COMMISSION STAFF WORKING DOCUMENT In-depth review for MALTA in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL AND TO THE EUROGROUP Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances
Date: 2013-04-10
Institutions: European Commission
Subjects: Malta, banking system, competitiveness, economic growth, economic recession, economic reform, macroeconomics, population ageing, property market, public debt

EUROPEAN 
COMMISSION 

Brussels, 10.4.2013  
SWD(2013) 120 final 

COMMISSION STAFF WORKING DOCUMENT 

In-depth review for MALTA 

in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and 
correction of macroeconomic imbalances 

Accompanying the document 

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN 
PARLIAMENT AND THE COUNCIL AND TO THE EUROGROUP 

Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and 
correction of macroeconomic imbalances 

{COM(2013) 199 final} 
{SWD(2013) 113 final} 
{SWD(2013) 114 final} 
{SWD(2013) 115 final} 
{SWD(2013) 116 final} 
{SWD(2013) 117 final} 
{SWD(2013) 118 final} 
{SWD(2013) 119 final} 
{SWD(2013) 121 final} 
{SWD(2013) 122 final} 
{SWD(2013) 123 final} 
{SWD(2013) 124 final} 
{SWD(2013) 125 final}

EN 

   EN 

 
 
 
 
 
  
 
 
 
 
 
Contents 

Executive summary and conclusions ......................................................................................... 3 

1. 

2. 

2.1. 

2.2. 

2.3. 

2.4. 

2.5. 

2.6. 

3. 

4. 

Introduction .................................................................................................................. 5 

Macroeconomic situation and potential imbalances .................................................... 5 

Macroeconomic scene setter ........................................................................................ 5 

Sustainability of external positions .............................................................................. 6 

Competitiveness and trade performance .................................................................... 11 

Private sector indebtedness ........................................................................................ 15 

Government debt........................................................................................................ 20 

Property market developments................................................................................... 21 

In-depth analysis of financial sector vulnerability ..................................................... 25 

Policy challenges........................................................................................................ 30 

REFERENCES......................................................................................................................... 32 

2 

 
 
 
 
 
 
EXECUTIVE SUMMARY AND CONCLUSIONS  

In the previous round of the MIP, Malta was not identified as experiencing imbalances. In the 
updated  scoreboard,  a  number  of  indicators  are  above  their  indicative  thresholds,  namely, 
private sector debt, the current account balance and government debt. In addition, the growth 
rate of total financial sector liabilities has exceeded the indicative threshold several times in 
the  past  decade  and  as  a  result  the  accumulated  growth  in  2011  significantly  exceeded  the 
average for the euro area. This in-depth review takes a broad view of the Maltese economy in 
order to identify actual or potential imbalances and the macroeconomic risks which they may 
entail. The main observations of this review are: 

•  After  posting  sizeable  deficits  for  most  of  the  past  decade,  the  current  account 
balance has been on an upward path since 2009 and turned into a surplus in late 
2011. The adjustment appears to reflect a structural improvement in the trade balance 
as services exports increased and goods imports growth moderated, both on the back 
of  a  lower  import  content  of  exports  and  the  slowdown  in  the  import-intensive 
construction sector. Additional factors, such as a positive net international investment 
position and Malta's position as a net external creditor contribute to the sustainability 
of the external position.   

•  The  level  of  private  debt  in  the  scoreboard  is  high,  but  there  are  mitigating 
factors.  Starting  from  a  low  level,  household  debt  has  increased  rapidly  in  recent 
years,  mainly  via  growing  mortgage  lending.  Nevertheless,  households  continue  to 
hold sizeable net financial wealth. High gross corporate debt and leverage raise more 
concern,  but  potential  risks  are  mitigated  by  a  number  of  factors  such  as  the  mainly 
long-term structure of liabilities and the diversification of sources. 

•  The  long-term  sustainability  of  public  finances  is  at  risk.  Government  debt 
amounted to 70.4% of GDP in 2011, up from 60.9% of GDP when Malta adopted the 
euro  in  2008.  The  government  is  currently  not  experiencing  problems  with  debt 
financing  thanks  to  high  domestic  demand  for  issued  securities,  but  sizeable  state-
guarantees  to  state-owned  companies,  some  of  which  not  in  a  sound  financial  state, 
represent an important risk to the future dynamics of government debt. Moreover, the 
long-term  projections  for  both  pension  and  healthcare  expenditure  in  Malta 
significantly exceed the EU average.  

•  Despite  some  overvaluation  and  possible  oversupply,  the  property  market  does 
not appear to be exposed to an immediate risk of a bust. Housing prices increased 
significantly over the past two decades. Overvaluation appears to have occurred in the 
years  before  euro  adoption,  but  since  then  some  correction  has  been  taking  place. 
Sharp downward adjustments in prices in the short-term are not expected: demand is 
robust  while  developers’  balance  sheets  are  strong  enough  to  allow  them  to  abstain 
from  selling  at  unfavourable  prices,  even  if  estimations  suggest  that  there  may  be 
oversupply in some segments of the market. 

3 

 
 
•  The  majority  of  the  very  large  financial  sector  is  internationally-oriented  with 
very little link to the domestic economy, and therefore does not pose large risks 
for  domestic  stability.  The  domestically-oriented  financial  sector,  which  invests  in 
resident  assets  and  funds  itself  in  Malta,  is  significantly  smaller,  relatively  well-
capitalised  and  profitable.  However,  its  high  exposure  to  the  real  estate  market 
warrants  close  monitoring,  also  in  view  of  a  relatively  low  coverage  of  non-
performing  loans  through  loan  loss  provisioning.    The  activities  of  the  non-core 
domestic  banks,  which  account  for  around  10%  of  total  assets,  appear  riskier  and 
therefore require strict supervision. 

The IDR also discusses the policy challenges stemming from these imbalances and possible 
policy  responses.  A  number  of  elements  can  be  considered  for  further  policy  action.  These 
include  the  need  to  closely  monitor  developments  in  the  financial  sector,  including  the 
internationally-oriented and non-core domestic segments, and to take any appropriate further 
measures to strengthen loan loss provisions in domestically-oriented banks; close monitoring 
of  developments on the property market,  in view of the exposure of the financial sector to it; 
finally, pension and healthcare reforms are needed to address the long-term sustainability of 
public finances, while measures to limit unsustainable growth of private indebtedness may be 
warranted. 

4 

 
 
1. 

INTRODUCTION 

On  28  November  2012,  the  European  Commission  presented  its  second  Alert  Mechanism 
Report (AMR), prepared in accordance with Article 3 of Regulation (EU) No. 1176/2011 on 
the  prevention  and  correction  of  macroeconomic  imbalances.  The  AMR  serves  as  an  initial 
screening device helping to identify Member States that warrant further in depth analysis to 
determine  whether  imbalances  exist  or  risk  emerging.  According  to  Article  5  of  Regulation 
No. 1176/2011, these country-specific “in-depth reviews” (IDR) should examine the nature, 
origin and severity of macroeconomic developments in the Member  State concerned, which 
constitute,  or  could  lead  to,  imbalances.  On  the  basis  of  this  analysis,  the  Commission  will 
establish  whether  it  considers  that  an  imbalance  exists  and  what  type  of  follow-up  it  will 
recommend to the Council. 

The  AMR  suggested  the  need  to  look  more  closely  at  whether  Malta  is  exhibiting 
macroeconomic imbalances of an external and internal nature. On the external side, the AMR 
highlighted persistent current account deficits in the past. On the domestic side, corporate and 
government debt levels are elevated. In addition, the size of the financial sector appears to be 
very  large  compared  to  the  domestic  economy  and  with  a  high  exposure  to  the  property 
sector, which has seen very dynamic price growth in recent years. Malta also faces challenges 
in ensuring the long-term sustainability of public finances in view of population ageing and 
sizeable  contingent  liabilities.  To  this  end  this  IDR  takes  a  broad  view  of  the  Maltese 
economy  in  line  with  the  scope  of  the  surveillance  under  the  Macroeconomic  Imbalance 
Procedure (MIP). 

Against  this  background,  Section  2  of  this  in-depth  review  looks  more  in  detail  into  these 
developments  covering  both  the  external  and  internal  dimensions,  followed  by  a  specific 
focus on potential vulnerabilities in the financial sector Section 3. Section 4 discusses policy 
considerations. 

2. 

MACROECONOMIC SITUATION AND POTENTIAL IMBALANCES 

2.1.  Macroeconomic scene setter 

The Maltese economy demonstrated resilience throughout the crisis. Economic growth in 
Malta  in  the  years  before  the  crisis  was  in  line  with  the  average  for  the  euro  area,  but  well 
below the group of new Member States (EU12 – see Graph 1). In the aftermath of the global 
crisis,  the  domestic  economy  proved  resilient:  in  2009,  real  GDP  declined  by  2.4%,  well 
below the 4.4% contraction in the euro area. The subsequent rebound was more pronounced 
than for the euro area average (2.7% of GDP against 2.0% of GDP in the euro area), mainly 
driven by exports, while domestic demand and in particular the import-intensive investment 
were subdued. As a result, the current account balance has been gradually improving. Against 
the  background  of  Malta's  still  very  low  participation  rates,  especially  among  women  and 
older  worker,  job  creation  was  strong  and  the  unemployment  rate  remained  at  a  low  level 
compared  to  the  euro  area  average.  According  to  the  Commission  services’  winter  2013 
forecast, after moderating in 2012, economic growth is projected to accelerate in 2013-14 and 

5 

 
 
to continue to outperform the euro area average, underpinned by gradually resuming business 
investment  and  household  consumption.  Growth  is  expected  to  remain  job-rich  and 
employment  is  forecast  to  continue  increasing  at  a  relatively  fast  rate,  mainly  thanks  to 
catching up participation and employment among women and older workers, also resulting in 
decreasing  unemployment.  Recovering  domestic  demand  is  expected  to  result  in  worsening 
external  trade  balance  over  2013-14,  although  the  current  account  is  forecast  to  remain  in 
surplus. 

