Some banks may “come under pressure” if the COVID-19 outbreak persists and economic recovery takes longer than expected, the Central Bank of Malta has warned.
The warning was made in a report which looks at developments in the financial sector in 2019 while giving an outlook on the impact which the pandemic might have in the coming months.
While acknowledging that COVID-19 had shocked the banking sector, the Central Bank said that the sector had shown a high-degree of resilience due to its strong financial standing. Such resilience was further reaffirmed by stress tests which showed that overall, banks still had capital levels above the minimum levels required, and only a few showed some vulnerabilities.
If the pandemic persists and recovery is prolonged, certain banking models could come under pressure for liquidity owing to suspended repayments and drawdowns of already committed credit lines- Central Bank
It was also pointed out that prior to the pandemic, bank liquidity was ample and this continued to improve as savings kept increasing nonetheless.
However, the Central Bank warned that if the pandemic persisted and recovery was prolonged, certain banking models could come under pressure for liquidity owing to suspended repayments and drawdowns of already committed credit lines.
“COVID-19 will have an impact on the extent of new credit and banks’ asset quality with a potential increase in provisioning levels and write-downs. The latter together with a prolonged low-interest rate environment would affect negatively banks’ future profitability,” the Central Bank warned.
Major trends of 2019
In 2019, the balance sheet of core domestic banks grew further to represent around 186 per cent of the gross domestic product. As in previous years lending for house purchases coupled with higher placements with the Eurosystem drove this expansion, the latter confirming the banks’ ample liquidity buffers.
While banks' profitability remained stable, in line with developments abroad, challenges to profitability persisted owing to the continued low-interest rate environment, narrowing of interest rate margins and higher operational costs.
Domestically-oriented insurance companies reported strong solvency positions and improved profitability. Meanwhile, investment funds continued to adopt prudent investment strategies. As in the case of banks, the low-interest rate environment is posing challenges for insurance companies, impacting their profitability, the Central Bank said.
The report says possible exposure to financial stability risks from real estate is abating on the back of more moderate growth in real estate prices coupled with a contraction in the number of development permits being issued. Moreover, household debt-to-GDP remained relatively stable and somewhat lower than the previous years’ highs.
Looking ahead, the report says that the low-interest rate environment, which is expected to persist, will also affect income generation from investments and the direction of credit markets is still uncertain.
While slower growth in credit demand, particularly for mortgages, may impact income from intermediation, this could be partly compensated by higher short-term demand for corporate loans to finance working capital requirements, the Central Bank said.
At the same time, asset quality is expected to weaken as those creditors affected directly by the pandemic crisis might be unable to meet their debt repayments.
However, the report says that swift action taken by the supervisory authorities including the European Central Bank, the Maltese Government, and the Central Bank of Malta itself are expected to alleviate some of the risk to the sector.
Central Bank calls for prudence
Against such a background, the Central Bank of Malta said it is recommending that banks continue to adopt prudent lending practices while at the same time exercising caution in taking on additional risks through the further easing of credit standards.
Financial institutions are being encouraged to maintain conservative investment strategies and to continue to improve cost synergies to ensure sustainable profitability in the longer term and strong capital buffers, the report added.
The full report can be downloaded from this link.