## 1mltea2019008

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### INTRODUCTION — executive summary and scope
- Purpose: Evaluate Malta’s domestic macroprudential policy framework and provide recommendations to strengthen it, assessing (1) institutional arrangements; (2) systemic risk monitoring framework; and (3) macroprudential policy toolkit. (¶2)
- Basis: Assessment conducted using IMF guidance (Staff Guidance Note (IMF, 2014a), background note (IMF, 2014b), and other IMF policy papers) and current financial vulnerabilities in Malta. (¶2)
- Structure: Section II reviews institutional arrangements and provides recommendations; Section III discusses systemic risk monitoring and options to enhance it; Section IV assesses systemic risks and maps them into macroprudential toolkit recommendations. (¶3)

### Institutional framework — roles, powers, and coordination
- EU context:
  - Single Supervisory Mechanism regulation (Council Regulation (EU) No. 1024) assigns national authorities and the ECB tasks on macroprudential policy instruments in the CRDIV/CRR for the banking sector. (¶1)
  - Malta is a member of the European Systemic Risk Board (ESRB). (¶1)
- Central Bank of Malta (CBM) as national macroprudential authority:
  - Empowered with the ultimate and intermediate objectives of macroprudential policy, tasks of macroprudential policy, powers to formulate and implement macroprudential instruments, and powers to collect information. (¶5)
  - Financial Stability Department (FSD) is a dedicated department; presents analysis and proposals to the Financial Stability Committee at least quarterly. (¶6)
  - Can issue, amend, or revoke Directives with force of law (Article 17A of the CBM Act). (¶8)
  - Powers to calibrate the countercyclical capital buffer and systemic risk buffers (Directive 11). (¶8)
  - Identifies systemically important institutions and sets additional capital buffers jointly with MFSA. (¶8)
  - Can introduce macroprudential instruments outside CRDIV/CRR, e.g., planned borrower-based measures. (¶8)
  - Has powers to collect information (Part IV of the CBM Act). (¶8)
- Domestic coordination:
  - Joint Financial Stability Board (JFSB) established January 2013 to ensure cooperation and policy coordination domestically. (¶9)
  - JFSB composition: five voting members—the CBM governor (chair), two CBM representatives, and two MFSA representatives; two government representatives as non-voting observers. (¶9)
  - JFSB meets at least quarterly; macroprudential recommendations sent to CBM governor, microprudential to MFSA’s board of governors. (¶9)
  - JFSB can issue non-binding recommendations for CBM, MFSA, and any public authority or public institution in Malta (Article 17B of the CBM Act).
- Accountability and transparency:
  - CBM published macroprudential policy strategy in 2016 (CBM, 2016). (¶7)
  - Public communications: Financial Stability Report, annual and quarterly reports, website, press releases, speeches, conferences. (¶7)
  - Financial Stability Forum (launched 2011) and accountability to Parliament per the CBM Act. (¶7)
- Cross-border cooperation:
  - CBM liaises with ESRB, ECB, and other national/international macro- and micro-prudential authorities; coordinates via ESRB reciprocity framework and the Single Supervisory Mechanism notification framework. (¶10)
  - CBM and MFSA contribute to ECB and ESRB analytical work; JFSB tasked to discuss cross-border cooperation under the CBM Act. (¶10)

### Institutional recommendations (selected)
- Amend CBM Act to provide CBM with power to recommend actions to public authorities/public institutions (including MFSA or Government) with a “comply or explain” mechanism (“semi-hard power”) and to issue warnings and opinions (“soft power”). (¶11,12) — Timing: NT
- Ensure MFSA has a financial stability objective (as planned in draft amendment to the MFSA Act). (¶11,13) — Timing: I

### Systemic risk monitoring — current practice and strengths
- Monitoring practices:
  - CBM conducts systemic risk monitoring and analysis effectively on a timely basis, closely collaborating with MFSA, NSO, and Ministry for Finance; uses a wide range of indicators, analytical models, stress tests, expert judgement, and qualitative information. (Executive summary; staff section)
  - CBM contributes to ECB Macroprudential Report and ESRB Country Risk Reports.
  - Reporting: annual Financial Stability Report and interim six-month report comprehensively cover macroprudential risks and policies; quarterly review of the countercyclical capital buffer calibration. (staff section)
- Data improvements to date:
  - Launch of Credit Central Register (CCR) and Survey on Residential and Commercial Real Estate Lending Practices in 2016 provided granular loan-level data. (staff section)
  - CBM and NSO compiled NFC data to examine intercompany lending. (staff section)
  - Authorities participate in ESRB’s Data Gaps project and ECB’s AnaCredit. (staff section)

### Data gaps and recommended actions
- Track CCR loans over time to identify when loans become nonperforming, rescheduled, or restructured, enabling panel data for risk analysis and calibration of borrower-based measures. (staff section)
- Integrate granular loan and borrower data; consider enhancing CCR by integrating Survey efforts and EU-level initiatives (AnaCredit). (staff section)
- Develop a commercial real estate price index using valuation data and the hedonic methodology; collect property valuation and characteristics through banks despite limited transaction volumes. (staff section)
- Continue compiling granular NFC data to understand intercompany loans and drivers of persistently high debt-to-equity ratios. (staff section)
- Strengthen systemic risk assessment of non-banks by developing analytical tools and integrating bank and non-bank analyses; monitor shadow banking activities and potential leakages. (staff section)

