Despite decrease in operating income, banks remained resilient in 2020, finds latest Financial Stability Report

The Maltese financial system remained resilient to the unprecedented economic shock brought about by the COVID-19 pandemic, with the strong capital and liquidity positions of Maltese banks – coupled with their prudent business models – enabling these institutions to support households and corporations as they weathered the effects of the pandemic.

Aided by the timely and targeted measures by Government, regulatory authorities and the Eurosystem’s monetary policy stance, banks have played an important role in supporting the economy during such testing times.

The findings emerge from the 13th edition of the Central Bank of Malta’s Financial Stability Report, which assesses the developments of the financial sector during 2020 – the year when the COVID-19 pandemic effectively began in Europe.

The evaluation is supplemented by top-down stress tests and sensitivity analysis to gauge the resilience of the financial system.

The report finds that the uncertainty caused by the pandemic affected banks’ profitability as they acted prudently by booking extraordinary provisions. As a result, the coverage ratio for non-performing loans (NPLs) increased, thus mitigating credit risk somewhat.

Some deterioration in asset quality was recorded, largely with respect to non-resident exposures.

In addition, banks experienced a decrease in their operating income as a result of both lower interest and non-interest income.

Banks continued to grant loans to residents, as the slowdown in mortgage lending was generally offset by higher corporate lending, in part driven by loans granted under the Malta Development Bank’s COVID-19 Guarantee Scheme.

Over the year, resident deposits grew markedly – particularly during the early months of the pandemic – reflecting a contraction in consumption and higher savings by economic agents. All this led to higher banks’ liquidity buffers, which in the main were deposited with the Central Bank.

The fallout from the pandemic also impacted non-bank institutions, with the profitability of domestically-relevant insurance companies declining due to lower investment income and premia.

Despite the challenges reported throughout the year, insurance corporations remained highly liquid and their solvency capital ratios remained well above regulatory minima, regardless of the declines reported in the first quarter of the year.

The wide-scale global sell-off of riskier assets and the ensuing market volatility, particularly in the early stages of the pandemic, spurred some domestically-relevant investment funds to shift towards less risky assets, especially bond holdings.

During this period, domestically-relevant investment funds did not report significant redemptions and their liquidity profile remained healthy, while leverage was contained.

The report concludes that support measures by the authorities have been crucial in mitigating the adverse effects of the pandemic, but the unprecedented shock of the pandemic challenged further the profitability of financial institutions given the increase in provisions and loss of other income sources.

The stress tests and sensitivity analyses show that the banking system remains resilient to a wide range of possible economic outcomes.

However, banks are encouraged to continue preserving capital and to continue to build their provisions to mitigate any potential rise in credit risk in view of the lingering uncertainty surrounding the pandemic.

Banks are encouraged to keep the momentum on their viability assessment of their loan portfolios and the corresponding provisioning needs.

This edition of the report also features a number of boxed articles, namely on the categorisation of banks; the bank lending survey results; an update on the methodology of the credit risk threshold model; and the methodology for selecting domestically-oriented investment funds.

Additionally, it contains a box on the non-bank financial sector in Malta as well as an in-depth assessment on the uptake of moratoria.

The general risk assessment conducted in this edition of the Financial Stability Report takes into account events occurring up to March 2021.