Central Bank Governor Michael Bonello yesterday suggested the banks may need to reassess their dividend policies in view of the expected increase in credit risk.
In his statement in the Central Bank of Malta's annual Financial Stability Report, published yesterday, Mr Bonello said:
"While the risk outlook for financial stability in Malta does not, therefore, give rise to concern at this time, its future evolution remains uncertain in a global scenario characterised by the prospect of weak growth, fiscal retrenchment and market volatility.
"These factors are reflected in the bank's latest forecasts for the Maltese economy, which point to relatively modest growth up to 2011. This suggests that the upward trend in non-performing loans evident in 2009 is likely to persist, a development which would, in turn, call for an increase in loan loss provisioning.
"Combined with the probable introduction of more stringent capital and liquidity requirements in the period ahead and the likely pressure on profitability deriving from an unfavourable economic conjuncture, the expected increase in credit risk suggests that the banks may need to reassess their dividend policies in order to be able to support a commensurate amount of capital."
Mr Bonello said that during 2009 and the early part of 2010, Malta's financial sector exhibited a high degree of resilience.
"As expected, the contraction in economic activity put some pressure on the debt-servicing capacity of households and corporates alike, which was reflected in somewhat higher levels of non-performing loans and an increased incidence of loan rescheduling.
"On the other hand, capital adequacy and liquidity ratios remained robust and well above the regulatory minima, while stress test results confirmed that the banks were able to withstand extreme but plausible shocks," Mr Bonello said.
The Financial Stability Report surveys the financial system in Malta with the objective of identifying possible sources of risk that could impact on the stability of the system while assessing its resilience to shocks. It is also intended to foster a better understanding of the financial system and of relevant financial stability issues.
The report concludes that the outlook points to further challenges ahead for financial stability in Malta, which may be more or less demanding depending on the strength of the economic recovery and its sustainability. There appear to be downside risks to household income prospects and corporate profitability.
Should these risks materialise, this could possibly impair debt-servicing capabilities such that non-performing loans may edge up further in the near term. Credit risk thus remains the main risk facing the banking sector, compounded by the structural dependence on property-related loans. On the other hand, no significant balance sheet deleveraging by the banks has been observed and none is anticipated. Indeed, the possibility of a credit crunch remains remote, particularly as credit demand has decelerated.