In its Financial Stability Report for the first half of 2012, the Central Bank of Malta said that a weak property market is fuelling a sharp increase in non-performing loans in the construction sector.

This, it said, has given rise to the fact that although Maltese banks have proven to be resilient in the face of economic challenges and their profits are rising, credit risk remains a key risk for the Maltese financial sector, according to the Central Bank of Malta, as the effect of a weak property market continues to be felt.

Construction and real estate account for just a sixth of banks’ loan portfolio, but they account for nearly half of non-performing loans. The Central Bank said that while no new risks or threats have emerged for the financial system, the financial sector is urged to continue to exercise the utmost prudence, especially as long as economic growth is contained.

On a more positive level, as we mentioned in a leading article yesterday, the Central Bank points out that the risks associated with the eurozone’s debt crisis appeared to have slightly abated this year. This, was echoed by the German Finance Minister, who said that the worst of the eurozone crisis seems to be over.

But to go back to the local scenario, the construction sector is, by far, the most troubled sector as far as keeping up with loan repayments is concerned: it accounts for 12% of total loans and a staggering 41% of non-performing loans.

To mitigate this issue, banks have resorted to further rescheduling of loans to stretch the time in which they are repaid.  Of course, however, this does not rule out that the situation may worsen in the future. The collateral for loans in the property market will invariably be property, and its value rests on the assumption that there is sufficient demand for what is sold – something which is far from a foregone conclusion.

The volume of collateral in the form of property, in fact, is also flagged as a cause for concern in the Central Bank report.

Despite the property market’s ills, core domestic banks continued to expand their operations, mainly through additional lending to households. This means that there is still money being earned and spent – and this has resulted in more business for banks and a stimulant to the local economy.

International economic conditions remain fragile, the Central Bank acknowledges, but European financial markets were calmer during the first half of the year, leading to a recovery of share prices.

It said that the eurozone’s debt crisis appeared to have receded in the wake of the European Central Bank’s September announcement that it would engage in what are known as outright monetary transactions (OMTs) in sovereign bond markets. In other words, it’s not all that bad. The Central Bank continues to highlight areas of risk, but at the same time is doing its utmost to reinforce the perception that everything is not all that bad. To go back to what was written on these pages yesterday, recession and non performance of an economy is often linked to perception. If people continuously hear that things are bad, they will believe it and their spending and borrowing patterns will alter. If, however, people start to believe that things are not all that bad, then their spending will continue and will stimulate the local economy. Having said that, Malta must be careful with the property bubble. It is becoming increasingly more difficult to sell property and that has caused a slowdown in construction. What we definitely cannot afford is to become another Ireland or Spain. That bubble cannot over inflate – it will burst if it does.