As another euro area country, Cyprus, was forced to seek an international bailout, attention focused on other EU countries with large financial sectors. Unfortunately, generalisations tend to be based on headline numbers and aggregate statistics that may lead to the wrong conclusions. Malta came under the spotlight as being similar to Cyprus. But there are some radical differences between the Maltese and Cypriot banking models.
Malta’s banking sector is diversified
Basing itself on a strict regulatory framework, the local banking sector has grown, and today its assets amount to almost 800 per cent of GDP. However, Malta’s banking sector is diversified and is home to the practice of three main business strategies and banking models. These include the core domestic group of five banks, the non-core domestic group of eight banks and a group of 15 international banks.
International banks account for the largest share, more than 490 per cent of GDP. These have very limited links to the local economy and to the rest of the Maltese financial system. Almost all their activity is focused on non-resident business, including trade finance, investment banking and intragroup transactions. Resident loans and deposits play a very small role in their business model, and they pose almost no burden on the deposit guarantee scheme.
An intermediate group consists of non-core domestic banks that have limited links with the economy, and are of relatively small systemic significance. Their volume of operations and range of banking services to residents is limited.
The core domestic banks, with assets equal to 218 per cent of GDP, below the EU average, are intrinsically linked to the Maltese economy. Operating on traditional business lines, these banks compete in the domestic retail deposit market, lend locally and hold securities issued in Malta. They have limited exposure to the troubles in a number of foreign economies.
The separation between international banks from the domestic banks is quite distinct in Malta. In contrast, in Cyprus, systemically significant banks took on a large international role, including large holdings of Greek paper and a large volume of funds from outside the EU. The combination of these factors led to the crisis in Cyprus.
The financial soundness indicators show that the different parts of the Maltese banking sector all compare very well to the European averages. The Capital Adequacy Ratio of Maltese banks is well above the eight per cent regulatory minimum, confirming that the sector is well capitalised.
In simple terms, a bank’s capital provides a cushion for potential losses, and protects the bank’s depositors and other lenders. The CAR for the core domestic banks is slightly above the EU average, and that for the rest of the banking system is considerably higher.
The profitability of core domestic banks is very high. Impressively, the return on assets is 16 times higher than the current EU average. Core-domestic bank profitability measured by the return on equity is achieving double-digit results, nearly 24 per cent, and it is close to nine times the European average.
The same can be said about the liquid assets to total assets ratio, which is almost three times higher than the euro area average. Having a low liquidity ratio, especially during a liquidity crisis, can pose serious risks to the stability of the financial sector. With a ratio of 28.8 per cent, Malta’s banking sector has ample liquidity, further confirming its soundness and robustness.
Another important measure of liquidity is the loan-to-deposit ratio, which stands at 70 per cent, compared to 110 per cent in the euro area. The low ratio is a reflection of the Maltese banks’ reliance on retail funding sources.
The selected financial soundness indicators confirm Malta has a sound and robust banking sector. The core domestic banks, deeply integrated with the local economy, are all highly capitalised, profitable and liquid, and the other parts of the banking sector also perform well. This was also confirmed last week by the European Commission in its review of the Maltese economy.
The Central Bank still argues for further improvements. It has long argued for the need of domestic banks to increase their relatively low loan loss provisioning, to limit risks that domestic banks may face due to their traditional exposure to the real estate market.
The banks are prudent enough to require collateral that far exceeds the amount that they lend. But given the prominence of provisions as an indicator of bank soundness, the supervisory authorities insist on meeting internationally-accepted criteria for provisioning against the risk posed by non-performing loans.
The high level of profitability provides a good opportunity for the allocation of a portion of profits to additional provisions and the Central Bank has repeatedly called for more prudent dividend policies so as to strengthen the financial characteristics of the domestic banks.
Although solvency ratios stand well above current regulatory requirements, banks can further increase their capital base through higher retained profits. It is also recommended that banks continue to strengthen the funding of the depositor compensation scheme as envisaged by the EU framework, and a three-year phase-in of higher bank contributions to the deposit guarantee scheme is under way.
Malta’s economic performance is encouraging, with positive GDP growth, moderate inflation and unemployment rates that are far below those in most other euro area countries. This further reinforces the strong fundamentals of the local financial and banking sector.
The Household Finance and Consumption Survey released by the European Central Bank last week provides positive indicators of family finances in Malta and a relatively high level of household wealth. The fact that Malta’s household wealth is the third highest in the euro area attests to the stability of the bank’s retail deposit base.
Any speculative doubting of the soundness of Malta’ banking sector is unwarranted.
Josef Bonnici is the Governor of the Central Bank of Malta.