and lending rates. the bank responded by widening the margin above the discount rate from three percentage points to ten, thus effectively freeing lending rates. the lifting of restrictions on both domestic lending and deposit rates simultaneously ensured adequate profit margins for the banks. in 1999 all restrictions on deposit rates were abolished, while in 2002 domestic lending was completely liberalised. with financial markets in an early stage of development, exchange control liberalisation had to proceed cautiously. it was felt that domestic markets should be allowed to grow, and financial asset prices to adjust, before being exposed to free cross - border movements of capital. a sequencing policy was adopted aimed at easing controls on longer - term capital flows while continuing to restrict shortterm flows. exchange control liberalisation began in earnest in the mid - nineties when malta accepted the article viii obligations of the imf ’ s articles of agreement and the process was completed immediately prior to malta ’ s accession to the european union on may 1st this year. the deregulation measures i have described were accompanied by institutional restructuring, which ensured that throughout the reform process the financial system was not subject to shocks. the new 1994 banking act and the related directives brought malta ’ s legislation in line with eu standards governing bank solvency, capital adequacy and large exposures. at the same time, the malta financial services centre was established as the regulator for financial services other than banking, which remained the responsibility of the central bank of malta. at this time, the central bank undertook a number of initiatives to develop a properly functioning money market, focusing mainly on the three - month treasury bill. an interbank market also began to operate and the bank began to trade actively in the money market through regular auctions of term deposits and repos. the central bank also ceased to extend credit to the government, thus further underlining its independence. to reduce its influence further, the government privatised a small bank in 1994 and one of the larger banks the following year. in 1999 it sold its majority shareholding in the other major bank to a global banking institution, hsbc. the arrival of this bank spurred competition and helped to promote better practices. in addition, operating licences were granted to several foreign - owned banks, including, i should add, austrian banking institutions, whose presence here is most welcome. thus, from a highly regulated system dominated by the public sector, the maltese banking system was transformed into a modern market - based system, geared to meet the financial needs of a growing

years, full responsibility for the supervision of institutions providing financial services. why central banks promote financial stability there are several reasons why the maintenance of a healthy financial sector is an essential function of central banks, and this irrespective of their involvement or otherwise in regulation and supervision. first, by virtue of their role as providers of liquidity to the banking system and their involvement in payment systems, central banks have a vested interest in the quality of their counterparties. any developments that could affect the financial health of their counterparties are of direct interest to a central bank, not least because the inability of the former to honour their commitments would have negative financial implications for the central bank. furthermore, instability in the financial system could hinder central banks from successfully pursuing their other objectives, particularly the achievement of price stability through monetary policy measures. indeed, monetary policy can only be implemented effectively if the financial system is stable, for only then can financial intermediaries respond to changes in interest rates and in liquidity conditions engineered by the central bank, and thus transmit these impulses on to non - financial intermediaries. at the same time, by pursuing price stability central banks contribute directly to financial stability, since a stable price environment reduces volatility in financial variables and ensures the smooth functioning of markets. from a central bank perspective, it is also evident that a healthy financial system contributes to stability in the exchange rate particularly where, in countries like malta, a fixed exchange regime coexists with the absence of capital controls. thus, in a situation where there are concerns about the robustness of the financial infrastructure, the regulatory framework or the integrity of financial intermediaries, the external account may be undermined through sizeable outflows of capital. in other words, what starts off as a crisis in an individual institution could easily develop into a balance of payments and currency crisis, which may, in turn, trigger off secondary effects throughout the rest of the financial sector, disrupting other sectors of the economy in the process and thus resulting in a fullblown financial crisis. in the case of the central bank of malta, these considerations assume even greater importance given the maltese economy ’ s small size, openness and lack of natural resources, which make it highly dependent on foreign markets. the small size of the domestic market, moreover, also has implications for savings and investment. thus a limited pool of savings is in turn reflected in a low volume of internally generated resources for investment purposes, making the country highly dependent