michael c bonello : central bankers ’ view of the new challenges speech by mr michael c bonello, governor of the central bank of malta, at a conference entitled “ the challenges for central banks in an enlarged emu ” organised jointly by the european community studies association ( ecsa austria ), research institute for european affairs ( ief ) and oesterreichische nationalbank, vienna, 20 - 21 february 2004. mr bonello was a panelist on the discussion regarding “ central bankers ’ view of the new challenges ”. * * * when ten countries, including malta, join the european union ( eu ) on 1st may, they will assume the status of “ member states with a derogation ”, meaning that they are exempt from the stricter rules of emu. this may seem to imply that the transition to emu is thereby rendered easier, but a careful examination of the conditions attached to the process reveals that the policy issues involved are anything but straightforward. this is particularly true of a small open economy like malta ’ s in which macroeconomic policy is strongly conditioned by the external environment, but which has nevertheless succeeding in reconciling a hard currency peg with relative exchange rate stability for over thirty years. malta has a population of only 400, 000. its nominal gdp of €4. 5 billion, or less than 0. 1 % of that of the eu, translates into a per capita income which is around 69 % of the eu average. market services, including tourism and finance, account for nearly two - fifths of gdp, while manufacturing contributes almost a quarter. given its size and lack of natural resources, it is not surprising that malta has one of the most open economies in the world, with imports and exports each almost as large as the gdp. the eu is malta ’ s main trading partner, accounting for over two - fifths of exports and two - thirds of imports in 2003. it is an even more important market for the tourism industry and is a major source of capital investment. for malta, therefore, the prospect of being anchored in the relative safety of the world ’ s second largest economy and of using that economy ’ s currency represents a considerable advantage. perhaps the foremost benefit of euro area membership is being able to share in the credibility of a europe - wide monetary policy. this will not only mean reduced exchange risks and less uncertainty for economic operators, but also the elimination of the risk premium on the maltese lira. the resulting reduction in interest rates

it anew. like their counterparts in the euro area, our banks have strengthened their balance sheets and capital positions in recent years, and this ensures that the sector is wellprepared to adapt to risks as, and when, they materialise. our stress tests also confirm that capital remains above regulatory requirements even under extreme scenarios, and that banks are operating with healthy liquidity buffers. profitability is also improving, so it is opportune to strengthen capital buffers rather than to have to re - build them in a potentially less benign environment at some point in the future. 3 / 5 bis - central bankers'speeches it is less painful to provide adequately for credit risks and the stock of doubtful loans through the cycle, rather than having to deal with a potential increase in non - performing exposures at some other time in the future. thus, an increase in forborne loans - mostly reflecting the expiration of pandemic related loan moratoria - need to be addressed at some stage or another. in this respect, i am pleased to note that banks have proven to be quite conservative when providing for risks during the pandemic. i encourage banks to be proactive in complying with micro and macro prudential policies when formulating distribution policies going forward. foresight is key, as the generation of resilience from within is ultimately what drives the long - term value of any firm's equity and its stability. of course, macroprudential policy has to do its part. efficiency demands of us to pinpoint specific sources of risks and, where possible, choose targeted measures over generic alternatives. in certain circumstances, specific tools such as adjusted riskweights, borrower - based measures or sectoral systemic risk buffers are better alternatives to a generic tool which affects all segments of credit indiscriminately, hindering the funding of the economy's productive capacity, which is much needed for the economy to keep growing. lastly macroprudential policy demands from banks a higher level of diversification and productive investment. as past financial stability reports indicate banks'loan portfolios are highly concentrated towards real estate. this is a structural characteristic which is very well documented, so is the fact that mortgages are the prime drivers behind this concentration. macroprudential policy has a role to play here to address systemic concentration risks. but, apart from policy prescription, the importance of portfolio diversification cannot be underestimated. similarly, banks have a crucial role