Graph 1: Malta's real GDP evolution, 2000=100 

155

145

135

125

115

105

95

0
0
1
=
0
0
0
2

,
x
e
d
n
I

forecast

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Malta

EA17

EU12- NMS

Source: Commission services 

2.2. 

Sustainability of external positions 

Malta’s  external  balance  has  been  characterised  by  persistent  current  account  deficits 
for several years up to 2011. After recording a surplus in 2002, the current account averaged 
a  deficit  of  6.4%  of  GDP  between  2003  and  2010  (see  Graph  2).  The  persistent  deficits 
mainly  reflected  a  negative  balance  of  goods,  related  to  the  large  import-dependence  of 
domestic  demand,  including  nearly  full  dependence  of  the  economy  on  imported  oil  for 
energy generation. The income account has also contributed significantly to the deficit in the 
current  account,  reflecting  the  big  share  of  foreign  companies  operating  in  Malta,  including 
the  very  large  internationally-oriented  banks.  Net  outflows  averaged  around  2%  of  GDP  in 
2000-08 before increasing substantially to average around 7% of GDP in 2009-11 on the back 
of higher profits by foreign-owned enterprises. The capital account, having averaged a surplus 
of just over 1% of GDP throughout the 2000s, has offset some of the current account deficit, 
thus contributing positively to the net external borrowing requirement. 

6 

 
 
 
 
 
Graph 2: Decomposition of Malta's current account balance 

25

20

15

10

5

0

-5

-10

-15

-20

-25

P
D
G

f
o
%

00

01

02

03

04

05

06

07

08

09

10

11

12*

Capital account
Income balance
Trade balance - goods
Current account balance (CA)

Current transfers
Trade balance - services
Trade balance
Net lending/borrowing (CA+KA)

Source: Commission services 

Past  current  account  deficits  have  been  comfortably  financed  by  FDI  inflows,  mainly 
thanks to an expanding banking sector. Malta has historically been an attractive destination 
for  foreign  investment,  despite  the  small  size  of  its  domestic  market.  FDI  inflows  have 
averaged around 10% of GDP since the beginning of the decade (see Graph 3). The majority 
of  respondents  in  a  recent  survey  by  Ernst  &  Young  (2012)  indicated  that  Malta's 
attractiveness as a destination for foreign investment is related to its stable social climate and 
corporate taxation regime as well as the reliable and transparent regulatory environment. As 
Graph 4 illustrates, FDI inflows have been largely dominated by the financial sector, which 
by 2009 represented around 56% of the total stock of FDI in Malta and this share increased to 
around  80%  in  2010,  with  the  arrival  of  a  major  German  international  bank.  In  fact,  FDI 
represents  a  relatively  small  proportion  of  the  gross  financing  flows  in  Malta.  The  banking 
sector  attracts  also  a  significant  amount  of  financing  reported  as  'other  investment'  in  the 
balance  of  payments  statistics,  which  mainly  represents  loans  and  deposits  transferred  from 
parent  institutions  into  their  banking  branches  and  subsidiaries  in  Malta.  As  Section  3 
discusses,  these  very  large  capital  flows  do  not  stay  in  the  country  but  are  invested  abroad 
either  as  loans  or  deposits  in  other  banks  or  in  the  form  of  portfolio  investment.1  The 
construction  sector  also  attracted  a  sizeable  share  of  FDI  inflows,  but  these  appear  to  have 
dried up after 2007-08.   

1  
does not interact with the domestic economy. 

Therefore,  the headline  capital  flows data  for  Malta  can be  misleading  as  a  significant share  of  those 

7 

 
 
 
 
 
                                                            
Graph 3: The financing of Malta's current account balance 

60

40

20

0

-20

-40

-60

P
D
G

f
o
%

00

01

02

03

04

05

06

07

08

09

10

11

12*

Net errors and omissions
Other investment (net)
Direct investment (net)
Net lending/borrowing (CAB+KAB), rhs

Official reserves (net)
Portfolio investment (net)
Current account balance, rhs

Source: Commission services 

Graph 4: Malta's inward FDI stocks  

15

10

5

0

-5

-10

-15

Source: NSO 

A  notable  improvement  in  the  current  account  balance  started  in  2009.  The  current 
account  balance  moved  from  a  deficit  of  nearly  8%  of  GDP  at  the  end  of  2009  to  a  2%  of 
GDP  surplus  in  the  second  quarter  of  20122.  The  improvement  is  mainly  attributable  to  the 
goods balance, which moved from -21% of GDP at the beginning of 2009 to -15% of GDP in 
the  third  quarter  of  2012.  The  slowdown  in  the  import-intensive  construction  sector  (see 
section  2.6  later),  also  related  to  the  completion  of  a  major  construction  project  in  2007,  as 
well  as  a  strong  increase  in  exports  are  key  drivers  of  this  development.  The  continuously 

2  

All Graphs in this paragraph refer to 4-quarter sums. The last available data are for Q3 2012. 
8 

 
 
 
 
 
 
                                                            
expanding  services  exports  also  contributed  to  the  improving  external  balance,  driven  in 
particular  by  tourism3  and  financial  services  as  well  as  the  remote  gaming  industry.  A 
shrinking deficit in the income account has also been contributing to the improvement of the 
current  account  balance  since  the  second  half  of  2011,  as  net  portfolio  investment  inflows 
started  recovering  after  the  financial  crisis  in  2008-2009.  According  to  the  Commission 
services'  2013  autumn  forecast,  the  current  account  is  projected to  remain  in  surplus  during 
the  forecast  horizon.  It  should  be  noted,  however,  that  quarterly  statistics  in  Malta  are  very 
volatile and subject to sometimes significant revisions (see Box 1) and therefore it is still early 
to draw definitive conclusions based on these data. 

The  sustainability  of  Malta's  external  balance  also  benefits  from  a  favourable  net 
external  debt  and  positive  net  international  investment  position.  Thanks  to  large 
investments  in  foreign  debt  instruments,  the  net  international  investment  position  (NIIP) 
averaged a surplus of over 20% of GDP over 2001-2011 (see Graph 5). Malta is a net external 
creditor and its positive balance has increased from 4.5% of GDP in 1995 to nearly 160% of 
GDP in 2011. 

Graph 5:  Composition of Malta's net international investment position 

P
D
G

f

o
%

300

200

100

0

-100

-200

-300

50

25

0

-25

-50

00

01

02

03

04

05

06

07

08

09

10

11

12*

Net financial derivatives
Other investment (net)
Net portfolio investment
Marketable debt

Net direct investment
Reserve changes (net)
Net external debt (neg. sign)
Net int'l investment position (rhs)

Source: Commission services  

Box 1 – Frequent revisions to Malta's economic data 

Revisions  of  economic  data  occur  frequently  in  Malta  and  at  times  their  magnitude  is  particularly 
large.  Table  1  illustrates  the  size  of  the  revisions  by  showing key balance  of  payments  and  national 
accounts data for 2011 as reported in successive data releases by the National Statistical  Office: the 
current account deficit was reported at 3.2% of GDP in March 2012, but was revised to only 0.3% of 

3  
despite the challenging macroeconomic environment in the EU – Malta's main market. 

The  tourism  sector  proved  particularly  resilient  and  managed  to  reach  record-high  levels  of  arrivals 

9 

 
 
 
 
 
 
                                                            
GDP six months later.  

Furthermore,  sizeable  reported  amounts  for  net  errors  and  omissions  in  the  balance  of  payments  – 
which  could  either  stem  from  the  current  account  side  (an  understatement  of  exports)  or  from  the 
financial side (an overstatement of capital outflows) - obscure the picture that comes out of the data. In 
annual  terms,  net  errors  and  omissions  are  reported  at  over  5%  of  GDP  in  2009  and  2010  (data  for 
these  years  is  still  provisional),  among  the  highest  in  the  EU.  Large  positive  amounts  for  this  item 
have  also  been  reported  in  the  quarterly  data  since  the  third  quarter  of  2011.  Finally,  changes  in 
inventories – which are normally used as a residual category in national accounts - are often reported 
to have a significant role in economic activity and are reported to have contributed 1.3pp on average to 
annual real GDP growth between 2001 and 2011.  

