housing simply becomes unaffordable. the bank ’ s property price index – which is based on advertised prices – fell moderately on a year earlier during the september quarter. while domestic banks have been more prudent than banks abroad, however, the continuing high dependence on property as a driver of credit growth, and as collateral for other lending, remains a source of risk. at the same time, it is important to reiterate the strengths of the domestic banking system. in june 2008, the capital adequacy ratio stood at 14 % on average, as against a statutory minimum of 8 %, while the average liquidity ratio was 48 %, well above the 30 % benchmark. the loan to deposit ratio averaged a prudent 77 %, while non - performing loans extended their downward trend. the central bank of malta has been playing an active role in responding to the events i have described. first, with the support of my bank colleagues, i have participated in the deliberations and decisions of the governing council of the ecb on the provision of liquidity and on monetary policy. allow me at this point to digress briefly. as we said in our statement after the november meeting, we expect the banking sector to make its contribution to restoring confidence. reinforcing this message, the president pointed out that central banks and governments had taken bold decisions, and now commercial banks, too, had to live up to their responsibilities, especially at a time of deteriorating growth prospects. with bank lending rates in malta being generally set with reference to official policy rates, i would, therefore, expect bank customers, particularly those whose borrowings promise most to support domestic economic activity, to benefit fully from the recent ecb rate cuts, which have totalled 175 basis points. apart from its monetary policy role, the central bank of malta is also charged with preserving financial stability, which it defines as a condition where the financial system is able to allocate savings towards investment opportunities and facilitates the efficient settlement of payments. a stable financial system is also one that is able to manage risks that may harm its performance, and consequently that of the economy, and that should be able to absorb shocks without impairing its operations. the bank carries out this task through the regular monitoring of the financial system, as well as of the domestic payment and securities settlement systems. the bank ’ s findings are shared with the malta financial services authority ( mfsa ) and with the ministry of finance. the authority

the captive insurance business is growing fast. these developments in malta mirrored, to a certain extent, those abroad. financial liberalisation, deregulation and the expansion of cross - border capital flows have driven the rapid growth of the financial sector globally. indeed, until the start of the turmoil last year, the global financial system had benefited from a long period of economic expansion, relatively easy monetary conditions and innovation. as a result, the size of the financial industry relative to the economy increased considerably. in the united states it grew to a point where it represented nearly 25 per cent of the stock market capitalization, while financial assets in britain in 2007 were equivalent to almost nine times the gdp. such a favourable combination of circumstances could not last. and when the whole edifice started to crumble, the shock waves travelled fast, a testimony to the efficiency of the transmission channels in a globalized economy. thus, in no time at all, a crisis that had its roots in a narrow segment of the housing market in the united states moved across the atlantic to britain and then to the euro area. and as demand in the advanced economies and commodity prices began to tumble, emerging economies started to decelerate rapidly. so much for the decoupling theory! unlike other recent crises, the current turmoil had its origin within the financial system itself. it followed a boom in asset prices, particularly house prices. although some observers, including central banks, had warned about mispricing of risk, many investors purchased what are now known as “ toxic ” assets in a search for yield, increasing leverage to generate higher profits. the growing use of securitisation allowed banks to originate loans and distribute them, packaging risk and selling it to other investors. it was believed that this would spread risks more evenly, enhancing the stability of the system as a whole. but the financial engineering involved in this process was so complex that neither the regulators nor the credit rating agencies could calculate the risks. what the regulators also overlooked were the dangers that were developing as banks moved further away from their customers. on the financing side, banks were becoming increasingly dependent on wholesale investors for funding. on the lending side, the dispersion of credit risks through securitisation lowered the incentive to monitor borrowers ’ behaviour and led to increased moral hazard. as information became ever more fragmented and financial instruments more opaque, confidence began to dissipate. now as we know, the market economy – and its ultimate objective, the creation of wealth –