FINANCIAL STABILITY ISSUES FOR SMALL STATES. Mirko Mallia Assistant Executive Financial Stability Surveillance, Assessment and Data
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1 FINANCIAL STABILITY ISSUES FOR SMALL STATES Mirko Mallia Assistant Executive Financial Stability Surveillance, Assessment and Data
2 Disclaimer: Any views expressed are only the author s s own and do not necessarily reflect the views of the CBM or the Eurosystem 2
3 Structure of Presentation Outline of the Presentation What is Financial Stability Small Island States Characteristics Key information/statistics concerning Malta The effect of the crisis on Malta Other considerations 3
4 What is financial stability? The Central Bank of Malta defines financial stability as: a condition where the financial system comprising institutions, markets and infrastructures 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. In this manner financial stability is conducive to a well functioning economy and leads to sustainable growth. 4
5 Sources of risks to financial stability Endogenous Institutions based financial, operational, legal, integrity, reputation, business strategy, concentration, capital requirements Markets based counterparty, asset price misalignment, contagion Infrastructure based payment and settlement systems, legal, regulatory, accounting, supervisory, loss of confidence leading to runs, domino effect Source: IMF/WP04/101 5
6 Sources of risks to financial stability Exogenous Macroeconomic disturbances economic environment risks (such as oil prices), policy imbalances (a balanced monetary and fiscal policy mix) Event risks natural disasters, political events, large business failures (e.g. Japan and Libya political upheaval) Source: IMF/WP04/101 6
7 Some examples of Financial Stability Risks Systemic risk: The risk that the failure of one financial institution may spread to other parts of the financial system, with possible serious implications for the performance of the broader economy Credit Risk: The risk of suffering a loss should the counterparty default on its payments obligations Market Risk: The risk that the value of a portfolio either an investment or trading portfolio held by a financial institution will decrease due to the change in value of the market risk factors
8 Concentration Risk: The risk that a financial institution is significantly exposed to one/few particular sectors and exposures to specific companies. Liquidity Risk: The risk that banks are not able to access liquid assets to meet its commitments Solvency risk: The risk of loss owing to the failure (bankruptcy) of an issuer of a financial asset or to the insolvency of the counterparty
9 Why do authorities promote financial stability? A stable financial system: is a key ingredient for a healthy and successful economy. Provides liquidity to the banking system; It enhances the efficiency of the Payment and Settlement Systems; Conducive to the effective implementation of monetary policy People need to have confidence that the system is safe and stable Important that problems in particular areas do not lead to disruptions across financial system (contagion) 9
10 The Financial Stability Report: A tool to safeguard Financial Stability What is a Financial Stability Report? A self contained regular publication that focuses on risks and exposures in the financial system as part of the macroprudential surveillance function of central banks Purpose To promote awareness in the financial industry and among the public at large of issues that are relevant for safeguarding the stability of the financial system. Attempt to be pro-active Hence concerned authorities/stakeholders are given the possibility to act on vulnerabilities identified this could increase the resilience and possibly avoid crises 10
11 The financial crisis: lessons learned and measures taken The on-going crisis has highlighted serious deficiencies in the assessment of systemic risks Specifically, it is important to: Properly reassess the existing framework of financial regulation strengthen financial stability analysis enhance framework for bank resolution and management of crisis situations enhance cooperation between central banks and supervisory authorities 11
12 The financial crisis: lessons learned and measures taken Ultimately translate macro-prudential recommendations by central banks into policy action The EU response to the Crisis: The EU Commission mandated a high Level Group to put forward recommendations on how to strengthen the European Supervisory Framework (The DeLarosiere Report) The Report recommended the establishment of a new European Supervisory Framework Two pillars macroprudential and microprudential 12
13 SMALL STATES DEFINTION According to the World Trade Organisation (2002), no general agreement on the definition of a small country exits as yet in literature. Hence, any definition to some degree of subjectivity However, the most commonly used criterion has been population A threshold of 1.5 million in population is the threshold generally accepted. Source: Commonwealth Report - Secretariat and World Bank Joint Task Force (2000) on Small States 13
14 SOME VULNERABILITIES OF SMALL STATES High dependence on Imports and Exports: Limited Natural Resource Endowment, low inter-industry linkages, necessities of food and energy, need for foreign exchange earnings (open economies) Limited Diversification Possible: Service-based economy based on Tourism and financial services Market Thinness and Limitation on Domestic Competition: Monopolistic market structures might lead to inefficiencies Face fierce competition: imports and barriers to trade 14
