## _cr03264 - 2003. An update was made on the occasion of the Article IV consultation mission May 14-16. ## Source details **Canonical URL:** [_cr03264 - 2003. An update was made on the occasion of the Article IV consultation mission May 14-16.](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03264.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03264.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03264.pdf.json) --- ### Mission and participation - Mission dates: May 14-16. - Mission chief: Piero Ugolini (IMF/MFD). - Deputy mission chief: Paula Perttunen (World Bank). - IMF/MFD participants: Terry Donovan, Sandra Marcelino, Andrea Schaechter, Mark Zelmer; administrative assistant Margarita Aguilar. - World Bank participants: Laura Ard, Luc Cardinal, Peter Kyle, Elisabeth Sherwood. - Other participants: Karsten Biltoft (Danmarks Nationalbank), Paolo Corradino (Banca d’halia), Giulio Sanarighi (Maggiore of the Italian Guardia di Finanza) — AMUCFI assessment contribution. - Authorities and market contacts: Minister of Finance; Governor of the Central Bank of Malta (CBM); Chairman/President of the Malta Financial Services Authority (MFSA); representatives of banks, insurance companies, investment funds, stockbrokers, audit firms, professional associations, and other market participants. - Main authors of the report: Piero Ugolini, Mark Zelmer, Andrea Schaechter. ### Executive findings — Overall stability assessment - System characterization: - Financial system: "sound and well supervised, but very concentrated and exposed to the country’s narrow economic base." - Domestic banks account for 90 percent of total financial sector assets. - Two domestic banks account for about 90 percent of total assets; failure of either could trigger a systemic crisis. - Domestic banks’ activities are largely funded by domestic currency deposits from residents. - Separate international banking component "does not appear to be a source of systemic vulnerability." - Insurance and securities segments: "small and not systemically important." - The financial system has never experienced a systemic crisis. - Financial soundness: - Domestic banks are profitable, liquid, and well capitalized (financial soundness indicators and stress tests). ### Key vulnerabilities and risks - Concentration: - Two domestic banks dominate domestic banking; systemic risk if either fails. - Domestic banking sector comprises four banks; two banks account for 90 percent of the sector’s assets. - Asset quality and collateral: - Limited diversification of banks’ loan portfolios; high exposure to tourism, retail trade, manufacturing, ship repair/shipbuilding, construction. - Domestic real estate represents almost three fourth of collateral used. - Banks use a 30 percent discount from appraised value for real estate collateral provisioning; mission notes this may understate liquidation losses in a systemic crisis. - Higher-than-normal EU-average nonperforming loans (NPLs) level; mission recommends reducing NPLs and enforcing loan classification and provision requirements introduced in 2001. - Legal and operational frictions: - Inefficiencies in the judicial system hinder rapid collateral liquidation. - Need to improve legal/regulatory foundation for securities settlement system (CSD/CSS) to enable integration with European systems and acceptance of Maltese government securities as collateral in ESCB operations (if Malta joins EMU). - Reputational and AML/CFT risks: - Reputational risks related to nominee companies and planned trust legislation during phase-out of offshore sector. - Financing of terrorism not yet fully criminalized; implementation gaps in some Basel Committee Customer Due Diligence elements. ### Stress tests and resilience (CBM quarterly stress testing introduced 2002) - Framework: - Quarterly stress testing exercise introduced in 2002 covering the four domestic banks; international/offshore banks excluded. - Bottom-up forward-looking approach for credit risk; nonperforming definition: overdue by 90 days or other doubts as to collectibility. - Credit risk findings: - Collateral valuations critical; need for real estate price index for stress testing. - Two largest banks have implemented credit scoring systems but need refinement; two smaller banks lack formal credit scoring. - Banks’ gross exposures relative to capital: greatest risk from wholesale and retail trade sector and household sector; a sector-wide default would force all four banks to raise capital. - Government securities and contingent liabilities represent more than 30 percent of bank holdings of loans and securities. - Stress scenarios of downgrades of one and two full grades: expected losses in each scenario were less than accumulated provisions plus collateral, conditional on ability to liquidate collateral at discounted values. - Market risk findings: - Interest rate shocks: parallel shocks of +/-100 and +300 basis points applied; three banks profit in first 12 months from an increase in domestic interest rates; the fourth bank has enough capital to remain above prudential requirements. - Longer-run interest risk: holdings of longer-term fixed-rate securities represent more than one third of assets; profits would decline over time absent balance-sheet adjustments. - Foreign exchange shocks: +/- 10, 20, and 50 percent applied to Maltese lira against basket currencies; prudential limits: net open FX positions not to exceed 20 percent of bank capital in aggregate; 5 percent on each individual currency except euro with 14 percent limit. All four banks keep capital adequacy ratios above the eight percent threshold under scenarios. - Equity price risk: equities represent less than 30 percent of capital. - Derivatives: stress tests include derivative positions used to offset exposures. ### Mission recommendations — banking sector and systemic infrastructure (summary) - Banking sector: - Continue holding more capital and provisions than currently required by prudential norms. - Improve credit risk management; monitor exposures and set provisions proactively. - Reduce NPLs and closely monitor asset quality. - Banking supervision: - Ensure effective cooperation and information exchange between CBM and MFSA; formalize cooperation via MoU (MoU signed February 4, 2003). - Consider prompt corrective action (PCA) framework and written formal agreements for significant problems; possibly amend Banking Act to ensure enforceability. - Revisit penalty structures to create meaningful monetary penalties. - Payment system (MaRIS): - Reduce recovery time in case of breakdown to less than four hours. - Complete and test the draft contingency plan. - Consider establishing a remote back-up site. - Complete establishment of an effective oversight function at the CBM and publicly disclose access criteria and pricing policy. - Securities settlement and capital markets: - Improve legal framework for central securities depository (CSD) after MSE status change in October 2002; consider placing CSD in a separate entity. - Ensure introduction of delivery-versus-payment (DVP) proceeds as planned (current practice: securities transferred on trade day, funds transferred three days later). - MFSA and CBM should cooperate closely and establish respective roles in an MoU. - Clarify MFSA and MSE roles and responsibilities; finalize directives for Recognized Investment Exchanges (RIEs). - Insurance supervision: - Improve supervision of insurance company internal controls and investment policies. - Formalize MFSA supervision of insurance corporate governance and move to a formal risk-based approach. - Revise minimum solvency margins to depend more fully on size, complexity, and business risks. - Public debt management: - Review CBM’s role in government securities market once a primary dealer system is implemented. - Use public debt management to foster a deeper and more liquid secondary market. - Government sinking funds should prudently reduce risk exposure. - AML/CFT and transparency: - Ensure financing of terrorism is fully and specifically criminalized. - Swiftly implement Basel Committee Customer Due Diligence measures. - Require financial institutions to verify due diligence carried out by nominees/trustees and ensure beneficial owner identity information is available when professional intermediaries act on behalf of clients. - Provide additional resources and expertise in AML/CFT at MFSA; increase frequency of on-site inspections and extend coverage to include a sample of domestic branches. - Anticipate an increase in Suspicious Transaction Reports (STRs) as FIAU becomes better resourced. - CBM should clarify objectives and procedures of its operations in the government securities market; frequently disclose off-balance-sheet commitments and issue an annual income statement. - Disclose arrangements for information exchange between supervisory and regulatory authorities domestically and internationally. ### Banking sector structure, funding, and supervision - Structure and concentration: - Domestic component: four banks; two largest each hold about 45 percent of domestic system assets (together about 90 percent). - Government stake: 25 percent in Bank of Valletta; government seeking buyers as part of privatization program. - International component: 10 international banks and 1 remaining offshore bank (deals mainly with nonresidents in foreign currency); international banks have no significant linkages to domestic system. - Funding and liquidity: - Domestic banks very liquid; holdings of liquid assets as share of short-term liabilities comfortably exceed the 30 percent prudential requirement. - Structural excess liquidity reduced need for wholesale money market funding. - Banks rely heavily on Maltese liri deposits from residents; resident foreign currency deposits are not significant. - Capital and provisioning: - Strong capital levels well in excess of capital adequacy requirements. - Banks may take collateral values into account when setting provisioning. - Supervision and regulatory changes: - MFSA assumed responsibility for supervising banks from CBM in January 2002; MFSA also supervises insurance and securities. - CBM retains responsibility for payments oversight and overall financial stability monitoring (financial soundness indicators and quarterly stress tests). - New central bank law (October 2002) increases CBM autonomy and sets price stability as main objective. - Regulation approving Deposit Guarantee Scheme and Investor Compensation Scheme entered into force January 3, 2003; compensation limit: the lesser of 90 percent of eligible deposits or up to the Maltese equivalent of EUR 20,000. - Permanent MoU between MFSA and CBM signed February 4, 2003; CBM responsible for database maintenance of statistical and prudential information. ### Payment, settlement, and market infrastructure - MaRIS (RTGS): - Operational since October/August 2002 (references vary); daily average: 140 transactions; value Lm 50 million. - Observes most CPSS core principles; minimum recovery time: 4 hours; no remote back-up site. - Participants: four deposit money banks and the CBM. - Recommendations: reduce recovery time, create remote backup, finalize and test contingency plans, disclose access/exit rules and pricing. - Securities settlement: - No delivery-versus-payment (DVP) currently; securities transferred on trade day, funds transferred three days later. - CSD functions embedded in MSE by-laws; no formal supervision over CSD; legal framework uncertainty if MSE loses license. - Market capitalization (June 2002): Lm 1,565 million (92 percent of GDP); government bonds ~ just over half; equities 39 percent; corporate bonds 7 percent. - MSE lists 13 equities and 16 corporate bonds; no market makers on MSE due to by-laws prohibiting proprietary trading. - Recommendation: dematerialize treasury bills; introduce European Master Repurchase Agreement; segregate CSD from MSE; implement DVP. ### Macro environment and financial statistics (selected) - Economy and exposure: - Malta: small island economy; tourism and manufacturing account for more than 50 percent of GDP. - Electronic products constitute three-quarters of manufactured exports. - Public administration and state-owned enterprises account for about one-fourth of