The International Monetary Fund has called for “urgent action” to address shortcomings in banking supervision by the Malta Financial Services Authority, in a report prepared at the request of the government.

"To strengthen bank supervision, the MFSA should take timelier supervisory actions, increase the frequency of onsite inspections, make more use of monetary fines as part of the sanctioning regime, and ensure supervisory action is not delayed through judicial appeal,” the authority and the Central Bank of Malta quoted the IMF report as saying, in a joint statement.

The IMF said that containing financial integrity risks is critical to financial stability, saying that a multi-prong approach was needed to address anti-money laundering and combating the financing of terrorism (AML/CFT) deficiencies.

The report noted that these AML/CFT threats affected not only the financial sector but the broader economy as a whole.

"Malta’s openness to financial flows makes it vulnerable to ML/TF risks. Increasing inflows, including from countries generally considered to pose greater ML/TF risks, may exploit vulnerabilities in the banking sector, real estate, remote gaming, virtual assets, and the IIP.

"A new legislative AML/CFT framework entered into force in 2018, but according to the opinion of the European Commission (July 2018), the transposition of the EU’s Fourth AML Directive is not complete and recent bank intervention cases exposed serious shortfalls in the framework. Malta is currently undergoing an assessment against the Financial Action Task Force 2012 standard," the report said.

It also highlighted the need for more strenuous verification of beneficial owner information and monitoring of risk-sensitive accounts, particularly for nonresident clients (including opaque companies), new technologies (e.g., virtual assets and e-gaming), and IIP-related funds.

“Customer due diligence for domestic and foreign politically exposed persons, their family members, and close associates and reporting suspicious transactions also need to be fortified,” it said.

Referring to blockchain and cryptocurrencies, the report also recommended that more resources should be immediately appointed to oversee virtual asset service providers.

The banking system remains resilient under a severe scenario, with weaknesses limited to a few small banks

The Financial System Stability Assessment Report summarised the findings of an on-site review was carried out by a team of IMF international experts in September 2018, as requested by the government in 2017. This is the second such report, the first having been carried out in 2002.

The IMF had also been asked by the government to assess its budgeting and presented its findings during the budget briefing last September.

The IMF's FSSA report issued on Thursday looked into other key metrics of the banking system – such as capitalisation and liquidity – saying that although it was in good health, challenges existed.

“The banking system remains resilient under a severe scenario, with weaknesses limited to a few small banks. The system is sufficiently capitalised to absorb losses in the event of a severe macroeconomic shock, but risky exposures would lead to potential losses at a few small banks.”

“Continued enhancements are encouraged in the macroprudential framework. While the recent strengthening of systemic risk monitoring is commendable, the legal framework should be enhanced, data gaps closed, and non-bank risk assessment strengthened. The planned introduction of borrower-based measures to address build-up of vulnerabilities in the housing and household sector is welcome,” it said.

The report also referred to the closure of banks - without mentioning either Pilatus or Satabank by name - saying that the MFSA should strengthen its supervisory and early intervention procedures, "including to mitigate its legal risks". One recommendation was to reduce the time in office for the competent person appointed to manage the affairs of a bank.

MFSA chairman John Mamo picked out the IMF’s comments on the authority’s needs for more resources:

“The report highlights the challenges facing the MFSA from the increased demands of supervising the growing number of licensed financial institutions in an evolving and more complex regulatory environment, as well as the need to upgrade the MFSA’s operational capacity to enable it to operate more effectively.”

With regards to the IMF’s call for strong supervision and enforcement, he said the recommendations had been noted.

The report was welcomed by the Governor of the Central Bank of Malta, Mario Vella, who noted its general positive outlook on financial stability risks in Malta, and the recommendations made, adding that these mainly reflect enhancements to the work already being carried out by the Central Bank.

What it said about the MFSA:

The review of supervisory measures reveals that the MFSA’s actions have not always been timely and effective. Significant delays exist between the end of onsite inspections and the date on which decisions were taken by the SC. The low and limited number of monetary sanctions has little deterrent effect.

Moreover, the limited scope of onsite inspections (low frequency and key
risks insufficiently covered) impair the detection of problems, including in the ML/TF area. Judicial appeals against monetary sanctions have suspensive effects, undermining the sanctions policy (e.g., MFSA has 27 pending appeals with some dating back to 2009).

The authorities should eliminate delays in supervisory actions (including by amending the law if needed) and take full advantage of the broad enforcement powers.

Important shortcomings in bank supervision practices need to be addressed. MFSA needs to complete the rollout of its supervision strategy, including the completion of the Supervisory Review and Evaluation Process for all HPLSIs, and address the low frequency of onsite inspections at LSIs. A more intrusive approach is needed to assess banks’ risk-management processes, including for asset recovery, related-party transactions, forbearance measures, and
collateral valuation. The focus should be on the main risks (credit, liquidity, and compliance), the adequacy of risk classification and provisioning, and on stronger follow-up on remediation progress.

Any possible limitations on the judicial review of supervisory/resolution actions should strike a balance between the right and a legitimate need for judicial review and the effectiveness of such actions.

Despite improvements, the related-party framework exhibits significant gaps with the BCP, requiring further action. Legal amendments are needed to increase MFSA’s powers and banks’ obligations related to: (i) the change of legal structures; (ii) major acquisitions; (iii) the review of the activities of
companies affiliated with banks’ parent companies; and (iv) the communication of materially adverse developments. Finally, the authorities should improve the supervision of non-EU branches.

Read the full report here. 

PN REACTION

In a reaction to the IMF report, the Nationalist Party observed that the European Commission had noted that Malta's economic performance, although positive, was facing sustainability challenges. 

The report noted that "children in single-parent, and medium-skilled families are at greater risk of poverty." With regards to public finance, the report commented on the increase in public expenditure stating that government was financing permanent expenditure with temporary income.

"This equates with what the Opposition has repeatedly stated, that is that government is recklessly increasing public expenditure basing its spending patterns on income, including income from proceeds of the IIP scheme, which might decrease sharply in the near future."

The PN also noted the IMF concerns about serious shortcomings in Malta's anti-money laundering enforcement framework, adding that "no significant steps have been taken to strengthen enforcement of the anti-corruption framework".

 The report noted that the MFSA's actions had not always been timely and effective.

A new legislative anti-money laundering framework entered into force in 2018, but according to the  European Commission, the transposition of the EU's Fourth AML Directive was not complete and recent bank intervention cases exposed serious shortfalls in the framework.

The PN said such reports echoed the positions adopted by the Opposition and other organisations over the past months. It pointed out that only recently the CEO of HSBC Malta said that the damage on Malta's reputation was harming banking profits.

"This report clearly shows that the government has failed in carrying out its duty of ensuring that our financial services sector is duly regulated. The lack of proper and efficient regulation has led to high profile cases that severely damaged Malta's standing as a financial services centre of excellence," the PN said.

"Financne Minister Scicluna has recently commented that the Panama papers debacle is history. Clearly it is not. Malta is suffering and will continue to suffer. The blame for this rests heavily on the Prime Minister and Minister Edward Scicluna."

Mario de Marco, shadow minister for finance and Kristy Debono, shadow minister for economic affairs, signed the statement. 

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