Issue link: https://maltatoday.uberflip.com/i/1437471
4 MARKET NEWS 16.12.2021 AS is well known the European Central Bank's primary mandate, like all national central banks including our own, is price stability. Since the financial crises the Eu- ropean Union has broadened this function to encapsulate financial stability at the EU level, especially at the Eurosystem level. is it did through other appropriate EU institutions, sharing resources with the ECB. ese comprise the European Sys- temic Risk Board and the three European Supervisory Authorities, the EBA, ESMA and EIOPA, and the Single Supervisory Mechanism. Locally the macro and micro-prudential authorities were entrusted to the CBM and MFSA respectively, while the Joint Financial Stability Board ensured better co-ordination between the two respective institutions and the Finance Ministry re- garding financial stability matters of na- tional importance. I will briefly touch upon the two inher- ently interlinked functions and the way they affect our economy. Because finally price stability and financial stability are a means to an end. e end being the coun- try's material welfare and its sustainability. But before let us look at the economy and its outlook. at the economy has opened up so quickly and so forcefully, as the results of the last reported quarter at- test, is due to the realisation that no matter how diversified our economy is, a vibrant tourism sector is important for the econ- omy to reach its full potential. We learnt the lesson that making our island safe for visitors is the best attraction Malta can have at the moment. Being an external and well respected institution the ECDC – the European Centre for Disease Control's own daily health reports at this moment in time compete with the best adverts the MTA might design. e population at large learnt this ba- sic lesson too and cooperated with the health authorities in their vaccination pro- grammes. e rewards are there for all to see. Not just more tourists, but also low unemployment rates, higher consumer expenditure, and higher value added in most of all the other economic sectors. e policy support was generous by any standard. Its gradual withdrawal will therefore be expected to be quite challeng- ing, at least no less than the ECB's eventual reduction of its own asset purchase pro- gramme. Flying into constant headwinds or should I say cross-winds of labour shortages, supply bottlenecks, rising com- modity prices including energy prices, which are so sensitive to daily events is no mean feat in withdrawing, especially, the fiscal supportive policy measures. Not to mention the reintroduction of the Growth and Stability Pact rules in some form or other in 2023. At the moment the ECB is being asked for an opinion on the princi- ples it believes the new fiscal rules should follow. Despite these challenging times, the Cen- tral Bank will be making significant up- ward revisions to its economic projections, which will be published later this month, based on better than expected recent eco- nomic and financial statistical data. Indeed we still expect the GDP to return to pre-crisis levels next year. Pushing the economy forward is do- mestic demand, strong performance of the labour market and high liquidity lev- els in the private sector - evidenced by the declining up-take of the MDB Guarantee Scheme. In fact in October there were no applications registered under this Scheme. e same may be said for the loan mor- atoria which are practically phased out. e Budget for 2022 is expected to give an added boost to public and private invest- ment and consumption. Rising international price pressures will lead to upward revisions to our inflation projections, particularly in 2022. Indeed, the Bank's Business Dialogue indicates that local firms reporting cost increas- es are now more prevalent than before. However there are no signs as yet of sec- ond round effects. In the international financial markets there is no consensus whether the current inflation is transitory and that it will re- treat to levels below Central Bank inflation objectives over the medium term or not. In any case, at the ECB, it is fair to say that the jury is still out. Within a fortnight at the Governing Council we should have a clearer picture of the outlook and the ap- propriate monetary policy decision is then taken. Financial Stability Each year the Bank identifies a number of systemic risks, some of which may be more elevated than others. Many of them are shared with other members of our Eurosystem in some degree or other. You may read about these in our Financial Sta- bility Reports published twice yearly. Starting with the good news. At the EU level the broadened economic recovery further reduced the risk of widespread defaults in the non-financial private sec- tor. Indeed, following the pronounced de- cline in 2020, the number of bankruptcies remained below pre-pandemic levels on aggregate in 2021. I must state that this success story was more accentuated in Malta, thanks to the timely intervention of the state, together with the leading regulatory authorities, the CBM, the MFSA, the MDB which managed to roll out a number of suitable schemes, together with the banking sys- tem's ability and its willingness to support its clients. With respect to credit risk, this remained in check at EU levels, in part reflecting the banks' own strategies as well as policy measures introduced by the authorities, to reduce their legacy stock of NPLs and provisioning prior to the pandemic, and their role in the moratorium during the