High exposure to the property market made the banking system in Malta vulnerable, the European Commission warned yesterday.
Banks are vulnerable to more deterioration in the quality of their loan portfolio
In a Commission communication to the EU Council, it urged the government to take measures “to ensure the robustness of the financial sector”.
The Maltese banking system has always done well each time it was put to the test, including at last year’s stress tests by the European Banking Authority.
However, its recent rapid growth and a noticeable increase in “problematic loans” seem to be worrying Brussels.
Central Bank governor Josef Bonnici made a similar warning last month when he urged the banks to continue strengthening their capital buffers to mitigate risks associated with non-performing loans, the concentration of property-related lending and the use of property as loan collateral.
The Commission described the need to strengthen the financial sector as “a new challenge” for Malta’s long-term economic sustainability.
While maintaining healthy solvency and profitability ratios throughout the recent global economic crisis, “Malta’s domestic banks were not shielded from the slowdown in economic activity and have seen a concomitant rise in problematic loans”, it said.
According to the Commission, these developments had not been accompanied by an increase in provisioning and, therefore, the non-performing-loan coverage remained low.
“As a result, banks are vulnerable to a further deterioration in the quality of their loan portfolio, especially as further correction in house prices cannot be excluded, while housing units may currently be in oversupply,” the Commission warned.
“The very large size of the banking sector raises supervisory challenges and concerns about the capacity to deal with a banking shock and its impact on the economy,” the EU Executive said.
The recommendation on the need to strengthen Malta’s banking sector is the only new one among the six made in the Commission’s communication.
Last year, Brussels gave Malta five further tasks to complete by the end of 2011, ranging from revising the pensions system to a reform in the cost-of-living-adjustment mechanism.
Noticing “limited progress”, the Commission has repeated the proposals.
In its assessment, the Commission said Malta had not made sufficient progress towards implementing the 2011 recommendations, so the challenges identified remained valid for this year too.
Malta faced the challenges of ensuring the long-term sustainability of public finances; improving the utilisation of human capital; ensuring appropriate wage developments; reducing its dependence on imported oil and safeguarding the robustness of the banking system.
According to the Commission, although the plans submitted by Malta earlier this year to reach these targets appeared relevant, “concrete reform plans in the area of wage indexation are still missing”.
Also, “the level of ambition in some areas, such as early school-leaving and pension reform, is insufficient to address these challenges in a comprehensive way”.
The Commission’s recommendations will have to be approved by EU leaders at their traditional mid-year summit at the end of June.
The six recommendations
• Reinforce the budgetary strategy in 2012 with additional permanent measures to ensure adequate progress towards the medium-term budgetary objective and keep the deficit below three per cent of GDP without recourse to one-offs. Implement, by end of 2012 at the latest, a binding, rule-based multi-annual fiscal framework.
• Take action, without further delay, to ensure the long-term sustainability of the pension system, comprising of: a significant acceleration of the progressive increase in the retirement age compared to current legislation; a clear link between the statutory retirement age and life expectancy; and measures to encourage private pension savings.
• Take steps to reduce the high rate of early school-leaving. Pursue policy efforts in the education system to match the skills required by the labour market. Enhance the provision and affordability of more childcare and out-of-school centres, with the aim of reducing the gender employment gap, and at the same time, reducing the effects of parenthood on female employment.
• Take the necessary further steps to reform, in consultation with social partners and in accordance with national practices, the system of wage bargaining and wage indexation to better reflect developments in labour productivity and reduce the impact of prices of imports on the index.
• Reduce Malta’s dependence on imported oil, step up efforts to promote energy efficiency and increase the share of energy produced from renewable sources by carefully monitoring the existing incentivising mechanisms and by prioritising the further development of infrastructure, including by completing the electricity link with Sicily.
• Strengthen the banking sector, take measures to mitigate potential risks arising from the large exposure to the real estate market. Take measures to further strengthen the provisions for loan impairment losses.