Barometers are more useful to forecast future weather conditions than to tell us what the current conditions are. The latest Concluding Statement of the IMF Mission gives us some very interesting readings on the economic conditions that are likely to affect us in the next few years while it confirms that we have weathered the recent global crisis aftershocks relatively well.
Our regulators must ensure they have more experienced staff to challenge the risk management strategies of banks- John Cassar White
The part of the IMF statement that captured my interest more intensely is the section subtitled “Improving Financial System Soundness”. I say this because some of the points raised are not well known beyond the closed doors of our regulators’ boardrooms. These points are also very rarely analysed by the financial media that seems more interested in splashing dramatic but rather superficial economic headlines on their front pages.
The IMF confirms that in the last few years the financial sector in Malta “continued to perform strongly”; but quickly adds a list of concerns that are worded in technical language that often hides the seriousness of the risks that this sector could pose to the rest of the economy. The financial sector’s size which is above eight times our GDP and large foreign ownership “represents a number of risks to financial stability and liquidity ratios”.
One could be complacent and argue that we need not worry about the consequences of being so successful in this sector. But worry we should, unless we take steps to strengthen our regulatory framework. One lesson that bank failures in the 2008 crisis has taught us is that regulators must be more thorough in their oversight of banking activities.
They should act when they see the first signs of weakness in the risk management function of banks. The IMF uses clinical but strong words when it lists its concerns as being: “too-big-to-save (financial operators), the adequacy of backstopping resources in case of default or deposit run, the capacity to deal with a banking shock and its impact on the economy, as well as supervisory challenges.” Can regulators sleep peacefully with this kind of concentration risk that is growing steadily?
Equally revealing and sobering are the IMF’s comments on “micro-prudential regulation and supervision”. The IMF statement acknowledges the value of the recent quality control exercise undertaken by the MFSA to ensure that its supervisory function was indeed up to scratch. But it also lists the work that still remains to be done to address the weaknesses in the important areas of “supervisory capacity (notably staffing), definition and monitoring of connected party transactions, and internal audit functions and better consumer protection”. Put in another way, our regulators must ensure that they have more experienced staff to challenge the risk management strategies of banks that often employ more experienced staff than the regulators. The issue of identifying the full extent of the concentration of risk in the hands of a few economic operators needs to be addressed vigorously.
The IMF statement sees other possible storm crowds on our economic horizon. “Lending is highly concentrated in housing and construction, loan quality has deteriorated, and the number of restructured loans increased”. The IMF prescription for this debilitating condition is for the riskier banks to “increase provisioning and restrain dividend payout and to strengthen capital buffers”. It also advises the MFSA to improve assessment of “the robustness of banks” processes for loan classification, impairment determination, and provisioning practices. In plain simple language, the regulator should have a good look at the banks’ cupboards to ensure that there are no old or recent skeletons lurking in some dark corner.
Equally sobering are the comments made on the adequacy of the Deposit Compensation Scheme (DCS) that protects bank depositors for up to €100,000 in case of a member bank’s failure. The IMF clearly says that the “target size of the scheme is unsatisfactory and a shortfall could have knock-on effects on the entire banking system and the Government’s budget.”
I would go a step further and recommend that the regulators scrutinise the business models of some banks operating in the local market offering retail deposits interest rates that are much higher than anything offered in international financial markets. One needs to ask in what high-yielding but virtually risk-free instruments these banks are investing the proceeds of these deposits most of which are guaranteed by the DCS and ultimately by the Maltese taxpayers.
As the IMF statement rightly warns, the “authorities should be giving due recognition to the potentially high risks in our financial sector”.
johncassarwhite@yahoo.com