Frequent data revisions and the large use of residual categories can to some extent be explained by the 
difficulty to represent the highly volatile and narrow-based Maltese economy. They are also the result 
of  a  number  of  attempts  by  the  National  Statistical  Office  (NSO)  to  gauge  the  ongoing  structural 
changes  in  the  domestic  economy.  In  particular,  in  2011,  the  NSO  undertook  a  major  revision  of 
national accounts data to take account of the emerging remote gaming industry. Table 2 shows that the 
impact  of  this  revision  on  reported  real  GDP  growth  was  very  sizeable,  although  it  was  partly 
corrected in the latest release. More recently, data revisions were undertaken to reflect the emergence 
of the oil re-exporting activity as well as the availability of data reclassified under the NACE Rev. 2 
methodology. 

Overall, the instability of statistical data makes adequate monitoring and forecasting of the domestic 
economy particularly challenging. 

Table 1: Overview of revisions to balance of 
payments  and  national  accounts  data  for 
2011 in latest releases 

Table  2:  Real  GDP  growth  (%  y-o-y)  before 
and  after  2011  revision  incorporating  the 
remote gaming industry 

% of GDP

Mar-12

Jun-12

Sep-12

Dec-12

Current account balance

Trade balance

   Balance of goods

   Balance of services

Income balance

Real GDP growth (y-o-y)

-3.2%

4.9%

-1.3%

4.2%

-0.3%

5.6%

-0.5%

5.2%

-15.3%

-15.8%

-15.6%

-16.0%

20.2%

19.9%

21.2%

21.3%

-8.6%

2.1%

-6.8%

2.1%

-6.3%

1.9%

-6.1%

1.6%

y-o-y

Before revision

After revision

Latest release

2006

3.3%

2.1%

2.6%

2007

3.9%

4.4%

4.1%

2008

2.7%

5.3%

3.7%

2009

-1.9%

-3.4%

-2.4%

Source: NSO, Eurostat 

Source: NSO, Eurostat 

The  net  international  investment  position  (NIIP)  reflects  large  asset  and  liability  stock 
positions, which largely offset each other. 4 Gross foreign assets amounted to 689% of GDP 
in  2011,  up  from  122%  of  GDP  in  1995.  Of  these,  gross  assets  of  monetary  financial 
institutions,  excluding  the  central  bank,  grew  from  62%  of  GDP  in  1995  to  581%  of  GDP, 
thereby  accounting  for  almost  the  entire  growth  of  assets  abroad  in  the  IIP.  Loans  and 
deposits abroad as well as holdings of debt instruments exceeded 600% of GDP in 2011 and 
represented  around  90%  of  total  assets.  The  liabilities  side  of  the  NIIP  consists  mainly  of 
loans and deposits by parent banks into their subsidiaries in Malta (as well as FDI). In light of 

4  
oriented banks. 

Total assets of resident banks exceed 800% of GDP.  Of these, 500% of GDP belong to internationally-

10 

 
 
 
 
                                                            
these  large  stock  positions,  the  NIIP  is  vulnerable  to  valuation  changes.  In  the  past,  the 
contribution of valuation changes to the annual changes in the NIIP has fluctuated between -
10pp. and +10pp (see Graph 6). Given the presence of two large branches of Turkish banks, 
the appreciation of the Turkish lira also has a notable impact.  

Graph 6: Decomposition of Malta's net IIP changes 

)

%

(

y
-
o
-
y
e
g
n
a
h
c

f

o
e

t

a
R

25

20

15

10

5

0

-5

-10

-15

-20

01 02 03 04 05 06 07 08 09 10 11 12

Valuation changes
Net transaction effect (rest FA bal.)
Investment income effect
Nominal growth effect
Change in NIIP (y-o-y)

Source: Commission services 

The  structure  of  liabilities  in  the  NIIP  appears  benign  although  unavailability  of  data 
the 
precludes  precise  conclusions.  The  majority  of  foreign 
internationally-oriented banks, which have very limited impact on the domestic economy (see 
Section 3). Furthermore, the high share of FDI in gross liabilities5 indicates significant shock-
absorbing  capacity  on  the  part  of  the  banking  sector  to  withstand  significant  losses,  should 
financial  market  conditions  worsen.  Available  data,  however,  is  not  disaggregated  between 
domestically-oriented  and  internationally-oriented  banks  and  therefore  it  is  not  possible  to 
fully distinguish the impact of the much larger internationally-oriented banks. 

liabilities  belong 

to 

2.3. 

Competitiveness and trade performance 

The Maltese economy is very open and total trade (exports plus imports) amounted to 
around  200%  of  GDP  in  2011.  In  the  trade  of  services,  the  main  exports  are  tourism  and 
remote  gaming6,  whereas  the  economy  imports  business  services,  in  particular  management 

FDI represented over 28% of total foreign liabilities of the Maltese economy, slightly higher than the 

5  
average for the euro area. 
6  
Following the so-called "VAT package" adopted by the council in Council Directive 2008/8/EC of 12 
February 2008, Malta's attractiveness as a location for remote gaming could diminish. Malta currently exempts 
from VAT such activities. The new Council Directive stipulates that as of 2015 VAT  must be charged on the 
basis  of  where  the  customer  is  located.  Since  several  Member  States  do  not  apply  a  blanket  exemption  to 
11 

 
 
 
 
 
 
 
 
                                                            
and accounting. In terms of goods, the main export is electrical machinery, while new high-
technology activities have emerged in recent years, namely in the aircraft and pharmaceuticals 
sectors. As Malta has increasingly become an important trans-shipment centre for crude oil in 
the  Mediterranean  area,  trade  in  oil  has  also  seen  significant  growth  over  the  past  several 
years. Its net impact on the trade balance, however, appears to be small as it mainly represents 
re-exporting. 

The trade balance has been gradually improving in recent years, mainly reflecting gains 
in market shares in services. Reflecting the structural shift in the economy, it was trade in 
the less import-intensive services that drove the improvement. This has been reflected in gains 
in  market  shares  in  the  trade  of  services  –  in  particular  recreational  services,  legal  and 
accounting  services  and  IT  –  while  losing  in  the  trade  of  goods  (machinery  and  electrical 
equipment as well as textiles, see Graph 7). The improvement in market share in the trade of 
goods in 2009 reflects the fact that goods exports in that year declined by much less than the 
world trade. 

Graph 7: Decomposition of Malta's export market shares  

30

20

10

0

)

%

(

e
t
a
r

h
t
w
o
r
G

-10

-20

-30

00 01 02 03 04 05 06 07 08 09 10 11

Denominator: World Export growth (neg. sign)
Numerator: Export growth
EMS growth rate

Source: Commission services 

Box 2: Economic restructuring in Malta 

Malta’s  production  structure  predominantly  consists  of  domestic-owned  micro  enterprises  operating 
alongside a small number of relatively large export-oriented subsidiaries of multinational companies. 
While  the  manufacturing  sector  remains  an  important  pillar  of  the  domestic  economy,  the  share  of 
total value added generated by this sector has been steadily declining - from 21% in 2000 to 13% in 

gaming, service suppliers established in Malta will have to charge and account for VAT where this is applicable. 
Any VAT advantage gained by choosing Malta as a location for remote gaming will thus disappear. 

12 

 
 
 
 
 
 
 
                                                                                                                                                                                          
2011 - and its share in total employment declined by almost 8 percentage points over the same period 
(see  Graph  8).  This  structural  change  started  already  twenty  years  ago,  thanks  to  foreign  direct 
investment and the birth of new and growing industries. In addition, important changes have occurred 
within  the  manufacturing  sector,  with  the  emergence  of  activities  in  pharmaceuticals,  precision 
engineering,  aircraft  maintenance  and  medical  devices  coming  to  complement  the  important 
electronics sector and moving the overall sector to higher technology activities.  

By  contrast,  the  services  sector  has  been  gaining  in  importance,  mainly  thanks  to  the  emergence  of 
new activities such as remote gaming, financial intermediation, tourism, as well as, more recently, IT, 
legal and accounting services. In particular, the rapid growth of the remote gaming sector is striking as 
the number of people employed in it doubled and this sector increased its share in gross value added 
by  around  8 percentage  points  since  2000.  The  shift  towards  services  plays  an  important  role  in  the 
current account balance improvement due to the much smaller share of imported inputs in total output 
in their production compared to the production of goods. 

Graph 8: Malta's production structure 
Panel A: Employment 

 Panel B: Gross value added  

100
90
80
70
60
50
40
30
20
10
0

l

a
t
o
t

f
o
e
g
a
t
n
e
c
r
e
p

100
90
80
70
60
50
40
30
20
10
0

l

a
t
o
t

f
o
e
g
a
t
n
e
c
r
e
p

2000

2003

2006

2009

2011

2000

2003

2006

2009

2011

Public administration
Services
Industry (except construction)
Construction
Agriculture, forestry, fishing

Source: Commission services 

Public administration
Services
Industry (except construction)
Construction
Agriculture, forestry and fishing

The economy has been gradually losing cost competitiveness vis-à-vis the euro area over 
the past decade. The growth of nominal unit labour costs, an indicator of the cost of labour 
needed  to  produce  one  unit  of  output,  was  notably  more  moderate  than  the  average  for  the 
new  Member  States  but  still  exceeded  the  average  for  the  euro  area  (see  Graph  9). 
Compensation per employee increased faster than in the euro area, in particular in the years 
following EU accession, also because skill shortages in the emerging new industries increased 
competition  for  qualified  employees  and  pushed  up  wages.  At  the  same  time,  labour 
productivity  growth  in  Malta  has  been  modest,  trailing  behind  the  average  increases  for  the 
euro  area.  After  2009,  however,  wage  developments  moderated  and  converged  to  the 
relatively  slow  productivity  growth,  thus  helping  the  economy  to  regain  some  cost 

13 

 
 
 
 
 
 
 
 
 
 
competitiveness  and  support  the  export-led  recovery  from  the  recession  in  2009.  While  the 
existing automatic wage indexation mechanism (Cost-of-Living Adjustment) does not appear 
to have been a major hindrance to wage adjustment and overall labour market performance so 
far,  looking  forward  it  poses  a  potential  risk  to  the  economy  in  particular  during  strongly 
adverse  phases  of  the  economic  cycle,  by  impeding  the  adjustment  of  real  wages,  in  turn 
impeding the absorption of unemployment and hampering competitiveness.  

