Malta
Financial System Stability Assessment
Author: International Monetary Fund. Monetary and Capital Markets Department
Publication Date:
27 Feb 2019
eISBN:
9781498300636
Language:
English
Keywords:
ISCR; CR; bank; banking sector; banking system; IMF staff calculation; potential GDP; regime
Download PDF (8.1 MB)

This Financial System Stability Assessment of Malta shows that while Malta has benefited from considerable financial inflows, the associated risks, especially related to money laundering and terrorism financing, need to be closely monitored and addressed. Key metrics suggest that the banking system is in good health, but challenges exist. The banking system remains resilient under a severe scenario, with weaknesses limited to a few small banks. The system is sufficiently capitalized to absorb losses in the event of a severe macroeconomic shock, but risky exposures would lead to potential losses at a few small banks. The analysis suggests that ensuring adequate resources is critical to preserve the effectiveness and operational independence of the Malta Financial Services Authority (MFSA). In order to strengthen bank supervision, the MFSA should take timelier supervisory actions, increase the frequency of onsite inspections, make more use of monetary fines as part of the sanctioning regime, and ensure supervisory action is not delayed through judicial appeal.

Abstract

This Financial System Stability Assessment of Malta shows that while Malta has benefited from considerable financial inflows, the associated risks, especially related to money laundering and terrorism financing, need to be closely monitored and addressed. Key metrics suggest that the banking system is in good health, but challenges exist. The banking system remains resilient under a severe scenario, with weaknesses limited to a few small banks. The system is sufficiently capitalized to absorb losses in the event of a severe macroeconomic shock, but risky exposures would lead to potential losses at a few small banks. The analysis suggests that ensuring adequate resources is critical to preserve the effectiveness and operational independence of the Malta Financial Services Authority (MFSA). In order to strengthen bank supervision, the MFSA should take timelier supervisory actions, increase the frequency of onsite inspections, make more use of monetary fines as part of the sanctioning regime, and ensure supervisory action is not delayed through judicial appeal.

Executive Summary

The financial sector in Malta is large compared to the economy and is strongly connected with the rest of the world. While Malta has benefited from considerable financial inflows, the associated risks, especially related to money laundering and terrorism financing (ML/TF), need to be closely monitored and addressed.

Key metrics suggest that the banking system is in good health, but challenges exist. Banks are well capitalized, liquidity is ample, and profitability is healthy. However, core domestic banks’ high exposure to property-related loans, together with the rapid house price appreciation, poses a risk. The significant share of nonresident deposits in international and noncore domestic banks makes them vulnerable, but their exposure to the domestic economy is limited. While nonperforming loans (NPL) remain below the euro area (EA) average, there are pockets of distressed corporate loans that continue to impact banks’ balance sheets.

The banking system remains resilient under a severe scenario, with weaknesses limited to a few small banks. The system is sufficiently capitalized to absorb losses in the event of a severe macroeconomic shock, but risky exposures would lead to potential losses at a few small banks. Under a stress event, large withdrawals of wholesale and nonresident deposits can put some banks under pressure. Contagion risk is estimated to be limited, but distress could impact smaller banks due to cross-border and cross-sectoral linkages. There is a need to closely monitor banks’ evolving business models to detect potential shifts in systemic risks, strengthen the stress test approaches, and enhance data quality and management.

Continued enhancements are encouraged in the macroprudential framework. While the recent strengthening of systemic risk monitoring is commendable, the legal framework should be enhanced, data gaps closed, and nonbank risk assessment strengthened. The planned introduction of borrower-based measures to address buildup of vulnerabilities in the housing and household sectors is welcome.

Ensuring adequate resources is critical to preserve the effectiveness and operational independence of the Malta Financial Services Authority (MFSA). It is a challenge to meet the increasing demands of supervising the growing number of financial institutions in an evolving and more complex regulatory environment. The MFSA is substantially understaffed, which undermines its effectiveness and operational independence. The authorities should upgrade the MFSA’s operational capacity and grant it full autonomy over its recruitment. The authorities should develop a five-year plan to ensure sustained budgetary resources for the MFSA. Further steps should be taken to enhance checks and balances in the MFSA’s decision-making process.

Shortcomings in bank supervision call for urgent action. To strengthen bank supervision, the MFSA should take timelier supervisory actions, increase the frequency of onsite inspections, make more use of monetary fines as part of the sanctioning regime, and ensure supervisory action is not delayed through judicial appeal. Supervision should focus on main risks (credit, liquidity, and compliance) and the adequacy of risk classification and provisioning. Further actions are needed to align the related-parties framework with the Basel Core Principles (BCP). Improving oversight of non-European Union (EU) branches is also important.

Actions are needed to support the use of early intervention and resolution powers, and to address weaknesses in the bank liquidation and insolvency framework. Policies and procedures should be developed for the MFSA’s early intervention and resolution powers, including to mitigate legal risks. An administrative bank insolvency framework should be adopted, and the creditor hierarchy clarified. Responsibility for decisions on bank liquidation and insolvency post-license withdrawal should be shifted from the MFSA’s supervisory function to its resolution function. The MFSA and the Ministry for Finance (MFIN) should develop their internal crisis management plans.

Containing financial integrity risks is critical to financial stability. The cross-border linkages of the large financial sector pose significant ML/TF risks, notably from foreign proceeds of crimes, which create challenges through growing reputational risks, pressure on correspondent banking relationships (CBR) and compliance costs. The fast-growing remote gaming activity, virtual-assets intermediation, and high demand for real estate and the Individual Investment Program (IIP) call for effective measures to contain financial integrity risks.

