Josef Bonnici: Achieving Malta's potential growth in challenging times
Address by Professor Josef Bonnici, Governor of the Central Bank of Malta, at the ifs Malta
Annual Dinner of the Institute of Financial Services, Saint Julian's, 29 November 2013.
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Hon. Minister, Excellences, Members of the Institute, Distinguished Guests
First of all, I would like to thank you, Mr President, and your Committee for the opportunity to
ifs
share my thoughts once again with such a distinguished audience at the Malta Annual
Dinner of the Institute of Financial Services.
Before I do so, however, I would like to commend the ifs for its perseverance in adapting
itself to the changing demands of a dynamic financial sector and its on-going commitment to
excellence in the provision of financial services education.
It is pleasing to hear that you had a successful year and that you are active on new initiatives
to promote even higher professional standards in the financial sector. Your collaboration with
other organisations is also noteworthy. The presence of representatives from the UK's ifs
University College and the European Banking & Financial Services Training Association is
evidence of the quality of the service provided by ifs Malta.
Mr President, well done and I wish you and your Committee success in your future
endeavours.
The ECB plays an important role in averting risks
As you are all aware, many of the Member States of the euro area are going through
fundamental reforms that would over time promote sustainable growth. This only can occur
with the support of a healthy financial sector, including a banking system that provides the
needed volume of credit at interest rates that reflect the European Central Bank's (ECB)
provision of ample and low-cost liquidity.
Over the course of the crisis the ECB has launched various measures to avert the risk of
more severe ramifications from the financial crisis. In July the ECB introduced forward
guidance, assuring the financial markets that its policy stance will remain accommodative
and interest rates low for as long as necessary. As a matter of fact, the recent interest rate
cut was consistent with this forward guidance.
Throughout the crisis, the ECB has played an important role in ensuring, within its price
stability mandate, the proper financing of the euro area economy in a context of subdued
credit dynamics. A series of measures were introduced to ensure that banks can pass on low
policy rates to the real economy, in particular where most needed. These measures include
providing ample liquidity to euro area banks, reviewing the collateral framework, lengthening
the maturity of operations to three years, and reducing redenomination risk in financial
markets through the announcement of Outright Monetary Transactions.
Over the longer term, further decisive steps are needed for the establishment of a genuine
banking union, so as to further enhance the resilience of the banking sector, reduce financial
fragmentation, and strengthen the institutional framework of the euro area. Certainly, in
various euro area countries, these measures need to be complemented by efforts to correct
past excesses in both the public and private sectors. And these reforms need to be
undertaken against the backdrop of a weak and fragile economic recovery, making the whole
process more challenging.
The first signs of recovery
The first signs of recovery are now visible. Chart 1 shows the level of systemic risk across
the euro area, as gauged by the Composite Indicator of Systemic Stress. This index has
reached the lowest levels since the euro area sovereign debt crisis started.
From the macroeconomic perspective, following a contraction that spanned over six quarters,
the euro area's real GDP rose marginally in the second and third quarters of 2013. Although
projections still see real GDP shrinking marginally in 2013 as a whole, a modest but positive
growth rate of around 1% is expected for 2014. Despite these positive developments, the
risks around the outlook for the euro area remain tilted to the downside. Moreover,
unemployment in the euro area remains excessively high, especially in the stressed
countries.
Heterogeneity in the euro area is evident both in terms of economic performance...
An underlying characteristic that is observed in the euro area is the uneven performance
across countries and the emergence of increased heterogeneity. As can be seen in Chart 2,
the uneven pace of economic recovery is evident: countries, such as Greece, Italy and
Portugal, are registering a contraction in their economies, while Germany, Austria and Malta
are among the countries that have recorded modestly positive growth rates. Chart 3 shows
that unemployment rates vary between less than 5% in the Netherlands, Austria and
Luxembourg to over 25% in Greece and Spain.
...and in terms of monetary policy transmission
Even on the monetary side, the transmission of accommodative monetary policy measures
across the euro area remains weak and uneven. Loans to the private sector have been
declining and the pace of contraction has actually accelerated in recent quarters, particularly
in the stressed countries. Although, on the demand side, subdued loan dynamics in the
weaker economies can largely be explained by the slow pace of economic activity, the
supply of credit is also constrained by banks' efforts to repair their balance sheets and
strengthen their capital position. For all these reasons, it will perhaps take a while for the
ECB's monetary policy to be reflected in credit creation in the weaker economies.
Though Malta is positioned with the stronger economies...
Various indicators place Malta with the stronger performers. Chart 2 shows a growth rate for
Malta that generally exceeds the corresponding rates for both categories of countries. A
similar conclusion can be drawn from Chart 3, which deals with the unemployment rate.
Similarly, the level of unit labour costs is lower in Malta than in both the weaker and stronger
groups, as will be discussed later. It is important that the public debate and the formulation of
policy focus more closely on what is needed for Malta to remain aligned with the better
performers.
In the first two quarters of 2013, Malta's GDP growth rate stood at 2.7%. Net exports have
been the main source of expansion. The outlook is for stronger growth in 2014 as Malta
continues to benefit from its competitiveness. The economy continues to diversify, creating
high value added job opportunities. While some sectors have had to downsize, there has
been a compensating expansion in other sectors, such as financial and other services. This
is shown in Chart 4.
An aspect that may go unnoticed is the role of the financial sector in the resilience of the
Maltese economy and its alignment with the stronger group of countries. Financial
soundness indicators confirm that Malta has a sound and robust banking sector. A three-way
split of the banking sector distinguishes between the core domestic banks that are closely
integrated with the domestic economy at one end and the international banks that conduct all
their business abroad at the other end, along with a relatively small sector, the non-core
domestic banks, in between, as shown in Chart 5.
