Updated 2pm
Higher home loans being granted by banks to cover increasing property prices could spiral to unsustainable levels and may even lead to a financial crisis followed by a recession, the Central Bank has said.
The Central Bank however emphasised that Malta was in no “imminent” danger of such a situation and that measures it had taken in recent months were designed to preempt any such a crisis (see reply below).
Property demand may keep rising despite the increase in prices, and banks may continue to extend high loans, which are backed by the rising collateral value of housing, the Central Bank said in its latest Financial Stability Report.
“Left unchecked, this process can spiral off, similar to the events that unfolded across several advanced economies in 2007/2008.”
While a single transaction may not pose any risks to the individual or to the financial system as a whole, highly-leveraged house purchases across a large cross section of households in the economy can lead to an overheated property market and ultimately increased systemic risk, it added.
Required to borrow more compared to their income
In a section on the affordability of property prices, the Central Bank held that high indebtedness makes households more vulnerable to negative shocks, such as rising interest rates or a fall in asset prices.
The Central Bank found that the increase in the price of property is leading young people to borrow more when compared to their salary, resulting in steeper loan repayments and less disposable income.
Many loans three times gross income
Nearly half of the loans from domestic banks are amounts which are three to five times the total gross income. A comparison to previous years also saw an increase in the share of loans with amounts of between five and six times the person’s gross income.
“Borrowers are increasingly required to borrow more compared to their income, resulting in higher loan repayments, possibly indicating increasing pockets of vulnerability should there be a downturn,” the Central Bank warned.
However, it said that according to regular stress tests conducted to measure households’ ability to pay, the debt burden was estimated to remain sustainable under a stressed scenario, even though pockets of vulnerability existed.
It found that while house prices had picked up, the monthly average repayment compared to the average wage was “much more contained” and below the levels reported in 2006-2007, when house prices grew at double-digit rates.
The Central Bank issued a directive earlier this year as a way to safeguard borrowers and lenders against cyclical fluctuations. It said that studies showed that the directive would impact 2.7 per cent of those buying their primary residence and 13.2 per cent of all buyers of residential property.
However, the directive gives lending institutions sufficient discretion to enable, where appropriate, some borrowers to provide lower upfront finance than the minimum prescribed in the directive.
Looking at the wider picture, the report establishes that buoyant domestic economic activity continued to buttress the resilience of the financial system. Credit growth by core domestic banks accelerated while asset quality improved further on the back of lower non-performing loans. Although still in line with other European peers, bank profitability weakened, largely reflecting increased provisions.
It found that the capital position of banks remained sound and within regulatory requirements, even following rigorous stress tests, and that they continued to operate “with ample liquidity”.
Central Bank reply
"The Central Bank of Malta refers to the article of Times of Malta of August 30 2019, where a section of the Financial Stability report (Panel B: Borrower-based Measures – Theory and Practice) was purported as a warning from the CBM that there is an imminent risk in Malta of a financial crisis followed by a recession because of developments in the property market. The CBM made no such warning in its report.
"The special feature was aimed at setting the context of why globally central banks look closely at the residential real estate market and design macro prudential polices such as borrower-based measures.
"The excerpts quoted by Times of Malta from this section explain the theoretical underpinnings for the implementation of such measures. However, these theoretical underpinnings do not imply that the actual situation in Malta is one that is imminently leading to the danger of a financial crisis or recession, as implied by Times of Malta. In fact, as stated in the special feature, the measures taken recently by the CBM with regards to the banks’ share of a mortgage were pre-emptive – rather than reactive to any looming crisis in the real estate or the credit markets.
"The CBM in its Financial Stability Report acknowledges that only some borrowers are taking on larger loans relative to their income, but it also says that overall house prices and monthly loan repayments relative to income remain significantly below the highs that were observed in 2006-2007 when the property market was at its previous peak (as indicated in Panel A: Trends in the Real estate Market and Banks’ Lending Practices in Malta).
"Indeed, the CBM in its latest projections published on 16 August 2019, shows that the Maltese economy is expected to remain strong in the coming years, in line with the outlook given by other institutions such as the European Commission, and this will continue to buttress the resilience of Malta’s financial system, as stated in the Financial Stability Report."