Graph 9: Unit labour costs in Malta 
Panel A: Composition  

Panel B: Evolution 

forecast

10

8

6

4

2

0

-2

-4

-6

-8

)

%

(

t

h
w
o
r
g
C
L
U
o

t

s
n
o
i
t
u
b
i
r
t
n
o
C

-10

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Inflation (GDP deflator) Compensation per Employee
Real Compensation per Employee
Productivity Contribution (negative sign)
Nominal unit labour cost
ULC in Euro Area

Source: Commission services 

170

160

150

140

130

120

110

100

90

0
0
1
=
0
0
0
2

,
x
e
d
n

i

forecast

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Malta

EA17

EU12- NMS

However, price competitiveness improved after the crisis. The real effective exchange rate, 
a  measure  of  the  economy’s  price  competitiveness  against  a  group  of  competitor  countries, 
appreciated  notably  before  the  crisis  also  reflecting  the  nominal  appreciation  of  the  euro 
against  the  US  dollar  (see  Graph  9,  Panel  A).  Following  2009,  the  nominal  exchange  rate 
depreciation, which is particularly relevant for Malta given that a significant part of exports 
goes  outside  of  the  EU,  and  moderate  price  growth  resulted  in  improving  price 
competitiveness.  This  trend  is  also  confirmed  by  dynamics  of  the  ECB's  Harmonised 
Competitiveness  Indicator,  which  looks  at  a  country's  price  competitiveness  vis-à-vis  the 
other  euro  area  Member  States  and  the  euro  area's  20  main  trading  partners  (see  Graph  9, 
Panel B). 

14 

 
 
 
 
 
 
 
 
 
 
Graph 10: REER 

Panel A: Composition  

4

3

2

1

0

-1

-2

-3

-4

)

%

(

h
t
w
o
r
g
R
E
E
R
o
t

s
n
o
i
t
u
b
i
r
t
n
o
C

Panel  B:  Evolution  of  HICP-deflated  real 
effective 
and 
HCI

exchange 

rate 

forecast

100

0
0
1
=
9
0
0
2

,
x
e
d
n

I

95

90

85

80

00 01 02 03 04 05 06 07 08 09 10 11

Malta REER

EA17 REER

Malta HCI

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Relative HICP (-)

NEER

REER (HICP)

Source: Commission services 

Source: Commission services and ECB 

Overall,  the  economy  does  not  appear  to  suffer  from  lack  of  competitiveness.  The 
economy underwent a structural shift away from traditional manufacturing and towards higher 
technology  activities,  mainly  in  services,  in  a  relatively  smooth  way.  The  restructuring  was 
job-rich and thus able to absorb a significant increase in labour participation, in particular as 
more  and  more  women  entered  the  labour  market.  While  remaining  well  below  the  EU 
average (at 57.6% and 41% in 2011 for the total population and for women, respectively), the 
employment  rate  in  Malta  thus  increased  substantially  since  the  beginning  of  the  decade, 
especially for women (7.9 pps). Export market shares increased, mainly in services, but also 
in  some  segments  of  the  trade  of  goods.  Price  and  cost  competitiveness  have  improved 
following the crisis, thereby supporting an export-led recovery of the economy and a further 
improvement in the current account balance. A stable regulatory environment and a relatively 
cheap  and  skilled  labour  force  certainly  contributed  to  these  favourable  developments, 
although skill shortages in some growing sectors, such as financial services, have resulted in 
upward pressure on wages, which may hamper competitiveness going forward. 

2.4. 

Private sector indebtedness 

Private sector debt expanded since Malta joined the EU, to reach 204% of GDP in 2012. 
Private sector debt increased from 178.2% of GDP in 2004 to peak at 213% of GDP in 2009 
before  moderating  to  204.4%  of  GDP  in  2012  (see  Graph  11,  Panel  A).  The  increase  was 
mainly  on  the  back  of  growing  household  indebtedness,  reflecting  a  quickly  expanding 

15 

 
 
 
 
 
 
 
 
 
 
 
mortgage market, as a result of which the share of household debt in total private sector debt 
increased from 25% in 2004 to 30% in 2011. Private sector credit flows (Graph 11, Panel B) 
exceeded  the  MIP  threshold  twice  during  that  period  on  the  back  of  spikes  in  corporate 
borrowing,  related  mostly  to  the  construction  and  real  estate  sectors.  After  2009,  private 
sector debt stabilised and started gradually decreasing, reflecting to some extent both tighter 
lending  standards  by  banks  and  more  moderate  demand  for  financing  by  non-financial 
corporations, as also evidenced by the relatively low investment-to-GDP ratio in a historical 
perspective.  

Graph 11: Private sector indebtedness 

Panel A: Decomposition of debt by sector   

Panel B: Decomposition of credit flows 

P
D
G

f
o
%

250

200

150

100

50

0

P
D
G

f
o
%

20

15

10

5

0

-5

04

05

06

07

08

09

10

11

12*

04

05

06

07

08

09

10

11

12*

Household

Private sector EA17

Private sector

Non financial corporations

MIP Threshold

Household

Private sector EA17

Private sector

Non financial corporations

MIP Threshold

Note: * indicates estimated Graph based on quarterly data 

Source: Commission services 

Household  debt  has  been  increasing  at  a  fast  pace,  but,  starting  from  a  low  level,  it 
remains below the euro-area average. At the time of EU accession in 2004, household debt 
in Malta was relatively low by EU standards, standing at 45% of GDP (see Graph 12, Panel 
A). Since then, it has increased at a fast pace to peak at nearly 63% of GDP in 2011, broadly 
catching  up  with  the  EU  average,  before  moderating  slightly  in  2012.  This  has  to  a  large 
extent  been  driven  by  strong  demand  for  loans  for  house  purchases,  typically  granted  at 
variable rates, and is reflected in the strong increase in house prices. The loan-to-value ratio 
granted  by  banks  was  relatively  low,  at  about  40%,  until  2008,  which  helped  to  keep 
household debt in check. However, as demand for housing remained strong, the loan-to-value 
ratio for new loans has increased to between 70% and 80%. Demand for new mortgage and 
consumer  loans  has  been  more  subdued  recently,  as  evidenced  by  the  results  of  the  ECB's 
regular Bank Lending Survey, although it remains more dynamic than the average for the euro 
area (see Graph 12, Panel B). 

16 

 
 
 
 
 
 
 
Graph 12: Households indebtedness 

Panel A: Leverage 

Panel B: loans 

70

60

50

40

30

20

10

0

P
D
G

f
o
%

50

45

40

35

30

25

20

15

10

5

0

P
D
G

f
o
%

04

05

06

07

08

09

10

11

Debt-to-GDP, EA17
Debt-to-assets, EA17

Debt-to-GDP, Malta
Debt-to-assets, Malta

Loans for house purchase, Malta
Loans for consumption, Malta
Loans for house purchase, EA17
Loans for consumption, EA17

00 01 02 03 04 05 06 07 08 09 10 11 12

Note: * indicates estimated Graph using quarterly data 

Source: Commission services, ECB 

Despite  the  increase  in  their  indebtedness,  households'  net  financial  assets  remain 
positive. Thanks mainly to a high propensity to save, reflected in a high deposit base in the 
absence  of  particularly  developed  domestic  insurance  and  investment  fund  industries,  net 
financial  assets  of  Maltese  households  are  among  the  highest  in  the  euro  area,  standing  at 
170%  of  GDP  in  2011  (see  Graph  13).  This  is  an  important  factor  underpinning  domestic 
financial  stability  as  it  allows  banks  to  fully  finance  their  lending  portfolio  with  retail 
deposits,  thereby  reducing  the  need  for  wholesale  funding.  Maltese  households  also  have 
considerably more assets invested in government debt securities: as of December 2011, some 
29% of Malta Government Securities were owned by individuals (MFEI 2011). 

17 

 
 
 
 
 
 
 
 
 
 
 
 
Graph 13: Financial balance sheets of households  

Panel A: Malta 

Panel B: Euro area 

Euro area

Malta

300

250

200

150

100

50

0

-50

P
D
G

f
o
%

-100

300

200

100

0

-100

P
D
G

f
o
%

04

05

06

07

08

09

10

11

12*

04

05

06

07

08

09

10

11

A - securities (other than shares)

A - loans

L - loans

A - shares and other equity

A - insurance & techn. reserves

L - insurance & techn. reserves

A - other accounts

A - currency and deposits

L - other accounts

Net financial assets

A - securities (other than shares)

A - shares and other equity

A - loans

A - other accounts

L - other accounts

A - insurance & techn. reserves

L - insurance & techn. reserves

L - loans

A - currency and deposits

Net financial assets

 Note: * indicates estimated figure using quarterly data. 

