The key challenge to the banking sector remained the upward trend in non-performing loans, according to the Central Bank of Malta’s update to its Financial Stability Report, which covers developments in the first half of 2014.

It said that the increase in non-performing loans was partly driven by the weak performance of some economic sectors which rely heavily on domestic bank credit. In response, banks increased their provisions which resulted in an amelioration of the coverage ratio.

They also continued to apply “conservative valuations” of collateral, backing their lending portfolio, and the loan-to-value ratios continued to be kept at a “prudent level”, it said.

It noted that the balance sheet strength and resilience to certain economic shocks of the banks, which were included in the ECB Comprehensive Assessment, were also demonstrated by the fact that following the assessment, their CET1 ratios remained above the baseline and adverse thresholds which were set at eight per cent and 5.5 per cent respectively.

The update did not identify any new risks and vulnerabilities to financial stability.

During the first six months of 2014, the core domestic banks’ balance sheet grew by 4.5 pr cent, mainly reflecting higher securities holdings and interbank exposures.

Placements with the Central Bank of Malta decreased considerably as the deposit facility rate turned negative.

The loan portfolio, however, remained the predominant asset component and continued to be funded by customer deposits.

Looking ahead, the update said that external pressures, particularly those arising from weak eurozone economic growth, low inflationary pressures and a prolonged low interest rate environment, could exert a marginally higher negative impact.

The Financial Stability Report Update can be downloaded from the Central Bank of Malta’s website.