The cloud over the soundness of Malta’s banking sector induced by the goings on in Cyprus has lifted. There was no cause for it in the first instance. There is no similarity in the structure of our banking sector and that of Cyprus. The comparable element is Malta’s core bank group, made up of five banks servicing the Maltese economy.

The three-year phase-in of higher bank contributions to the deposit guarantee scheme can be accelerated

Of the remainder, eight have minor dealings and the rest are international banks who do not feature at all in servicing the domestic economy. The international banks account for 490 per cent of gross domestic product. The core group accounts for only 218 per cent of GDP.

Any comparison with the Cyprus structure, massively dependent on external deposits including some of a dubious nature, and on investments in Greece, including Greek sovereign debt, was totally out of tune. That was made clear by several correspondents in the local media, and authoritatively so by Josef Bonnici, Governor of the Central Bank of Malta, as well as in a pithy statement by the Ministry of Finance, and in interviews with the Minister of Finance.

Facts speak louder than uninformed doubts and hasty conclusions. Nevertheless the Governor returned to the theme once more in another very good article in The Sunday Times (April 14). He reiterated the basic facts about the banking system to conclude that it is diversified and robust. “Any speculative doubting of the soundness of Malta’s banking sector, which is strictly regulated and boasts strong liquidity ratios and loan-to-deposit ratios, is unwarranted,” said Prof. Bonnici.

However he did not rest on the obvious laurels. He took the opportunity to indicate some of the exchanges with the domestic banks, principally the two dominant ones, using words that necessitate reflection and action.

“The Central Bank,” said the Governor, “still argues for further improvements (in the banking sector). 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,” he went on. “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.”

There is much to chew on in these words. Though strong, the banking system needs to become healthier. It is in a position to do so by finding a better balance between the interests of shareholders and those of its long-term strength. Shareholders are always after high dividends. But the banks should also be driven by other considerations.

That is what the Central Bank Governor spelled out in public, indicating that the domestic banks have not adequately heeded the Central Bank’s advice in private. Moral suasion, a bit of arm twisting by the Governor, apparently has not worked. Stronger behind the scenes action is required.

The public shareholders of the listed banks should also note the Governor’s implicit warning. Obviously they want good dividends. But the listed banks are generally so profitable that they can afford leaving part of their net earnings as retained profit to further strengthen their capital base.

They should also find it possible to increase their loan loss provisions, both general and specific, in view of their lending to the property sector. That is not to deny that the banks have strong collateral against such loans. Also, the property sector has corrected itself over the last three years or so, such that it is not felt that a bubble exits.

Nevertheless strengthening the capital base by retaining a higher level of profits would be wiser than distributing too much of them.

The discussion should be continued at the level of the Central Bank and the Malta Financial Services Authority. It will not be easy, not least because the listed banks have institutional shareholders who probably press for strong dividend distribution more so than the individual shareholders.

But plain speaking is necessary. The ball is rolling. It should not stop in the columns of the press. The Governor’s recommendation that banks should continue to strengthen the funding of the depositor compensation scheme as envisaged by the EU framework should also be taken to heart. The three-year phase-in of higher bank contributions to the deposit guarantee scheme can be accelerated, given that it should already be in place.