michael c bonello : launch of the forum for financial stability introductory remarks by mr michael c bonello, governor of the central bank of malta, at the launch of the forum for financial stability, valletta, 23 may 2011. * * * ladies and gentlemen, i should first of all like to thank you for having accepted our invitation to today ’ s launch of the forum for financial stability. i would also like to extend a special welcome to our guest speakers, the chairman of the mfsa, the secretary general of the mba and mr john fell, deputy director general of the ecb ’ s financial stability ( directorate general ). in my own introductory remarks i shall attempt to provide a context for the creation of this forum, in which i trust your respective institutions will play an active role. in this regard it is important to note that central banks have an intrinsic interest in financial stability. indeed, this interest is recognized in statutory instruments. thus while the treaty states that the ecb ’ s primary objective is to maintain price stability, it also stipulates that it should contribute to the stability of the financial system. echoing this thinking, our own central bank of malta act, while giving primacy to the implementation of the ecb ’ s monetary policy, also enjoins us to ensure the stability of the financial system. the concern of central banks with the health of the financial system is explained by the fact that price stability and financial stability complement one another. a monetary policy that succeeds in maintaining stable prices promotes financial stability by encouraging investment and economic growth. conversely, a stable financial system helps monetary policy achieve its primary objective by, for example, ensuring the smooth propagation of the central bank ’ s interest rate signals throughout the economy. at this point it is useful to dwell briefly on the meaning of the concept of financial stability. in malta we define it as “ a condition where the financial system – comprising institutions, markets and infrastructure is able to : allocate savings to investment opportunities efficiently ; ensure the rapid settlement of payments ; effectively manage potential risks that may harm its performance ; and absorb shocks without impairing its operations. ” if there was ever any doubt as to the importance of ensuring the realization of such conditions, it can surely no longer be the case after the experience of the past three years. the financial crisis has clearly underlined the vital role of central banks in safeguarding financial stability and the importance of adopting a macro - prudential approach to regulation and supervision. this thinking

on trade and stringent controls on capital movements, at least in the early decades. by the mid - 1990s, however, trade and financial market liberalisation meant that these factors became less and less important. instead, major reforms in 1994 brought about fuller independence for the central bank and a gradual liberalisation of interest rates amid increasing recognition that, in the absence of capital controls, monetary policy had to be more actively oriented towards maintaining the peg. throughout, the lira was buttressed by a healthy stock of external reserves. the central bank of malta was legally bound to maintain reserves equivalent to at least 60 % of the monetary base, but in for a review of malta ’ s monetary and exchange rate policy over the years, see anton caruana galizia “ malta ’ s exchange rate policy since the breakdown of the bretton woods system ” in the central bank of malta quarterly review, june 1989 and aaron g grech ( 2003 ) “ the framework of monetary policy in malta ”. mpra paper no 33464. practice this ratio normally exceeded 100 %. as capital controls were eased, interest rate policy was increasingly set with an eye on the spread vis - a - vis interest rates offered on the basket currencies ( and, later, the euro ). more profoundly, maintaining the exchange rate peg required discipline in domestic wage and price setting to safeguard malta ’ s external competitiveness. despite an element of wage indexation, the labour market was fairly flexible, with relatively low coverage of collective bargaining in the private sector and with wage negotiations being handled at the level of the individual firm. broadly speaking, fiscal discipline was also maintained. the government debt to gdp ratio remained below 60 % until the late 1990s, peaked at around 72 % in 2004, and is now just at about the 60 % threshold again. this discipline helped establish the credibility of the exchange rate peg, which became embedded in the decision - making process across the economy. for this reason, the bank never adopted policy options that would have entailed greater exchange rate flexibility, even when this became possible, for instance in erm ii. subsequently, this internal discipline also served in good stead after euro adoption, which, as we have seen before, entails the loss of the exchange rate and interest rates as a policy tool. despite the several shocks that have hit the euro area since 2008, the maltese economy has performed well. malta has taken full advantage of the opportunities offered by eu accession and euro adoption to diversify its