A multi-prong approach is needed to address anti-money laundering and combating the financing of terrorism (AML/CFT) deficiencies. Enhancing the AML/CFT system is required to protect the financial sector and the broader economy from the ML/TF threats. Efforts should focus on banks’ application of preventive measures (including customer due diligence with efficient verification of beneficial ownership (BO)), in particular regarding their higher risk activities and clients, including the significant nonresident sector. Additional supervisory resources are needed for Financial Intelligence Analysis Unit (FIAU) and the MFSA to bolster the application of risk-based AML/CFT supervision. The authorities should take appropriate corrective actions—including timely, dissuasive, and proportionate sanctions—in case of breaches of AML/CFT requirements. Establishing an EU-level arrangement responsible for AML/CFT supervision should be supported to facilitate a consistent and comprehensive approach and minimize regulatory arbitrage.

Table 1.

Malta: Key Recommendations

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I = Immediate (within 1 year); ST = Short Term (within 1–2 years); MT = Medium Term (within 3–5 years)

Macrofinancial Background

A. Context and Risks

1. Malta’s highly open economy is strongly connected to the rest of the world. After joining the EU in 2004 and the EA in 2008, Malta harmonized its financial sector legislation with that of the EU. Its favorable tax environment, the EU passporting of financial institutions, use of the English language, and relatively low costs have attracted international businesses, including in finance.1 During the global financial crisis (GFC), domestic banks were shielded by their relatively simple business models, reliance on domestic funding, and limited exposure to structured products and wholesale funding. Post-GFC, several financial institutions have downsized or left Malta, consistent with their foreign owners’ deleveraging strategies. The country became the first EU jurisdiction to adopt a regulatory framework for virtual financial assets (VFA) in 2018.

2. Malta’s economic growth has been one of the strongest in Europe (Figure 1, Table 2). The annual GDP growth averaged 6.8 percent in 2013–17, supported by rapid expansion of export-oriented services, including tourism and remote gaming.

Figure 1.
Figure 1.

GDP Growth, 2004–17

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: CBM; Eurostat; IMF World Economic Outlook; and IMF staff calculations.
Table 2.

Malta: Selected Economic Indicators, 2016–24

(Year-on-year percent change unless otherwise indicated)

article image
Sources: Maltese authorities and IMF staff projections.

Share of population with an equivalized disposable income (including social transfers) below the threshold of 60 percent of the national median equivalized disposable income after social transfers. Data as of 2017.

3. Credit growth has been lagging the rate of economic expansion (Figure 2). The credit-to-GDP gap has been negative, reflecting the broad-based slowdown in credit growth post-GFC. Credit grew at 3½ percent per annum in 2015–17, mostly supported by mortgage lending. Bank credit to the private sector declined to a historic low of about 80 percent of GDP by end-2017, with bank credit to nonfinancial corporates (NFC) declining and the NFCs increasing their intercompany borrowing (Figure 3). Banks’ tighter lending standards, NFCs’ improved cash positions, low opportunity costs, and tax advantages have contributed to increasing intercompany lending.

Figure 2.
Figure 2.

Broad Credit Conditions

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Source: Malta authorities and IMF staff calculations.1/ All banks, excluding foreign branches.
Figure 3.
Figure 3.

Lending to Nonfinancial Corporations

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese Authorities and IMF staff calculations.1/ “Other holders: include Government, households, and the rest of the world. 2/ “Non-Group companies” include related non-group companies. 3/ Profit share here is the two-year moving average of the ratio of gross operating surplus to gross value added. 4/ The consolidation is done at the domestic group level.

4. NFCs’ leverage is high compared to their European peers. Construction and real estate exhibit the highest leverage ratios, reflecting capital-intensive nature in these sectors. Mitigating factors include the relatively high profitability of Maltese firms and requirements for high collateralization of bank loans.

5. Household debt is above the EA average, and home ownership is high (Figure 4).2 Household debt stood at 108 percent of gross disposable income in 2017, while the home ownership ratio was 82 percent. Post-GFC households’ financial wealth has increased, leaving the debt-to-financial-wealth ratio stable at 23 percent. The loan-to-value (LTV) and the debt-service-to-income (DSTI) ratios of new mortgages remained broadly unchanged since 2011, averaging 77 percent and 21 percent, respectively, in 2017 (Figure 5).

Figure 4.
Figure 4.

Household Indicators

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Source: Maltese Authorities; 2017 Eurosystem Household Finance and Consumption Survey; IMF staff calculations.1/ Household leverage includes non-profit institutions serving the household sector. Household balance sheets were stressed, using the adverse macroeconomic scenario used to stress test banks. Debt consists of outstanding amounts of mortgages and on credit cards, credit lines/bank overdrafts, and outstanding amounts of other, non-collateralized, loans (including loans from commercial providers and private loans).
Figure 5.
Figure 5.

Banks’ Mortgage Lending to Residents

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.1/ All banks, including non-EU branches. At end-2017, total property-based lending (i.e., to residents and nonresidents) was 40 percent of total loans to customers. For core domestic banks, the ratio was 56 percent.

6. Property-related lending is increasing fast. With mortgage lending growing by 8½ percent annually since 2013, and bank lending to NFCs declining, concentration of mortgage loans has risen, making banks susceptible to a potential sharp decline in housing prices.

7. Residential housing prices have risen quickly in recent years (Figure 6). Employment growth, influx of foreign workers, rising disposable income, and portfolio rebalancing toward property investments in a low-interest-rate environment have pushed residential property prices up by 33 percent in 2010–17. Demand is also fueled by buoyant tourism, tax benefits for first-time homebuyers, lower tax on rental income, and the IIP. Construction investment has recently picked up, reflecting a supply response to rising property prices.

Figure 6.
Figure 6.

Housing Prices

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.1/ Two different house price indexes are used in the model. The price index published by the CBM is based on advertised prices of the residential property, while the price index published by the NSO is based on reported market transactions. See the 2019 Article IV Staff Report.