Looking more closely at the external dimension, an important characteristic that distinguishes
us from other models, such as the one in Cyprus, is the fact that the international banking
sector in Malta is only lightly linked to the domestic economy and to the remainder of the
Maltese banking system. Meanwhile, unlike the situation in other countries, the core
domestic banks have very low reliance on non-resident deposits. They operate along
traditional lines, applying a prudent business model and, like the rest of the banking sector,
carrying minimal exposure to securities issued in the distressed economies. The core
domestic banks are highly capitalised, profitable and liquid, and the other categories of the
banking sector are similarly robust.
...in terms of interest rates, Malta needs to further align with its peers.
Although various indicators place Malta with the stronger performing group, there is room for
further improvement. Interest rates on loans to businesses are currently around 2% to 3%
higher in Malta as compared with Germany, the Netherlands, Finland, Austria, and
Luxembourg. In contrast, deposit rates offered by Maltese banks are broadly in line with
those across the euro area, as shown in Chart 6. As a result, bank interest margins are
higher in Malta, as shown in Chart 7. A closer alignment of margins with those of our peers
appears to be warranted. The recently proposed Budget measure to conduct a review of
bank charges to businesses makes sense. The benefits of having a robust banking sector
would then be passed more fully to the rest of the economy.
This would be reflected in faster growth in the volume of credit, which recently has been
trending downwards, although it should also be pointed out that credit growth in Malta
continues to outpace that in the euro area, as can be seen in Chart 8. The expected
settingup of the Development Bank will also contribute to filling a funding gap that currently exists in
the financial sector in Malta, which could provide relief to the cost and difficulty of access to
finance, particularly for SMEs, and may serve to compliment the core banks in the funding of
larger projects.
Preparations for the banking union are underway...JFSB and BR/09/2008
We are now entering the first phase of the banking union, where major financial institutions
will be supervised directly by the ECB under the Single Supervisory Mechanism (SSM). At a
second stage, all other institutions will be adopting the single rulebook. This requires
preparation for the new challenges ahead.
In the local context, an important step in the preparation for the SSM was the establishment
of the Joint Financial Stability Board (JFSB), set up jointly by the Central Bank and the
MFSA, and now part of the Central Bank of Malta Act.
Amongst the issues that are being discussed by the Joint Financial Stability Board, there is
the proposed revision of the Banking Rule BR/09/2008. This revision is currently at
consultation stage in the financial sector. The rule deals with provisioning for non-performing
loans (NPL), taking into account the duration of the NPLs, and also calls for a specific buffer
linked to the gap between provisions and NPLs.
Safeguarding fiscal stability by expanding growth...competitiveness is key
Economic and financial stability also require fiscal consolidation, so that the deficit
progressively declines towards the Fiscal Compact target. The debt-to-GDP ratio is expected
to reach a plateau and then start declining, as planned by the Government. Budget figures
project the debt-to-GDP ratio at 73% in 2013, along with a deficit ratio of 2.7%. An exit from
the Excessive Deficit Procedure is essential.
Indeed, the Fiscal Compact involves strict budgetary commitments and places limits on the
Government's deficit. Moreover, even in the absence of the obligations under the Fiscal
Compact, public debt cannot be allowed to accumulate persistently as this could lead to
unsustainable debt dynamics.
GDP growth reduces the debt ratio first by automatically raising tax revenues and reducing
Government spending. Second, it expands the denominator of the debt-to-GDP ratio.
Obviously, resolving fiscal excess through an expanding GDP is less painful.
To sustain economic growth, the economy needs to offer products and services with high
value added and at competitive prices. The alignment of wages and productivity is crucial for
competitiveness, particularly at a time when neighbouring economies are undergoing an
internal devaluation. Because of this correction, unit labour costs in the stressed economies
have plateaued and are now converging with those in the better performing countries (refer
to Chart 4). While unit labour costs in Malta have been lower than in other euro area
countries, it is crucial to ensure that higher productivity supports wage growth, thereby
safeguarding the country's competitiveness.
Conclusion - Malta as a regional hub
In the recent past, our economy was able to attract sectors and niche markets, such as
financial and business services, and the aviation maintenance sector. Further investment
promotion calls for continued efforts to identify new areas of growth, and to develop a labour
force with the necessary skills and qualifications.
The financial and other service sectors have been crucial for economic stability and growth.
Recent expansion in the financial services sector can serve as a springboard for further
development in view of new opportunities in the Mediterranean region. Further diversification
of the range of financial and other services will provide opportunities for Malta to develop
further as a regional hub for various activities. Proficiency in the English language, a sound
legal system, the high standards of the legal and accounting professions and the mantle of
EU membership offer fertile ground for those who want to do business here.
Certainly, a growing financial sector needs to be supported and protected by appropriate
legislative and supervisory frameworks to ensure that potential risks are minimized. Malta
has managed to host a relatively large financial sector without exposing itself to excessive
risks. Yet this has not been the case in other countries. We need to be on the lookout for
potential threats to our system so as to reap the benefits of the financial sector without
exposure to excessive risk. In the past year we have been under the spotlight and operators
need to ensure that the appropriate regulations are carefully followed.
Malta should look optimistically to the future, not only because it has managed to ride the
downturn quite well, but also because it has the ingredients for further growth and prosperity.
A concerted and unified effort is essential to achieve our potential growth.
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