### Macroprudential toolkit — existing measures and implementation
- CRDIV/CRR adoption since 2014 and phased-in measures, including additional capital buffers for three banks identified as O‑SII (Article 131 of Directive 2013/36/EU). (Executive summary)
- Countercyclical capital buffer framework introduced; buffer rate set at zero percent due to a negative credit-to-GDP gap. (Executive summary)
- Stricter risk weights for residential mortgage loans than in the CRR introduced. (Executive summary)
- CBM can implement macroprudential tools outside CRD IV/CRR (e.g., LTV ratios, DSTI caps, sectorial buffers). (banks section)
- Notification: Apart from the Single Supervisory Mechanism, the CBM is not legally bound to notify other European authorities about its macroprudential measures. (banks section)

### Borrower-based measures — draft Directive and recommended refinements
- Draft Directive features and calibration (Box 1 summary):
  - Public consultation: October 1–24, 2018; intention to start ECB Single Supervisory Mechanism notification process and announce measures possibly in early 2019.
  - Measures apply to all banks in Malta; three macroprudential limits: LTV-O cap, stressed DSTI-O cap, and maturity limit.
  - Two borrower categories:
    - Category I: primary residential property.
    - Category II: second/additional residential property or buy-to-let.
  - Exemption: Category I loans with property values less than €175,000 are exempted.
  - Speed limits (draft): exempt up to 10 percent of Category I loans and 20 percent of Category II loans from LTV-O limits each quarter (volume defined as number of new loan contracts on a semi-annual basis in the draft).
  - Calibrated limits in draft:
    - Category I:
      - 90 percent LTV-O cap; “speed limit” 10 percent; applies to loans with market value > €175,000.
      - Stressed DSTI-O of 40 percent with a shock to interest rates of 150 bps.
      - Maturity term of 40 years or official retirement age, whichever occurs first.
    - Category II:
      - 1st year: 85 percent LTV-O cap; “speed limit” 20 percent.
      - 2nd+ year: 75 percent LTV-O cap; “speed limit” 20 percent.
      - Stressed DSTI-O of 40 percent with a shock to interest rates of 150 bps.
      - Maturity term of 20 years or official retirement age, whichever occurs first.
  - Definition: stressed DSTI-O is the DSTI ratio calculated with a 150 basis points higher interest rate than the actual interest rate at origination.
- Recommended refinements:
  - Replace speed-limit condition based on the share of the number of new loans on a semi-annual basis with a condition based on the share of nominal euro amount of new loans per quarter. (¶29)
  - Narrow the larger speed limit for Category II loans (secondary residences and buy-to-let) as soon as concerns about initial disruptions dissipate; specifically lower the 20 percent speed limit for Category II once initial disruptions dissipate. (¶29)
  - Extend scope of borrower-based measures to cover all mortgage loans originated in Malta, including those provided by non-bank financial institutions, to minimize leakage (arbitrage) effects. (¶29)
- Monitoring: CBM plans to monitor implementation quarterly and review calibration upon market developments. (Executive summary; staff section)

### Systemic risks — broad-based credit, housing, household sector
A. Broad-based credit booms
- Credit-to-GDP gap based on bank credit has been in negative territory for several years; reflects broad-based slowdown in credit growth since the Global Financial Crisis. (staff section)
- Household and corporate debt as percent of GDP declined since the crisis. (staff section)
- Basel III leverage ratio in the banking system is well above the regulatory minimum of three percent. (staff section)
- Policy stance: countercyclical capital buffer kept at zero percent; CBM assesses quarterly using credit-to-GDP gap with a 2 percent reference threshold complemented by debt-to-GDP ratios, current account balance, and bank balance sheet indicators. (staff section)
- Recent mitigating measures:
  - MFSA phased in the Basel III capital conservation buffer in 2016.
  - IFRS 9 adopted January 1, 2018; expects to reduce systemic NPL problems.
  - 2016 measure requires banks with two-year average NPL ratios above the 6 percent threshold to draw up a concrete reduction plan.

B. Residential housing and household sector
- Housing price and demand dynamics:
  - Residential property prices rose by about 33 percent between 2010Q4 and 2017Q4. (staff section)
  - Drivers: strong employment growth, rising disposable income, influx of foreign workers, portfolio rebalancing towards property, buoyant tourism, lower withholding tax on rental income, Individual Investor Program. (staff section)
  - Construction investment has picked up in response to rising prices. (staff section)
- Signs of overheating and valuation:
  - House price indices have gone beyond long-term trends; house price-to-income ratio around historical average, house price-to-rent ratio higher than historical average as of end-2017. (staff section)
  - IMF staff econometric analyses suggest some overvaluation, magnitude dependent on house price index choice. (staff section)
- Mortgage lending and household exposure (end-2017 and new lending characteristics):
  - 99.6 percent of mortgage loans to residents as of end-2017 were provided by core domestic banks. (staff section)
  - Mortgages account for 51 percent of total bank loans to residents at end-2017, up from 37 percent at end-2012. (staff section)
  - About 70 percent of mortgages to residents are granted for purchases of a primary residence. (staff section)
  - Median LTV of new loans around 80 percent. (staff section)
  - Median DSTI of new loans around 20 percent. (staff section)
  - Median DSTI and LTV declined in 2017 for secondary residences and buy-to-let loans. (staff section)
  - Nonperforming mortgages historically low in recent years. (staff section)
  - FX risks limited: core domestic banks granted around 1.7 percent of their total loans in foreign exchange to households as of end-2017. (staff section)
  - Mortgage lending: almost all at variable rates; about 1 percent of new mortgage lending is “interest only”. (staff section)
- Household balance sheet metrics (end-2017):
  - Household debt stood at 108 percent of gross disposable income at end-2017. (household section)
  - Household debt was at 23 percent of gross financial wealth at end-2017. (household section)
  - Share of homeowners with debt about 20 percent; homeownership rate about 80 percent. (household section)
- Vulnerabilities and recommendations:
  - Variable rate mortgages imply sensitivity to interest rate shocks.
  - Lack of professional appraisers; valuations often by architects with potential conflicts of interest.
  - Recommendation: refine speed limits, replace number-based metric with nominal euro amount per quarter, lower Category II speed limit after initial disruptions dissipate, and extend coverage to non-bank mortgage originators. (household section; ¶29)