15 VULNERABILITIES OF SMALL STATES Important role of state in the economy: Provision of goods which private sector is unwilling to provide Inability to Exploit Economies of Scale higher average costs hence more difficult to compete in international markets Limited Access to International Finance due to creditworthiness, stringent Security requirements this can lead to sluggish investment growth Hence more dependence on External Finance - e.g. International AID, FDI 15
16 VULNERABILITIES OF SMALL STATES Nonetheless Certain advantages exist including: Increased flexibility Presumably lower bureaucracy Ease of adaption to change 16
17 Specific Finance Issues for Small States Reliance of the economy to the banking sector (Concentration in particular sectors - e.g. Construction Sector, Tourism, fishing etc. Foreign ownership of banks is substantial (home host divide) Importance of external finance to foster growth Money Laundering Regulatory forbearance 17
18 Reliance on the Banking Sector Dependence of small state economy to the banking system is larger when compared to larger more sophisticated countries. The Insurance, Investments, Capital markets are less developed compared to the banking sector Dominant presence of SME (including small family-run businesses ) 18
19 Foreign Ownership of Banks Foreign Ownership is high This has both advantages and disadvantages (e.g. in NMS Baltic countries- in the EU foreign ownership can reach 99%) Advantages More sophisticated risk management policies Increases confidence in Banking System Reduces reliance on possible Government intervention Containments of domestic shocks (De Haas and Van Lelyveld- 2005) Disadvantages Barriers to Entry Transmission of External Shocks (Home Host Divide) 19
20 External Finance Dependence of the Country on International Aid is substantial This kind of finance is Volatile/Discretionary FDI Is a long-term process and may be concentrated in specific sectors Expose the economy to cyclical fluctuations in that industry (e.g. manufacturing) May depend on remittances from migrants 20
21 Money Laundering Offshore Banking Centres Bank Privacy Tax Shelters Money Laundering Heavens. In some cases inexistent taxation Capture of Financial Institutions by Criminals According to the 2010 Global Financial Centres Index (GFCI) the world's five leading offshore finance centres are Jersey, Guernsey, Isle of Man, Bermuda, Cayman Islands Following the financial crisis offshore banking centres have recorded a decline in activity attributable to increased scrutiny 21
22 Regulatory Forbearance Three Forms of forbearance: Insolvent but Remain Open Under-Capitalised but Remain Open Temporary Relaxation of Regulations Relaxing Requirements when Needed 22
23 Statistics related to Malta Population: 412,970 (2009) GDP per capita in PPS relative to the EU-27 average (2009) 81.0% Ratio of exports of goods and services to GDP 85%. Imports to GDP ratio 83% Domestically oriented sector is almost 3 times the size of the GDP contributing to around 7.5% of gross value added. 23
24 Statistics related to Malta Total banking sector employs about 4,800 people (3.3% of the gainfully occupied). Bank Assets/Financial System 83.4% Banks remain traditional in their business model - continuing to rely strongly on retail deposits -customers deposits 71.2% of total liabilities Foreign ownership of banks 61% Herfindahl-Hirschmann index 3205 EU 27 average 1,120 Market Capitalisation/GDP 134% ( 8.4 billion) 24
25 The effect of the Crisis in Malta GDP % dropped by 3.4% in 2009 recovered in % Unemployment rate remained relatively stable since 2008 Banking sector profitability recorded valuation losses in 2008 although in aggregate remaining profitable In 2009, aggregate profitability improved also driven by the reversal of valuation losses 25
26 The effect of the Crisis in Malta NPL s ratio increased % Capital adequacy and liquidity ratios remained robust and well above the regulatory minima Stress test confirmed banks are able to withstand extreme but plausible shocks Financial Stability Report indicates that since the onset of the financial crisis the financial sector exhibited a high degree of resilience 26
27 Other considerations - Concentration Risk Malta From a financial stability perspective concentration risk is problematic as diversification reduces the exposure to co-movements of related risks Concentration in domestically oriented banks refers to particular types of assets, such as property HHI in lending portfolio reached 1,961 This characteristic remained evident across all banks 27
28 Concentration Risk in Malta Property-related loans raise concentration even further, as over 80% of the collateral backing loans is also in the form of property Property-related loans are substantial with a number of them being classified as Large Exposures Other large exposures related to the hotels & restaurants sector, the wholesale & retail trade and the manufacturing sector 28
29 Home Host Supervision 29
30 Home Host Supervision 30
31 Home Host Supervision 31
32 The new EU financial stability and supervision architecture 32
33 Thank you Questions? Contact details:
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