Source: Commission services 

The debt ratio of non-financial corporations (NFC) increased substantially until 2009 on 
the back of increased borrowing. As a result of improving financing conditions, facilitated 
by  EU  and  euro-area  entry,  and  partly  also  thanks  to  a  bias  against  equity  in  corporate 
taxation,7  the  non-consolidated  debt  of  non-financial  corporations  grew  substantially,  from 
133.2% of GDP in 2004 to 151% in 2009. The increase was entirely driven by loans, while 
debt in the form of securities is relatively low at around 13% of GDP due the underdeveloped 
domestic  corporate  bond  market.  Since  2009,  corporate  debt  has  been  on  a  downward  path 
and reached 143% of GDP in 2012. The main reason for this has been lower credit demand by 
companies,  in  line  with  the  more  subdued  macroeconomic  environment  in  Malta  and  in  the 
euro area, leading to a drop in the investment-to-GDP ratio. Another important factor is the 
halt of bank lending to construction and real estate activities, as banks sought to reduce their 
concentration to the real estate market, as a result of which the share of these two sectors in 
total lending to residents (including lending to the public sector) fell from over 23% in 2009 
to below 17% in November 2012. 

The  large  gross  debt  figure  for  corporates  hides  some  positive  features.  The  term 
structure of debt has been fairly stable over time, with some 50% of total debt in long-term 

7  
Malta  has  the  largest  gap  between  the  effective  marginal  tax  rates  on  debt-  and  equity-financed  new 
corporate investment among the 27 Member States. See Tax reforms in EU Member States 2012 – Tax policy 
challenges for economic growth and fiscal sustainability/ 

18 

 
 
 
 
 
 
 
 
 
 
 
 
                                                            
loans, 40% in short-term loans and the rest in securities other than shares. 2011 brought about 
a slight shift, as a result of which the share of short-term loans decreased to 32%. The sources 
of  financing  for  Maltese  NFCs  are  quite  diverse  and  in  fact  despite  the  presence  of  a  large 
banking system, bank loans represent only about half of total loans to corporates, or 64% of 
GDP in 2011, down from a peak at 69% of GDP in 2009 (see Graph 14). In the same year, 
total  loans  in  non-consolidated  terms  were  134%  of  GDP.  An  important  part  of  the  debt  of 
non-financial  corporations  is  in  the  form  of  short-term  intra-company  loans,  including  from 
abroad, which are fully matched by intra-group loans on the asset side. Thus, in consolidated 
terms corporate debt was much lower, at 106.3% in 2011 (up from 93% in 2004). Financing 
in the form of loans and deposits from non-residents increased from 6.6% of GDP in 2004 to 
14.4% of GDP in 2011. Additional sources of financing include inter-sectorial and household 
loans. A diverse mix of funding sources reduces the funding risk for companies and therefore 
contributes to domestic financial stability. 

Graph 14: Financial balance sheets of non-financial corporations, non-consolidated 

Panel A: Malta 

Panel B: Euro area 

P
D
G

f

o
%

300

200

100

0

-100

-200

-300

-400

P
D
G

f

o
%

300

200

100

0

-100

-200

-300

-400

04

05

06

07

08

09

10

11

12*

04

05

06

07

08

09

10

11

A - currency and deposits
A - other accounts
A - insurance & techn. reserves
A - shares and other equity
A - loans
A - securities (other than shares)

L - other accounts
L - insurance & techn. reserves
L - shares and other equity
L - loans
L - securities (other than securities)
Net financial assets

A - currency and deposits
A - other accounts
A - insurance & techn. reserves
A - shares and other equity
A - loans
A - securities (other than shares)

L - other accounts
L - insurance & techn. reserves
L - shares and other equity
L - loans
L - securities (other than securities)
Net financial assets

Note: * indicates estimated figure using quarterly data. 

Source: Commission services 

The  leverage  of  non-financial  corporations  appears  high,  but  corporations  still  have 
sizeable financial assets. Despite the high level of debt, the corporate sector also has sizeable 
assets  and  when  expressed  as  a  ratio  to  financial  assets,  Malta  stands  below  the  euro  area 
average. In addition, the ratio has been declining since 2004 to reach 53.9% in 2011 thanks to 
increases in total financial assets and in particular in unquoted shares, trade credits and bank 
deposits.  However,  the  debt-to-equity  ratio  exceeds  the  euro-area  average,  reflecting  an 
underdeveloped  domestic  equity  market  and  the  tendency  for  the  smaller  family-owned 
Maltese  enterprises  (which  make  up  the  overwhelming  majority  of  firms)  to  refinance 
themselves internally or take bank loans rather than to look for equity financing. The elevated 

19 

 
 
 
 
 
 
 
 
 
 
 
 
ratio  is  also  encouraged  by  the  high  bias  towards  debt-financing  in  corporate  taxation.8 
Although the debt-to-equity ratio for NFCs in Malta has been gradually declining since 2004, 
companies  face  a  growing  debt-servicing  burden  as  indicated  by  the  relatively  high  ratio  of 
debt  to  the  gross  operating  surplus,  which  exposes  them  to  interest  rate  fluctuations.  Even 
though  major  liquidity  problems  are  not  expected  in  the  short  term  due  to  the  favourable 
structure  of  the  debt,  some  deleveraging  might  be  needed,  in  an  environment  of  projected 
slower  growth  compared  to  the  pre-crisis  years,  in  order  to  free  up  more  resources  for 
productive investment thereby improving the economy's growth potential. 

2.5. 

Government debt 

A  public  debt  above  the  Treaty  threshold  and  an  ageing  population  pose  risks  to  the 
long-term sustainability of Malta’s public finances. The government debt ratio in Malta is 
lower  than  the  euro-area  average  but  exceeds  the  reference  value  of  60%  of  GDP  and  has 
been  on  a  rising  trend,  reaching  70.9%  of  GDP  by  end-2011.  In  the  period  prior  to  EU 
accession, Malta's government debt increased steadily, up from around 34% of GDP in 1995 
to  69.8%  of  GDP  in  2004,  as  a  result  of  high  primary  deficits.  In  the  run-up  to  the  euro 
adoption, Malta's government debt fell from the peak reached in 2004 to around 62% in 2008, 
mainly thanks to an improving fiscal position and proceeds from the privatization process. In 
2008,  after  euro  adoption,  the  primary  surplus  turned  negative  and  the  debt-to-GDP  ratio 
started increasing again (see Graph 15). The worsening fiscal position reflected the onset of 
the crisis as well as substantial deficit-increasing one-off measures (i.e., the reclassification of 
Malta  Shipyards  Ltd  within  the  general  government  sector)  and  some  slippages  in  current 
expenditure. Still, the increase in the general government debt was more moderate than in the 
rest of the euro area, also because the banking sector did not require public support. 

The  government  debt  does  not  have  potential  spillovers  to  other  countries  of  the  euro 
area.  Government  debt  in  Malta  is  almost  entirely  held  by  residents,  with  non-residents 
accounting for only 2% of the outstanding debt. Financing Malta’s debt has so far not posed 
any  problems  and  spreads  between  yield  on  Maltese  and  German  sovereign  bonds  have  not 
been  significantly  affected  by  the  tensions  in  financial  markets  generated  by  the  sovereign 
debt  crisis.  In  fact,  the  apparent  cost  of  debt  (interest  expenditure  over  total  nominal  debt) 
decreased over the period 2008-2012 from 5.1% to 4.4%, in spite of a large (around 12 pp due 
to the real GDP contraction in 2009) increase in the debt ratio. In addition, short-term debt has 
decreased  significantly  since  the  EU  accession  and  in  2011  it  accounted  for  6.7%  of  total 
government  debt  (from  20.2%  in  2004).  The  lengthening  of  the  maturity  structure  of 
government debt is expected to further reduce the risk of a sudden increase in the interest rate 
on government debt that may materialise in the future should economic conditions deteriorate 
or sudden changes in interest rates and market sentiment occur. 

8  

2011 data showed that Malta had the highest debt bias in the EU (EC 2012f).  

20 

 
 
 
 
                                                            
However,  population  ageing  will  result  in  age-related  expenditure  growing  faster  than 
the EU-average (EC 2012h). Age-related expenditure in Malta is projected to increase by 8.2 
pps. of GDP between 2010 and 2060, more than double the increase projected for the EU as a 
whole.  The  increase  in  pension  expenditure,  incorporating  the  impact  of  the  2006  pension 
reform,  accounts  for  more  than  half  of  the  total  projected  increase.  Under  the  European 
Semester  in  20119  the  Council  issued  a  country-specific  recommendation  to  Malta  to  take 
action to ensure the long-term sustainability of the pension system. In response, consultation 
with  social  partners  has  taken  place,  but  concrete  action  has  yet  to  be  taken.  Another 
important  contributor  to  the  increase  in  age-related  expenditure  is  health  care,  which  is 
projected to increase by 2.9 pps. of GDP over the period 2010-2060, the highest increase in 
the EU.  