pandemic. Speaking for ourselves, credit risk re- mained broadly stable, although we still expect some residual risk from those with weak business models that did not ade- quately adapt to the pandemic, and from those who do not do so, by the time all support measures are completely lifted. In this regard, banks are encouraged to stay on course with their prudent internal assessments of their loan books to help identify potential risks at an early stage. Another risk faced by banks in a num- ber of EU Member States is that of a sig- nificant price correction which actually occurred in some EU member state's res- idential and commercial real estate mar- kets. In many EU Member States residential real estate prices continued to increase during the pandemic, supported by strong housing demand on the back of low inter- est rates and a strengthening preference for more living space. With respect to the EU commercial real estate sector the outlook for low quality structures remains weak. Remote work- ing and environmental concerns led to an increase in high quality buildings, thereby exerting pressure on rents for low- quality buildings. How does the Bank see the situation locally? Property prices in Malta had started to moderate prior to the pandemic, reflect- ing the strong growth experienced in the last few years. However, on the onset of the COVID-19 pandemic, property pric- es moderated further. is year, growth in transacted property prices resumed, growing by 5.3% in 2021 Q2, exceeding the 3.9% in Q2 2020. On the supply side, we also saw declines in permits, admittedly from very high lev- els, thus leaving the construction industry ample order books. e banks' concentration in their lend- ing portfolio towards property is about 64% of resident lending, with growth in credit being driven by mortgages. One must acknowledge that there was some frontloading due to the temporary gov- ernment tax incentives, but the recom- mendation for banks to diversify further their portfolio and reduce their concen- tration on real estate exposures continues to remain relevant. e Bank on its part launched borrow- er-based measures (BBMs) in 2019 to curtail any potential risks from residential real estate. ese contributed towards im- provements in the resilience of both bor- rowers and lenders. On balance, financial stability risks stem- ming from the housing market remained contained and may be described as mod- erate, with no significant signs of misalign- ment between prices and fundamentals. With regards to system-wide cyber inci- dents, what is being observed here is that cyberattacks are becoming more sophis- ticated. What is at stake is our financial system. e bottom line is that we need to invest more in this area to keep up with the rapid evolution of technology and strengthen our resilience to cyber risks. For this, we may need to be involved in Europe-wide and global cooperation. At present we are participating in a Europe wide effort preparing the ground work for a cooperative monitoring and report- ing framework. Cyber attacks know no boundaries. AML/CFT ere is not doubt that the FATF rec- ommendations have made some financial operators in the financial industry more aware of the big reforms needed to be carried out within our institutions, reg- ulatory and operators alike. But we need to remind ourselves that some eight years ago if not more there were credit institu- tions and here I include the correspondent banks who had the foresight to act quickly and do what was need to conform with new international norms, EU AML direc- tives and such like and acted decisively. Recall that Malta's first National Risk As- sessment was carried out in 2013 on the advice of Moneyval and the FIAU. We may recall too, Malta getting the brunt of correspondent banks' de-risking strategies which found Malta's market not profitable enough to outweigh the in- creasing AML/CFT regulatory exigencies tied to their activities. ose operators who did not see the writing on the wall with the transpositions of successive EU AML directives 3, 4 and 5 especially, and who thought that their practices need not change, have by now realized that precious time has gone by. To give one example, the days of undertaking manual KYC processes are no longer fea- sible and investment in effective automat- ed systems are today a minimum pre-req- uisite for entering new correspondent banking relationships. Whatever the FATF recommendations are, nobody can deny the need for the banking sector to continuously show that its frameworks are sufficiently robust to address such risks. Indeed, all stakeholders and practitioners in the broader context, and not just the banks, need to do their part and strive to achieve higher stand- ards, which are suited to today's financial world. ey will of course be fulfilling the FATF requirements and recommenda- tions as delegated by the G7 no less within the earliest feasible time. Effectiveness in the FATF dictionary reads results now. But to reach that goal we need to raise efficiency. For that to happen systems in certain work areas have to change. In conclusion, I would have liked to discuss other important subjects such as digital currencies, payment platforms and green financing. We'll definitely find other fora to do that. e Governor of the Central Bank of Malta, Professor Edward Scicluna, addressed the guests at the annual dinner organised by the Institute of Financial Services Malta, which this year commemorates its 60th anniversary. is is his full speach Resilience and financial stability in pandemic times Edward Scicluna