8. Banks’ exposure to government debt is low and concentrated (Figures 7, 8). Malta’s sovereign debt is largely domestically held. Banks held 29 percent of total government debt (3.3 percent of assets) in 2017, with 90 percent of these holdings concentrated in core banks (6.6 percent of their assets).

Figure 7.
Figure 7.

Bank-Sovereign Nexus

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.Note: Total banking sector, non-EU branches included.1/ “International” are shown without non-EU branches but “Total” includes all banks, including non-EU branches.
Figure 8.
Figure 8.

Sample Banks’ Balance Sheet Composition

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.

9. Malta has recently seen some high-profile ML/TF-related incidents in the banking sector.3 In July 2018, the European Banking Authority (EBA) established that the FIAU had breached the Third EU Directive on the prevention of AML/CFT in case of Pilatus Bank and issued a series of recommendations. Reflecting supervisory actions taken by the MFSA and the current requirements of Union law, EBA decided in September 2017 not to open a breach of Union law investigation for the MFSA.

B. Financial Sector Landscape

10. Malta’s financial system is large compared to its economy and is strongly linked with the world. The financial system comprises banks, insurance companies, investment funds (Figure 9), and a large residual category of “other financial institutions” (OFIs).4 The cross-sectoral linkages show that a part of the banking sector and OFIs hold large assets and liabilities mostly vis-à-vis the rest of the world (Figure 10).

Figure 9.
Figure 9.

Structure of Financial System1/

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities, ECB, and IMF staff calculations.1/ Total banking sector, non-EU branches included.
Figure 10.
Figure 10.

Cross-Sectoral Linkages (Gross Exposures, 2017)1, 2, 3

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: CBM and IMF staff estimates.1/ Prepared by Giovanni Ugazio (Statistics Department, IMF).2/ Based on financial account data (“from-who-to-whom”), the nodes’ size represents the size of the net balance between funds borrowed and lent by a sector, while the nodes’ color represents whether a sector is a net debtor (red) or creditor (green). The thickness of arrows from a sector to another depicts the bilateral exposures.3/ “OFIs” include captive financial institutions and money lenders.

11. Most banks, insurers, and funds orient their business models either domestically or internationally (Appendix II). Malta’s economy continues to exhibit some features of its previous offshore regulatory regime, where the institutions licensed under the regime were restricted from doing business with residents. While financial institutions now operate under a unified licensing regime, there continues to be strong segmentation across several dimensions, including the geographical concentration of their funding sources and assets.

Malta: Structure of the Financial System, 2004–17

Assets in Multiples of GDP (unless otherwise indicated)1

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Sources: CBM and MFSA.

European system of national and regional accounts (ESA 2010); CBM excluded. Other financial institutions comprise captive financial institutions and money lenders.

12. Maltese banks are the most important players in the financial sector. Their roles vary considerably depending on their business models and market orientation. There are 25 banks, of which six account for about half of system assets, 95 percent of resident deposits, and 98 percent of loans to residents. Two non-EU bank branches hold 39 percent of system assets but have no exposure to Maltese residents.

13. Key metrics suggest that the banking system is in good health. Banks’ total capital adequacy ratio is high (21.2 percent of risk-weighted-assets (RWA) in 2017; Tier 1 Capital ratio at 19 percent) and liquidity is ample (Figure 11, Table 6).

Figure 11.
Figure 11.

Banking Sector Overview

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: FSI, CBM, MFSA, and IMF staff calculations.1/ Sample banks.Note: Total banking sector, non-EU branches included.
Table 3.

Malta: Insurance Market Structure

(percent of GDP)

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Source: Maltese authorities

The assets of composite insurers are allocated under non-life, as this is the dominant business.

Table 4.

Malta: Analysis of Gross Written Premiums in 2017

(€ million)

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Sources: Maltese authorities and IMF staff calculations.
Table 5.

Malta: Investment Fund Structure

(percent of GDP)

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Source: Maltese authorities.
Table 6.

Malta: Financial Soundness Indicators/1

(Percent unless otherwise indicated)

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Sources: Maltese authorities and IMF staff estimates.

Based on CBM Financial Stability Report (except for leverage ratios) https://www.centralbankmalta.org/financial-stability-report.

International Banks and Total Banks include non-EU branches.

14. Some challenges exist with asset quality, profitability, funding, and CBRs:

  • Asset quality has been improving with challenges remaining in real estate-related lending (Figure 12). Banks’ NPL ratio declined from 6.6 percent in 2014 to 4.1 percent by end-2017 (excluding non-EU branches). NPLs of NFCs declined from 11.8 percent in 2014 to 9 percent in 2017 and remained persistently high in construction (27.8 percent) and corporate real estate (13.9 percent). Asset quality remained weak in a few small banks and, in 2016, the authorities mandated banks to reduce their NPL ratio below 6 percent over five years. Loan loss provisions (LLP) stood at 34 percent of NPLs in core domestic and international banks, and 57 percent in noncore domestic banks.

  • Bank profitability remains good, but uncertain going forward. Stable net interest margins (NIM) and operating costs help maintain profitability (Figure 13). For core domestic banks, NIM is relatively high. However, if corporate loan books continue contracting and the property market weakens, the sustainability of core banks’ profitability and business models would be challenging, given the large exposure to low-yield bonds, increased regulatory compliance costs, higher LLP requirements, and the implementation of Minimum Required Eligible Liabilities (MREL) which will likely raise funding costs.

  • Funding has been ample but depends on banks’ business models. While banks’ funding structure varies by business orientation, loan-to-deposit ratios are generally low and liquidity high. However, the high and growing reliance on nonresident deposits (especially by smaller banks) and the high share of sight deposits raise concerns about funding stability in the case of adverse shocks.