### Systemic risks — corporate sector, intercompany lending, and funding
- Corporate and intercompany lending:
  - Bank loans to NFCs as percent of GDP declined from 57 percent in 2007 to 30 percent in 2017. (corporate section)
  - Intercompany loans increased from 34 percent of GDP in 2007 to 64 percent of GDP in 2017. (corporate section)
  - When consolidated at domestic group level, NFC debt-to-GDP almost halves to 70 percent because domestic intra-group loans are offset. (corporate section)
  - Bond financing and loans by non-bank financials remain small, accounting for about 5 percent of GDP. (corporate section)
  - Intercompany loans in Malta are larger than in other European countries. (corporate section)
  - Authorities report limited use of collateral in intercompany lending; needs confirmation with more comprehensive information (e.g., survey). (corporate section)
  - Persistently high debt-to-equity ratio is a concern despite declining debt-to-GDP ratio; possible drivers include tax advantages of borrowing and statistical issues from international intra-group finance. (corporate section)
  - Suggested further analysis: assess Notional Interest Deduction Rules impact, compute debt-to-equity for NFCs without foreign parent, and assess company types with higher ratios using granular data. (corporate section)
- Funding and liquidity:
  - Average liquidity coverage ratio (LCR) in the system around 200 percent as of 2017Q4. (corporate section)
  - Fully phased-in regulatory LCR requirement is 100 percent. (corporate section)
  - Loan-to-deposit ratios generally low across banks; funding structures vary by business orientation. (corporate section)
  - Recommendation: implementation of Basel III’s Net Stable Funding Ratio would be beneficial to contain longer-term funding risk. (corporate section)

### Banks, O‑SIIs, and sovereign exposure
- Banking sector scale and domestic footprint:
  - Banks: €48 billion in assets at end-2017, 4.3 times GDP. (banks section)
  - Insurance: 1 time GDP. (banks section)
  - Investment funds: 1.1 times GDP. (banks section)
  - Core banks (six banks) account for 95 percent of resident deposits and 98 percent of mortgages to residents. (banks section)
- O‑SII buffers:
  - Three banks identified as O‑SIIs in 2015 required to hold additional capital buffers. (banks section)
  - O‑SII buffers phased in from January 1, 2016 to January 1, 2019. (banks section)
  - Identified O‑SII capital surcharges range between 0.5 percent and 2.0 percent. (banks section)
  - FSAP risk analysis finds O‑SIIs generally resilient under a severe economic downturn. (banks section)
- Sovereign–bank nexus and exposures:
  - Banking system exposure to Maltese sovereign bonds: 3.3 percent of total assets at end-2017. (banks section)
  - Banking sector holds 29 percent of total stock of Maltese government bonds. (banks section)
  - Most banks hold Maltese sovereign bonds in amounts accounting for less than 10 percent of their total assets; largest exposure around 22 percent. (banks section)
  - Sovereign risks assessed as contained given declining public debt-to-GDP ratio and sovereign ratings as of November 2018: A3 (Moody’s), A- (S&P), and A+ (Fitch). (banks section)
  - Investor base of Maltese sovereign bonds (December 2017, percent):
    - Resident credit institutions: 28.7
    - Resident insurers: 7.3
    - Resident other financials: 8.7
    - Resident non financials: 45.7
    - Non-residents: 9.6
  - FSAP’s risk analysis does not point to sizable losses from sovereign exposures. (banks section)

### Selected policy actions and timelines (from recommendations)
- Complete ongoing work on introducing borrower-based instruments to proactively address buildup of vulnerability in housing and household sectors. (¶28) (CBM) — Timing: I
- Refine the “speed limits” for the proposed LTV limits; replace number-based metric with nominal euro amount per quarter. (¶29) (CBM) — Timing: I
- Extend the scope of borrower-based measures to apply to all mortgage loans originated in Malta, including those provided by non-bank financial institutions. (¶29) (CBM) — Timing: I
- Narrow the percentage of loans allowed under the “speed limit” in Category II once concerns for any initial disruptions dissipate. (¶29) (CBM) — Timing: NT
- Continue closing data gaps, including for existing loan data, commercial real estate price indices, and granular data on intercompany lending. (¶17) (CBM, NSO) — Timing: NT/MT
- Expand the CCR by integrating the Survey on Residential and Commercial Real Estate Lending Practices, while evaluating benefits of further integration with EU-level initiatives. (¶17) (CBM, NSO) — Timing: MT
- Continue to strengthen monitoring of systemic risks in the non-bank financial sector by enhancing analytical tools. (¶17) (CBM, MFSA) — Timing: NT/MT