GDP and employ about one-third of the labor force. - Population and income: - Population: about 394,000 (text); Total population: 397,296 (December 2002). - GDP per capita: about US$9,200 (text); GDP per capita: US$9,740 (Table 1). - Real GDP growth (selected series): - 1998: 3.4; 1999: 4.1; 2000: 6.4; 2001: -1.2; 2002: 1.0; May 2003: -1.9. - Inflation rate (2002=100, 12-month moving average): - 1998: 2.4; 1999: 2.1; 2000: 2.4; 2001: 2.9; 2002: 2.2; May 2003: 1.3. - Unemployment rate (end-of-period): - 1998: 5.6; 1999: 5.8; 2000: 5.0; 2001: 5.1; 2002: 5.2; May 2003: 5.3 (February 2003 for May 2003 figure). - CBM gross official reserves (millions of US$): - 1998: 1,696; 1999: 1,794; 2000: 1,471; 2001: 1,682; 2002: 2,209; May 2003: 2,541. - Reserve cover (months of imports): - 1998: 7.4; 1999: 7.8; 2000: 5.2; 2001: 7.4; 2002: 8.6; May 2003: 8.4 (April 2003 for May 2003 figure). - Central government financial balance (percent of GDP): - 1998: -10.2; 1999: -7.8; 2000: -5.5; 2001: -5.2; 2002: -5.9; May 2003: -6.8. - Total outstanding public debt (percent of GDP): - 1998: 56.0; 1999: 57.6; 2000: 59.2; 2001: 61.9; 2002: 64.3; May 2003: 67.8. - Public debt composition and maturity: - Direct public debt: 64 percent of GDP in December 2002. - Government-guaranteed debt: additional 22 percent of GDP. - About 75 percent of direct debt consists of fixed-rate bonds with maturities up to 20 years. - Only 26 percent of bonds and treasury bills outstanding mature in one year or less. - Banks hold most treasury bills (73 percent); most bonds held by nonbank financial institutions and the general public (52 percent). ### Nonbank financial sector, capital markets, and market activity - Nonbank financial sector: - Contributes about 3 percent of GDP. - Twenty-one insurers (all onshore); total insurance sector assets equal about 15 percent of GDP. - Total insurance sector assets nearly doubled over four years; life insurance main growth driver. - No private pension schemes, mortgage institutions, credit unions/cooperatives, or microfinance institutions. - Market statistics (1998–2002 excerpts): - Interbank money market turnover (Liri millions): 955, 955, 301, 208, 98. - Interbank turnover to GDP (percent): 70.1, 65.6, 19.3, 12.7, 5.8. - Foreign exchange turnover (Liri millions): 1,783, 2,504, 2,499, 2,393, 2,811. - Foreign exchange turnover to GDP (percent): 130.9, 172.0, 160.0, 146.8, 166.8. - Equities market capitalization (Liri millions): 296, 790, 882, 610, 552. - Market capitalization to GDP (percent): 21.8, 54.3, 56.5, 37.4, 32.8. - Market thinness drivers: seasonality, banks often on same side of market, exporters/importers use foreign currency accounts. ### Supervisory framework, enforcement, and recommended supervisory enhancements - MFSA and CBM roles: - MFSA: single regulatory authority for banks, securities firms, insurance businesses, and bureaux de change; assumed bank supervision from CBM in January 2002. - CBM: payments oversight, lender of last resort (LOLR), financial stability monitoring and stress testing. - Observance and recommendations: - MFSA’s compliance with Basel Core Principles generally good; supervisory staff qualified and practices risk-based supervision. - Areas for strengthening: - Develop prompt corrective action (PCA) provisions and intermediate enforcement tools. - Strengthen collateral valuation guidelines and supervisory assessment of collateral. - Present examination reports to bank boards; recalculate provisions and capital adequacy based on examination results and take corrective action. - Enhance rules of procedure for Supervisory Council and signature authority for examination reports. - Increase frequency and scope of on-site ML/FT inspections, including for international banks and domestic branch samples. - Negotiate and sign MoUs with foreign supervisors where banks have a presence. - Supervisory enforcement: - Historically relied on "moral suasion"; recommendation to ensure prompt, definable remedial actions and consider legislative amendments to enforce directions. - Monetary penalty structure to be revisited for meaningful deterrence. ### Insurance supervision — governance, internal controls, and prudential rules - Sector structure: - Five local insurance companies, fourteen foreign insurance companies, and one affiliated insurer. - Total assets: 15 percent of GDP at end-2001. - Penetration ratio end-2001: 4.6 percent; density: US$100 per capita. - Two largest local life insurers receive ~90 percent of gross premiums; two largest non-life insurers receive nearly 45 percent. - MFSA insurance supervision: - Insurance Business Unit: 12 staff; inspections conducted; prudential rules on solvency margins, asset valuation, liabilities, and equalization reserves. - Recommended actions: - Issue corporate governance guidance and formalize governance procedures. - Require ongoing internal audit functions appropriate to size and complexity. - Introduce comprehensive investment risk management policies for derivatives and review minimum solvency margins to reflect size/complexity. - Move to a more formal risk-based approach and formalize exchange-of-information arrangements with foreign supervisors. ### Financial market reforms and the Financial Market Act (effective October 2002) - Financial Market Act effects: - Removed regulatory functions from MSE; MSE now Recognized Investment Exchange (RIE) licensed, regulated, and supervised by MFSA. - Objectives: remove MSE exclusivity; rationalize licensing, investigation and sanctioning; merge tribunals; provide defined right of appeal. - MFSA drafting regulations for listing authorizations and listing processes. - Market composition: - Market capitalization (June 2002): Lm 1,565 million (92 percent of GDP); government bonds just over half, equities 39 percent, corporate bonds 7 percent. - Mutual funds/CIS: 57 locally based schemes and 300 foreign-based schemes; primary listed CISs increased from 12 to 50 between 1998 and 2002; net asset value of primary listed CISs: Lm 138 million (1998) to Lm 218 million (2002); end-2000 figure Lm 331 million. - Observance and priorities: - Observance of IOSCO Objectives and Principles: good, but enforcement under new regime too recent to assess. - Key weakness: legal/regulatory clarity for CSD and CSS functions and their oversight; recommended segregation of CSD from MSE and issuance of dematerialization and CSD/CSS legislation. ### Payment systems oversight — status and recommended actions - Oversight establishment: - Oversight function being established within CBM; CBM Act amendments effective October 1, 2002 provide CBM authority to oversee payment systems. - CBM has not fully explained public objectives and role in payment system oversight; intends to make operating procedures publicly available. - Recommended actions (selected): - Complete establishment of payment systems oversight function; formulate and convey policies and objectives to public. - Define CBM–MFSA relationship for payment system oversight and securities settlement in an MoU and make MoUs publicly available. - Disclose costs of operating and overseeing payment systems; consider internal audit assistance for oversight. - Reduce MaRIS recovery time from minimum four hours; consider distant backup site; finalize and test contingency plans. ### AML/CFT assessment — main findings and recommended action plan - Legal and institutional framework: - Main legislation: Prevention of Money Laundering Act (enacted 1994; amended 1998, 2001, 2002); Prevention of Money Laundering Regulations of 1994 (amended 2000, 2002). - Malta has ratified Vienna Convention, signed Palermo Convention, ratified Council of Europe Convention on Laundering, Search, Seizure and Confiscation, and implemented UN Resolutions related to financing of terrorist acts. - FIAU became fully operational in October 2002; FIAU is competent authority for AML/CFT. - Criminalization and enforcement: - Money laundering broadly criminalized; financing of terrorism not specifically criminalized — mission recommends enacting a specific FT offense. - Only one successful ML prosecution to date (subject to appeal). - STR numbers appear low; FIAU expected to increase STR quantity/quality and provide systematic feedback. - Customer due diligence and nominees/trusts: - Provisions on customer identification, record keeping, and STR reporting broadly in line with standards. - Recommendations include mandatory implementation of Basel Committee CDD paper, extending identification requirements for nominees/trustees, requiring financial institutions to verify nominee/trustee due diligence, and ensuring beneficial owner identity information is available when professional intermediaries act on behalf of clients. - Introduce enhanced scrutiny for wire transfers lacking originator information. - Institutional capacity and recommended actions: - Increase frequency of on-site ML/FT inspections, particularly for international banks; introduce program of bank branch ML/FT inspections. - Augment FIAU staff as full implementation proceeds; improve AML/CFT awareness and training across reporting institutions and law enforcement. - Consider asset forfeiture fund, civil forfeiture mechanisms, and expanded training for investigative, prosecutorial, and judicial authorities. - Authorities’ response: - Authorities broadly agree with positive assessment and accept recommendations; note some recommendations may be implemented by directives where appropriate. - Authorities believe financing of terrorism is already adequately criminalized but take note of recommendation to further strengthen FT criminalization. ### Summary institutional and market structure (selected headline facts) - Banking sector accounts for 90 percent of financial sector assets. - Domestic banking sector: four banks; two large banks each hold about 45 percent of banking sector assets. - Insurance sector: 21 insurers; total assets ~15 percent of GDP; dominated by two life insurers. - Domestic capital market: small with low secondary market activity; CBM acts as market maker in government securities; treasury bills mostly held by banks. - Macroeconomic preparedness for EU accession: many capital account restrictions lifted/relaxed; remaining restrictions on short-term capital flows to be phased out before EU accession. *Source: IMF staff report _cr03264 - 2003. An update was made on the occasion of the Article IV consultation mission May 14-16.