  • Some banks’ CBRs are subject to pressures and various restrictions, particularly when they themselves provide correspondent banking services and channel flows from high-risk jurisdictions or deal with high-risk clients (e.g., nonresidents, e-gaming, virtual-asset operators, IIP, and politically exposed persons). The concerns stem from reasons such as profitability (e.g., low volume of transactions and high compliance costs), risk appetite, and reputational risk.

Figure 12.
Figure 12.

Banking Sector Asset Quality

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese Authorities and IMF staff calculations.Note: Total banking sector, foreign branches excluded.
Figure 13.
Figure 13.

Sample Banks’ Profitability

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.Note: Sample banks (11 banks), covering 93 percent of total assets, foreign branches excluded.

15. Insurers, investment funds, and investment service firms in Malta focus mainly on foreign markets (Tables 3, 4, 5). Except for eight domestic insurers, the insurance sector writes predominantly non-Maltese risks, mainly in other EU countries. Domestic insurers’ assets amounted to 37 percent of GDP at end-2017; they have large exposures to core domestic banks and underwrite a negligible amount of foreign risk. The insurance market is sophisticated, as evidenced by the presence of professional reinsurers, captive insurers, protected cell companies (PCC), and one reinsurance special purpose vehicle. Domestic investment funds’ assets amounted to 16.8 percent of GDP at end-2017. The top three domiciles for the Undertakings for Collective Investment in Transferable Securities (UCITS) passporting into Malta were Luxembourg, Ireland, and the United Kingdom. The top three jurisdictions where the Maltese investment service licensees passported their services to were Italy, Germany, and the United Kingdom. The Malta Stock Exchange had a market capitalization of 1.1 times GDP at end-2017, but market turnover is thin.

16. The OFI sector is large and mostly exposed to foreign affiliates. With total assets amounting to 16¾ times GDP, these companies are typically tax-minimizing Maltese entities (holding, invoicing, and royalty companies) that transact with their foreign affiliates (parent companies or subsidiaries) and are therefore not engaged in shadow banking.5 At end-2017, 98 percent of the OFIs’ assets were invested abroad; 65 percent of assets were unlisted shares; and equity prevailed on the liability side. At end-2017, OFIs held deposits with 11 Maltese banks, amounting to 4.5 percent of banking sector deposits.

Financial System Resilience

17. Challenges to financial stability stem from global and Malta-specific factors (Risk Assessment Matrix (RAM), Appendix I). The risks could materialize as follows:

  • Reputational risks, including from ML/TF, loss of CBRs, sanctions, and changes in international corporate taxation, could negatively affect Malta’s attractiveness as a financial and business center.6

  • A sharp correction in housing prices would trigger adverse wealth effects and a deterioration of NPLs for domestically oriented banks.

  • Given the openness of Malta’s economy, weaker external demand would adversely affect domestic confidence and growth prospects.

  • A sharp tightening of global financial conditions would lead to declines in asset prices and cause valuation losses and higher funding costs.

18. The FSAP assessed the capacity of the banking system to withstand losses and continue supporting the real economy (Appendix III). The analysis was conducted in collaboration with the authorities. Going forward, the authorities need to closely monitor bank activities to detect potential shifts in systemic risks, strengthen the stress test approaches, and enhance data quality. New dimensions should be introduced in liquidity stress testing (e.g., residents versus nonresidents and longer time horizon) and regular sensitivity analysis conducted on solvency for selected vulnerabilities (e.g., credit and funding concentration risks).

A. Solvency and Sensitivity Analysis

19. Top-down solvency stress tests were conducted using baseline and adverse scenarios for 2018–20. The baseline was aligned with the April 2018 World Economic Outlook. The adverse scenario was based on the IMF Flexible System of Global Models and covered the risks identified in the RAM. It envisaged a cumulative deviation of GDP from the baseline of 15.4 percent (2.07 standard deviations) over three years (Figures 14, 15). The magnitude of the shock is similar to that in the 2018 EBA stress test and is more severe compared to past crisis periods in Malta, largely motivated by the current buoyant macroeconomic conditions. The sample accounts for 93 percent of bank assets (excluding foreign branches).

Figure 14.
Figure 14.

FSAP Stress Test Scenarios1/

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: CBM, ECB, and IMF staff calculations.1/ The baseline was aligned with the April 2018 World Economic Outlook.
Figure 15.
Figure 15.

FSAP Macroeconomic Projections1/

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: CBM, ECB, and IMF staff calculations.1/ The baseline was aligned with the April 2018 World Economic Outlook.

20. In the baseline, the banking system remains resilient. Capital ratios remain high after declining slightly on account of balance sheet expansion (leading to RWA growth) and valuation losses caused by higher yields (Figures 16, 17, Table 7). The total capital ratio stabilizes at 19.4 percent and the leverage ratio (Tier 1 to total assets) at 9.1 percent for the sample.

Figure 16.
Figure 16.

Results of the Top-Down Solvency Stress Test—Quasi-Static Approach

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.Note: Sample banks (11 banks), covering 93 percent of total assets, foreign branches excluded.
Figure 17.
Figure 17.

Contribution to the Results of the Top-Down Solvency Stress Test—Quasi-Static Approach

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.Note: Sample banks (11 banks), covering 93 percent of total assets, foreign branches excluded.
Table 7.

Malta: Solvency Stress Test Results

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Sources: Maltese authorities and IMF staff estimates.

21. High initial capital ratios make the banking system resilient to a severe economic downturn, with vulnerabilities found in a few small banks.

  • For sample aggregate, all capital ratios remain comfortably within the Basel III requirements. The Common Equity Tier 1 (CET1) ratio would decline by 329 bps to 14.5 percent compared to end-2017. The total capital ratio would decline by 390 bps to 16 percent. The results are driven by loan loss provisions, increased RWA, and valuation losses.