*Source: INTRODUCTION and IMF staff sections extracted from 1mltea2019008*

### INTRODUCTION ________________________________________________________________________________7

### INTRODUCTION

### Executive summary and scope
- Purpose: Evaluate Malta’s domestic macroprudential policy framework and provide recommendations to strengthen it, assessing (1) institutional arrangements; (2) systemic risk monitoring framework; and (3) macroprudential policy toolkit. (¶2)
- Basis: Assessment conducted using IMF guidance (Staff Guidance Note (IMF, 2014a), background note (IMF, 2014b), and other IMF policy papers) and current financial vulnerabilities in Malta. (¶2)
- Structure: Section II reviews institutional arrangements and provides recommendations; Section III discusses systemic risk monitoring and options to enhance it; Section IV assesses systemic risks and maps them into macroprudential toolkit recommendations. (¶3)

### Major findings on institutional framework
- Malta shares macroprudential responsibilities with European institutions:
  - The Single Supervisory Mechanism regulation (Council Regulation (EU) No. 1024) provides national authorities and the ECB with tasks on macroprudential policy instruments in the CRDIV/CRR for the banking sector. (¶1)
  - Malta is a member of the European Systemic Risk Board (ESRB). (¶1)
- The Central Bank of Malta (CBM) is the national macroprudential authority with a clear mandate established by 2014 legal amendments:
  - CBM empowered with the ultimate and intermediate objectives of macroprudential policy, tasks of macroprudential policy, powers to formulate and implement macroprudential instruments, and powers to collect information. (¶5)
  - The Financial Stability Department (FSD) is a dedicated department fulfilling statutory macroprudential obligations; presents analysis and proposals to the Financial Stability Committee at least quarterly. (¶6)
- Accountability and transparency:
  - CBM published its macroprudential policy strategy in 2016 (CBM, 2016). (¶7)
  - Public communications through Financial Stability Report, annual and quarterly reports, website, press releases, speeches, conferences. (¶7)
  - The Financial Stability Forum (launched 2011) and accountability to Parliament per the CBM Act. (¶7)
- CBM’s legal powers ("hard power") and data access:
  - Can issue, amend, or revoke Directives with force of law (Article 17A of the CBM Act). (¶8)
  - Has powers to calibrate the countercyclical capital buffer and systemic risk buffers (Directive 11). (¶8)
  - Identifies systemically important institutions and sets additional capital buffers jointly with MFSA. (¶8)
  - Can introduce macroprudential instruments outside CRDIV/CRR, e.g., planned borrower-based measures. (¶8)
  - Has adequate powers to collect information for macroprudential policy (Part IV of the CBM Act). (¶8)
- Domestic coordination via the Joint Financial Stability Board (JFSB):
  - Established January 2013 to ensure cooperation and policy coordination domestically. (¶9)
  - Composition: five voting members—CBM governor (chair), two CBM representatives, and two MFSA representatives; two government representatives as non-voting observers. (¶9)
  - JFSB meets at least quarterly; recommendations of macroprudential nature sent to CBM governor, microprudential to MFSA’s board of governors. (¶9)
- Cross-border cooperation:
  - CBM liaises with ESRB, ECB, and other national/international macro- and micro-prudential authorities; coordinates with EU countries via ESRB reciprocity framework and the Single Supervisory Mechanism notification framework. (¶10)
  - CBM and MFSA contribute to ECB and ESRB analytical work; JFSB tasked to discuss cross-border cooperation under the CBM Act. (¶10)

### Key recommendations (institutional and monitoring)
- Institutional enhancements:
  - Consider providing the CBM with powers to recommend actions to public authorities or public institutions in Malta, including the MFSA or the Government, with a “comply or explain” mechanism and to issue warnings and opinions. (¶11,12) (Ministry for Finance) — Timing: NT
  - Add a financial stability objective to the MFSA. (¶11,13) (MFSA) — Timing: I
- Systemic risk monitoring improvements:
  - Continue closing data gaps, including for existing loan data, commercial real estate price indices, and granular data on intercompany lending. (¶17) (CBM, NSO) — Timing: NT/MT
  - Expand the Central Credit Register (CCR) by integrating the Survey on Residential and Commercial Real Estate Lending Practices, while evaluating benefits of further integration with EU-level initiatives. (¶17) (CBM, NSO) — Timing: MT
  - Continue to strengthen monitoring of systemic risks in the non-bank financial sector by enhancing analytical tools. (¶17) (CBM, MFSA) — Timing: NT/MT

