The International Monetary Fund gave Malta’s banks a clean bill of health on Friday, possibly putting to rest once and for all previous controversy and concern regarding the size of the country’s banking sector.

In its final statement following its Article IV consultation with Malta last month, the IMF’s board of directors noted: “The banking system is sound and risks from its large international bank segment appear contained because of limited balance sheet exposures to the domestic economy”.

However, the IMF did call for “stronger efforts to monitor developments in all banks, given the size of the banking sector relative to GDP, some weakening in asset quality, and concentration of loans to the real estate and construction sectors”.

The IMF board welcomed progress in strengthening the regulatory framework for banks and the recent establishment of the Joint Financial Stability Board, and encouraged “additional steps to shore up the resilience, including by tightening rules on loan loss provisioning and boosting the funding of deposit insurance”.

It also noted that the increasing complexity of Malta’s financial sector “warrants further strengthening of the anti-money laundering regime” and encouraged the authorities to participate in the IMF’s Financial Sector Assessment Programme.

Malta “has shown remarkable resilience in the face of a major crisis in Europe” according to the IMF’s statement. “Since the beginning of the crisis, the average growth of the Maltese economy has been one of the best in the euro area and the unemployment rate remains one of the lowest.

“This resilience,” it noted, “was underpinned by robust service sector export growth and a sound banking sector, which resulted in the current account balance having improved gradually in recent years, turning into surplus in 2012”.

The IMF added: “The performance of Maltese banks has been satisfactory, despite turbulence in the euro area. All banks report adequate capitalisation, liquidity, and profitability and are well positioned to transition to the Basel III regime. In contrast to many European countries, domestic banks’ deposits and credit to the private sector continued to increase in 2012, albeit at a slower pace than in 2010-11”.

It did, however, sound a note of warning on the banking sector’s exposure to the local property market: “These banks are heavily exposed to the local property market and loan loss provisions are low. The large international banking segment and smaller group of non-core domestic banks have limited balance sheet exposures to the Maltese economy, but recent events in Europe have heightened perceptions about risks of hosting a large banking segment in a small country. In response, the authorities have strengthened supervision and monitoring of banks’ liquidity positions.”

 

Economic growth ‘below potential’

The IMF pointed out that economic growth had slowed in 2012 and “remains below potential”, reflecting a weak external environment and subdued domestic demand.

“Although activity is expected to pick up moderately going forward, uncertainties abound. A protracted period of slower growth in Europe or re-emergence of euro area financial stress would negatively affect the Maltese economy.”

In terms of the country’s fiscal position, the IMF observed: “After notable progress in 2011, the fiscal position deteriorated in 2012 amid the election cycle, and the high level of public debt and guaranteed debt constrains the fiscal space in the event of further shocks.

“Against this backdrop, the European Commission has recently decided to initiate the excessive deficit procedure for Malta. The government’s deficit target of 2.7 per cent of GDP in 2013 appears unattainable in light of expansionary discretionary measures, optimistic revenue targets, and developments so far. The new government is committed to restructure Enemalta, the loss-making and highly indebted public utilities corporation, and has embarked on a major energy reform programme to reduce energy costs and diversify energy sources.”

Overall, the IMF commended Malta’s resilience through the global and European crises, which has been underpinned by solid macroeconomic and financial fundamentals. Nevertheless, it warned that the growth outlook is vulnerable to external and fiscal risks and it has encouraged the Maltese authorities to continue to pursue prudent policies and deepen structural reforms.

The IMF’s board underlined “the importance of reducing the fiscal deficit this year and achieving a balanced budget over the medium term. In this context, it generally emphasised the need for stronger measures to rein in current expenditure, particularly the wage bill, and to advance pension and health care reforms. Restoring the profitability and viability of public corporations would also help reinforce Malta’s fiscal position.

It also agreed that “fiscal governance would benefit from a clear rules-based multi-year policy framework that would reinforce the link between annual budget laws and the medium-term target” and that an independent fiscal council would also support the credibility of the government’s consolidation plans.

The IMF also emphasised that the steady implementation of structural reforms is essential to achieve a higher growth trajectory and enhance competitiveness. “Priority should be given to diversifying the economy, improving the business environment, encouraging female participation in the labour force, enhancing education attainment, and strengthening wage-setting mechanisms by better aligning wages with productivity growth.

“Timely implementation of the energy reform will also be helpful.”

 

Government welcomes findings

In a reaction yesterday, Finance Minister Edward Scicluna said he welcomed the IMF’s conclusions “as further confirmation that the new government’s policies are taking the country in the right direction”.

“I am especially pleased to note that the IMF’s executive directors have reconfirmed the resilience of our economy, underpinned by solid macroeconomic and financial fundamentals, and the underlying soundness of our banking system,” he said.

“It is also encouraging to note that the IMF has recognised the government’s commitment to addressing the key priority issues that the IMF recommended be addressed in their own report,” Prof. Scicluna added. These issues are mainly energy planning, higher female labour participation, enhancing education attainment, and overall economic diversification.

In this regard, he welcomed the IMF’s remark that the government is committed to returning Enemalta Corporation to profitability, and “has embarked on a major reform programme to reduce utility costs and diversify energy sources”.

He also stressed that the government is already actively working towards addressing labour participation through the free child-care centres initiative, addressing early school leaving and exploring economic diversification through the nurturing of new markets, such as the maritime industry.

Regarding the fiscal deficit and the IMF’s observation that the 2012 deterioration arose from the election cycle, Prof. Scicluna said that the IMF’s medium-term recommendations for addressing the deficit, which include a clear rules-based budgetary framework and an independent fiscal council, “are among those measures that have been taken on board by the new government”.

The Finance Minister also noted the IMF’s recommendations regarding the concentration of loans to the real estate and construction sectors.

He said: “The [IMF] directors welcomed the progress in strengthening the regulatory framework for banks. The government is, in fact, in the process of passing legislation in Parliament to enshrine the recently established Joint Financial Stability Board in the Central Bank Act.

“Furthermore, the Ministry is drafting a Memorandum of Understanding between it, the Central Bank of Malta, the Malta Financial Services Authority and the Financial Intelligence Analysis Unit in order to monitor financial activity on the island and to coordinate financial stability measures.

“The conclusions reached by the IMF Directors are reassuring as they strengthen the new government’s resolve to pursue its economic and financial targets.”