  • Three small banks would see at least one of their capital ratios decline below the regulatory thresholds. Total recapitalization needs would remain manageable at 0.14 percent of GDP.7 These banks’ weakness stems from lower starting capital ratios and lower quality of their loan portfolios (particularly in the corporate sector) and high lending to mortgage, real estate, and construction.

  • No bank would see its leverage ratio below the 3 percent threshold, with one bank just above it.

22. Sensitivity tests showed vulnerabilities to asset concentration in some small banks. On aggregate, banks would absorb the defaults of large exposures (including to the construction and real estate). However, a simultaneous default of five largest exposures would cause four banks’ CET1 to fall under the regulatory 4.5 percent threshold. Interest rate sensitivity tests and a single-factor funding cost shock show low exposure to direct interest rate risks, partially explained by the prevalence of variable rate loans, including mortgages.

B. Liquidity Stress Tests

23. On aggregate, the banking system is resilient to short-term liquidity pressures, but some banks would struggle to meet the liquidity coverage ratio (LCR) requirement under stress conditions. High liquidity buffers help banks withstand short-term liquidity shocks (Figure 18). However, heavy reliance of some small banks on wholesale and nonresident deposits (both retail and wholesale) makes them susceptible to combined large withdrawals of wholesale and nonresident deposits. Under each of the LCR liquidity stress tests, a few small banks fail to meet the minimum requirement.

Figure 18.
Figure 18.

Results of the Top-Down Liquidity Stress Test

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculationsNote: Sample banks (11 banks), covering 93 percent of total assets, foreign branches excluded.

24. A liquidity stress test based on the net stable funding ratio (NSFR) showed that most banks do not face structural long-term liquidity risks. The relatively high capital and share of retail deposits drive this result. Only a few small banks struggled to meet the requirement, mostly due to their high share of mortgage and long-term corporate loans.

25. Cashflow-based tests reveal funding gaps in some small banks over five day, one-month, and three-month time horizons. These tests use the maturity ladder data to assess banks’ resilience to funding outflow shocks. Some banks experience negative cash balance after utilizing their counterbalancing capacity. The cashflow-based tests point to vulnerabilities resulting from the substantial share of short-term deposits.

26. Reliance on large depositors makes some small banks vulnerable. Withdrawals of the five largest depositors caused the LCR of three banks to fall below the 80 percent threshold. Similarly, three banks failed under large withdrawals of depositors from certain economic sectors.

C. Contagion Risks and Interconnectedness Analysis

27. The risk of contagion through domestic intersectoral linkages is higher than through cross-border interbank exposures due to cross-ownership and deposit concentration. The analysis used model-based simulations of bilateral exposures.

  • The analysis of financial sector’s domestic interlinkages reveals the potential for cascade effects and spillovers mainly from core banks to insurers, and to a lesser degree, funds (Figure 19). Though capital buffers help mitigate contagion risks, the high concentration of exposures makes some entities vulnerable.

  • The analysis of cross-border interbank exposures points to a relatively strong level of interconnectivity with the EA and other European banks, which can generate contagion losses to Maltese banks (Figures 20, 21). The overall losses are limited, with the distress concentrated in a few smaller banks.

Figure 19.
Figure 19.

Domestic Cross-Sectoral Exposures

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: Maltese authorities and IMF staff calculations.1/ Cross-sectoral network comprises 24 banks (red), 8 insurers (blue) and 8 funds (green). Nodes indicate vulnerability to contagion and lines reflect the prominence of large exposures normalized by absorption capacity of financial entities.2/ Sector-wide losses caused by one sector to another. For example, core banks on average cause contagion losses to insurers of about 55 percent of the capital of the insurance sector (represented by the 8 domestically-oriented insurers).3/ Total number of contagion defaults of a sector, triggered by simulated defaults of all entities in another sector.
Figure 20.
Figure 20.

Cross-Border Exposures

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: ECB, MFSA, Bloomberg, and IMF staff calculations.1/ Cross-border banking network comprise 21 Maltese banks (red nodes) and 58 non-Maltese banks (blue) nodes. Nodes indicate the degree of vulnerability to systemic risk and lines are proportional to relative size of large exposures with respect to capital.2/ Node size indicates relative size of inward spillover to Maltese banks (purple) from thirteen EA (red), eight other European (green), eight advanced economies (blue) and five emerging markets (yellow); color and thickness of nodes indicate “total connectedness to others” with darker and thicker lines indicating stronger pairwise relationships. Node location is derived with ForceAtlas2 algorithm (Jacomy and others, 2014), a network spatialization tool based on nodes repulsing each other like magnets, while edges attract their nodes, like springs, with these forces creating a movement that converges to a balanced state.
Figure 21.
Figure 21.

Contagion Mapping of Cross-Border Exposures/1

Citation: IMF Staff Country Reports 2019, 070; 10.5089/9781498300636.002.A001

Sources: ECB, MFSA, and IMF Staff calculations.1/ The cross-border contagion mapping is based on a sample of 21 Maltese banks with large exposures to a total of 58 banks outside. The numbering of columns indicates only the respective ranking in each chart. For example, the hypothetical default of the most contagious bank, Bank 1, results in the average losses to the Maltese banks of close to 5 percent of their capital buffer (columns in the upper panel). The most vulnerable bank, also labeled Bank 1, incurs average losses of about 13 percent of its capital buffer (lower panel).

Financial Stability Policy Framework

A. Macroprudential Policies and Systemic Risk Monitoring

28. Malta’s institutional framework for macroprudential policy is broadly in line with IMF guidance for effective macroprudential policymaking.8 The CBM is empowered to pursue its statutory macroprudential functions and has communication tools to ensure accountability and transparency. The CBM’s ability to act is supported through regulatory powers and access to data. The Joint Financial Stability Board ensures effective coordination with relevant agencies, including MFIN and MFSA, and with European counterparts on cross-border issues.

