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Publication of Financial Stability Report 2012

The Central Bank of Malta is publishing on its website the fifth edition of its annual Financial Stability Report, covering the year 2012 and the first months of 2013. The Report analyses the financial system in Malta identifying potential risks and vulnerabilities and the system’s resilience to shocks. The main focus of the Report is on financial institutions which play a significant role in the economy, referred to as the core domestic banks. Developments relating to the other two categories of banks (non-core and international banks) and the rest of the financial system are analysed separately. The Report first describes the macroeconomic and financial environment within which the financial system operated in the period under review. It then considers the challenges to financial stability and the resilience of the core domestic banks. The Report then continues with an analysis of the other components of the financial system and concludes with an assessment of the risks identified and the respective recommendations to address them. The Report also contains a boxed article on the EU’s Single Supervisory Mechanism.

Overall, the Report concludes that throughout 2012 the domestic financial sector remained robust, supported by positive, albeit modest economic growth. However, it continued to face challenges from an uncertain external environment, characterised by fragile conditions in international financial markets.

The core domestic banks, which mainly fund themselves from local retail deposits and lend to residents, remained well capitalised, highly liquid and profitable. The balance sheets of the core domestic banks expanded by 3.5% during 2012, reflecting to a large extent growth in their lending portfolios. As in past years, mortgage lending remained the main driver of credit activity, increasing by 6.8%. However, consumer lending contracted by 1.2%, while corporate credit contracted by 1.1%. Customer deposits remained the main source of funding of the core domestic banks, increasing by 5.6% during the year. As a result, the customer loan to deposit ratio stood at a high level of around 70%. Owing to ample liquidity conditions, the liquidity ratio, at 49.1%, remained well above the minimum regulatory requirement of 30%, while the core domestic banks made relatively little use of Eurosystem or other wholesale funding. Contagion effects from financial markets in the euro area remained limited as the core domestic banks continued to shift their investment portfolios towards higher-rated securities. In 2012 the profits of the core domestic banks rose by more than a third, reflecting a steady income stream from their traditional banking business operations. This led to a higher return on equity ratio, up from 19.5% in 2011 to 23.9% in 2012. The return on assets also improved from 1.3% in 2011 to1.6% in 2012.

Throughout 2012, the core domestic banks remained well capitalised. The capital adequacy ratio of these banks increased from 13.5% in 2011 to 14.3% in 2012, significantly higher than the 8% minimum threshold, while the Tier 1 capital ratio also improved from 9.6% in 2011 to 10.3% in 2012, also well above the regulatory minimum of 4%.

The other two categories of banks, namely the non-core banks and international banks, which have limited links to the domestic economy and to the rest of the financial sector, maintained high capital adequacy ratios. These banks also remained highly liquid and profitable. In their operations they continued to focus mainly on transactions with non-residents. Both the non-core and international banks reported solvency ratios significantly in excess of the regulatory requirements, with the capital adequacy ratio standing at 29.1% and 102.7%, respectively. In aggregate their liquidity ratios also remained well above the minimum regulatory requirement standing at 82.4% for the non-core banks and 146.3% for the international banks. The profitability of these banks remained strong with a return on equity of 6.5% for non-core banks and 3.6% for international banks. With regard to the non-bank financial sector, namely the insurance firms and investment funds, their performance remained robust throughout 2012.

The Report highlights the risks and threats faced by the local financial sector. These remained broadly stable, with no new challenges emerging since the previous Financial Stability Report and its Update. With respect to credit risk, the core banks’ exposure to specific sectors, particularly the construction and real estate sector, resulted in an elevation of this risk as reflected in the increase in the level of non-performing loans, especially in the construction and real estate sector. The higher level of non-performing loans was however attenuated by a strengthening of provisioning by the banks.

The banks were encouraged to continue monitoring their loan books, increase provisions and to periodically assess their customers’ creditworthiness, apart from maintaining haircuts at high levels on immovable property offered as collateral. Furthermore, ahead of the deadline to meet new regulatory requirements, in particular the Capital Requirements Directive (CRD IV/ CRR), the banks were encouraged to further augment their capital positions through higher levels of retained earnings.

Risks emanating from the balance sheets of other segments of the financial sector, namely the insurance and the investment fund, remained broadly low and unchanged. While they continued to have a close relationship with core domestic banks, such linkages posed little risk to the overall financial system.

The Financial Stability Report can be downloaded from www.centralbankmalta.org.