### Macroprudential toolkit and borrower-based measures
- Progress and current toolkit:
  - Since 2014 Malta has adopted CRDIV/CRR and phased-in measures including additional capital buffers for three banks identified as O-SII (Article 131 of Directive 2013/36/EU). (Executive summary)
  - Countercyclical capital buffer framework introduced; buffer rate set at zero percent due to a negative credit-to-GDP gap. (Executive summary)
  - Stricter risk weights for residential mortgage loans than in the CRR introduced. (Executive summary)
- Planned borrower-based measures:
  - CBM prepared a draft Directive to introduce limits on LTV-O, DSTI-O, and to restrict maturities at origination for residential real estate bank loans; implementation includes “speed limits” allowing banks to exempt some loans from LTV-O limits. (Executive summary)
  - CBM plans to monitor implementation quarterly and review calibration upon market developments. (Executive summary)
- Recommended refinements to borrower-based measures:
  - Refine “speed limits” by:
    - Replacing the condition based on the share of the number of new loans on a semi-annual basis with a condition based on the share of nominal euro amount of new loans per quarter. (¶29)
    - Narrowing the larger speed limit for “Category II” loans (secondary residences and buy-to-let properties) as soon as concerns about initial disruptions dissipate. (¶29)
  - Extend scope of borrower-based measures to cover all mortgage loans originated in Malta, including those provided by non-bank financial institutions, to minimize leakage (arbitrage) effects. (¶29)
- Recommendation summary from Table 1 (selected macroprudential toolkit items):
  - Complete ongoing work on introducing borrower-based instruments to proactively address build-up of vulnerability in the housing and household sectors. (¶28) (CBM) — Timing: I
  - Refine the “speed limits” for the proposed LTV limits. (¶29) (CBM) — Timing: I
  - Extend the scope of borrower-based measures to apply to all mortgage loans originated in Malta, including those provided by non-bank financial institutions. (¶29) (CBM) — Timing: I
  - Narrow the percentage of loans allowed under the “speed limit” in Category II once concerns for any initial disruptions dissipate. (¶29) (CBM) — Timing: NT

### Systemic risk monitoring: assessment and actions
- Monitoring effectiveness:
  - Systemic risk monitoring is effective and timely; CBM regularly analyzes systemic risks and collaborates closely with other agencies including MFSA. (Executive summary)
  - Analysis uses a wide range of indicators and models, combined with expert judgment and qualitative information; publications comprehensively cover macroprudential issues and policies. (Executive summary)
- Data improvements and remaining gaps:
  - Progress: launched real estate lending survey for banks; CCR introduced; intercompany loan dataset being compiled. (Executive summary)
  - Remaining gaps and recommended actions: track performance of existing loans; introduce commercial real estate price indices; collect granular data on NFC debt including intercompany loans; consider enhancing the CCR by integrating bank lending survey efforts and EU-level initiatives; strengthen non-bank financial sector risk assessment by developing analytical tools and integrating bank and non-bank analyses. (Executive summary, ¶17)

*Source: INTRODUCTION, 1mltea2019008*

### 11.      The legal backing of inter-agency coordination could be further strengthened. While

### 11.      The legal backing of inter-agency coordination could be further strengthened. While

### Inter-agency coordination and legal framework
- Current arrangements:
  - Joint Financial Stability Board (JFSB) facilitates inter-agency coordination for financial stability.
  - Inter-agency working groups are formed as needed.
  - The MFSA set up the Regulatory Development Unit to facilitate collaboration and policy coordination and to deal with MFSA’s responsibilities that interface between macro- and microprudential aspects of regulation.
  - JFSB can issue non-binding recommendations not only for the CBM and the MFSA, but also for any public authority or public institution in Malta (Article 17B of the CBM Act).
  - JFSB composition: Voting members: The CBM governor (Chair), two CBM deputy governors, the MFSA chairman, and the MFSA chief executive officer. Non-voting observers: Minister for Finance and the Parliamentary Secretary for Financial Services, Digital Economy & Innovation. Secretary: a CBM official.
- Recommendations to strengthen legal backing:
  - Amend the CBM Act to additionally provide the CBM with the power to recommend actions to be taken by a public authority or public institution, including the MFSA or the Government, with a “comply or explain” mechanism (“semi-hard power”) and issue warnings and opinions (“soft power”).
  - Ensure that the MFSA—the microprudential authority—also has a financial stability objective, as planned in the draft amendment to the MFSA Act.
- Rationale:
  - Providing the CBM with semi-hard and soft powers would be useful because financial stability is affected by monetary, fiscal, structural, competition, microprudential, and crisis management and resolution policies.
  - Legal backing for such powers would enhance effectiveness and accountability of macroprudential policy and increase transparency regarding cooperation by other agencies.
  - While shared objectives are useful, functions (or tasks) and powers of macroprudential and microprudential authorities should remain distinct to avoid confusion.

*Italic: Source: IMF staff section on inter-agency coordination and legal framework.*

### Systemic risk monitoring — current practice and strengths
- CBM systemic risk monitoring:
  - The CBM conducts systemic risk monitoring and analysis effectively on a timely basis, closely collaborating with other agencies.
  - The Financial Stability Department (FSD) regularly analyzes systemic risks, using a wide range of indicators, analytical models, stress tests, and expert judgment.
  - Close collaboration with MFSA, National Statistics Office (NSO), and the Ministry for Finance; technical working groups formed as needed.
  - As a member of the European System of Central Banks and the ESRB, the CBM collaborates with the ECB and the ESRB in macroprudential analysis and contributes to the ECB Macroprudential Report and the ESRB Country Risk Reports.
- Reporting and analytical practices:
  - CBM’s annual Financial Stability Report and interim (six-month) report comprehensively cover macroprudential risks and policies, including key indicators and stress test results.
  - Quarterly review of the countercyclical capital buffer calibration provides signals from key indicators and other complementary data and qualitative information.
  - Approach avoids mechanical application of indicators and is consistent with IMF guidance.

