Publication of Financial Stability Report 2013
The Central Bank of Malta is publishing the sixth edition of its Financial Stability Report, covering the year 2013. The Report covers developments in the Maltese financial system, identifying potential risks and vulnerabilities and evaluating the system’s resilience to such risks. The Report mainly concentrates on those banks which have significant links to the Maltese economy, referred to as the core domestic banks. Developments in the non-core domestic and international banks, as well as insurance companies and investment funds are analysed separately.
The Report first sets, as a backdrop, the local and international macroeconomic and financial environment within which the financial system operates. It proceeds to analyse the financial stability risks and vulnerabilities identified in the financial system and assesses the resilience of the core domestic banks against these challenges, even under stress scenarios. The Report then continues with an analysis of the other components of the financial system. It concludes with an assessment of the identified risks and highlights the measures addressing them. The Report also contains several special articles namely on State Aid; Developments in the ECB’s Asset Quality Review and Stress Tests; the Bank Lending Survey Results; the revised Banking Rule 09; the Credit Risk Threshold Model and on Macro-prudential Policy.1
Despite the fragility of the external macroeconomic environment and a fragmented euro area financial system, the Report concludes that in 2013, the domestic financial sector remained sound with risks remaining broadly stable. This was supported by economic growth as well as regulatory developments.
During 2013, the balance sheet size of the overall banking system contracted from 774.8% of GDP to 697.3% of GDP. This was mainly the result of voluntary reduction in operations of a small number of international banks owing to consolidation of activities. The balance sheet of the core domestic banks expanded by 2.5% reflecting to a large extent a rise in deposits which resulted in higher holdings of securities, and an increase in placements with the Central Bank of Malta. The loan portfolio, which remained the main asset component, rose marginally, as lending to households increased, partly offset by higher net loan repayments to the non-financial corporate sector. The core domestic banks continued to maintain prudently diversified investment portfolios. Customer deposits remained the main funding source for the core domestic banks, rising by 5.8%, reaching almost 85% of total liabilities. As a result, the loan-to-deposit ratio stood at 66.5%, significantly below the euro area average of 105.8%. Wholesale and euro system funding declined and remained low.
Credit risk remained a key challenge for the banks arising particularly from specific weak performing sectors. Non-performing loans of the core banks reached 9.2% of total loans by the end of the year. In response the banks increased their provisioning levels further, resulting in improved coverage ratios. In addition, the introduction of the revised Banking Rule BR/09 as at end-2013, mitigated further credit risk.
During 2013, the core domestic banks’ capital buffers improved further, with the capital adequacy and Tier 1 capital ratios reaching 14.9% and 11.1%, respectively, well-exceeding the regulatory thresholds. This placed the banks in a stronger position to meet the requirements of the new CRD IV/CRR-framework. Furthermore, the core domestic banks’ liquidity position remained ample, with the liquidity ratio significantly above the statutory 30% minimum requirement. During the year, the profits of the core domestic banks declined by 8.6%, generally owing to lower net interest income. However, profitability ratios still compared well with historical averages, and are significantly better than those of their EU counterparts. The results of the top down stress tests undertaken by the Central Bank of Malta reaffirmed the banks’ overall underlying strength to various hypothetical shocks.
Risks arising from the non-core domestic and international banks remained generally low and stable. The balance sheet of these banks contracted on aggregate, reflecting developments by the international banks which consolidated their balance sheet in line with their group’s strategic direction. Meanwhile capital and liquidity levels remained very healthy. The two groups of banks both registered relatively high profits though somewhat lower than in the previous year. Linkages of these banks with the domestic economy and to the financial sector remained very limited. Similarly systemic risks posed by the insurance and investment funds sectors continue to be low. The insurance sector reported higher capital levels and technical reserves. Although their profits dropped, these still compared well with those of EU insurance groups.
The Report also gives a summary of the main vulnerabilities and risks faced by the local financial sector. During the year, risks from the local economy have eased, driven by the positive growth trends reported in 2013 and early 2014. Risks from the EU sovereign debt crisis abated and yields have declined significantly. Credit risk arising from specific economic sectors, increased due to higher levels of non-performing loans but this was mitigated by higher provisions and capital buffers. The risk of prospective lower profitability levels remains, largely due to the low interest environment and subdued credit growth. The prolonged low interest rate environment could increase the level of risk in investment portfolios of financial institutions in an effort to search for a higher yield in an attempt to limit as much as possible the downward pressure on profitability. Nevertheless, the risk outlook for 2014 remains broadly stable. Banks are anticipated to meet the new and more stringent regulatory requirements, especially with respect to capital and liquidity positions, although regulatory challenges remain. Banks are therefore still encouraged to diversify their funding sources to promote higher credit growth; increase further their provisions and strengthen their capital base by adopting prudent dividend policies.
The Financial Stability Report can be downloaded from www.centralbankmalta.org or obtained in printed form from the Central Bank of Malta.