29. The legal backing of interagency coordination could be strengthened. The CBM should be empowered to recommend actions to a public authority or institution with a “comply or explain” mechanism and to issue warnings and opinions. The MFSA should be provided with a financial stability objective while making sure its powers and functions (or tasks) remain distinct from those of the CBM. These measures would raise the accountability and awareness of macroprudential policy and reduce potential conflicts with microprudential policies in times of stress.

30. Continued efforts are encouraged to strengthen systemic risk monitoring. Efforts should focus on developing commercial real estate price indexes and collecting granular data on loans, including intercompany loans. The authorities are encouraged to strengthen the risk assessment of the nonbank financial sector, including the OFIs.

31. The planned introduction of borrower-based measures is a welcome step. Malta’s macroprudential policy toolkit has expanded considerably in line with the EU Capital Requirement Regulation and Directive IV (CRR/CRDIV). For residential mortgages the authorities introduced stricter risk weights than prescribed by the regulation. To address possible buildup of vulnerabilities in the housing and household sectors, the authorities are preparing to introduce LTV and DSTI limits and restrict maturities for residential real estate bank loans. The authorities should further refine the measures, including by reducing exemptions from LTV limits for loans against secondary and buy-to-let properties.

B. Financial Sector Supervisory Resources and Operational Independence

32. The MFSA’s prudential and conduct supervision mandate covers a broad range of entities. It includes banks, insurance, securities, and other regulated entities. The MFSA is also tasked to assist the FIAU in supervising subject persons in the financial sector. In support of the national strategy to promote blockchain, the MFSA has developed a regulatory framework for VFA (Appendix IV).

33. Resources are stretched and insufficient for the nature and range of tasks the MFSA must carry out for effective supervision. The MFSA’s resources have not kept pace with the increased demands on supervision. Difficulties exist with planning and timely execution of supervision actions, including delays in review of recovery plans and strategic documents, and with maintaining regular contacts with all less significant institutions (LSI). The MFSA has already taken steps to address the severe capacity gaps. Staff remuneration was recently improved, and plans are prepared to: (i) increase the number of staff by 50 percent over the next three years; and (ii) formalize a new human resources strategy. In addition, the MFSA has launched a Business Process Reengineering exercise to overhaul its supervisory processes and enhance its technology. The MFSA urgently needs to increase its staff and quantify more precisely the resources necessary to conduct a more intrusive risk-based supervision, including by mapping the required skills (e.g., extensive credit and IT risk experience, and statistics and VFA knowledge).

34. Some aspects of the MFSA’s operational independence raise concerns. The MFSA has the supervisory authority to carry out its tasks, but the necessary preconditions for operational independence are not all met.

  • MFSA should have stable funding. With the separation of the Registry of Companies (ROC) from the MFSA in April 2018, a significant part of its funding was redirected to the government. Going forward, the government will cover MFSA’s funding gaps. To avoid uncertainties, the MFSA should develop a five-year plan to increase its budgetary resources in a sustained way, which should be supported by a strong public commitment from the government. To further enhance funding stability, the MFSA should revisit its policy for license fees and the basis used for other regulatory charges.

  • MFSA should have full autonomy over its recruitment process. Currently, the MFIN is required to endorse the human resources budget on a yearly basis, and the Office of the Permanent Secretary for Financial Services, Digital Economy and Innovation (under the Prime Minister’s office) is required to approve recruitments on a case-by-case basis.

  • MFSA should maintain a dedicated statutory committee tasked with supervisory and enforcement powers. All supervisory powers currently vested in MFSA’s Supervisory Council (SC), which focuses only on supervisory issues, are planned to be transferred to the MFSA’s executive committee chaired by the CEO and made up of five MFSA staff members reporting to the CEO. To enhance checks and balances in the decision-making process, a dedicated statutory committee tasked with supervisory and enforcement powers should be maintained, ensuring that enough attention, time, and resources are devoted to supervisory actions.

C. Banking Supervision

35. Bank supervision has been upgraded in recent years. The implementation of EU directives and regulations helped close several gaps identified in the 2003 FSAP and in an independent assessment in 2011. The definition of related parties has been broadened and the administrative penalties and measures have been set out. The MFSA has been empowered to issue binding regulations (e.g., requiring banks to submit NPL reduction plans). More recently, the European Central Bank’s (ECB) Banking Supervision has raised the level of supervisory intensity and intrusiveness of three significant institutions (SI). The MFSA is responsible for supervision of 18 LSIs, subject to ECB oversight, and two non-EU branches. For three High-Priority LSIs (HPLSI), the ECB receives mandatory reporting and ex-ante notifications on certain supervisory actions by the MFSA. In the bank supervision area, the FSAP focused primarily on the supervision of LSIs.

36. The review of supervisory measures reveals that the MFSA’s actions have not always been timely and effective. Significant delays exist between the end of onsite inspections and the date on which decisions were taken by the SC. The low and limited number of monetary sanctions has little deterrent effect. Moreover, the limited scope of onsite inspections (low frequency and key risks insufficiently covered) impair the detection of problems, including in the ML/TF area. Judicial appeals against monetary sanctions have suspensive effects, undermining the sanctions policy (e.g., MFSA has 27 pending appeals with some dating back to 2009).9 The authorities should eliminate delays in supervisory actions (including by amending the law if needed) and take full advantage of the broad enforcement powers.