Graph 15: Government debt and primary balance 

P
D
G

f
o
%

  80.0

  70.0

  60.0

  50.0

  40.0

  30.0

  20.0

  10.0

    .0

2

0

-2

-4

-6

-8

00 01 02 03 04 05 06 07 08 09 10 11

Total general government debt
Government guaranteed debt
Primary balance (rhs)

Source: Eurostat 

The  high  level  of  contingent  liabilities  represents  an  additional  risk  for  Malta's  public 
finances. Government-guaranteed debt in Malta is high, following a substantial increase since 
the  start  of  the  crisis.  At  16.4%  of  GDP  in  2011,  contingent  liabilities  imply  a  total  public 
guaranteed debt of around 87% of GDP in 2011. More than half of these liabilities, as well as 
most  of  their  increase  since  2008  are  accounted for  by  the  public  energy  utility  corporation 
(Enemalta). A debt restructuring plan for Enemalta, adopted by the authorities in December 
2012,  concerns  about  half  of  the  company's  current  debt  (which,  at  end-2010  and  including 
only  bank  and  other  borrowings,  stood  at  EUR  687mn,  or  EUR  836mn  when  adding  also 
trade-related  and  other  payables).  Currently,  Enemalta  remains  in  a  challenging  financial 
state. 

9  

See http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2011:215:0010:0012:EN:PDF. 
21 

 
 
 
 
 
 
 
                                                            
2.6. 

Property market developments 

The real estate market is very important for domestic financial stability due to the high 
exposure of the banking sector to it. Real estate-related lending amounted to more than half 
of the total lending portfolio to residents in November 201210. In addition, domestic lending is 
heavily collateralised with real estate. According to the national authorities, the valuation of 
real estate collateral is conservative as banks apply a significant haircut on an already prudent 
value, determined by third-party experts. This creates a significant buffer on banks’ books and 
regular stress tests conducted by the Central Bank of Malta on the core domestic banks (see 
Section 3) show that it would take a further drop of over 50% in house prices, coupled with an 
increase in non-performing loans, to have a notable impact on the Core Tier I capital ratio of 
the  banking  sector  (CBM  2012a).  Moreover,  banks  are  encouraged  to  monitor  the  value  of 
their  collateral  on  a  regular  basis,  which  further  mitigates  potential  risks  arising  from  the 
banking sector’s exposure to real estate. The stress tests, however, are top-down and therefore 
do not exclude the existence of specific problems at individual-bank level.  

Housing  prices  have  been  rising  steadily  for  a  prolonged  period  of  time.  Estimations  in 
the  December  2012  Quarterly  Report  on  the  Euro  Area  (EC  2012e)  show  that  the  latest 
pronounced  growth  phase  of  house  prices  from  trough  to  peak  (Q2  2002  –  Q1  2008)  has 
largely been in line with the average for the euro area and notably milder than countries like 
Ireland, Spain and Estonia. A downward correction started at the end of 2008, which brought 
prices down by 9% by the end of 2009. Since then, prices appear to have stabilised. Graph 16 
below shows that  despite  some correction, prices in Malta are still considerably  above  their 
trough (the red line). This benchmark, however, needs to be interpreted with caution as price 
correction may not necessarily reach the previous trough.  

10  
to residents in November 2012 (Source: Central Bank of Malta). 

Loans for construction and real estate activities and mortgage loans amounted to 52.4% of total lending 

22 

 
 
                                                            
Graph 16: House price cycle   

Cumulated growth from trough to peak (%)

)

%

(
a
t
a
d
t
s
e
t
a

l

o
t

k
a
e
p
m
o
r
f

l
l

a
f
d
e
t
a
u
m
u
C

l

10

0

-10

-20

-30

-40

-50

-60

-70

-80

DE

0

FI

LU

BE

SE

50

100

IT

FR

150

200

250

300

350

AT

PT

CZ
EL

MT

SI

SK

PL

NL
UK

DK

HU

ES

BG

EE

IE

RO

LV

Previous 

Source: Eurostat, ECB, OECD 

Estimations  show  that  in  the  years  before  euro  adoption,  an  overvaluation  of  housing 
prices developed. Indeed annual growth in nominal housing prices accelerated notably in the 
years  before  euro  adoption  and  averaged  around  20%  over  2006-2007.  These  years  were 
characterised  by  fast  expansion  of  mortgage  lending:  between  January  2005  and  December 
2007, the annual growth in mortgage loans averaged 18.5%.11 Faster price dynamics was also 
fuelled  by  the  increasing  demand  for  real  estate  from  abroad,  either  from  Maltese  citizens 
living  abroad  (also  thanks  to  fiscal  incentives)  or  foreign  buyers.  Additional  factors 
supporting  this  trend  have  been  the  demographic  developments  and  the  lack  of  a  recurrent 
property  tax  in  Malta  (see  Box  3).  Overvaluation  estimates  carried  out  by  the  European 
Commission (EC 2012e) show that the adjustment in housing prices that began at the end of 
2009 is at a relatively early stage and further downward correction can be expected in order to 
bring prices in line with their long-run trend. However, in light of the recent modest rebound 
in house prices, reaching the conservative scenario of a further drop of over 50% depicted in 
the stress test by the Central Bank of Malta appears unlikely. There are downside risks related 
to a weaker-than-expected macroeconomic environment and depressed domestic demand, and 
also in view of the high number of vacant properties. However, the extent to which the latter 
may  indicate  oversupply  is  not  straightforward  as  a  significant  amount  of  vacant  properties 
are not for sale for different reasons. 

11  
(Source: ECB). 

For reference, the  average  annual  growth  in  mortgage  lending  for  the  euro  area  in 2006-7  was  9.9%. 

23 

 
 
 
 
 
 
 
 
 
 
 
                                                            
Graph 17: Mortgage lending (stock) and house price growth 

300

250

200

150

100

50

0
0
1
=
4
0
0
2

,
x
e
d
n

i

04Q105Q106Q107Q108Q109Q110Q111Q112Q1

Lending for house purchase

House prices

Source: Central Bank of Malta, ECB, Commission services 

Box 3: Immovable property taxation in Malta 

Immovable  property  taxes  include  different  types  of  levies.  One  important  distinction  is  between 
recurrent taxes, which typically take the form of annual payments due by the owner, whose amount is 
linked to some measure of the value of the property; and transaction taxes that are typically charged on 
the occasion of the sale or transfer of the property.  

Taxes on immovable property represent 3.2% of total taxation in Malta (the EU-27 average is 3.6%). 
The Graph shows that Malta is the only EU country which does not have recurrent taxes. Looking at 
transaction taxes, the situation is exactly reversed for Malta, which raises  a high amount of revenue 
(1.1 % of GDP in 2010, almost double the EU-27 average, equal to 0.6% of GDP) from these taxes.  

Graph 18: Property taxation 

Malta
EA17

EU27

1.2

1.0

0.8

0.6

0.4

0.2

0.0

P
D
G

f

o
%

Recurrent taxes on
immovable property

Transaction taxes on
property in general

Source: EC 2012f 

24 

 
 
 
 
 
 
 
Transaction taxes on property are generally considered more distortive than a recurrent tax. Indeed, a 
transaction tax reduces the number of transactions and hampers the price discovery process. Moreover, 
revenue from transaction taxes is often highly volatile, as it tends to follow the business cycle. At the 
same  time,  a  transaction  tax  on  real  property  transactions  could  deter  speculation  and  thus  possibly 
help to reduce the risk of housing market bubbles. A recurrent tax on immovable property is generally 
considered  the  least  distortionary  type  of  tax.  In  addition,  revenue  from  these  taxes  is  highly 
predictable,  since  they  are  more  difficult  to  evade  than  taxes  such  as  PIT  or  CIT.  This  also  makes 
them, at least potentially, attractive from an equity point of view. Recurrent property taxes are usually 
characterised by low compliance costs for taxpayers and, once a system is set up, administrative costs 
for tax authorities are also moderate.  

On the positive side, Malta does not have tax deductibility of mortgage interest payments. Normally, 
tax deductibility of interest payments leads to a favourable treatment of debt, which, coupled with low 
taxation of the return of the property (i.e. the imputed rent) encourages over-investment in the housing 
sector compared to other sectors and leads to growing incentives for debt accumulation by households. 

The  increase  in  property  taxes  might  theoretically  offer  some  potential  for  limiting  'boom  and  bust' 
cycles in housing prices, by dampening excessive price increases in the build-up phase. 

3. 

IN-DEPTH ANALYSIS OF FINANCIAL SECTOR VULNERABILITY 

The  financial  sector  expanded  very  rapidly  after  EU  accession,  with  total  liabilities, 
excluding  equity,  reaching  around  850%  of  GDP  as  at  end-2011.  The  majority  of  these 
liabilities,  over  600%  of  GDP,  belong  to  the  banking  sector.  At  the  same  time,  the  non-
banking  financial  sector  has  expanded  rapidly,  with  sizeable  insurance  and  collective 
investment  schemes,  each  with  liabilities  exceeding  100%  of  GDP,  also  reflecting  the 
emergence of new activities such as captive insurance and asset management. In terms of total 
assets  in  relation  to  GDP,  the  Maltese  banking  sector  is  among  the  biggest  in  the  euro  area 
(see  Graph  19).  Regulatory  responsibilities  at  micro  level  lie  with  the  Malta  Financial 
Services  Authority  (MFSA),  whereas  the  Central  Bank  of  Malta  (CBM)  is  in  charge  of 
ensuring financial stability from a broader perspective. To strengthen co-operation as well as 
to follow up on recommendations issued by the European Systemic Risk Board (ESRB),12 in 
January 2013, the two institutions set up a Joint Financial Stability Board (JFSB), which will 
be responsible for macro-prudential supervision in Malta.  