* ### 2003. An update was made on the occasion of the Article IV consultation mission May 14-16. ### _cr03264 - 2003. An update was made on the occasion of the Article IV consultation mission May 14-16. ### Mission and participation - Mission dates: May 14-16 (update occasion). - Mission chief: Piero Ugolini (IMF/MFD). - Deputy mission chief: Paula Perttunen (World Bank). - Other IMF/MFD participants: Terry Donovan, Sandra Marcelino, Andrea Schaechter, Mark Zelmer; administrative assistant Margarita Aguilar. - World Bank participants: Laura Ard, Luc Cardinal, Peter Kyle, Elisabeth Sherwood. - Other participants: Karsten Biltoft (Danmarks Nationalbank), Paolo Corradino (Banca d’halia), Giulio Sanarighi (Maggiore of the Italian Guardia di Finanza) — AMUCFI assessment contribution. - Authorities and market contacts: Minister of Finance, Governor of the Central Bank of Malta, Chairman/President of the Malta Financial Services Authority, representatives of banks, insurance companies, investment funds, stockbrokers, audit firms, professional associations for the financial sector, and other market participants. - Main authors of the report: Piero Ugolini, Mark Zelmer, Andrea Schaechter. ### Executive findings — Overall stability assessment - The financial system is described as "sound and well supervised, but very concentrated and exposed to the country’s narrow economic base." - Domestic banks account for 90 percent of total financial sector assets. - Two domestic banks account for about 90 percent of total assets; failure of either could trigger a systemic crisis. - Domestic banks’ activities are largely funded by domestic currency deposits from residents. - There exists a separate international component of the banking system that "does not appear to be a source of systemic vulnerability." - Financial soundness indicators and stress tests show domestic banks are profitable, liquid, and well capitalized. - Insurance and securities segments are "small and not systemically important." - The financial system has never experienced a system crisis. ### Legal, regulatory, and institutional framework - A new central bank law introduced in October 2002 provides more autonomy to the central bank and officially establishes price stability as the main objective. - The supervisory framework has been strengthened to bring it in line with EU standards. - A contingency plan for crisis coordination is in place. - A regulation approving the creation of a Deposit Guarantee Scheme and the Investor Compensation Scheme entered into force on January 3, 2003. - Malta’s legal framework comprises essential elements for AML and CFT; "all institutional elements of an Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) regime are now in place." - FSAPs are designed to assess the stability of the financial system as a whole and not that of individual institutions; they help identify and remedy weaknesses in financial sector structure and do not cover institution-specific risks such as operational or legal risks, or fraud. ### Key vulnerabilities and risks identified - High concentration: two domestic banks dominate domestic banking, creating systemic risk if either fails. - Limited diversification of banks’ loan portfolios. - Strong reliance on real estate properties as collateral. - Inefficiencies in the judicial system that hinder rapid collateral liquidation. - Higher-than-normal EU-average nonperforming loans (NPLs) level. - Need for improved legal/regulatory foundation for the securities settlement system to enable integration with other European systems and acceptance of Maltese government securities as collateral in ESCB monetary operations (if Malta joins EMU). - Reputational risks related to nominee companies and planned trust legislation during phase-out of offshore sector. ### Stress tests and financial soundness indicators - Financial soundness indicators and stress tests indicate banks are: - profitable, - liquid, - well capitalized. - Despite healthy indicators, concentration and asset-quality issues weaken resiliency to large economic shocks. ### Mission recommendations (summary of Box 1) - Banking sector: - Banks should continue holding more capital and provisions than currently required by prudential norms. - Improve credit risk management to monitor exposures and set provisions proactively. - Reduce the level of NPLs and closely monitor banks’ asset quality. - Banking supervision: - Ensure effective cooperation and information exchange between the Central Bank of Malta (CBM) and the Malta Financial Services Authority (MFSA). - Formalize cooperation via Memorandum of Understanding (MoU) — an MoU was signed in February 2003; build strong cooperation among officials. - Operational recommendations are listed in Section IV.G (report). - Payment system: - Reduce recovery time in case of breakdown to less than four hours. - Complete and test the draft contingency plan. - Consider establishing a remote back-up site. - Complete establishment of an effective oversight function at the CBM. - Securities settlement systems: - Improve legal framework governing the central securities depository after MSE status change in October 2002. - Create a separate legal and supervisory framework for the depository’s activities. - Ensure introduction of delivery versus payment (DVP) in the securities settlement system proceeds as planned. - MFSA and CBM should cooperate closely and establish respective roles in an MoU. - Capital markets supervision: - MFSA and the Malta Stock Exchange (MSE) should delineate roles and responsibilities to optimize scarce resources and avoid supervisory gaps. - Insurance supervision: - Improve supervision of insurance company internal controls and investment policies. - Formalize MFSA supervision of insurance corporate governance and move to a formal risk-based approach. - Public debt management: - Review CBM’s role in the government securities market once a planned primary dealer system is implemented. - Use public debt management to foster a deeper and more liquid secondary market for government securities. - Government sinking funds should prudently reduce their risk exposure. - AML/CFT: - Ensure financing of terrorism is fully and specifically criminalized. - Swiftly implement newly introduced elements of the comprehensive methodology, particularly Basel Committee’s Customer Due Diligence paper. - Require financial institutions to verify due diligence carried out by nominees/trustees and ensure beneficial owner identity information is available to financial institutions when professional intermediaries act on behalf of clients. - Provide additional resources and expertise in AML/CFT at the MFSA, increase frequency of on-site inspections, and extend coverage to include a sample of domestic branches. - Anticipate an increase in Suspicious Transaction Reports (STRs) as the Financial Intelligence Analysis Unit (FIAU) becomes better resourced. - Transparency: - CBM should clarify objectives and procedures of its operations in the government securities market. - CBM should frequently disclose its off-balance-sheet commitments and issue an annual income statement. - Once payment systems oversight is established, CBM should publicly disclose related policies, objectives, and procedures. - Disclose arrangements for information exchange between supervisory and regulatory authorities domestically and internationally. ### Table of contents and appendices (selected structural elements from the report) - Main sections include: - I. Overall Stability Assessment - II. Macroeconomic Environment and Risks - III. Soundness and Vulnerabilities of the Financial System (Banks, Insurance Companies, Capital Markets, Payment and Settlement Systems, Systemic Liquidity and Monetary Management, Public Debt Management, Supervisory and Regulatory Framework, Transparency, Legal Framework, Financial Stability Policy and Safety Nets, AML/CFT) - Boxes and appendices include: - Box 1: Summary of Mission Recommendations - Box 2: FSAP Stress Test Exercise - Appendices: Financial System Overview; Observance of Financial System Standards and Codes; multiple Appendix Tables on financial system structure, markets, and recommended actions to improve observance of standards and codes. *Source: IMF staff report _cr03264 - 2003. An update was made on the occasion of the Article IV consultation mission May 14-16.* ### 4. The domestic banking sector, which comprises four banks, is dominated by two ### _cr03264 - 4. The domestic banking sector, which comprises four banks, is dominated by two ### Structure and concentration of the banking sector - The domestic banking sector comprises four banks, with two banks accounting for 90 percent of the sector’s assets. - The government has a 25 percent stake in one bank, Bank of Valletta; the government is seeking buyers for this 25 percent stake as part of its privatization program. - There are no significant links between the domestic and international segments of the banking system described in footnote 1. - The Central Bank of Malta’s (CBM) financial stability office monitors the financial situation of local large borrowers as part of the Early Warning System. ### Financial soundness and vulnerabilities (banks) - Overall assessment: - The Maltese banking system is healthy but exposed to the country’s narrow economic base. - Financial soundness indicators indicate domestic banks are profitable, liquid, and well capitalized. - Key risks and exposures: - The system’s soundness is highly dependent on the financial condition of the two largest institutions and could be undermined by a major systemic shock given: - High concentration of banks’ loan portfolios in a few sectors (tourism, retail trade, manufacturing, ship repair/shipbuilding, construction). - Strong reliance on domestic real estate properties as security in lending operations (domestic real estate represents almost three fourth of collateral used). - Lending to nonresidents is insignificant; more than 95 percent of lending to residents is denominated in Maltese liri. - Banks’ discounts on collateral: a 30 percent discount from appraised value for real estate collateral is used for provisioning; mission noted this may not reflect low liquidation values in a systemic crisis given Malta’s narrow economic base, real estate dominance, restrictions on sale of real estate to nonresidents, and judicial inefficiencies. - Liquidity and funding: - Domestic banks are very liquid: holdings of liquid assets as a share of short-term liabilities comfortably exceed the 30 percent prudential requirement. - Structural excess liquidity has reduced banks’ need for wholesale money market funding. - Domestic banks rely heavily on Maltese liri deposits from residents; resident foreign currency deposits are not significant. - Capital and provisioning: - Maltese banks show strong capital levels well in excess of capital adequacy requirements. - Banks are allowed to take collateral values into account when setting provision requirements. - Mission recommendations (bank sector): - Reduce the level of NPLs and strictly enforce the new loan classification and provision requirements introduced in 2001. - Be vigilant on the quality of banks’ loan portfolios. - The mission welcomed the CBM’s initiative to begin publishing aggregate NPLs data. ### Insurance, capital markets, and international business - The insurance and capital market sectors are small and at an early stage of development. - The largest institutions in both markets are affiliated with the two large domestic banks. - Maltese residents have significant investments offshore and a long history of accessing foreign financial institutions to manage savings. - Offshore business and regulatory reform: - All remaining business operated under specific offshore legislation will be phased out by September 2004. - Going forward, all business with non-residents will be regulated on the same basis as for domestic banks and nonbanks. - Authorities are considering complete elimination of regulated nominee company structures under draft legislative proposals that would also update trust law and provide for regulated trustees to attract “regulated” international business. - Mission did not observe additional factors that give rise to particular negative implications for the stability of the Maltese financial system from offshore activities, though reputational risk exists. ### Payments, securities settlement, and infrastructure - Payments system: - CBM manages liquidity using indirect instruments and has an explicit mandate to provide collateralized liquidity as a lender of last resort (LOLR). - The Real-Time Gross Settlement System (RTGS) became operational in October 2002, is cost-effective, and functions well. - Retail payments infrastructure remains relatively fragmented; authorities and banks are working on a project to integrate the various systems. - Securities settlement vulnerabilities: - There is currently no delivery-versus-payment (DVP) for securities transactions. - Significant legal and technical steps have been taken toward introducing DVP. - No formal supervision over the central securities depository (CSD) that is part of the Malta Stock Exchange (MSE); the depository’s legal framework is embedded in the MSE by-laws, creating uncertainty if the exchange were to lose its license. - Authorities are taking steps to establish a separate legal and supervisory framework for the depository’s activities. - Supervision of payments and CSD: - CBM operates the RTGS and is working to improve oversight. - Being integral to the MSE, the CSD’s functions are difficult to separate from the exchange, resulting in no direct supervision and absence of laws addressing securities settlement and CSD functions. ### Supervision and regulation - Institutional changes and capacity: - The Malta Financial Services Authority (MFSA) assumed responsibility for supervising banks from the CBM in January 2002; MFSA also supervises insurance and securities sectors. - CBM retains responsibility for supervising the payments system and monitoring overall financial stability