The recent IMF report on Malta’s economy has an important section on the financial services sector that is assuming increasing importance in our economy. It is reassuring that our banking sector withstood the impact of the ongoing economic turmoil quite successfully, but as the IMF report implies the stability of the financial sector is a task that needs to be carried out constantly with vigilance and prudence.
We need to underpin our financial system with prudent and determined management of the risks which so far have not been addressed sufficiently- John Cassar White
One point that the IMF report makes is that the actual and simulated stress tests that our financial system underwent in the last few years did not include “a systemic crisis or the failure of systemically important financial institutions”. We are living in turbulent times where we are forced to think the unthinkable on issues that up to some time ago were considered as purely speculative like the question of how our financial system and economy could cope in case of a major failure in our financial system. The IMF is justified in insisting that the effects of exposure to systemic risk should be properly monitored by our regulators especially when one considers that just two major banks control over 90 per cent of our economy.
It is no secret that in the last two decades banks in Malta stimulated the property development market to the point that a bubble may arguably have been created. Banks not only financed massive property development projects but also granted generous mortgagees to those who considered buying property not just to have a home, but also as a means of investment. Even lending to other business organisations is generally secured by collateral in the form of residential or commercial property.
With the property industry facing bleak times and with some of the major property development projects stalling it is reasonable for the IMF to remark that “the framework for asset classification and provisioning is not fully in line with sound practice”. The latest European Commission report on Malta reiterates this concern. It is likely that provisions for property backed lending may need to increase when this framework is updated.
The need for consumer protection understandably comes under the scrutiny of the IMF in the context of worrying cases of alleged overselling by certain financial institutions. The IMF recommends “prompt execution” of the consumer protection mandate insisting that “Consumer protection and business conduct needs to be integrated into the overall financial sector regulatory and supervisory framework.”
The current deposit protection arrangements are also deemed to be inadequate by the IMF team. Put simply this is the insurance fund that banks in Malta manage to ensure that any depositor will recover the first €100,000 of his deposits should his bank be unable to repay his deposits. As was already remarked by the Central Bank in its last Financial Stability Report, the way the deposit insurance scheme is being administered is inadequate. The IMF is therefore recommending that our regulators should “err on the conservative side by imposing buffers (in the deposit guarantee scheme) above the EU proposed minima.”
The IMF team also reiterated a comment that has often been made about Malta’s financial sector vulnerability to shock as a result of substantial credit concentration. “Lending is highly concentrated in housing and construction, loan quality has deteriorated and the number of restructured loans increased. Worryingly, provisioning is a mere 19 per cent of non-performing loans, substantially below the euro area average”.
With our property market being less than transparent it is difficult to determine whether the value given to property held as collateral by the bank is adequate. Although banks do apply “haircuts” to the assumed value of the property they hold as collateral, the IMF recommends that banks should build higher provisions to cater for any unrecognised devaluation in the forced sale value of property held as security.
The regulators should insist on stricter bank processes “for loan classification, impairment determination and provisioning. Non-performing loans have risen to historically high levels in recent years: on loans to corporates it amounted to 12 per cent in June 2011 and is especially high among the construction and real estate firms, while NPL on household loans remained at three per cent”.
We should be satisfied with the fact that our banking sector has remained substantially sound mainly thanks to our low exposure to troubled economies and low-risk financing models that are mainly based on raising funds locally. We now need to underpin our financial system with prudent and determined management of the risks which so far have not been addressed sufficiently.
johncassarwhite@yahoo.com