Asset quality reviews carried out in Malta’s two largest banks have uncovered a greater proportion of non-performing loans than previously thought, leading the International Monetary Fund to suspect that a similar situation may be found in smaller Maltese banks.

While the latest IMF staff report on Malta is generally positive – it revises upwards its economic growth projections from Malta – the high proportion of non-performing loans (NPLs) is flagged as a cause for concern.

NPLs accounted for just over 9.5% of total loans in the second quarter of 2014. But this proportion was revised substantially upwards after the European Banking Authority carried out an asset quality review of Malta’s two largest banks, namely Bank of Valletta and HSBC Malta, similar to the ones carried out on Europe’s largest banks.

As a result, the NPL ratio is believed to exceed 13%. But the ratio could be even higher: the IMF points out that the NPL ratio for the rest of the banking sector could also be higher under the stricter loan classification rules the two largest banks were subject to.

While the revised NPL ratio is only slightly higher than the average for the Eurozone, this average is skewed due to a high proportion of NPLs in countries which have faced significant economic or financial crises in recent years. In fact, the ratio exceeds 50% in Cyprus and exceeds 40% in Greece.

Seven Eurozone members have a higher NPL ratio than Malta, but Malta’s ratio could be the highest among those countries which are not believed to be facing an economic or financial crisis.

Four of the countries with a higher NPL ratio – Greece, Cyprus, Ireland and Portugal – have required bailouts to keep their financial systems afloat, while the remaining three – Slovenia, Italy and Spain – have all faced economic or financial crises of their own.

The IMF notes that one of the main risks facing core domestic banks – such as BOV and HSBC – is their exposure to the real-estate sector: Two-thirds of loans extended by banks are secured with real estate collateral.

“It is important to continue mitigating the risk of exposure concentration to the real estate sector by the application of a cautious collateral valuation and conservative loan-to-value ratios. There is also room to enhance the loan foreclosure process by advancing judicial reform. This risk can be exacerbated by the weak performance of the EU countries, generating negative spill-over effects on the Maltese economy and its financial sector,” the IMF maintained.

But according to the IMF, the Maltese authorities were less concerned than it was about the exposure of banks to the real estate sector, and expected NPL ratios to drop as economic growth picked up.

“They were of the view that delinquency rates on mortgages have traditionally been one of the lowest, the exposure of banks to speculative property trading is very small, and household income (the main source of vulnerability for mortgages) is growing at a healthy rate,” the IMF maintained.