Interim Financial Stability Report 2020

The Central Bank of Malta has just published its Financial Stability Report – Interim 2020 which assesses financial sector developments in Malta during the first six months of 2020 and potential risks and vulnerabilities going forward.

The Report details how the financial sector was being affected by the COVID-19 pandemic, which in line with global trends presented unparalleled challenges to both the sector as well as the economy at large. Coupled with pre-existing challenges, such as the low-for-longer interest rate environment and geopolitical tensions, the pandemic continued to exert pressure on the profitability of financial services providers. The Report maintains the outlook of the 2019 Financial Stability Report, where the financial system was deemed to be sufficiently resilient to weather this storm, albeit with downside risks.

The Report refers to developments being partly driven by the adverse movements in prices of financial assets and the subsequent credit rating downgrades. The containment measures employed to stop the pandemic spread invariably affected economic activity, bringing a number of sectors to a halt. This created uncertainties – particularly about the likelihood of creditors being able to meet their payment obligations. In this regard, the Bank issued Directive No.18 regulating moratoria, launched to ease the burden on borrowers whose income was impacted. In a bid to anticipate any potential losses arising from credit defaults, banks have started to set aside additional provisions, which also adversely affected profitability.

Concurrently, the containment measures to control the spread of the pandemic had a negative effect on consumption that resulted in lower card usage and payments business, and hence lower fees and commission income. This – coupled with lower credit growth – had a negative effect on banks’ net interest income as this fell for the first time in many years.

Growth in resident private credit slowed down, mainly on the back of slower growth in mortgages and to a much lower extent resident corporate credit. Resident consumer credit turned into negative territory once again, as consumer confidence deteriorated significantly in March and in subsequent months, only to recover slightly in June 2020. This – coupled with the postponement of spending and the corresponding increase in household saving – led to an increase in customer deposits. Despite these challenges, the Report points to core domestic banks remaining well capitalised and operating with ample liquidity buffers, also reflecting the significant increase in deposits.

Looking at the non-core domestic banks, the Report finds the profitability of this category of banks was also adversely impacted, while their balance sheet contracted. This group of banks nonetheless remained well capitalised and operated with ample liquidity buffers. The operations of international banks remained broadly focused on non-residents and, despite consolidating further, remained dominated by the developments in the largest branches of foreign banks.

Similar to banks, the pandemic had an adverse impact on the profitability of domestically-relevant insurance companies, with profits more than halving, on the back of lower investment income and premia. This was, in turn, amplified by a slow-down in new business and higher cancellations of events affecting several economic sectors. Despite these challenges these financial institutions remained well capitalised and highly liquid.

Domestic investment funds’ assets under management contracted, mainly due to redemptions, coupled with valuation losses on both equity and bonds holdings. Nonetheless, the liquidity profile of domestic relevant investment funds remained healthy.

The Report reiterates also its main message to key players in the sector: that in such challenging times, financial institutions should remain vigilant to new risks and keep a healthy capital and liquidity position. The recovery of the financial sector depends largely on the economic recovery, which in turn depends on how quickly consumer and business confidence recover. This also depends on the timing of the rollout of a vaccine. In the meantime, banks should seek to continue to adopt prudent lending practices and continue to recognise provisions where required, to avoid any possible cliff effects when moratoria expire. In addition, banks should seek alternative sources of income and embark on sustainable cost containment measures to improve profitability without compromising their capital and liquidity buffers. Meanwhile, investment funds and insurance companies’ investment strategies should remain conservative, particularly in the current uncertain environment.