12  

See ESRB/2011/3.  

25 

 
 
                                                            
Graph 19: Banking sector assets in selected euro-area countries in October 2012, % of 
GDP 

800

700

600

500

400

300

200

100

0

P
D
G

f
o
%

SK SI EL IT BE AT DE FI PT ES NL FR CY IE MT

Source: ECB 

The banking sector in Malta is very diverse in terms of interlinkages with the domestic 
economy.  The  sector  can  be  split  into  three  groups  according  to  the  extent  to  which  it  is 
interlinked with the domestic economy: (i) five core domestic banks whose main activities are 
collecting deposits and granting loans to Maltese residents, (ii) eight non-core domestic banks 
that  have  some  business  with  residents  but  not  as  their  core  activity,  and  (iii)  thirteen 
internationally-oriented institutions that have almost no links with the domestic economy. In 
terms of gross liabilities, the third group is by far the biggest and has assets of over 500% of 
GDP. The core and non-core domestic banks have assets of around 220% and 80% of GDP, 
respectively. 

Table 1: Selected Financial Soundness Indicators for Maltese banks 

Core domestic banks

Non-core domestic banks

Internationally-oriented banks

2009

2010

2011 Jun-12

2009

2010

2011 Jun-12

2009

2010

2011 Jun-12

Tier 1 capital adequacy ratio

Non-performing loans ratio

Return on assets

Return on equity

Coverage ratio

Distribution of total loans

   to residents as % of total loans

   to non-residents as % of total loans

Investment securities to total assets

   Domestic investment securities

   Foreign investment securities

10.1

6.2

1.6

26.6

22.0

98.7

1.34

11.9

13.2

9.2

7.5

1.4

22.4

19.8

98.4

1.63

12.3

11.9

Source: Central Bank of Malta 

9.6

7.3

1.3

19.5

19.8

9.8

8.2

1.4

20.6

20.1

30.5

27.9

27.4

25.9

31.8

110.2

114.4

103.4

2.4

3.1

14.0

84.3

3.6

1.3

4.4

4.5

0.5

1.4

4.3

0.5

1.5

31.7

42.8

38.3

0.5

1.7

22.6

63.8

0.6

1.1

3.1

0.5

1.2

3.9

0.3

1.1

4.0

76.0

107.7

101.5

98.4

98.3

9.7

1.7

1.7

90.3

11.0

89.0

13.1

86.9

13.6

86.4

0.0

0.0

0.1

0.0

100.0

100.0

99.9

100.0

12.8

11.5

13.3

11.1

2.9

2.2

2.2

1.8

27.0

35.1

36.1

41.5

0.0

27.8

0.0

28.8

0.0

0.0

31.5

32.8

26 

 
 
 
 
 
 
Core  domestic  banks  do  not  appear  to  be  exposed  to  the  volatility  on  international 
financial markets. The group consists of five banks, with Bank of Valletta (BoV) and HSBC 
Malta owning over 80% of the 220% of GDP of total assets held by this group. The Maltese 
government holds a 25% stake in BoV. The BoV successfully passed the EU-wide stress test 
conducted  by  the  European  Banking  Authority  in  2011,  which  revealed  a  healthy  capital 
position, with a Core Tier I ratio of 10.6% in June 2012, in line with the average for the group 
of tested banks, and very limited exposure to non-Maltese sovereign debt.13 The core banks 
exercise a rather conservative business model that relies mainly on resident deposits for their 
funding  and  have  low  loan-to-deposit  ratios,  at  around  70%.  This,  combined  with  a  stable 
deposit  base,  thanks  to  the  high  propensity  to  save  by  Maltese  households,  helped  the  core 
domestic banks cope with the financial crisis and the volatility on the international wholesale 
markets. The banks did not need government support nor did they need to resort to the ECB's 
long-term refinancing operations to any significant degree to improve their liquidity.  

The  core  domestic  banks  are  profitable  but  specific  provisioning  against  loan  losses  is 
rather low. About two-thirds of the private sector loans extended by the core domestic banks 
are secured with real estate collateral.14 Banks apply a rather cautious valuation of collateral: 
they  apply  a  significant  discount  on  its  value  and  this  value  is  regularly  monitored  through 
third-party  valuation  and  verification  by  the  regulators.  This  practice,  added  to  a  still 
conservative,  albeit  increasing,  loan-to-value  ratio,  mitigate  the  concentration  risk  arising 
from  the  high  exposure  of  the  core  domestic  banks  to  the  real  estate  sector.  Indeed,  the 
slowdown  in  the  construction  sector  did  not  hit  banks'  balance  sheets  particularly  hard:  the 
share of non-performing loans increased moderately in recent years, from around 5% in 2008 
to  just  above  8%  in  June  2012  (see  Graph  20).  The  return  on  equity  remained  strong 
throughout the crisis and as a result, the banking sector was able to generate own capital and 
no significant recapitalisations were needed. However, since banks provision against only the 
unsecured  part  of  an  exposure,  the  coverage  ratio  is  relatively  low  at  about  20%.  Higher 
provisioning  to  strengthen  NPL  coverage  as  recommended  by  the  Council  under  the  2012 
European  Semester,15  as  well  as  discouraging  an  increase  in  the  loan-to-value  ratio  of  real 
estate loans would further improve the soundness of the core domestic banks. In addition, it is 
important to ensure that the domestic judiciary system is efficient. The recently published EU 
Justice  Scoreboard  (EC  2013a)  and  successive  World  Bank’s  Doing  Business  reports 
highlight potential challenges in this area. Namely, Malta scores significantly worse than the 
EU average in terms of the time needed to resolve non-criminal cases and the clearance rate – 
i.e. the number of resolved cases as a share of incoming cases. It also compares unfavourably 
with the OECD average in terms of enforcing contracts and resolving insolvency, due to the 

Exposure to non-Maltese sovereign debt amounted to 7.7% of the gross direct sovereign exposures in 

13  
June 2012, up from 6.3% in December 2011 (Source: EBA). 
14  
collateral. 
15  
guidance from the European Banking Authority. 

27 

This  refers  just  to  the  loan-replacement  value  of  collateral,  i.e.  the  value  of  loans  fully  backed  up  by 

Measures  to  address  this  recommendation  are  in  the  pipeline,  but  the  authorities  are  awaiting  further 

 
 
                                                            
long  time  the  procedure  takes  and  the  limited  amount  of  assets  that  claimants  are  able  to 
recover from an insolvent entity.  

Graph 20: Evolution of non-performing loans in the core domestic banks 

Source: IMF Financial Soundness Indicators 

The  group  of  international  banks  are  profitable  and  well  capitalised.  The  international 
banks have assets of over 500% of GDP, mainly owned by branches and subsidiaries of large 
international  institutions.  They  fund  themselves  mainly  through  the  wholesale  market  or 
through  the  parent  banks  and  deal  mainly  with  intragroup  activities.  Overall,  this  group  of 
banks  is  profitable  and  very  well  capitalised  with  their  risk-weighted  assets  more  than  fully 
covered by Tier 1 capital (CBM 2012b), mainly reflecting the healthy position of one major 
bank that is almost entirely funded with equity. Furthermore, these banks have strong liquidity 
as evidenced by the very high ratio of liquid assets to short-term liabilities16. Tax incentives, 
alongside a trustworthy regulatory environment (these banks are subject to the same type of 
scrutiny  as  the  domestically-oriented  banks)  and  the  advantage  of  having  English  as  an 
official language appear to be the main reasons attracting financial institutions to Malta. 

Even  though  registered  in  Malta,  the  internationally-oriented  banks  hardly  do  any 
business in Malta, which limits the potential risk to domestic financial stability that they 
carry.  Total  resident  liabilities,  including  private  sector  deposits,  represented  only  0.3%  of 
total liabilities in 2011 (around 1.5% of GDP). Similarly, the international banks do not fund 
domestic  businesses  or  resident  households.  Loans  to  residents  represented  only  0.01%  of 
their  total  lending  portfolio,  while  they  did  not  hold  any  domestic  investment  securities  in 
June 2012. Links with domestically-oriented banks in terms of liquidity management are also 
very limited due to the very small size of the domestic interbank market. In addition, while 
some banks have tapped the domestic bond market in the past, the obtained amounts represent 
a  very  small  share  of  the  listed  private  sector  bonds  and  equity  (CBM  2011).  Overall,  this 

16  
30% ratio (CBM 2012b).  

The ratio of liquid assets to short-term liabilities was 153.4% in June 2012, far surpassing the required 

28 

 
 
 
                                                            
group of banks carries out its business from and not in Malta, which significantly limits their 
impact on stability of the financial sector. Finally, the existing tax regime sets a lower tax rate 
for  institutions  that  obtain  a  very  small  share  of  their  profits  from  business  with  residents, 
which  provides  a  further  disincentive  for  these  large  international  banks  to  increase  their 
exposure to the domestic economy. The very small size of business with residents as well as 
the  fact  that  the  big  institutions  are  foreign-owned  indicates  that  the  contingent  fiscal 
liabilities  that  the  internationally-oriented  banks  carry  are  minimal.  As  a  result,  the  only 
channel  through  which  potential  problems  in  one  or  more  banks  that  belong  to  this  group 
could impact the domestic economy appears to be through possible negative reputational risks 
for Malta as a safe jurisdiction for the financial services industry. 