through financial soundness indicators and quarterly stress tests. - Accounting and audit standards are high. - Quality of supervision: - MFSA’s supervision of banks is characterized as good: independent and effective with qualified and experienced staff using on- and off-site supervision. - MFSA has developed an insurance supervision function since 1994; all insurance companies and intermediaries have been inspected at least once. - Regulation of the securities market is transitioning to be completed in 2003: creation of a single regulatory authority in MFSA, with MSE retaining Recognized Investment Exchange (RIE) status; regulatory powers placed in MFSA; more detailed directives to RIEs issued in April 2003. An enforcement track record under the new regime still needs to be established. ### Anti-money laundering and transparency - AML/CFT framework: - All institutional elements of an anti-money laundering regime are now in place following establishment of the Financial Intelligence Analysis Unit (FIAU). - Malta’s legal framework includes essential components for AML and CFT, but some points are not covered explicitly in legislation and rely on interpretations of common law. - Financing of terrorism is not yet fully criminalized. - AML/CFT implementation measures for MFSA-regulated institutions are well developed and observed in practice, though newly introduced elements of the comprehensive methodology have yet to be implemented. - Transparency: - Monetary and financial policies are conducted transparently; authorities use annual and more frequent reports, press releases, brochures, and speeches for public disclosure. ### Macro environment and implications for financial stability - Economy and external dependence: - Malta is a small island economy, highly dependent on a few sectors: tourism and manufacturing account for more than 50 percent of GDP. - Electronic products constitute three-quarters of manufactured exports. - Public administration and state-owned enterprises account for about one-fourth of GDP and employ about one-third of the labor force. - Population and income (as reported): - Population: about 394,000 (text) and Total population: 397,296 (December 2002) (Table 1). - GDP per capita: about US$9,200 (text) and GDP per capita: US$9,740 (Table 1). - Recent macro performance and effects on banking: - Real GDP growth: recovered to 1.0 percent in 2002 after a 1.2 percent drop in 2001; growth between 1997 and 2000 exceeded 4 percent annually. - Slow economic performance in 2001–2002 slowed credit growth and contributed to raising levels of NPLs, though exact impact is difficult to quantify due to simultaneous improvements in credit risk management and loan reclassification after on-site examinations. - Strong growth in deposits combined with slowdown in credit demand led to rapid buildup of liquidity in the banking system over the past two years. - Interest rates are fully liberalized and have gradually fallen. - Inflationary pressures from liquidity buildup have been modest; price developments are mostly determined externally due to the exchange rate peg and openness of the economy. - Housing prices are rising rapidly because of strong demand. - Balance of payments surpluses enabled the CBM to build reserves and strengthen its position to maintain the peg ahead of EU accession: CBM’s foreign reserves stood at about 50 percent of GDP or about nine months of imports of goods at end-2002. - EU accession preparedness: - Malta is well placed to benefit from EU accession; some capital account restrictions have been lifted or relaxed over the past five years. - Remaining restrictions on short-term capital flows (in particular loans with a maturity of less than six months) are to be phased out before Malta joins the EU. - Levies and subsidies are being lifted; expectations are that Malta’s economy will remain competitive. - Selected macro and financial statistics (Table 1 highlights): - Real GDP growth: 1998: 3.4; 1999: 4.1; 2000: 6.4; 2001: -1.2; 2002: 1.0; May 2003: -1.9. - Total population: 397,296 (December 2002). - GDP per capita: US$9,740. - Inflation rate (2002=100, 12-month moving average): 1998: 2.4; 1999: 2.1; 2000: 2.4; 2001: 2.9; 2002: 2.2; May 2003: 1.3. - Unemployment rate (end-of-period): 1998: 5.6; 1999: 5.8; 2000: 5.0; 2001: 5.1; 2002: 5.2; May 2003: 5.3 (February 2003 for May 2003 figure). - CBM gross official reserves (millions of US$): 1998: 1,696; 1999: 1,794; 2000: 1,471; 2001: 1,682; 2002: 2,209; May 2003: 2,541. - Reserve cover (months of imports): 1998: 7.4; 1999: 7.8; 2000: 5.2; 2001: 7.4; 2002: 8.6; May 2003: 8.4 (April 2003 for May 2003 figure). - Central government financial balance (in percent of GDP): 1998: -10.2; 1999: -7.8; 2000: -5.5; 2001: -5.2; 2002: -5.9; May 2003: -6.8. - Total outstanding public debt (in percent of GDP): 1998: 56.0; 1999: 57.6; 2000: 59.2; 2001: 61.9; 2002: 64.3; May 2003: 67.8. *Source: IMF staff report content provided in the supplied document.* ### 25. The CBM introduced a quarterly stress testing exercise in 2002 to assess the four ### _cr03264 - 25. The CBM introduced a quarterly stress testing exercise in 2002 to assess the four ### Stress testing framework and methodology - The CBM introduced a quarterly stress testing exercise in 2002 to assess the four domestic banks’ ability to cope with various economic and financial shocks. - The mission relied on these stress tests and supplemented them with an examination of banks’ ability to absorb changes in the average credit quality of their domestic loan portfolio and securities holdings. - International and offshore banking institutions operating in Malta were excluded from the exercise because they do not represent a source of systemic risk. - A “bottom-up” forward-looking approach was used for credit risk because (i) managements of the two largest banks had undergone significant changes and (ii) rules governing credit classification and loan loss provisioning had been significantly revised, undermining time-series analysis. - Credit classification rule noted: a loan is considered nonperforming when it is overdue by 90 days or when there are other reasons to believe that there is doubt as to the collectibility of funds. ### Credit risk: key findings - Malta’s narrow economic base significantly influences domestic banks’ financial condition; limited diversification of loan portfolios and reliance on real estate property as collateral increase systemic vulnerability. - Collateral valuations are a major determinant of banks’ ability to withstand deterioration in average credit quality. - Given large indirect exposure to real estate property prices, authorities should remain vigilant in appraisal of real estate collateral; introducing a real estate price index is important for stress testing. - Credit risk management weaknesses: - The two largest banks have implemented credit scoring systems but need further refinements to assess implications of economic outlook for future loan losses and to provision proactively. - The two smaller banks have not yet introduced formal credit scoring systems. - Exposures to key sectors and large borrowers: - Banks’ gross exposures relative to capital indicate greatest risk from private sector defaults in the wholesale and retail trade sector and the household sector; a default by any one of these sectors would result in all four banks needing to raise new capital to meet prudential requirements. - Banks are better able to withstand a default of a sub-sector or a large borrower than a sector-wide default. - Government default vulnerability: government securities and contingent liabilities arising from guarantees represent more than 30 percent of bank holdings of loans and securities. - Capacity to withstand downgrades: - Private sector claims were allocated into credit rating buckets broadly corresponding to Moody’s credit ratings; government domestic debt is single-A by Moody’s, all other credit exposures were rated Baa or below. - Expected loss of the total portfolio was computed using default probabilities associated with Moody’s credit ratings (probabilities constructed using Moody’s historical transition data for the United States (1980–1999); rating qualifiers disregarded). - Stress scenarios explored downgrades of one and two full grades; most banks should be able to cope with a decline of one or two full grades in average credit quality—the expected losses in each scenario were less than the sum of accumulated provisions and collateral pledged by borrowers. - Banks’ ability to weather credit quality declines depends critically on being able to liquidate collateral at a price close to the reported “discounted value.” ### Market risk: key findings and scenarios - Interest rate risk: - Historical interest rate stability in Malta prevented use of historical shocks; interest rate risk was assessed using arbitrary parallel shocks to the yield curve of +/-100, and +300 basis points. - Banks computed effects on pre-tax profits using internal risk systems (repricing gap analysis). - Results: three banks are positioned to profit in the first 12 months from an increase in domestic interest rates; the fourth bank has more than enough capital to absorb an interest rate increase without falling below prudential requirements. - Longer-run note: profits would decline over the longer run absent balance sheet restructuring since holdings of longer-term fixed-rate securities represent more than one third of assets. - Foreign exchange risk: - Exchange rate shocks applied: +/- 10, 20, and 50 percent to the value of the Maltese lira against individual currencies in the basket (euro, pound sterling, and the U.S. dollar). - Prudential limits: net open foreign exchange positions in aggregate are not allowed to exceed 20 percent of bank capital; limits of 5 percent on each individual currency exposure (except the euro with a 14 percent limit, since it represents 70 percent of the currency basket). - All four banks are well positioned to cope with direct effects of exchange rate movements under these scenarios; their small positive net open positions imply profits would decline only if the Maltese lira appreciated against basket currencies. - Capital adequacy ratios for each of the four banks would stay above the eight percent threshold under all scenarios considered. - Equity price risk: - Exposure to unexpected movements in equity prices is manageable, since equities represent less than 30 percent of capital. - Derivatives: - Stress tests incorporate derivative positions used to offset balance sheet exposure. ### International banks - International banks operating in Malta have no significant linkages to the domestic financial system and therefore do not pose systemic risks. - Funding and asset composition: - Rely on funding provided by deposits from foreign banks (notably parents/affiliates) and nonresident deposits obtained in part through parent banking groups. - Assets primarily invested in deposits of foreign banking institutions (often related affiliates), foreign securities, and loans to nonresidents sourced through parents’ global networks. - Per agreement with Maltese authorities, weak loans do not remain on Maltese books but are transferred back to foreign parents. - None of these banks has encountered any difficulties. ### Insurance companies - Sector characteristics: - Insurance sector is very concentrated and indirectly linked to banking. - One local group (Middlesea), affiliated with Bank of Valletta and partly government-owned, dominates the insurance market; its failure would pose systemic risk to the insurance sector. - Direct links between insurance and banking industries are limited; insurance companies’ funding through bank loans is insignificant. - Financial condition: - Insurance sector is profitable and complies with solvency margin requirements, although profitability ratios are declining. - Sector is conservative in provisioning; reinsurance is kept to a reasonable level; provisions have increased gradually. ### Capital markets - CBM as market maker: - CBM functions as market maker in the government securities market, quoting daily bid and offer prices to guarantee liquidity to MGS holders and stimulate trading. - CBM pricing policy seeks to be market-driven