37. Important shortcomings in bank supervision practices need to be addressed. MFSA needs to complete the rollout of its supervision strategy, including the completion of the Supervisory Review and Evaluation Process for all HPLSIs, and address the low frequency of onsite inspections at LSIs. A more intrusive approach is needed to assess banks’ risk-management processes, including for asset recovery, related-party transactions, forbearance measures, and collateral valuation. The focus should be on the main risks (credit, liquidity, and compliance), the adequacy of risk classification and provisioning, and on stronger follow-up on remediation progress. Despite improvements, the related-party framework exhibits significant gaps with the BCP, requiring further action. Legal amendments are needed to increase MFSA’s powers and banks’ obligations related to: (i) the change of legal structures; (ii) major acquisitions; (iii) the review of the activities of companies affiliated with banks’ parent companies; and (iv) the communication of materially adverse developments. Finally, the authorities should improve the supervision of non-EU branches.

D. Insurance and Securities Market Supervision

38. The MFSA should continue its efforts to strengthen the supervision of the evolving insurance and securities markets. The complexity and sophistication of the insurance market, its high exposure to EU countries, and the high concentration of life insurance and reinsurance industries call for continued close monitoring of the evolving business models of the supervised entities.

39. Enhancing the risk-based supervision frameworks (RBSF) should be a priority. The RBSF for the insurance sector and the investment firms assesses the licensees based on their risk impact and the probability of risk, which drives the annual supervisory plan. There is scope for improving the monitoring of macro-risks and business model analysis in the RBSF. The supervisory program for conduct supervision should be expanded to include banks acting as distributors of insurance and securities products.

Financial Safety Net and Crisis Management

40. Financial safety net and crisis management arrangements are generally sound but staffing needs to be increased. A Domestic Standing Committee comprising relevant staff from the CBM, MFSA, and MFIN has a mandate to enhance crisis preparedness and to facilitate the management of an actual crisis. Within the MFSA, the supervisory and resolution functions are adequately separated, and the Depositor Compensation Scheme (DCS) has its own Management Committee. Given the current workload, a review of the adequacy of MFSA’s Resolution Unit staffing should be undertaken, and its resources increased.

41. An administrative bank insolvency regime should be adopted, and the creditor hierarchy clarified. Multiple laws and regulations govern bank failures, creating uncertainties in their application, including regarding the creditor hierarchy. The uncertainties affect potential DCS recoveries in insolvency, its role in creditor-led insolvency, the use of DCS funds for resolution, and the application of the shareholder and creditor safeguards under the resolution tools provided in the European Bank Recovery and Resolution Directive (BRRD). The MFIN should initiate the reform of the bank insolvency framework in line with the international standards, including providing explicit powers to transfer assets and liabilities of failing banks. In the meantime, the DCS should clarify its legal interpretation of and policies under the current framework, and the MFSA should adopt a policy to place a bank into liquidation when a deposit payout is made.

42. The MFSA should assess recent bank failures and strengthen its supervisory and early intervention procedures, including to mitigate its legal risks. This should include reducing the time in office for the competent person appointed to manage the affairs of a bank.10 Responsibility for decisions on bank insolvency and liquidation of banks whose license is withdrawn needs to shift from the MFSA’s supervisory function to its resolution function.

43. Preparations to operationalize the BRRD resolution tools should be accelerated and internal crisis management plans developed. Ensuring the availability of sufficient MREL is critical, as the resolution regime mandates the bail-in of creditors. Issuing sufficient MREL may prove challenging for banks, considering the limited domestic professional investor market and issuance sizes that may be small for potential external investors. The Resolution Unit should prepare the use of the business transfer and the bridge bank tools, including ownership and governance structure of the latter. The MFSA and the MFIN should develop internal crisis management plans to supplement the Interagency Crisis Management Framework currently under review by the Domestic Standing Committee.

Financial Integrity

44. Malta’s openness to financial flows makes it vulnerable to ML/TF risks. Increasing inflows, including from countries generally considered to pose greater ML/TF risks, may exploit vulnerabilities in the banking sector, real estate, remote gaming, virtual assets, and the IIP. A new legislative AML/CFT framework entered into force in 2018, but according to the opinion of the European Commission (July 2018), the transposition of the EU’s Fourth AML Directive is not complete and recent bank intervention cases exposed serious shortfalls in the framework. Malta is currently undergoing an assessment against the Financial Action Task Force 2012 standard.

45. The authorities’ national AML/CFT strategy and action plan are ambitious. The National Risk Assessment (NRA) of ML/TF risks was updated in 2017 but was not published. Subsequently, the authorities published an ambitious national AML/CFT strategy and a comprehensive AML/CFT action plan. However, their implementation is at the initial phase.

46. Cooperation among concerned entities (FIAU, MFSA, law enforcement agencies) vested with AML/CFT oversight must be strengthened. The recent efforts to step up joint FIAU and MFSA AML/CFT supervision are welcome. Further efforts to improve operational cooperation between FIAU and law enforcement and among AML/CFT supervisors are needed. The authorities should consider supporting the establishment of an EU-level arrangement directly responsible for AML/CFT supervision. It could enhance convergence of supervisory practices and minimize regulatory arbitrage.

47. The authorities’ and market players’ understanding of risks is uneven. The NRA noted that the threat posed by the foreign proceeds of crime to Malta is high. However, there are no measurable estimates of the amount of proceeds of crime possibly laundered through and in Malta. Furthermore, there is a lack of appreciation of risks innate to Malta as an international financial center heavily relying on nonresident clients and of threats emanating from the significant cross-border financial flows and of their nature (e.g., rationale, origin, and destination). Despite acknowledging the importance of CBRs, the authorities lack comprehensive understanding of ML/TF risks that could affect these relationships.

48. A multi-prong strategy is needed to address deficiencies in the AML/CFT framework, with particular focus on preventive measures.

  • Banks’ verification of BO information and ongoing monitoring of risk-sensitive accounts should be strengthened, especially by applying enhanced measures for nonresident clients (including opaque companies), new technologies (e.g., virtual assets and e-gaming), and IIP-related funds. Customer due diligence for domestic and foreign politically exposed persons, their family members, and close associates and reporting suspicious transactions also need to be fortified.