### Data improvements, gaps, and recommended actions
- Recent improvements:
  - Launch of the Credit Central Register (CCR) and the Survey on Residential and Commercial Real Estate Lending Practices in 2016 closed data gaps and provided granular loan-level data used for monitoring risks and designing borrower-based macroprudential measures.
  - CBM, in collaboration with NSO, compiled NFC data to examine intercompany lending.
  - Authorities participate in EU-level initiatives: ESRB’s Data Gaps project and ECB’s AnaCredit.
- Remaining data gaps and recommended measures:
  - Track the loans in the CCR over time so analysts know if and when the loans were classified as nonperforming, rescheduled, or restructured — enabling panel data for risk analysis and calibration of borrower-based measures.
  - Integrate existing efforts to collect granular data on loans and borrower characteristics; consider enhancing the CCR as the main database and integrating survey efforts and related EU-level initiatives.
  - Develop a commercial real estate price index using valuation data and the hedonic methodology, although the number of commercial real estate transactions is limited in Malta. Data on property valuation and characteristics could be collected through banks.
  - Continue efforts to compile granular NFC data to understand intercompany loans and drivers of persistently high debt-to-equity ratios in Malta’s NFCs.
  - Continue strengthening systemic risk assessment of non-banks, developing analytical tools and integrating bank and non-bank analyses; monitor shadow banking activities and potential leakages from regulatory gaps between financial sectors.

*Italic: Source: IMF staff section on systemic risk monitoring and data gaps.*

### Systemic risks and macroprudential tools — assessment and recommendations

A. Vulnerabilities from broad-based credit booms
- Findings:
  - The credit-to-GDP gap, based on bank credit, has been in negative territory for several years, reflecting a broad-based slowdown in credit growth since the Global Financial Crisis.
  - Household and corporate debt as a percent of GDP has declined since the crisis.
  - Supported by strong economic growth in recent years, credit growth and asset quality are gradually recovering.
  - The Basel III leverage ratio in the banking system is well above the regulatory minimum of three percent, indicating bank balance sheets are not stretched.
- Policy stance:
  - Countercyclical capital buffer has been kept at zero percent.
  - CBM assesses quarterly the calibration of the countercyclical capital buffer based on quantitative indicators and expert judgement; the credit-to-GDP gap serves as a headline indicator with a 2 percent reference threshold, complemented by debt-to-GDP ratios, current account balance, and bank balance sheet indicators.
- Recent mitigating measures:
  - MFSA phased in the Basel III capital conservation buffer in 2016, increasing banks’ loss absorption capacity.
  - Adoption of International Financial Reporting Standard 9 in January 2018, which uses a forward-looking approach to determine provisions against credit risk, is expected to reduce systemic nonperforming loan (NPL) problems.
  - A 2016 measure requires banks with two-year average NPL ratios above the 6 percent threshold to draw up a concrete reduction plan.

B. Vulnerabilities from residential housing and household sector
- Findings on prices and demand:
  - Residential property prices rose by about 33 percent between 2010Q4 and 2017Q4.
  - Drivers include strong employment growth, rising disposable income, an influx of foreign workers, portfolio rebalancing towards property investments in a low interest rate environment, buoyant tourism, lower withholding tax on rental income, and the Individual Investor Program.
  - Construction investment has picked up in response to rising prices.
- Signs of over-heating:
  - House price indices have gone beyond long-term trends; price ratios have increased.
  - House price-to-income ratio is around its historical average, but house price-to-rent ratio is higher than its historical average as of end-2017.
  - Econometric analyses by IMF staff suggest some overvaluation, with magnitude dependent on house price index choice.
- Mortgage lending and household exposure:
  - Almost all mortgage loans to residents (99.6 percent of total mortgages as of end-2017) were provided by core domestic banks.
  - Mortgages account for 51 percent of total bank loans to residents at end-2017, up from 37 percent at end-2012.
  - About 70 percent of mortgages to residents are granted for purchases of a primary residence.
  - Bank mortgage lending practices: median loan-to-value (LTV) around 80 percent and median debt-service-to-income (DSTI) around 20 percent; these ratios declined in 2017 for secondary residences and buy-to-let property loans.
  - Nonperforming mortgages have been historically low in recent years.
  - Foreign exchange risks in household lending are limited as most household loans are provided in euros.

*Italic: Source: IMF staff section on systemic risks, macroprudential toolkit, and housing market vulnerabilities.*

### 26.      Household balance sheets appear sound. Since household income  and wealth have grown

### 1mltea2019008 - 26.      Household balance sheets appear sound. Since household income  and wealth have grown

### Household balance sheets and leverage
- Household debt stood at 108 percent of gross disposable income at end-2017.
- Household debt was at 23 percent of gross financial wealth at end-2017.
- Household leverage definition: the sum of debt securities, loans, and other accounts payable; includes non-profit institutions serving the household sector.
- Share of homeowners with debt is about 20 percent; homeownership rate is about 80 percent.
- Implication: despite high homeownership, financial stability concerns from housing wealth effects may not be particularly large because relatively few homeowners extract housing equity.

### Mortgage characteristics and household resilience
- Mortgages are largely granted at variable rates and are indirectly linked to the ECB’s Main Refinancing Operations rate.
- About one percent of new mortgage lending is “interest only”; these tend to have special characteristics, including low LTV and short maturities.
- Median LTV of new loans is around 80 percent.
- Median DSTI of new loans is around 20 percent.
- Around 70 percent of new mortgages are for primary residences.
- Low-income households tend to have higher DSTI ratios but lower LTV ratios.
- Low-income households are more vulnerable to shocks but are not systemic in terms of the amount of outstanding debt nor the share of the population.
- Household stress test by staff indicates overall household resilience against adverse economic shocks.