and is independent of the monetary operations framework. - Narrow spreads quoted by CBM may have inhibited private participants from becoming market makers. - CBM was encouraged to consider reducing market presence once a system of primary dealers has been implemented. ### Payment and settlement systems - MaRIS system: - MaRIS exhibits no major weaknesses and observes most CPSS core principles. - Number of failed payments has fallen to an acceptable level of less than five per day. - System is relatively new; some procedures not yet in place or tested. - Technical issues to address: relatively high minimum four hours recovery time in case of breakdown; lack of a remote back-up site. - Recommendation: CBM should develop and test contingency plans, especially if system is extended to more members. - Retail payments: - Given Malta’s size, retail payments infrastructure could be better integrated via a single retail system handling several means of payment. - Central System of Securities Settlement (CSS) and CSD: - Operational arrangements for CSS and CSS functions in the MSE are appropriate for market nature/size, but uncertainties exist around role, regulation, and supervision of the CSD. - CSD is integral to MSE, making separation of functions difficult and resulting in no direct supervision of the CSD. - Priorities: ensure CSD has a well-founded legal basis including finality of securities transactions; consider placing CSD in a separate entity; MFSA and CBM should continue close cooperation and establish respective roles through MoUs. - Delivery-versus-payment (DVP): - Authorities should ensure planned steps to introduce DVP in Maltese securities settlement system are implemented as soon as possible. - Current practice: securities transferred on trade day, funds transferred three days later. ### Systemic liquidity and monetary management - CBM liquidity instruments: reserve averaging, foreign exchange operations, repo operations, and marginal lending facility. - Required reserves: - Full averaging allowed over one-month holding period. - Required reserves remunerated at a fixed rate of 2.7 percent, which is below market rates. - Foreign exchange operations and repos: - CBM buys and sells spot foreign exchange in the three basket currencies as needed. - If entire banking system short of liquidity, CBM injects liquidity through weekly auctions of repurchase agreements with government securities. - Marginal lending facility: - Collateralized marginal lending (stand-by) facility can be automatically activated to provide overnight loans if a bank account is overdrawn at end of day or upon banks’ request for up to 12 months. - MaRIS interaction: - MaRIS ensures payments are settled only if enough collateral is pledged to the CBM. - Intra-day lack of funds triggers intra-day loan; if outstanding at day end is accounted as overnight loan and charged a penalty interest rate. - Collateral and market development: - CBM only accepts government bonds as collateral for CBM loans. - Dematerializing treasury bills and introducing the European Master Repurchase Agreement would make them more usable as collateral, make treasury bill market more accessible to foreign investors, and encourage development of an interbank repo market. - Liquidity management in excess liquidity environment: - CBM manages liquidity through weekly auctions of deposits with maturity of two weeks to accommodate entire demand. - CBM’s overnight deposit facility is remunerated below market rates and below required reserves remuneration; typically accessed only on last day of reserve maintenance period. - CBM produces daily liquidity forecasts but focuses on auction days; liquidity forecasting could be improved by including daily/weekly government cash-flow projections produced by the Ministry of Finance (MoF) under a new cash-flow management system. - Lender of last resort (LOLR): - CBM has an explicit mandate to provide liquidity as lender of last resort; can grant collateralized loans to any bank incorporated in Malta against such forms of security as the Board may consider appropriate. - Recommendations to dematerialize treasury bills and strengthen risk controls apply to strengthening the use of the LOLR facility. ### Public debt management - Debt characteristics: - Public debt management practices are not a source of systemic risk. - Debt stock is conservatively managed; most consists of longer-term fixed rate securities denominated in Maltese liri, protecting debt service costs from sharp interest rate or exchange rate fluctuations. - Institutional structure: - Debt management activities are scattered across several agencies (MOF, CBM, Accountant General’s Office) and coordinated by the Public Debt Advisory Committee (PDAC), which includes senior officials from these agencies plus one from the MSE. - Authorities are obtaining technical assistance from the Commonwealth Secretariat to create a debt management office to centralize day-to-day activities and refocus PDAC on strategic issues. - Plans include introducing more formal risk management procedures to monitor and manage financial risks embedded in the debt stock and ensure debt sustainability. - Guarantees and privatization: - Area requiring attention: management of large stock of guarantees; as state enterprises are privatized, associated guarantees should be extinguished or priced appropriately. - Developmental role: - Authorities encouraged to use public debt management to help develop more liquid domestic capital markets over the medium term. ### Supervisory and regulatory framework (banking supervision) - Compliance and governance: - Authorities’ compliance with the Basel Core Principles for Effective Banking Supervision is good. - Structure of MFSA is clearly established but internal governance processes should be more explicit and further developed. - Supervisory Council: - Supervisory Council, represented by Director General and heads of each supervisory arm, is responsible for licensing decisions and for monitoring and supervision of entities licensed by MFSA. - Review identified need for more developed rules of procedure for the Council. - Council must ensure it receives timely and comprehensive information on status of supervised entities, particularly when deteriorating trends or problems are detected, to execute responsibilities and make well-informed decisions. - Governance emphasis: - Supervisor should further emphasize sound governance in the industry by explicitly holding boards accountable for condition and performance of their banks. *Source: _cr03264 - 25. The CBM introduced a quarterly stress testing exercise in 2002 to assess the four (IMF staff report).* ### 45. Supervisory enforcement and corrective action are also key areas requiring ### _cr03264 - 45. Supervisory enforcement and corrective action are also key areas requiring ### Supervisory enforcement and corrective action - The supervisor has historically used “moral suasion” in problem situations; this produced gradual corrective action but involved some delay to elicit response. - Where supervisory response is needed to address poor bank management or to arrest unsafe and unsound activity, the supervisor should ensure that definable actions are taken promptly. - There is no current legal provision requiring the supervisor to take prompt corrective action (PCA) based on certain evolving and existing conditions. - Considerations and recommendations: - Consider developing a PCA provision that requires the supervisor to take gradually increasing remedial action when certain conditions exist. - The supervisor should have some form of written formal agreements or memorandum of understanding in the case of significant problems, not necessarily exclusively based on capital impairment. - An amendment to the Banking Act or other legislation may be necessary to ensure the enforceability of such regulatory directions. - The magnitude of monetary penalties for breaches of regulation may not have the desired impact and the penalty structure should be revisited. ### Risk management, credit classification, and provisioning - Increased emphasis is needed on overall assessment of banks’ internal risk management systems and on methods (accuracy and effectiveness) of risk measurement, monitoring, control and reporting. - Credit risk instructions provided in the Banking Directive 09 are generally adequate, but there is opportunity to strengthen classification and provisioning guidance. - Additional focus needed on collateral valuation and the subsequent credit given to it in classification and provisioning: - Currently full credit is given to collateral values when making loan provisions. - No guidelines or directives address acceptable collateral valuation processes. - Legal impediments to efficient foreclosure and liquidation actions exist. - Without rigorous collateral valuation guidelines and given dependence on collateral to support required loan loss provisions, the accuracy of classifications and loan loss provisions could be potentially questioned. ### Supervisory examination process and documentation - The supervisory process and the examination technique practiced by supervisors are good. - Need to enhance impact, accuracy, and timeliness of examination results through several steps. - Capital adequacy figures reflecting examination classifications and provisioning results should be: - Presented in the reports of examination. - Included in the supervisor’s monitoring systems and documentation. - If material misstatements of financial position have been made by the bank based on examination results, any pertinent violations of law and supervisory actions should be triggered. ### Information sharing and cooperation with foreign supervisors - Appropriate legal provisions exist to allow information sharing and reciprocal cooperative agreements with foreign supervisors; however, no MoUs are yet in place. - The supervisor should continue to pursue communications with foreign supervisors to establish reputation as an effective and transparent regulator and to enhance the reputation of the Maltese banking system. - Efforts to formalize cooperative agreements with pertinent authorities should continue. ### Insurance supervision and regulation - Authorities have made significant progress in creating an effective insurance supervisory framework and comply with most IAIS Core Principles, but some areas need further strengthening. - Specific recommendations: - The MFSA should formalize insurance company corporate governance procedures. - Move to a more formal risk-based approach to supervision. - Develop a consistent approach for exchange of information with foreign insurance supervisory authorities. ### Securities markets supervision and regulation - Observance of IOSCO Objectives and Principles for Securities Regulation is good. - Given recent legislative reform, it is too early to assess enforcement track record under the new regime. - MFSA’s new supervisory and regulatory responsibilities likely place serious strains on MFSA staff resources due to mismatch between number of regulatory subjects and number of staff in the MFSA Investment Services Unit. - Enforcement powers are appropriate and well established in law; established enforcement practices to date seem appropriate. - Statutory capital requirements of stock trading and investment services firms should be risk-adjusted. ### Payment systems - The CBM (competent authority for payment systems) shows strong observance of the CPSS Core Principles for Systemically Important Payments System. - Further work is needed to improve the securities settlement system. - Central Bank of Malta Act: no person should organize, establish, operate, and participate in a domestic payment system unless such system is approved and authorized by the CBM. ### Transparency of monetary and financial policies - The CBM has made significant efforts to improve transparency of monetary policy and observes most practices outlined in the Code of Good Practices for Transparency in Monetary and Financial Policies. - The amended CBM Act (came into effect in October 2002) is in line with EU requirements; it: - Focuses monetary policy on pursuit of price stability. - Reinforces independence of the CBM. - Clarifies