FINANCIAL STABILITY ISSUES FOR SMALL STATES
Mirko Mallia
Assistant Executive
Financial Stability Surveillance,
Assessment and Data
Disclaimer: Any views expressed are only the author’s own
and do not necessarily reflect the views of the CBM or the
Eurosystem
2
Structure of Presentation
Outline of the Presentation
•What is Financial Stability
•Small Island States Characteristics
•Key information/statistics concerning Malta
•The effect of the crisis on Malta
•Other considerations
3
What is financial stability?
The Central Bank of Malta defines financial stability as:
‘a condition where the financial system – comprising institutions, markets
and infrastructures – is able to: allocate savings to investment
opportunities efficiently; ensure the rapid settlement of payments;
effectively manage potential risks that may harm its performance; and
absorb shocks without impairing its operations. In this manner financial
stability is conducive to a well functioning economy and leads to
sustainable growth.’
4
Sources of risks to financial stability
Endogenous
•Institutions
based – financial, operational, legal,
integrity, reputation, business strategy, concentration,
capital requirements
•Markets
based – counterparty, asset price
misalignment, contagion
•Infrastructure
based – payment and settlement
systems, legal, regulatory, accounting, supervisory,
loss of confidence leading to runs, domino effect
Source: IMF/WP04/101
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Sources of risks to financial stability
Exogenous
•Macroeconomic
disturbances – economic
environment risks (such as oil prices), policy
imbalances (a balanced monetary and fiscal policy
mix)
•Event
risks – natural disasters, political events, large
business failures (e.g. Japan and Libya political
upheaval)
Source: IMF/WP04/101
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Some examples of Financial Stability Risks
•
Systemic risk: The risk that the failure of one financial
institution may spread to other parts of the financial
system, with possible serious implications for the
performance of the broader economy
•
Credit Risk: The risk of suffering a loss should the
counterparty default on its payments obligations
•
Market Risk: The risk that the value of a portfolio either
an investment or trading portfolio held by a financial
institution will decrease due to the change in value of the
market risk factors
•
Concentration Risk: The risk that a financial institution
is significantly exposed to one/few particular sectors and
exposures to specific companies.
•
Liquidity Risk: The risk that banks are not able to
access liquid assets to meet its commitments
•
Solvency risk: The risk of loss owing to the failure
(bankruptcy) of an issuer of a financial asset or to the
insolvency of the counterparty
Why do authorities promote financial stability?
A stable financial system:
•is
a key ingredient for a healthy and successful economy.
•Provides liquidity to the banking system;
•It enhances the efficiency of the Payment and Settlement
Systems;
•Conducive to the effective implementation of monetary
policy
People need to have confidence that the system is safe
and stable
Important that problems in particular areas do not lead to
disruptions across financial system (contagion)
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The Financial Stability Report: A tool to safeguard
Financial Stability
What is a Financial Stability Report?
A self contained regular publication that focuses on risks and
exposures in the financial system as part of the macroprudential surveillance function of central banks
Purpose
•To promote awareness in the financial industry and among the
public at large of issues that are relevant for safeguarding the
stability of the financial system.
Attempt to be pro-active – Hence concerned authorities/stakeholders
are given the possibility to act on vulnerabilities identified – this could
increase the resilience and possibly avoid crises
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The financial crisis:
lessons learned and measures taken
The on-going crisis has highlighted serious deficiencies in the
assessment of systemic risks
Specifically, it is important to:
•
Properly reassess the existing framework of financial
regulation
•
strengthen financial stability analysis
•
enhance framework for bank
management of crisis situations
•
enhance cooperation
supervisory authorities
between
resolution
central
and
banks and
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The financial crisis:
lessons learned and measures taken
•
Ultimately translate macro-prudential recommendations
by central banks into policy action
The EU response to the Crisis:
•
The EU Commission mandated a high Level Group to put
forward recommendations on how to strengthen the
European Supervisory Framework (The DeLarosiere
Report)
•
The Report recommended the establishment of a new
European Supervisory Framework – Two pillars
macroprudential and microprudential
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SMALL STATES DEFINTION
•According
to the World Trade Organisation (2002), no
general agreement on the definition of a small country exits
as yet in literature. Hence, any definition to some degree of
subjectivity
•However,
the most commonly used criterion has been
population
•A
threshold of 1.5 million in population is the threshold
generally accepted. Source: Commonwealth Report Secretariat and World Bank Joint Task Force (2000) on
Small States
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SOME VULNERABILITIES OF SMALL STATES
•High
dependence on Imports and Exports: Limited Natural
Resource Endowment, low inter-industry linkages, necessities
of food and energy, need for foreign exchange earnings (open
economies)
•
Limited Diversification Possible: Service-based economy
based on Tourism and financial services
•
Market Thinness and Limitation on Domestic Competition:
Monopolistic market structures – might lead to inefficiencies
•
Face fierce competition: imports and barriers to trade
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VULNERABILITIES OF SMALL STATES
•Important role of state in the economy: Provision of
goods which private sector is unwilling to provide
•Inability to Exploit Economies of Scale – higher
average costs hence more difficult to compete in
international markets
•Limited Access to International Finance – due to
creditworthiness, stringent Security requirements – this can
lead to sluggish investment growth – Hence more
dependence on External Finance - e.g. International AID,
FDI
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VULNERABILITIES OF SMALL STATES
Nonetheless Certain advantages exist including:
•Increased flexibility
•Presumably lower bureaucracy
•Ease of adaption to change
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Specific Finance Issues for Small States
•
Reliance of the economy to the banking sector
(Concentration in particular sectors - e.g. Construction
Sector, Tourism, fishing etc.