  • The authorities should continue addressing ML/TF risks related to expanding blockchain technologies and virtual assets. It is important to close any related gaps in the AML/CFT framework and ensure that the definition and AML/CFT oversight of a “subject person” are in line with the requirements of the Financial Action Task Force regarding virtual asset service providers. Immediate action is also needed to strengthen resources for AML/CFT oversight of virtual asset service providers.

  • The authorities need to fully implement a risk-based AML/CFT supervision of banks, evaluate banks’ risk mitigation models more stringently, and develop more effective AML/CFT enforcement, including by applying dissuasive and proportionate sanctions and eliminating delays in their application. More vigilant application of the fit-and-proper requirements, including the assessment of the reputation of bank owners and managers, would help improve bank governance.

  • The ROC should be adequately resourced and required to properly verify and update the BO information.

Appendix I. Risk Assessment Matrix (RAM)

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 percent and 30 percent, and “high” a probability between 30 percent and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Appendix II. Financial System Features

Malta’s economy exhibits features of its previous offshore regulatory regime, where the institutions licensed under the regime were restricted from doing business with residents. While financial institutions now operate under a unified licensing regime, irrespective of market orientation, there continues to be strong segmentation across several dimensions, including the geographical concentration of their funding sources and assets. The authorities group financial institutions into domestic and international based on their exposures to residents and the perceived potential effect on financial stability.

Banking System

1. Maltese banks vary considerably in their business models and market orientation. For analytical purposes, the authorities group banks into three categories based on their role in the domestic economy and exposures to residents:

  • Core domestic banks are mainly operating in the domestic economy, attracting household and corporate deposits and lending domestically. They account for 99 percent of mortgages to residents. Sovereign debt securities account for a quarter of their total assets. Claims on the Eurosystem are high, reflecting excess liquidity of these banks. Two core domestic banks each own a large domestic insurer.

  • Non-core domestic banks are small, foreign owned, funded from wholesale markets and nonresident deposits, and have limited exposure to residents. Some banks focus on syndication, factoring and finance, and other banks on private banking and conventional lending. Two banks account for about 80 percent of this category’s assets.

  • International banks are foreign-owned with insignificant domestic exposures. They account for over 80 percent of the banking system’s total nonresident deposits and 77 percent of lending to nonresidents. These banks rely mostly on wholesale (including intragroup) funding of relatively long maturities and focus on group custodian services, trade finance, and investment banking. Two branches of Turkish banks account for 83 percent of this category’s assets (€19 billion).

2. For supervisory purposes, three largest core domestic banks are classified as SIs. The SIs hold 86 percent of category assets (42 percent of total bank assets) and account for 81 percent of all mortgages. The remaining banks are classified as LSIs (18 banks), a subsidiary and a branch of banks of other EA countries (one parent entity is an LSI and one is a SI), and non-EU branches. Non-EU branches are not subject to the ECB oversight.

Malta: Banking System Assets, end-2017

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Sources: Maltese authorities and IMF staff calculations.

These are a subsidiary and a branch of banks of other EA countries and are classified under the home state of their respective group parent.

Malta: Banks’ Market Share, end-2017 (percent)

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Sources: Maltese authorities and IMF staff calculations.

“Other” includes credit and financial institutions, investment funds, and government. Deposits with CBM are excluded.

About half of resident deposits of international banks are concentrated in one bank (LSI) and were largely accumulated during 2016 and 2017. The two non-EU branches are branches of Turkish banks and are both classified as “international banks” in the authorities’ classification.

These are a subsidiary and a branch of banks of other EA countries and are classified under the home state of their respective group parent.

3. Branches of two large Turkish banks have no direct exposures to the Maltese economy.

  • The Turkish branches were established in Malta in the late 90s, benefiting from the absence of withholding tax in Malta and associated opportunities for cashflow management for Turkish corporates. The branches’ assets declined from about 300 percent in 2012 to about 140 percent of GDP by mid-2018.

  • The Turkish branches have no exposures in Malta and mostly operate with Turkish counterparties. The branches do not source deposits locally and do not extend loans to residents. Moreover, their deposits are not covered by the DCS in Malta (but are subject to the deposit insurance in Turkey). About half of Turkish branches’ assets are invested in sovereign papers, of which 60 percent is denominated in US dollars. The entire sovereign portfolio of these branches is invested in Turkish sovereign bonds.

  • The Turkish branches have general banking licenses in Malta without the passporting rights into the EU. Special licensing agreements exempt the branches from all prudential rules in Malta, prohibit them from having NPLs on their books, and prescribe NPLs transfer to their head offices’ books. The branches deal exclusively with the customers introduced by the parent bank.

Domestic Insurance

4. The authorities have identified eight domestic insurers, whose assets totaled 37 percent of GDP at end-2017. The domestic insurers consist of three life insurance companies, four non-life insurance companies, and one non-life PCC. Two of the eight domestic insurers hold over 80 percent of their total assets, operate exclusively in Malta, and are majority owned each by a SIs.

Domestic Investment Funds

5. There were 46 domestic investment funds at end-2017, with assets under management amounting to 16.8 percent of GDP. More than 60 percent of the domestic investment funds were UCITS funds. Most domestic investment funds do not use borrowing except temporarily, and not to exceed 15 percent of total assets, and invest mainly in bonds, accounting for 67 percent of assets under management as of end-2017. About 80 percent of the assets under management is managed by banks’ subsidiary fund management companies.

Malta: CBM Methodology to Categorize Institutions for Financial Stability Purposes

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Source: CBM.

Appendix III. Stress Test Matrix (STeM)

Banking Sector: Solvency Risk

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