The  non-core  domestic  banks  also  display  healthy  financial  soundness  indicators, 
although they invest in riskier assets. The non-core domestic banks are the smallest group 
of banks in terms of size with total assets at around 80% of GDP. Similar to the international 
banks, their funding comes mostly from the wholesale market. Unlike the international banks, 
however,  these  banks  are  much  more  intertwined  with  the  domestic  economy  and  resident 
liabilities  account  for  around  12%  of  the  total,  including  deposits17  and  bonds  and  equity 
issued locally (around 9.5% of GDP). The asset side is rather diversified between non-resident 
(largely  also  non-EU)  loans  to  companies  and  banks  as  well  as  a  mix  of  corporate, 
government  and  other  banks'  debt  securities.  A  significant  proportion  of  the  investment 
portfolio (around 30% as at end-2011; CBM 2012a) was invested in bonds issued by residents 
of EU Member States currently receiving financial assistance under an EU/IMF programme. 
This illustrates the riskier business profile of these banks, although the fact that the majority 
of  these  securities  are  not  government  bonds  can  be  a  mitigating  factor.  On  the  asset  side, 
resident  assets  account  for  around  9%  of  total  assets.18  The  lending  portfolio  is  oriented 
predominantly  towards  the  corporate  sector  and  about  half  of  the  resident  loans  are  for 
construction  and  real  estate  activities.  This  portfolio  performs  better  than  that  for  the  core 
domestic banks as the ratio of non-performing loans was relatively low at just 4.5% at the end 
of 2011 (CBM 2012a). On aggregate, the shock absorbing capacity of the non-core domestic 
bank appears sufficient to absorb a deterioration in the quality of its assets as the Tier I capital 
adequacy ratio, although lower than for the international banks, stands much higher than the 
ratio for the core domestic banks. As a result, due to their limited exposure to the domestic 
economy, the non-core domestic banks do not represent significant contingent fiscal liabilities 
and  do  not  seem  to  pose  an  immediate  threat  to  domestic  financial  stability.  Nevertheless, 
potential reputational and confidence risks could emerge should one of these banks run into 
trouble. Thus, strict scrutiny by the regulators is essential to ensure that financial stability is 
maintained. 

Resident deposits represented around 10% of total liabilities for this banking group but still remained 

17  
less 5% of total resident loans as at June 2012 (CBM 2012b).  
18  
In  total,  resident  loans  extended  by  non-core  domestic  banks  and  international  banks  accounted  for 
around  3%  of  total  resident  loans  as  at  end-2011.  Source:  Financial  Stability  Report  2011,  Central  Bank  of 
Malta, September 2012 

29 

 
 
                                                            
4. 

POLICY CHALLENGES  

The  analysis  in  sections  2  and  3  identifies  potential  imbalances  for  Malta  in  the  financial 
sector, in particular as regards its exposure to the real estate market. Against this background, 
this  section  discusses  different  avenues  that  could  be  envisaged  to  address  the  policy 
challenges posed by these potential imbalances. 

Ensuring the proper functioning of the real estate market is of particular importance for 
financial stability, given the strong link with the banking sector. Past dynamics of real estate 
prices  may  have  been  partly  supported  by  the  taxation  regime  in  Malta,  which  lacks  a 
recurrent  property  tax,  while  transaction  taxes  may  impede  the  price  discovery  process. 
Therefore,  the  real  estate  market  would  benefit  from  reviewing  the  property  tax  system  to 
ensure  that  it  provides  the  right  incentives  to  market  participants.  Furthermore,  regular 
monitoring  of  property  price  developments  and  collateral  valuation  by  commercial  banks  is 
important in maintaining financial stability. Supporting the development of the rental market 
would  also  contribute  towards  preventing  excessive  price  growth  and  the  accumulation  of 
price bubbles. 

Risks  to  domestic  financial  stability  appear  small  but  continued  monitoring  appears 
warranted. Risks to domestic financial stability stemming from the presence of a very large 
financial  sector  appear  small  due  to  the  very  limited  exposure  of  internationally-oriented 
banks to the domestic economy. Nevertheless, continued regular monitoring and assessment, 
including more regular data dissemination of banking soundness indicators, of the activities of 
the  internationally-oriented  and  the  non-core  domestic  banks  and  their  implication  for 
financial stability is important. This is particularly relevant for the non-core domestic banks, 
which despite their smaller relative size and robust financial soundness indicators engage in 
riskier  activities  that  necessitate  strict  supervision  to  ensure  that  risks  are  adequately 
provisioned against. 

The stability of the core domestic banks would benefit from strengthening the provisions 
for loan losses to limit risks arising from their exposure to the property sector. Lending 
standards  for  construction  and  real  estate  services  have  already  been  tightened.  Keeping 
household mortgage lending in check, also through a conservative policy on the loan-to-value 
ratio,  is  also  essential  in  preventing  excessive  debt  build-up  and  asset  bubbles.  Improving 
loan-loss  provisioning  to  increase  the  relatively  low  coverage  ratio  would  also  contribute 
towards  maintaining  banking  sector  soundness,  as  recommended  by  the  Council  under  the 
2012 European Semester. Finally, the proper functioning of the financial sector would benefit 
from  a  review  and,  if  necessary,  improvements  in  insolvency  legislation  to  make  sure  that 
collateral rights are enforceable when needed. 

High  public  and  private  debt  warrant  policy  attention.  Given  the  small  size  in  nominal 
terms, public debt issuances do not attract significant interest from foreign investors, leaving 
the burden of funding the government almost entirely on Maltese residents. This may crowd 
out  private  investment  and  consumption  in  case  of  insufficient  liquidity  in  the  financial 

30 

 
 
system.  Therefore,  ensuring  that  public  debt  is  put  on  a  downward  path  and  addressing  the 
challenges to the long-term sustainability of public finances, namely through timely pension 
and  healthcare  reforms,  would  be  beneficial  for  domestic  stability  and  would  ensure  that 
financial intermediation works properly to finance economic growth in the medium to long-
term. As regards private sector debt, while the current level of indebtedness does not appear to 
be  excessive,  measures  to  prevent  unsustainable  increases,  such  as  by  limiting  the  loan-to-
value  ratio  for  mortgage  loans  and  addressing  the  debt  bias  in  corporate  taxation,  could  be 
considered. 

31 

 
 
 
REFERENCES 

Central Bank of Malta – (CBM 2011), Financial Stability Report 2010, Central Bank of Malta, June 
2011 

Central  Bank  of  Malta  –  (CBM  2012a),  Financial  Stability  Report  2011,  Central  Bank  of  Malta, 
September 2012 

Central  Bank  of  Malta  –  (CBM  2012b),  Financial  Stability  Report  Update  2012,  Central  Bank  of 
Malta, December 2012 

Ernst & Young (2012), Malta Attractiveness Survey, November 2012 

European Commission (EC 2012a), Assessment of house price dynamics – Note for LIME, Directorate 
General for Economic and Financial Affairs, October 2012 

European  Commission  (EC  2012b),  Fiscal  sustainability  report  2012,  European  Economy, 
Directorate-General Economic and Financial Affairs, No 8/2012, 2012a. 

European  Commission  (EC  2012c),  Imports  and  Competitiveness:  a  first  look  using  descriptive 
statistics, 2012 – Note for LIME, Directorate General for Economic and Financial Affairs, 2012a 

European  Commission  (EC  2012d),  Possible  reforms  of  real  estate  taxation:  Criteria  for  successful 
policies, Directorate General for Economic and Financial Affairs, October 2012 

European  Commission  (EC  2012e),  Quarterly  Report  of  the  Euro  Area,  DG  ECFIN,  Directorate 
General for Economic and Financial Affairs, Vol. 11, No 4, 2012 

European Commission (EC 2012f),  Tax reforms in EU Member States 2012 – Tax policy challenges 
for  economic  growth  and  fiscal  sustainability,  Directorate  General  for  Economic  and  Financial 
Affairs, Directorate General for Taxation and Customs Union 

European  Commission  (EC  2012g),  Taxation  trends  in  the  European  Union:  Data  for  EU  Member 
States, Iceland and Norway, EUROSTAT, 2012 

European Commission (EC 2012h), The 2012 Ageing Report, Directorate General for Economic and 
Financial Affairs, May 2012 

European  Commission  (EC  2013a).  The  EU  Justice  Scoreboard,  Directorate  General  for  Justice, 
March 2013  

European Commission (EC 2013b), Cuerpo, C., Drumond, I., Lendvai, J., Pontuch.P. and Raciborski, 
R.:  `Indebtedness,  Deleveraging  and  Macroeconomic  Adjustment',  European  Economy  -  Economic 
Papers, forthcoming, 2013 

Ministry  of  Finance  the  Economy  and  Investment  (MFEI  2011),  Treasury  Department:  Annual 
Directory Report 2011 

World Bank (WB 2013), Doing Business report, 2013 

32