•
Foreign ownership of banks is substantial (home host
divide)
•
Importance of external finance to foster growth
•
Money Laundering
•
Regulatory forbearance
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Reliance on the Banking Sector
•
Dependence of small state economy to the banking
system is larger when compared to larger more
sophisticated countries.
•
The Insurance, Investments, Capital markets are less
developed compared to the banking sector
•
Dominant presence of SME (including small family-run
businesses )
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Foreign Ownership of Banks
Foreign Ownership is high – This has both advantages
and disadvantages (e.g. in NMS –Baltic countries- in the
EU foreign ownership can reach 99%)
Advantages
• More sophisticated risk management policies
• Increases confidence in Banking System
• Reduces reliance on possible Government intervention
• Containments of domestic shocks (De Haas and Van
Lelyveld- 2005)
Disadvantages
• Barriers to Entry
• Transmission of External Shocks (Home Host Divide)
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External Finance
•
Dependence of the Country on International Aid is
substantial
– This kind of finance is Volatile/Discretionary
•
FDI – Is a long-term process and may be concentrated in
specific sectors
– Expose the economy to cyclical fluctuations in that
industry (e.g. manufacturing)
•
May depend on remittances from migrants
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Money Laundering
•
Offshore Banking Centres – Bank Privacy
•
Tax Shelters – Money Laundering Heavens. In some
cases inexistent taxation
•
Capture of Financial Institutions by Criminals
•
According to the 2010 Global Financial Centres Index
(GFCI) the world's five leading offshore finance centres
are Jersey, Guernsey, Isle of Man, Bermuda, Cayman
Islands
•
Following the financial crisis offshore banking centres
have recorded a decline in activity attributable to
increased scrutiny
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Regulatory Forbearance
Three Forms of forbearance:
• Insolvent but Remain Open
• Under-Capitalised but Remain Open
• Temporary Relaxation of Regulations
•Relaxing Requirements when Needed
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Statistics related to Malta
•
Population: 412,970 (2009)
•
GDP per capita in PPS relative to the EU-27 average
(2009) 81.0%
•
Ratio of exports of goods and services to GDP 85%.
Imports to GDP ratio 83%
•
Domestically oriented sector is almost 3 times the size of
the GDP contributing to around 7.5% of gross value
added.
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Statistics related to Malta
•
Total banking sector employs about 4,800 people (3.3%
of the gainfully occupied).
•
Bank Assets/Financial System 83.4%
•
Banks remain traditional in their business model continuing to rely strongly on retail deposits -customers’
deposits 71.2% of total liabilities
•
Foreign ownership of banks 61%
•
Herfindahl-Hirschmann index – 3205 – EU 27 average
1,120
•
Market Capitalisation/GDP 134% (€8.4 billion)
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The effect of the Crisis in Malta
•GDP – 2008 + 5.3%
dropped by 3.4% in 2009 –
recovered in 2010 +3.7%
•Unemployment rate remained relatively stable since
2008
•Banking sector profitability recorded valuation losses in
2008 although in aggregate remaining profitable
•In 2009, aggregate profitability improved– also driven by
the reversal of valuation losses
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The effect of the Crisis in Malta
•
NPL’s ratio increased 6.8 – 7.4%
•
Capital adequacy and liquidity ratios remained robust
and well above the regulatory minima
•
Stress test confirmed banks are able to withstand
extreme but plausible shocks
•
Financial Stability Report indicates that since the onset
of the financial crisis the financial sector exhibited a high
degree of resilience
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Other considerations - Concentration Risk Malta
•
From a financial stability perspective concentration risk is
problematic as diversification reduces the exposure to
co-movements of related risks
•
Concentration in domestically oriented banks refers to
particular types of assets, such as property
•
HHI in lending portfolio reached 1,961
•
This characteristic remained evident across all banks
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Concentration Risk in Malta
•
Property-related loans raise concentration even further,
as over 80% of the collateral backing loans is also in the
form of property
•
Property-related loans are substantial with a number of
them being classified as Large Exposures
•
Other large exposures related to the hotels & restaurants
sector, the wholesale & retail trade and the
manufacturing sector
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Home Host Supervision
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Home Host Supervision
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Home Host Supervision
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The new EU financial stability
and supervision architecture
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Thank you
Questions?
Contact details:
malliam@centralbankmalta.org