CBM’s role in fostering financial stability. - Main shortcomings in transparency: - Lack of clarity in description of objectives and procedures of the CBM’s operations in government securities markets. - Lack of monthly information about the CBM’s off-balance sheet commitments, especially its forward contracts in the foreign exchange market. - Improvements recommended: - Clearly define and publicly disclose both (i) the roles of the MFSA and CBM in regulating and supervising the securities depository and settlement system, and (ii) the arrangements for exchange of information between domestic as well as international supervisory and regulatory authorities. ### Legal framework and judicial system - Malta has a sound and well-established legal system combining civil and common law provisions; respect for rule of law, judiciary, and legal profession is high. - Courts regarded as responsive but delays in resolution of commercial cases are widely regarded as excessive. - Financial sector laws and regulations are comprehensive, well drafted and consistent with international best practices. - Recent reforms (1994–1998 and more recent revamps) bring legislation into line with EU norms and directives and international standards. - Collateral/debt enforcement provisions satisfactory but implementation problematic: - Land registration system appears to work well though significant areas of Malta are still not subject to individual title. - Company register is highly efficient and accessible on-line. - Excessive delays in resolving court cases and enforcing judgments are significant concerns. - Insolvency regime is comprehensive but lacks a corporate restructuring (“Chapter 11”-type) facility; such a change is under consideration. ### Financial stability policy and safety nets - Malta’s banking system has never experienced a systemic crisis. - A contingency plan exists and is being refined; plan prescribes responses based on classification of severity of crisis and requires coordination and exchange of information with the CBM. - Financial Stability Office of the CBM is developing an Early Warning System based on prudential returns of reporting institutions; system includes monitoring of local large borrowers’ financial situation via examination of their financial statements and banking exposures. - No rating agencies operate in Malta. - The Financial Stability Office produces a stability report analyzing banks’ credit risk management issues and trends of nonperforming loans and provisions; analyses are discussed informally with MFSA, with regular contacts and exchange of information in place. - A permanent MOU between the MFSA and CBM, covering coordination in the event of a banking crisis, was signed on February 4, 2003. - Under this MoU, the CBM will be responsible for maintenance of the database comprising statistical and prudential information sent by reporting institutions. - Deposit Guarantee Scheme and Investor Compensation Scheme: - Legislative amendments enabling setting up of the schemes were approved by Parliament in July 2002. - New regulation providing legal basis entered into force January 3, 2003. - Scheme developed along lines of EU standards; under general control of a Management Committee appointed by the MFSA and is a corporate body with distinct legal status. - Apart from special circumstances (winding up by the Court or voluntary winding up), the MFSA has power to trigger activation of the scheme within 21 days from the day that any particular credit institution is unable to meet its obligations arising from claims by its depositors. - Sources of funding for the scheme will include contributions from participants, and other sources. - Participation: - Every credit institution licensed in Malta under the Banking Act shall participate in the scheme, including a branch of a credit institution operating in another country. - Compensation limit: - The total amount of compensation that may be paid out to any depositor shall be the lesser of 90 percent regarding that depositor’s eligible deposits, or up to the Maltese equivalent of EUR 20,000, in line with the EU minimum level of protection. ### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) - Authorities in Malta have long recognized importance of an effective AML/CFT regime and demonstrated strong commitment to fulfilling international obligations. - Legislative framework first enacted in 1994 has been updated and strengthened on several occasions, most notably in 2001/02. - Malta has signed, ratified, and adopted most key international conventions, treaties, and UN Resolutions relevant to AML/CFT and is committed to achieving full compliance. - No major legislative or regulatory gaps identified, though some technical refinements required to achieve full compliance with legal and institutional methodology aspects: - Issue of whether financing of terrorism has been adequately criminalized needs further consideration. - Certain aspects from the Basel Committee’s Customer Due Diligence paper, particularly implementation measures for high-risk customers, need incorporation into regulations or guidance notes as appropriate. - Institutional elements are in place following establishment of the FIAU, which became fully operational in October 2002. - At this early stage, detailed assessment of FIAU effectiveness is not feasible. - The Unit is expected to be in a position during 2003 to satisfy requirements for membership of the Egmont Group of financial intelligence units. - Current level of Suspicious Transaction Reports in Malta appears low by international comparison; creation of the FIAU may increase reporting as awareness rises. - Level of resources available to the FIAU should be kept under review to ensure adequacy for growing demands. - Implementation and supervision: - FIAU is designated competent authority for AML/CFT. - MFSA, as single regulatory authority for banks, securities firms, insurance businesses, and bureaux de change, carries out on-site and off-site supervision incorporating AML/CFT. - Recommendation: Review and increase level of resources and specialist expertise in the area of AML/CFT in the MFSA as necessary to expand program of on-site inspections, particularly for international banks and a sample from the branch network of domestic banks. - High standard of awareness, acceptance, and implementation of AML/CFT provisions observed in a range of regulated institutions. - Law enforcement: - Recommendation: Explicitly introduce, equally for drug and non-drug related investigations, all possible investigative measures on ML/FT in the work of the police. - Consider development of specialist expertise within the Economic Crimes Unit of the police in the areas of CFT and AML analytics. - Note: Assessment of criminal law enforcement measures was conducted by an expert not under the supervision of Fund and Bank staff; portions attributable to him are shown in italicized text in the source. - Nominees and high-risk business: - When reviewing regime for nominees, pay particular attention to risk control in AML/CFT area. - Nominees are regulated by the MFSA and required to apply customer due diligence procedures, but additional measures are recommended for nominee companies’ financial transactions due to high risk and potential reputational implications. - Recommendation: Extend current bank identification requirements to require independent application by regulated financial institutions of full customer identification procedures as applied to customers generally; same recommendation applies to proposed amendments to the trust regime. - Strengthening of regulatory requirements in current draft legislative proposals is welcomed but cannot be assessed in detail since associated regulations have yet to be drafted. ### Financial system overview — the banking sector (selected facts) - The banking sector is the largest segment of Malta’s financial system and dominates insurance and securities industries through subsidiaries and affiliates. - The sector consists of domestic and international components operating independently. - The domestic component is highly concentrated and consists of four banks. - The two largest domestic banks: - Are roughly the same size. - Dominate the sector, representing more than 90 percent of domestic system assets, with similar shares of the deposit and loan markets for residents. - Also dominate insurance and securities industries through subsidiaries and affiliates. - Maltese bank profit margins and operating expenses are broadly comparable to those in the EU. ### Table 3 (selected indicators and notes) - Table header: Malta: Financial System Structure, 1998–2002 - Memorandum item: - Nominal GDP: 1,362 (Dec-98), 1,456 (Dec-99), 1,558 (Dec-00), 1,630 (Dec-01), 1,685 (Dec-02). - Sources: Central Bank of Malta, and Malta Financial Services Authority. - Notes: - 1/ Total assets for December 2002 includes one offshore bank. - 2/ The three insurance companies that are composite have been grouped in the category of their major business. The subtotals of life and non-life companies do not sum up to the total insurance companies. *Source: _cr03264 - 45. Supervisory enforcement and corrective action are also key areas requiring (IMF PDF).* ### 69. The international component consists of 10 international banks and 1 remaining ### _cr03264 - 69. The international component consists of 10 international banks and 1 remaining ### International banks and offshore banking - The international component consists of 10 international banks and 1 remaining offshore bank that deals mainly with nonresidents in foreign currency. - The international banks mainly consist of branches and subsidiaries of Austrian and Turkish banks that have established offices in Malta mainly for tax purposes. - The last offshore bank, Erste Bank, plans to become an onshore international bank in 2003. - Malta marketed its offshore regime between 1988 and 1994, with offshore businesses then given until September 2004 at the latest to either convert to the domestic regulatory standard or cease operations. - Only one bank remains under the offshore regime and will soon convert. - The authorities encourage international financial services business from Malta subject to regulatory requirements equivalent to the domestic market. - Administrative categorization distinguishes “international” banks, not any legal licensing distinction. - Mission recommendation: additional supervisory attention by the MFSA to banks conducting international business, potentially increasing the frequency of on-site inspection work. - On consolidated supervision, the MFSA seeks to maintain close contact with relevant home country regulators (particularly in Austria and Turkey). ### Government involvement and financial intermediation - Government involvement in the banking system has been significantly curtailed: the 70 percent government stake in Mid-Med Bank was sold in 1999 to HSBC, and its stake in Bank of Valletta reduced to 25 percent. - Level of financial intermediation: - M2 exceeds 150 percent of GDP. - Credit extended to the private sector is more than 90 percent of GDP. - Drivers: many years of banking stability and historically significant offshore holdings by Maltese residents. - Some offshore money was repatriated to Malta in 2002 due to a temporary tax amnesty program; wider spreads between Maltese and European interest rates; and weaker international equity markets. - Overall banking system contribution and employment: - The banking system contributes about 6 percent of GDP. - Employs about 2.5 percent of the labor force. ### Offshore nominee companies and trust reform - Of 2,600 offshore nominee companies on the register (from approximately 30,000 total companies registered in Malta), less than 300 remain. - The last of these must cease operations by September 2004. - Nominee companies primarily shield beneficial owners from public identification for tax and other reasons. - Providers of nominee registration service are regulated and subject to AML/CFT provisions under Maltese legislation. - Authorities are considering terminating the overall nominee structure (not just offshore element) and introducing an expanded trust structure; draft legislation for expanded