The Central Bank of Malta has just published the twelfth edition of its Financial Stability Report (the Report) which assesses financial sector developments in Malta during 2019. It sets out an update of the risks and vulnerabilities originating from both the domestic financial system and the global macroeconomic environment, coupled with policy measures taken to minimise those risks. The assessment is supplemented by top-down stress tests, together with sensitivity analyses, to ascertain the resilience of the financial system. The Report features a number of boxed-articles, including an analysis of recent macroprudential measures and results of the bank lending surveys. Although the Financial Stability Report typically covers the developments of the previous calendar year, this edition carries a special feature on the main channels through which the COVID-19 pandemic is impacting the domestic financial system.
The Report shows that the resilience of the banking sector has improved and the sector entered the pandemic phase with healthy capital levels and strong liquidity. During 2019, the balance sheet of the core domestic banks grew further to represent around 186% of GDP. Similar to previous years, lending for house purchases coupled with higher placements with the Eurosystem drove this expansion, the latter evidencing the banks’ ample liquidity buffers. These banks remained focused on domestic business activities, primarily funded by domestic short-term retail deposits. The quality of their loan book continued to improve, on the back of lower resident non-performing loans in the construction and real estate sector, and – to a lower extent – the resident household sector, reflecting the banks’ conservative lending policies. While bank profitability remained stable, in line with developments abroad, challenges to profitability persisted owing to the continued low interest rate environment, narrowing of interest rate margins and higher operational costs.
The operations of non-core domestic banks remained generally oriented towards non-resident customers. International banks also maintained their international business profile with negligible links with the domestic economy. Their operations are primarily dominated by the two largest branches of foreign banks, which further consolidated their local operations. Both groups of banks reported positive profits, on the back of strong capital and liquidity buffers. In general, risks and vulnerabilities of these banks remain contained.
Domestically-oriented insurance companies reported strong solvency positions and improved profitability. Meanwhile, investment funds continued to adopt prudent investment strategies. Similar to banks, the low interest rate environment is posing challenges for insurance companies, impacting their profitability. This notwithstanding, the Report highlights that the recent surge in global financial market volatility may trigger a resurgence of a re-pricing of risk premia and a consequent increase in liquidity risks for the domestic investment fund sector.
The analysis confirms that the domestic financial system remained resilient to a number of key challenges in 2019, buttressed by favourable domestic macroeconomic conditions. In addition, financial stability risks from real estate were abating on the back of more moderate growth in real estate prices coupled with a contraction in the number of dwelling permits. Moreover, household debt-to-GDP remained relatively stable and somewhat lower than the previous years’ highs.
Nevertheless, going forward, the COVID-19 outbreak is expected to exert unprecedented pressure on key sectors of the economy, which in turn, is very likely to affect the domestic financial system.
Profitability will come under further pressure, whilst banks and insurances will strive to seek alternative sources of income or reduce costs to maintain a healthy profitability. The low interest rate environment, which is expected to persist, will also affect their income generation from investments and the direction of credit markets is still uncertain. While slower growth in credit demand, particularly for mortgages, may impact their income from intermediation, this could be partly compensated by higher short-term demand for corporate loans to finance working capital requirements. At the same time, asset quality is expected to weaken as those creditors affected directly by the pandemic crisis, may be unable to meet their debt repayments. However, swift action taken by the supervisory authorities including the ECB, the Maltese Government, and the Central Bank of Malta are all expected to alleviate some of the risk to the sector. Against such a background, the Central Bank of Malta recommends that banks continue to adopt prudent lending practices while at the same time exercising caution in taking on additional risks through the further easing of credit standards. Financial institutions are encouraged to maintain conservative investment strategies, and to continue to improve cost synergies to ensure sustainable profitability in the longer term and strong capital buffers.
The Financial Stability Report can be downloaded from www.centralbankmalta.org or obtained in printed form from the Central Bank of Malta.