### Key vulnerabilities and prudential observations
- Variable rate mortgages imply sensitivity to interest rate shocks via higher debt servicing costs.
- Lack of professional appraisers in Malta noted; valuations are performed by architects who may be subject to conflicts of interest.
- As of end-2017, core domestic banks granted around 1.7 percent of their total loans in foreign exchange to households.
- LTV and DSTI ratios have become more prudent for loans for secondary residence and buy-to-let properties.
- The share of mortgages by interest rate type shows prevalence of variable rate or up to 1 year initial rate fixed.

### Planned borrower-based macroprudential measures (policy intention)
- The Central Bank of Malta (CBM) drafted a Directive to introduce limits on the LTV and DSTI ratios, as well as on the maturity for residential real estate bank loans.
- Proposed features:
  - Limits tailored to different loan segments using granular data and banks’ current internal policies.
  - Flexible implementation features called “speed limits” that allow banks to exempt some loans from LTV limits.
  - CBM plans to monitor implementation on a quarterly basis.

### Recommendations to refine borrower-based measures
- Consider refining the “speed limits” for LTV to apply to the share of loans calculated based on the nominal euro amount of new loans per quarter, instead of the number of new loans on a semi-annual basis, to reduce uncertainty over the total nominal euro amounts of exempted loans.
- Lower the 20 percent speed limit for loans against secondary and buy-to-let properties as soon as concerns about any initial disruptions dissipate to strengthen LTV limit effectiveness.
- Extend the scope of borrower-based measures to cover all mortgage loans, irrespective of whether they are originated by banks or non-banks, to minimize leakage (arbitrage) effects.

### Box 1 — Draft Borrower-Based Macroprudential Measures (summary of proposed calibration)
- Implementation timeline: Draft Directive launched public consultation October 1–24, 2018; intention to start ECB Single Supervisory Mechanism notification process and announce measures possibly in early 2019.
- Measures apply to all banks in Malta and consist of three macroprudential limits: LTV-O cap, stressed DSTI-O cap, and maturity limit.
- Two borrower categories:
  - Category I: borrowers purchasing primary residential property.
  - Category II: borrowers purchasing second or additional residential property or buy-to-let properties.
- Exemption: Category I loans with property values less than €175,000 are exempted from the measures.
- Speed limits (flexibility clauses):
  - Allow banks to exempt up to 10 percent of Category I loans and 20 percent of Category II loans from the LTV-O limits each quarter (volume of loans defined as number of new loan contracts on a semi-annual basis in the draft).
- Calibrated limits (as in draft):
  - Category I borrowers:
    - 90 percent LTV-O cap, with a “speed limit” of 10 percent on the volume of loans; applies to loans with a market value in excess of €175,000.
    - Stressed DSTI-O of 40 percent for loans with a market value in excess of €175,000 with a shock to interest rates of 150 bps.
    - Maturity term of 40 years or the official retirement age, whichever occurs first.
  - Category II borrowers:
    - 1st year: 85 percent LTV-O cap, with a “speed limit” of 20 percent on the volume of loans.
    - 2nd+ year: 75 percent LTV-O cap, with a “speed limit” of 20 percent on the volume of loans.
    - Stressed DSTI-O of 40 percent with a shock to interest rates of 150 bps.
    - Maturity term of 20 years or the official retirement age, whichever occurs first.
- Definition: stressed DSTI-O is the DSTI ratio calculated with a 150 basis points higher interest rate than the actual interest rate at origination.
- Official retirement age schedule provided for cohorts born 1952–55 through post-1961.

### Vulnerabilities from corporate sector and intercompany lending
- Bank loans to NFCs as percent of GDP declined from 57 percent in 2007 to 30 percent in 2017.
- Intercompany loans increased from 34 percent of GDP in 2007 to 64 percent of GDP in 2017.
- Bond financing and loans by non-bank financials remain small, accounting for only about 5 percent of GDP.
- Intercompany loans in Malta are larger than in other European countries.
- When consolidated at the domestic group level, NFC debt-to-GDP almost halves to 70 percent because domestic intra-group loans are offset.
- Reliance on internal cash buffers exposes firms to business cycle risks; bank exposure to NFCs has declined including in sectors vulnerable to the business cycle (e.g., construction).
- Authorities report limited use of collateral in intercompany lending, implying low risk of “fire sales” of collateral assets, but this needs confirmation with more comprehensive information (e.g., a survey).
- Persistently high debt-to-equity ratio is a concern despite declining debt-to-GDP ratio.
- Possible drivers of high debt-to-equity ratio:
  - Tax advantages of borrowing over equity financing.
  - Statistical issues related to international intra-group finance because NFC data are consolidated only at the domestic group level.
- Suggested further analysis:
  - Examine impact of Notional Interest Deduction Rules (effective in 2018) on the debt-to-equity ratio when data become available.
  - Compute debt-to-equity ratio for NFCs that do not have a foreign parent company and compare with the ratio for all NFCs in Malta.
  - Assess types of companies with higher debt-to-equity ratios using granular data (domestic vs. foreign-owned, group vs. non-group, and industry).