trusts is in final draft and has been seen by the mission. - Draft trust legislation includes provisions dealing with access to identification information in respect of all parties to the trusts for the regulatory and tax authorities and for regulated institutions providing the trusts with financial services. - Risk note: while nominee structures do not have direct financial stability implications, abuse of anonymity could cause reputational damage to Malta. ### Nonbank financial sector - Size and contribution: - The nonbank financial sector is very small in asset terms, but contributes about 3 percent of GDP. - Twenty-one insurers (all onshore) operate in Malta but the sector is highly concentrated on only two of them. - Total insurance sector assets equal to about 15 percent of GDP. - Growth: - Total assets nearly doubled over the past four years with life insurance business providing the main impetus for growth. - Gaps: - Penetration and density ratios are still low compared to EU member countries. - There are no private pension schemes, mortgage institutions, credit unions/cooperatives, or microfinance institutions. ### Capital, money, and foreign exchange markets — structure and activity - Domestic capital market is small; number of investment vehicles is limited; secondary market is thin. - Malta Stock Exchange commenced operation in 1992; share prices rose until 2000 then fell in line with international developments. - Corporate bond issuance has been low, but picked up in 2002. - Central Bank of Malta (CBM) acts as market maker for government securities; operates only on the buy-side due to virtually no government securities in its portfolio. - Government bonds historically important savings vehicle in absence of private pensions and in view of one pillar Pay-as-You-Go system. - Money market characteristics: - Trading activity in Maltese lira money market is very low due to excess liquidity in banking system and small number of banks. - Money market consists of an unsecured cash market and a treasury bill market. - Treasury bills are almost all held by banks, are not dematerialized, and trading is on an unregulated over-the-counter basis. - Very few interbank transactions occur; interbank interest rates (mostly one-week tenor) align closely with central bank rates. - No interbank repo markets, commercial paper, or certificates of deposit. ### Market statistics (1998–2002) - Interbank money market - Turnover (Liri millions): 955, 955, 301, 208, 98 - Turnover to GDP (in percent): 70.1, 65.6, 19.3, 12.7, 5.8 - T-bill market - Turnover (Liri millions): 344, 287, 74, 154, 124 - Turnover to GDP (in percent): 25.3, 19.7, 4.7, 9.4, 7.4 - Government bonds - Turnover (Liri millions): 109, 48, 53, 125, 41 - Turnover to GDP (in percent): 8.0, 3.3, 3.4, 7.7, 2.4 - Turnover to capitalization (in percent): 17.2, 6.8, 8.1, 15.4, 5.0 - Equities - Market capitalization (Liri millions): 296, 790, 882, 610, 552 - Market capitalization to GDP (in percent): 21.8, 54.3, 56.5, 37.4, 32.8 - Turnover to market capitalization (in percent): (blank for 1998), 7.2, 17.4, 9.2, 3.4, 3.8 - Corporate bonds - Market capitalization (Liri millions): 27, 41, 106, 108, 159 - Market capitalization to GDP (in percent): 1.9, 2.8, 6.8, 6.6, 9.4 - Turnover to market capitalization (in percent): (blank for 1998), 5.8, 5.1, 4.2, 13.9, 6.5 - Foreign exchange - Turnover (Liri millions): 1,783, 2,504, 2,499, 2,393, 2,811 - Turnover to GDP (in percent): 130.9, 172.0, 160.0, 146.8, 166.8 - The foreign exchange market was the most active financial market with turnover of over 167 percent of GDP in 2002, though low compared to other EU accession countries. - Market thinness drivers: strong seasonality, banks often on same side of market, exporters and importers use foreign currency accounts. ### Public debt management - Direct public debt: 64 percent of GDP in December 2002. - Government-guaranteed debt: an additional 22 percent of GDP. - Debt composition: - Most debt denominated in Maltese liri; Malta has not issued foreign currency denominated securities. - Some 75 percent of the direct debt consists of fixed-rate bonds with maturities ranging up to 20 years. - Only 26 percent of bonds and treasury bills outstanding mature in one year or less. - Guarantees mainly to domestic banks covering loans to government agencies and state-owned enterprises. - Holdings: - Banks hold most treasury bills (73 percent). - Most bonds are held by nonbank financial institutions and the general public (52 percent). ### Payment, settlement infrastructure, and supervision - Payment systems: - In August 2002, the CBM introduced RTGS system (MaRIS) handling large-value interbank and customer transactions; operated and supervised by the CBM. - Amendments to the CBM Act gave CBM legal powers for regulating and overseeing all payments systems in Malta. - Four deposit money banks and the CBM participate in MaRIS, which handles a daily average of 140 transactions for a value of Lm 50 million. - Retail payments: - Relatively fragmented; checks widely used. - The only retail payment system is the CBM-operated Malta Clearing House (clearing checks and money orders). - Securities settlement: - Highly integrated: MSE provides trading and clearing of securities and owns and operates the central securities depository. - All securities except treasury bills and collective investment schemes (CIS) are dematerialized. ### Supervisory framework and standards observance - Banking supervision: - Substantial progress since 1970; legislative framework in substantial compliance with EU directives and international standards. - Supervisors practice risk-based supervision with on- and off-site supervision and targeted on-site examinations. - Staffing adequate; staff generally qualified with emphasis on training and international best practice. - Areas noted for improvement: - Strengthen remedial action and enforcement aspects of supervision. - Strengthen MFSA’s process of assessing collateral values for asset classification and provisioning (given importance of real estate as collateral). - Enhance emphasis on sound corporate governance and build on technical analysis to draw more informed conclusions about risk, performance, and board and management oversight and systems. - Insurance supervision: - Process initiated in 1994; comprehensive prudential rules and regulations introduced in 2000. - MFSA has inspected all insurance companies and intermediaries at least once since 2001. - MFSA handles licensing, mergers, and bankruptcy proceedings. - Areas for further improvement: - Improve supervision of insurance company internal controls and investment policies. - Formalize MFSA supervision of insurance company corporate governance procedures. - Move to a more formal risk-based approach. - Establish formal arrangements for exchange of information with foreign insurers’ home supervisors. - Securities regulation: - October 2002 amendments created a single competent regulatory authority (MFSA) for the entire capital market; MSE retains status as a Recognized Investment Exchange (RIE). - All regulatory powers placed with the MFSA. - Need to clarify legal framework for Central Securities Depository (CSD) and Clearing and Settlement of Securities (CSS) functions within the MSE. - Payment systems oversight weaknesses identified: - Relatively long recovery time. - Lack of a remote backup site. - Incomplete and untested contingency plan. - Transparency and AML/CFT: - Recommendation to disclose more frequently the CBM’s off-balance-sheet commitments. - AML/CFT: need to specifically criminalize financing of terrorism and provide additional resources and expertise. *Source: IMF staff report content (appendix material provided).* ### 88. The setting and circumstances in which the banking sector operates are generally ### _cr03264 - 88. The setting and circumstances in which the banking sector operates are generally ### Banking sector setting and supervisory framework - The setting and circumstances in which the banking sector operates are generally satisfactory. - Legislative framework for banking law and the powers provided to the MFSA to set implementing regulation are adequate, although certain issues require strengthening (see below). - The legislative framework surrounding collateral and loan recovery requires strengthening; the foreclosure process can be lengthy and costly given inefficiencies in the legal system. - Approximately 75 percent of the collateral held by banks is in the form of real estate. - The financial and enterprise sectors are required to use International Accounting Standards (IAS). - Banks are audited according to international standards by recognized international auditing firms; the MFSA has full access to auditors’ reports and to the auditors themselves. - A contingency plan exists to coordinate authorities’ action in the event of a crisis. - An MoU was signed in February 2003 providing for information sharing on an ongoing basis between regulatory bodies. - A regulation approving the creation of a deposit insurance scheme came into force January 3, 2003; the scheme is being developed along the lines of EU standards. ### Main findings on banking supervision (Basel Core Principles) - The MFSA’s compliance with the Basel Core Principles for Effective Banking Supervision is generally good. - Progress of banking supervision has been commendable since the start of the regulatory process in 1970. - Supervisory effort is well supported by qualified and experienced staff who oversee the banking sector through comprehensive on- and off-site processes. - Identified enhancements: - Strengthen emphasis on sound corporate governance (internally for MFSA and externally for bank boards and management). - Improve identification and conclusions about risk levels, risk management, and board and management oversight. - Strengthen remedial action and enforcement aspects of supervision. - Develop additional intermediate tools to facilitate timely remedial supervisory action. ### Detailed observations by principle (selected CPs) - Objectives, autonomy, powers, and resources (CP 1) - MFSA enjoys relative legislative and operational independence; MoF remains responsible for some subsidiary legislation, penalties, and dispute processes. - Recommendation: MFSA should assume complete responsibility for all relevant aspects of the supervision structure. - Bank licensing and structure (CPs 2–5) - Banking legislation provides MFSA full powers to license institutions and reject applications not meeting standards. - Legal Notice 155 provides authority to assess penalties for misuse of the word “bank”; the penalty magnitude is considered minimal. - Prudential regulations and requirements (CPs 6–15) - Adequate prudential framework and guidelines exist covering capital adequacy, credit policies, large exposures, market and other risks, internal control and audit, and anti-money laundering. - Observations: - Definition of related or connected parties in banking legislation is not all-encompassing; it does not include executive management, significant shareholders, and auditors and related interests. - Guidelines for credit risk management are generally adequate but can be further strengthened. - An updated regulation should emphasize proper reflection of fair value in financial reporting via accurate asset classification, timely loan loss provisioning, and well-supported collateral valuation. - Loan loss provisions are not tax deductible. - Board governance and management oversight review should be elevated through evaluation of risk management processes, internal control adequacy, and audit processes. - Methods of ongoing supervision (CPs 16–20) - Supervisors practice risk-based supervision; validation via off-site review, on-site evaluation, and external audit. - Supervisor has authority for consolidated supervision and frequent communication with bank management. - Areas for strengthening: more formal examination procedures, regular communication with bank boards, frequency of on-site examinations, and MFSA’s role in identifying and monitoring systemic risk with CBM. - Information requirements (CP 21) - Framework for regulatory reporting, external audit, and financial statement disclosure is in place; Banking