strategy, leveraging the benefits granted by the public cloud--including its cost efficiency, scalability and agility--while better addressing data security and compliance-related issues.

Similar to other countries, we expect banks to remain at the center of cyber-risk attacks. Through the height of remote-working in 2020, banks were the institutions with the most cyber-risk incidents in 2020, according to Bank of Portugal. Other studies point in the same direction; for instance, Portugal's "Segurança Informatica" Threat Reports for 2021 show that the banking sector received the highest number of phishing and malware campaigns in Portugal during the first three quarters of 2021. In April 2021, the Bank of Portugal created the Banking Industry Forum on Cybersecurity and Operational Resilience, with the aim of reinforcing cybersecurity of the financial sector (see "Cyber: Are Credit Markets Ready For A Systemwide Attack?", published Dec. 1, 2021; and "Cyber Risk In A New Era: The Effect On Bank Ratings," published May 24, 2021, on RatingsDirect).

Technology offers important benefits and opportunities for the financial industry, and the pandemic has only emphasized this. For a country like Portugal, whose banking sector's revenue remain pressured, digitization remains an important lever to drive productivity gains, in our view. But this must come with reinforced operational and cyber-risk resilience, as otherwise cyberattacks and mismanagement of customer data can undermine banks' reputation and customers' trust. Furthermore, embracing technology might allow Portuguese banks to preserve or improve efficiency.

Regulation: Disruption Risk | Moderate

Broadly aligned with that of the eurozone

We see Portugal's regulatory environment as a neutral disruption risk for domestic retail banks. In line with other European countries, we believe the regulator tries to balance the increasing demand for digital innovation with the need to ensure the system's stability. Regulators do not protect incumbents, but neither do they proactively foster fintechs' developments as much as in other countries such as the U.K. According to the 2021 Portugal Fintech Survey, fragmentation is the main hardship in regulation, followed by access to partners. The survey shows that in 37% of cases, regulation restricts business development very much, in 32% it does not have an impact, and in the remaining 32% it is an enabler.

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Despite this, different organizations have been created over the last half decade. In 2016, Portugal Fintech was launched, as the first non-profit FinTech community in the country. Two years later, Portugal Finlab was created in collaboration with Portuguese Financial regulators (Bank of Portugal, CMVM [capitals' market authority] and ASF [authority for the supervision of the insurance and pension fund industries]), enabling entrepreneurs to receive an opinion about regulatory issues that might arise from their proposed projects. Other organizations were launched afterward, including Fintech House and Fintech Solutions.

Unlike other advanced economies such as Spain, the U.K., Denmark, Poland, or the Netherlands, there is no regulatory sandbox in Portugal yet. There is already a law allowing the creation of sandboxes for different sectors, but so far we do not see signs of creation of a regulatory sandbox for the financial sector. Given Portugal's links with other Portuguese speaking countries (including Brazil, Angola, and Mozambique), the sandbox could further reinforce fintechs' businesses in those countries. Still, obtaining the necessary licenses required to operate in certain business segments in Portugal can sometimes be difficult and a lengthy process.

Finally, Portugal is one of the friendliest crypto countries in Europe. Earnings from crypto are tax-free for as long as they are not done as a main and professional activity, and there is limited regulatory burden on cryptocurrency businesses. This gives indication that banks in the country might have some flexibility when it comes to crypto assets compared with other countries.

No Imminent Risk From Tech Disruption On Portuguese Bank Ratings

Compared with many Western European peers, our ratings on Portuguese banks are lower, reflecting their exposure to higher economic risks in Portugal, as well as the sector's profitability challenges, which the pandemic intensified. The significant share of mortgages in banks' loan books and declining, but still higher than average, stock of nonperforming assets continue to weigh on Portuguese banks' earning capacity, while banks' relatively dense branch networks weigh on their operating expense.

In our view, digital disruption is unlikely to trigger rating actions on Portuguese banks in the next couple of years. We believe that digitalization will give banks opportunities to at least partly compensate for pressured revenue and improve their efficiency further. Nevertheless, those banks that are not able to keep at speed with the much needed and fast-evolving digital transformation and digitization may see their business prospects at risk. Eventually, smaller banks may prove slower to adapt or unable to cope with costly digitization, and thus come under greater pressure. This is, though, a common trend for some of Portugal's peers, including Italy and Spain.

Related Research

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• Cyber Risk In A New Era: The Effect On Bank Ratings, May 24, 2021
• The Future Of Banking: Research By S&P Global Ratings, April 8, 2021