### Funding and liquidity
- Average liquidity coverage ratio (LCR) in the system was around 200 percent as of 2017Q4.
- Fully phased-in regulatory LCR requirement is 100 percent.
- Loan-to-deposit ratios are generally low across banks, though funding structures vary by business orientation.
- Recommendation: implementation of Basel III’s Net Stable Funding Ratio would be beneficial to contain funding risk over a longer time horizon.

*Source: IMF staff extract from 1mltea2019008.*

### 35.      Banks play a dominant role in Malta’s domestic financial system. The main components

### Banks play a dominant role in Malta’s domestic financial system.

### Financial system composition and domestic footprint
- Banks: €48 billion in assets at end-2017, 4.3 times GDP.
- Insurance: 1 time GDP.
- Investment funds: 1.1 times GDP.
- A large residual category of “other financial intermediaries” is recorded in Malta’s flow of funds but these entities have limited domestic activities.32
- Core banks (as classified by Maltese authorities) refer to six banks that are exposed mostly to the domestic economy and account for 95 percent of resident deposits and 98 percent of mortgages to residents.33

### Other Systemically Important Institutions (O‑SIIs) and capital buffers
- Three banks were identified as O‑SIIs in 2015 and were required to hold additional capital buffers.
- The CBM and the MFSA developed an indicator-based methodology for identifying and calibrating O‑SII capital buffers, considering both (1) the relative importance within the domestic financial system and (2) the absolute importance to the domestic economy.34
- The O‑SII buffers were phased in from January 1, 2016, to January 1, 2019.
- The identified O‑SII capital surcharges range between 0.5 percent and 2.0 percent and have been phased in from January 1, 2016 to January 1, 2019.
- The current O‑SII buffers appear appropriate—the FSAP’s risk analysis finds that O‑SIIs are generally resilient under a severe economic downturn (see the Technical Note on Risk Analysis).

### Sovereign–bank nexus and sovereign exposures
- Banking system exposure to Maltese sovereign bonds: 3.3 percent of total assets at end-2017.
- Banking sector holds 29 percent of the total stock of Maltese government bonds (Figure 9).
- Concentration: holdings of Maltese sovereign bonds are concentrated in core banks; most banks hold Maltese sovereign bonds in amounts accounting for less than 10 percent of their total assets, with the largest exposure at around 22 percent.
- Sovereign risks are assessed as contained at this juncture given:
  - Declining public debt-to-GDP ratio.
  - Relatively high sovereign ratings (as of November 2018: A3 (Moody’s), A- (S&P), and A+ (Fitch)).36
  - Historically moderate Maltese sovereign yields and spreads.
- Investor base of Maltese sovereign bonds (December 2017, percent):
  - Resident credit institutions: 28.7
  - Resident insurers: 7.3
  - Resident other financials: 8.7
  - Resident non financials: 45.7
  - Non-residents: 9.6
- The FSAP’s risk analysis does not point to sizable losses from sovereign exposures (see the Technical Note on Risk Analysis).

### Macroprudential policy toolkit and implementation
- Countercyclical capital buffer:
  - Framework introduced in January 2016.
  - Buffer rate is at 0 percent as of September 2018.
- Capital Conservation Buffer (CCB):
  - Phased in at annual intervals of 0.625 percent of risk-weighted assets with effect from January 1, 2016.
  - Reached a final level of 2.5 percent of risk-weighted assets on January 1, 2019, in line with Article 160 of the CRD IV.
  - The CBM, as designated authority, may increase the CCB in line with Article 458 of the CRR above the microprudential level.
- Liquidity Coverage Ratio (LCR):
  - LCR requirement progressively implemented in accordance with the CRR:
    - 60 percent on October 1, 2015
    - 70 percent on January 1, 2016
    - 80 percent on January 1, 2017
    - 100 percent on January 1, 2018
  - The CBM may amend LCR requirements as per Article 458 of the CRR.
- Forward-looking loan-loss provisioning requirement:
  - IFRS 9 endorsed by Member States on July 27, 2016, and became effective on January 1, 2018.
- Household sector measures:
  - Mortgage risk weights for residential property (announced June 26, 2013):
    - A 35 percent risk weight applies to the part of the loan that does not exceed 70 percent of the market value of the property.
    - The rest of the loan is assigned a risk weight of 100 percent.
  - Exposure caps on foreign-currency-denominated household loans (announced December 12, 2012; effective January 1, 2013):
    - Credit institutions must identify foreign currency lending risk to unhedged borrowers where such loans constitute at least 10 percent of an institution’s total loan book, and where such total loan book constitutes at least 25 percent of the institution’s total assets.
- Limits on exposures between financial institutions:
  - Under the Capital Requirements Regulation Articles 392 and 395 to 403 (announced June 26, 2013; effective January 1, 2014), institutions shall not incur an exposure to a client or group of connected clients (including financial institutions) the value of which exceeds 25 percent of their eligible capital or EUR 150 million, whichever the higher.
- Other instruments and CBM powers:
  - The CBM can resort to macroprudential tools outside the CRD IV/CRR toolkit (e.g., LTV ratios, DSTI caps, sectorial countercyclical capital buffers).
  - Apart from the Single Supervisory Mechanism, the CBM is not legally bound to notify other European authorities about its macroprudential measures.

*Source: Malta authorities and IMF staff calculations.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1mltea2019008.pdf_