The Central Bank has just published its 2012 Annual Report. The report carries a review of the bank’s policies and operations during the year and presents detailed financial statements. It starts off with an introductory statement by the Governor, followed by an analysis of economic and financial developments in Malta and abroad.

It is noted that credit growth in Malta remained positive even during the crisis, and exceeded by a considerable margin the corresponding rate for the euro area between December 2007 and December 2012.

During 2012, credit growth in Malta, excluding government, amounted to 1.8 per cent, compared with a contraction of 1.1 per cent in the euro area. On the liabilities side, Maltese banks continued to make modest use of Eurosystem funding, reflecting the absence of funding distress.

For the banking sector as a whole, the main indicators are positive

The Maltese banking system is categorised into three groups, differentiated by the degree of systemic relevance.

While the internationally oriented banks are a large component of the banking sector, they have minimal links to the domestic economy or to the rest of the financial sector. Overall, this group of banks is highly capitalised with a very high ratio of regulatory capital to risk weighted assets, and is also highly liquid and profitable.

The non-core domestic banks, which have moderate systemic importance due to limited links with the economy, are similarly well capitalised, liquid and profitable.

The core domestic banks, which have the highest systemic importance, fund themselves mainly from local retail deposits and are also important sources of funds for domestic borrowers. The profitability of this core group is reflected in the increase in the return on equity, from 19.6 per cent in 2011 to 23.9 per cent in 2012.

The high level of profitability provides ample opportunity for a further increase in provisioning levels to strengthen resilience, particularly in relation to lending to particular sectors, such as commercially-oriented construction. Towards this end, the Governor stresses the importance of prudent dividend policies.

This group of banks is well capitalised, with a ratio of regulatory capital to risk-weighted assets that increased from 13.5 per cent in 2011 to 14.3 per cent in 2012, considerably above the eight per cent minimum.

Ahead of more stringent regulatory requirements under the Capital Requirements Directive IV, banks are encouraged to enlarge further their capital buffers and better align the maturity of their liabilities with that of their assets.

For the banking sector as a whole, the main indicators are positive, with continued high-solvency ratios, higher profitability and with increases in liquidity. The ratio of capital to risk weighted assets for the entire banking system stood at 53.3 per cent, well in excess of the required eight per cent.

The return on assets as well as on equity increased in 2012. Moreover the ratio of liquid assets to short term liabilities rose from 49.6 per cent in 2011 to 55.6 per cent in 2012, exceeding by far the 30 per cent minimum, as required in Malta.

This positive picture for the overall sector holds well in each of the three components, namely the core and non-core domestic banks and the international banks.

In the light of the various issues pertaining to the banking system, the regulatory structure was further strengthened by the formation of the Joint Financial Stability Board in January 2013, which was an important institutional development.

This board was set up jointly by the Central Bank and the Malta Financial Services Authority to establish mechanisms of cooperation between the two institutions with regard to macro and microprudential issues.

The Governor also refers to the Single Supervisory Mechanism (SSM), which is a supervisory mechanism covering all commercial banks in the euro area and which will begin operations in 2014. The SSM will be composed of the national competent authorities and the ECB, with the MFSA serving as the Maltese authority.

The Governor highlights the uncertainty that continues to surround the outlook for the euro area, notwithstanding an easing of financial tensions in the second half of 2012.

He notes that the impairment in the transmission of monetary policy in the euro area has resulted in financial fragmentation and divergent economic performances across countries. Thus, after having expanded by 1.4 per cent in 2011, real GDP in the euro area contracted by 0.5 per cent in 2012.

As regards the Maltese economy, this continued to endure adverse conditions in important export markets. As a result, the economy grew by 0.8 per cent in 2012, down from 1.7 per cent a year earlier.

The Maltese economy had the third highest growth rate among the euro area’s member states in 2012, compared with a negative growth rate of 0.5 per cent in the euro area as a whole. The bank estimates Malta’s GDP growth in 2013 to pick up to 1.4 per cent.

On the inflation front, the Governor notes that, on the basis of the retail price index, the rate of inflation is expected to decline from 2.4 per cent in 2012 to two per cent in 2013.

The Governor raises a number of longer-term considerations related to the competitiveness of the Maltese economy. He notes that many countries responded to the macroeconomic imbalances exposed by the crisis by introducing structural reforms and fiscal consolidation measures, while engaging in an internal devaluation involving cuts in wages and other costs.

Such measures will leave these countries in a stronger competitive position in the eventual recovery. This is set to pose an increased competitiveness challenge to Malta’s economy. Only higher productivity can provide sustainably higher wages and living standards. Towards that end, the quality of the human capital has to adapt to the changing needs of both the domestic and export markets.

Moreover, prudence is important on the issue of minimum wage setting, as unjustified increases in Slovenia and Cyprus have led to losses in competitiveness and weaker employment prospects in those countries.

On the government finance side, the bank expects the deficit ratio to fall to 2.6 per cent in 2013, while the debt ratio is expected to rise slightly to 72.5 per cent. Although the government has not experienced any funding difficulties, it is essential that the debt ratio is brought down to the 60 per cent benchmark in a deliberate manner, since at current levels the room for fiscal manoeuvre is limited. Fiscal prudence will also promote the sustainability of public sector financing and ensure compliance with the new EU fiscal rules.

Fiscal consolidation should be complemented with improvements in the regulatory infrastructure, while the current economic situation calls for the enhancement of the business environment.

The Governor supports the establishment of a development or promotional bank in Malta. Such a bank would improve the capacity of the financial system to meet medium and long-term financing needs.

In particular, a development bank could be instrumental in mobilising the excess liquidity characterising the financial system more effectively and deploying certain government assets efficiently. The bank encourages the Government to explore the possibility of establishing a development bank.

Such an institution can serve to unlock further the financial potential that is available, in order to spur competitiveness and economic growth with a limited added burden on government finance.

In reviewing the bank’s operations during 2012, the Governor highlights the bank’s responsibilities in relation to the formulation and implementation of monetary policy in the euro area. In this context, he recalls that the bank conducted market operations with eligible counterparties in Malta worth an aggregate of €11.2 billion.

Funds transferred to the government increased by €10 million to €52 million

The bank also continued to monitor the domestic financial system, to assess potential risks to which the system could be exposed. In this respect, it maintained close contacts with the MFSA and with the Ministry of Finance, the Economy and Investment.

The bank also participated in the work of the European Systemic Risk Board. In liaison with the MFSA, the bank played a key role in the European Banking Authority’s recapitalisation exercise, which replaced the stress test in 2012. The Maltese bank which participated in this exercise met the necessary requirements of the exercise and comfortably exceeded the capital threshold.

The bank issued euro banknotes and coins and also continued to regulate and oversee the payment and securities settlement systems. It provided various banking services to the government, to the broader public sector and to the banks.

The bank’s net operating profit for 2012 amounted to €78.2 million, as against €52.5 million a year earlier. A provision was established for the first time in 2012, in the amount of €11.4 million.

In addition, €14.8 million was added to reserves, compared with €10.5 million the year before. Funds transferred to the government increased by €10 million to €52 million.

The annual report is available on the Central Bank’s website at www.centralbankmalta.org.