The property market is rarely absent from a comprehensive assessment of the economic prospects of the country. This market is both a stimulator of growth as well as a beneficiary.
In the last few years, the prices of property have risen at an exponential rate thanks to significant demand from local and foreign individuals who have benefited from the impressive growth rates of the local economy.
It would, however, be fallacious and dangerous to assume that such strong growth will keep recurring year after year. The property market will be the first to absorb price corrections when the inevitable economic slowdown sets in. It is, therefore, essential to hedge against the inevitable risks that particular economic sectors, as well as individuals, will have to face in a slowdown.
The Central Bank of Malta recently instructed local banks to tighten their criteria for lending to first-time home buyers, to those buying a second home and to those buying residential property as an investment to rent it out. The new criteria are similar to those that most banks adopt internationally. However, it must be said that banks sometimes are more generous in their mortgage lending in search of profitability. Such liberal attitudes come with their risks.
It is no secret that banks in Malta are highly competitive in the mortgage market. Mortgages are perceived as a safe lending sector as the spread of risk is very broad. Most people will do what it takes to repay the loans on their homes even when economic conditions are harsh. However, even this relatively safe strategy comes with some risks.
Some banks’ balance sheets have a concentration risk in the form of portfolios secured by residential property. Regulators rightly fret about this situation as an economic downturn in any particular country could have substantial adverse effects on banks with substantial loan portfolios secured by residential property.
The Central Bank of Malta must have had these considerations in mind when it advised banks to change their criteria for lending.
The surge in property prices has meant that those who bought their home in the last few years have probably committed themselves to significant repayments that will carve out a substantial part of their disposable income for several decades until they retire. The risk that this phenomenon carries with it is that if people lose their jobs or have to accept lower salaries in an economic downturn they will find it increasingly hard to honour their commitments with the banks.
Such a development would not be beneficial for individuals or for the banks that lend them money.
Many argue the financial markets at present are operating in an artificial mode because the low-interest rate regime is under-pricing the risk involved in lending. Low-interest rates cannot last forever.
When interest rates start to go up, mortgagees will have to carry a more significant burden to repay their loans.
Applying more favourable criteria for first-time buyers was a good move by the CBM. Curbing speculation of even just a desire to exploit the favourable upturn in property prices was equally good practice.
Hedging against the risk of an economic downturn makes good business sense. It will mitigate the pain of those who will inevitably be affected by such a downturn.