25/07/2022

Financial system’s resilience and performance improve despite challenging times

The Central Bank of Malta has just published its fourteenth edition of the Financial Stability Report (Report) which assesses developments in 2021 relevant for domestic financial stability, covering the activities of banks, as well as domestically-relevant insurances and investment funds.

The Report notes that the macroeconomic environment in the EU improved over a year ago as vaccination programmes aided the reopening of economic activity. However, recovery was uneven across sectors, partly due to supply bottlenecks, coupled with the emergence of new COVID variants which led to the reintroduction of containment measures. Geopolitical risk rose further exacerbated by the Russia-Ukraine war and its compounding effect on the already-rising inflationary pressures particularly for energy and commodity prices with potential ramifications on growth prospects, going forward. As pandemic-related government support measures were maintained in 2021, government debt levels continued to increase with potential debt sustainability concerns for some jurisdictions, particularly due to the strengthening of links between governments, banks, and corporates.

On the domestic front, despite the high uncertainty surrounding the global economic climate, banks reported improved asset quality owing to both reduced NPLs and higher loan volumes. The latter was largely driven by increased mortgages as lending to corporates was solely driven by the Malta Development Bank's COVID-19 Guarantee Scheme. This edition of the Report carries a Special Feature which assesses the potential drivers of cyclical risks, highlighting the increased concentration towards property-related loans within the loan portfolio. Such developments reaffirm the need for continuous monitoring of increasing concentration risk in the banks' loan portfolios for the timely adoption of targeted policy measures if the need arises. The profitability of banks recovered strongly reflecting lower provision charges and, to a lower extent, higher fees and commission income. Yet, the banks' main source of income remained related to net interest income.

The overall solid performance of financial markets in 2021 had a positive impact on domestically-relevant investment funds as their holdings of equities rose, which were partly offset by lower bond holdings amidst increasing inflationary pressures. Similarly, domestically-relevant insurance companies also benefitted from the general upswing in financial markets as they raised their exposures in equities and investment funds. As a result, the profitability of this sector also improved, coupled with a general increase in premia, supported, in turn, by the overall economic recovery.

Overall, the Report finds that the domestic financial sector has shown strong resilience in 2021 despite challenges for certain sectors. The findings are corroborated by results of the liquidity and solvency stress test exercises, which reveal an overall resilient financial system. Nevertheless, going forward, financial stability risks remain, mainly due to the war between Russia and Ukraine, largely through second-round effects, as the direct exposure to these two countries is limited. Furthermore, inflationary pressures and downside risks to economic growth could possibly impact debt servicing capabilities, which in turn, could test the resilience of the domestic financial sector. This highlights the importance for credit institutions not to engage in excessive risk taking and set aside adequate provisions whilst maintaining healthy liquidity and capital buffers. The cybersecurity landscape is always shifting with more sophisticated threats emerging. Financial institutions should therefore remain at the forefront for the adoption of the latest technological advancements to safeguard themselves against cybersecurity risks.

This edition of the Report features for the first time a climate risk related adverse scenario for the macro stress testing framework, including two related boxes explaining in detail the assumptions and methodology applied for this framework. The scenario seeks to assess the impact on banks' capital from heightened transitional risks following oil price hikes to disincentivise its use and reach net zero emissions by 2050. The impact of the climate related test on the overall capital of the banks is not low but does not indicate any specific needs for recapitalisations. The significance of the test is, however, to shed light on banks' preparedness under such a scenario and thus, on the importance of assessing risks related to exposures linked with high CO₂ emissions and associated climate-related costs going forward.

The Report also includes a second Special Feature and two other boxed articles. The Special Feature details the methodological framework of a newly added liquidity test which assesses banks' liquidity stance over a one-year horizon against the Net Stable Funding Ratio regulatory requirement. One of the boxes presents the main results of the bank lending surveys, while the other box reports the results of a Central Bank of Malta's survey on buffer usability. It highlights the importance of adequate capital buffers for banks to continue supporting the economy during adverse shocks, as well as the importance of targeted policy tools and active communication with the industry.

The Financial Stability Report can be downloaded here or obtained in printed form from the Central Bank of Malta.

Watch the video to learn more about the main points.

Back to Archive