The Malta Stock Exchange Index lost 35 per cent of its value in 2008, according to the first edition of the Central Bank of Malta's annual Financial Stability Report. The MSE Index ended at 3,208, the lowest level since 2005.
"The overall decline was largely due to the weight of the banks' shares in the MSE Index. Although most of the banks in Malta did not suffer directly from the international crisis, some banks did suffer losses from valuation adjustments. As a result, particularly following the announcement of a fall in profits as a result of these losses, bank share prices declined by about 48 per cent during the year," the report said.
The report says that the drop in the rest of the market was more contained, at 28 per cent.
"As share prices declined, volatility increased throughout 2008. This was particularly evident in the case of bank equity, reflecting a higher risk perception and greater uncertainty in the market. Nonetheless, the MSE Index is still less volatile than other indices, such as the S&P 500 and the DJ EUR STOXX," it added.
It said that government bond yields declined during 2008, but they too displayed significant volatility.
"In the early months of the year, concerns about inflation and related rising interest rates resulted in higher yields. As the financial crisis intensified, however, flight-to-safety, as well as expectations of lower interest rates, led to a reversal of this trend," the report said.
Secondary market activity remained limited in 2008, with trading volume down by about seven per cent. The drop was most pronounced in equity trading. Although still accounting for 63.5 per cent of transactions, this was lower than the 69.4 per cent share recorded in 2007.
"The turnover ratio remained low, confirming the lack of liquidity in the market," it said.
The report says that in spite of the international crisis, the banks remained sufficiently liquid and adequately capitalised to continue to extend credit. "Indeed, during 2008 their loan portfolio grew by 12.9 per cent (€915.2 million), compared to 4.1 per cent in 2007. Thus, in spite of tighter lending conditions, the supply of credit to the domestic economy accelerated, with lending to residents growing by €813.4 million or 12.9 per cent."
The Central Bank, added, however, that if deteriorating macroeconomic conditions lead to higher unemployment and or falling demand, the repayment capabilities of both households and corporates may be impaired, leading to higher default rates and pressure on the banks' profitability and capital.
In his introduction to the report Central Bank of Malta Governor Michael Bonello said the publication of the Financial Stability Report coincides with a crisis of unprecedented proportions in the global financial system.
"The resilience of the sector is confirmed by the results of stress tests carried out in connection with this report, which show that the banks generally have adequate capital buffers and sufficient liquidity to withstand extreme, but plausible shocks. The liquidity profile of the banks remains strong, largely supported by their focus on funding their liquidity needs through retail deposits," he said.
Mr Bonello said that as with banks elsewhere, credit institutions in Malta are increasingly vulnerable to the negative feedback from the sharp slowdown in the real economy. He added that non-performing loans of the non-financial sector are likely to increase as debt-servicing capabilities deteriorate during 2009.
"This expectation is linked in particular to the significant concentration risk to which banks in Malta are exposed, stemming from both a direct, and an indirect exposure through collateral, to the property sector. As the re-pricing of risk is likely to continue in the near term, moreover, there will also be further downside risks to earnings growth," he added.
The Governor said that as the domestic financial system is still vulnerable to secondary shocks, largely stemming from valuation effects, dysfunctional international market conditions and diminished debt repayment capacities of corporations and households in the context of a decelerating domestic economy, the banks would do well to strengthen capital buffers further beyond statutory ratios.
"This should help the banking system become less vulnerable to risks originating from these sources," he said.
The Financial Stability Report 2008 is available on the Central Bank of Malta's website at http://www.centralbankmalta.org.