Act requires accuracy and truthfulness of submitted information. - Verification relies on on-site examinations and external/internal audit. - Enforcement provisions (including penalties for inaccurate financial statements) have not been frequently required; supervisor should establish and use tests of materiality and substance to determine remedial actions. - Formal powers of the supervisor (CP 22) - Legal framework for enforcement powers is relatively broad, ranging from moral suasion to penalties and license restriction. - No intermediate tool exists between monetary penalties and license restrictions; supervisor could expand and strengthen corrective actions. - Cross-border banking (CPs 23–25) - Legal framework authorizes cross-border supervision and consolidated supervision and exchange of supervisory information. - Domestic banks currently have no international operations. - MFSA has authority to enter cooperative agreements with foreign supervisors but has not yet negotiated any MoUs. ### Recommended actions (summary of Table 5) - Remedial Action and Enforcement - Develop an internal corrective action policy. - Present examination reports to bank boards and require oversight of the bank’s response. - Recalculate provisions, earnings, and capital positions based on examination results; take corrective actions if warranted. - Develop prompt corrective actions provisions tied to capital thresholds. - Consider formal written agreements or MoUs with banks in cases of significant and/or ongoing deficiencies. - Legal Framework for Banking Supervision - Enhance remedial action framework; evaluate fuller set of intermediate measures. - Loan Evaluation and Loan Loss Provisioning - Establish guidelines for collateral valuation; require banks to reflect well-supported valuations. - Tighten guidelines for writing off assets. - Include off-balance sheet assets in classification and provisioning. - Include provisions for upgrading classified assets, placing credits back on accruing status, and rebooking charged off assets. - Credit, Country, Market and Other Risks - Draw higher-level conclusions about overall risk levels and oversight. - Consider a supervisory directive consolidating risk management roles and board responsibilities. - Prepare examination procedures for analyzing various risks. - Have supervisor or independent body set required levels of loss provisioning related to country risk. - Provide additional training in market risk. - Internal Control and Audit - Further evaluate adequacy of board governance via assessment of internal control and audit processes. - Accounting Standards - Take remedial actions based on examination results, particularly for identified material financial misstatements. - Consider material misstatements of financial position as violations of law. - Capital Adequacy - Recalculate loan loss provisions and capital adequacy based on examination results; take supervisory action based on adjusted figures, as warranted. - On-Site and Off-Site Supervision - Develop annual risk rating reports drawing conclusions on supervisory activities and risk analyses. - Develop supervisory strategies and procedures for each bank; evaluate frequency of on-site events. - Ensure adequate supervisory attention to the international banking sector. - Enhance MFSA’s role in monitoring and concluding on systemic risk. - Money Laundering - Require banks to establish a policy statement on staff ethics and professional behavior. - Introduce administrative penalties for banks failing to comply with MFSA money laundering guidelines. - Connected Lending - Implement the recently revised legislative definition of and restrictions on connected parties. - Objectives, Autonomy, Powers, and Resources - Establish “Rules of procedure” for Supervisory Council oversight role and process. - Establish signature authority for bank examination reports and other correspondence. - Operational Independence and Adequate Resources - Review penalty structure and amend to create meaningful penalties. - Bank Management Contact - Conduct periodic meetings with bank boards to reinforce responsibilities and accountabilities. - Host Country Supervision - Include existing banking directive in explicit legal provision prohibiting banks or affiliates from establishing operations in countries with secrecy laws or that prohibit flows of information necessary for supervision. - Supervision Over Foreign Banks’ Establishment - Continue efforts to negotiate and sign MoUs with countries whose banking institutions have a presence in Malta. - Devote additional supervisory attention to international banking groups, as warranted. ### Authorities’ response (banking) - Authorities took note of Recommended Actions; most recommended actions have already been implemented. - Other actions will be implemented in line with adoption of appropriate EU Directives and/or IASs, or following approval of amendments to the legislation. - Regarding CP 10: widening of the definition of connected parties is being discussed with the Bankers’ Association and should be issued as a banking directive within the next three months. - Regarding CP 15 (Money Laundering): all banks in Malta already have a code of ethics and professional behavior; the Banking Act provides for administrative penalties (Article 35) for non-compliance with guidance notes. - Authorities agree that recommendations relating to on-site and off-site supervision would enhance present methodologies, which already meet Basel Methodology criteria. - Legal framework for remedial measures is in place; timely corrective action has always been taken in the interest of depositors and the financial system. Malta has never experienced a banking crisis or a single bank failure. Authorities will give due consideration to mission recommendations. ### Insurance sector: institutional setting and main findings (IAIS Core Principles) - Key legal changes and dates: - Insurance Act of 1998 and amendments came into force October 1, 2002. - Insurance intermediaries’ activities regulated by Insurance Act and the Insurance Brokers and Other Intermediaries Act, 1998. - MFSA Act amendments entered into force October 1, 2002. - Sector composition: - Five local insurance companies, fourteen foreign insurance companies, and one affiliated insurer. - Recognized Insurance Body: group of insurance syndicates from the U.K., Lloyd’s. - Thirteen companies conduct only non-life business, two concentrate on life insurance, and three offer both. - The only state-owned insurer conducts export credit insurance business. - One “Insurance Manager” administers a captive insurer writing exclusively for its parent company. - Four foreign “Mutual Associations” have permits to conduct insurance business. - Registration of offshore activities in Malta ceased in January 1997; no offshore insurance companies remain. - Size and concentration: - Total assets stood at 15 percent to GDP at end-2001; nearly double that of 1997. - Penetration ratio (gross premium as percentage of GDP) at end-2001 was 4.6 percent (compared to 17 percent in Italy). - Density ratio (market premium income per capita) was US$100 (compared to US$1,085 in Italy). - The two largest local life insurance companies receive approximately 90 percent of gross premiums. - The two largest non-life insurers receive nearly 45 percent. - Preconditions and supervisory tools: - MFSA issued Insurance Directives and Insurance Intermediaries Directives in 1999; regularly revised. - In 2000, prudential rules issued on solvency margins, assets valuation, determination of liability rules, and equalization reserves. - Insurance legislation updated in 2002 to align with international commitments and other financial services amendments. - Main findings: - MFSA observes most IAIS Core Principles but further efforts needed to strengthen supervision of internal controls, investment policies, and corporate governance. - MFSA responsibilities include licensing, refusing or revoking licenses, approving mergers/splits, initiating bankruptcy proceedings, and ongoing supervision of insurers, reinsurers, and intermediaries. - Insurance Business Unit of MFSA comprises 12 staff; staff meet high professional standards and are protected against legal prosecution for actions taken as part of their duties by legislation. - Licensing requires fit and proper directors/managers and adequate accounting and control systems; Insurance Act includes detailed provisions on changes in ownership and qualifying shareholdings. *Source: _cr03264 - 88. The setting and circumstances in which the banking sector operates are generally* ### 114. The MFSA’s role in supervising internal controls of insurance companies needs to be ### _cr03264 - 114. The MFSA’s role in supervising internal controls of insurance companies needs to be ### Corporate governance and internal controls (insurance supervision) - The MFSA places great emphasis on corporate governance but a guideline or directive in that area is lacking. - During on-site inspections, the MFSA scrutinizes in great detail board minutes and investment committee minutes. - The MFSA indicated that it will establish corporate governance rules for all financial services license holders, including insurance license holders. - The MFSA is committed to ensure that insurers have appropriate internal controls in place. - Steps have already been taken to amend the on-site inspection program to assess systems of internal controls, which insurers have in place. - Inspection reports will include summaries of the conclusions of the review of these controls. - Recommended actions (from Table 6): - Ensure that insurers have internal controls in place, which are of a nature and scope appropriate to the type and scale of their business. - Issue more detailed guidance to the insurance companies and groups on how internal controls should be arranged and implemented. - Require insurers to have an ongoing internal audit function of a nature and scope appropriate to the type and scale of the business. - Ensure that the internal audit function has unfettered access to all the business lines and support departments, is independent, has sufficient resources and staff, and employs a risk-based methodology. - Amend the on-site inspection program to state more precisely the work that has to be done by inspectors/supervisors with regard to the review of internal controls. - Include summaries of the conclusions in the inspection reports. ### Prudential rules (CPs 6–10) - Legislation and regulations set out some asset management standards for insurers. - These need to be extended, in particular with regard to investment risk management policies and systems, and more effectively supervised. - The minimum solvency margins do not yet fully depend on the size, complexity, and the business risks of the insurance company. - The minimum solvency margin shortcoming "has not been an issue in Malta due to only one insurance group operating in Malta and the smallness and simplicity of the Maltese insurance market." - Local insurance companies only make sporadic use of derivative and off-balance sheet instruments. - The MFSA should introduce requirements to establish adequate risk management and internal controls for derivative positions, and review them regularly as part of the on-site and off-site supervisory exercise. - The MFSA will review the investment policy guidelines even though it points out that insurers in Malta do not trade in derivatives and the Insurance Business (Company Assets and Liabilities) Regulations, 2000 already contain detailed valuation rules. - Recommended actions (from Table 6): - Require insurers to put in place comprehensive investment risk management policies and systems for derivatives. - Ascertain the effectiveness of on-site inspection of assets and their valuation through formalizing the inspection procedures and their documentation. - Revise minimum solvency margins to depend more fully on the size, complexity, and the business risks of the insurance company. ### Market conduct (CP 11) - The MFSA has an extensive inspection program on market conduct. - The MFSA has a very well organized separate business unit that deals uniquely with complaints. ### Monitoring, inspections, and sanctions (CPs 12–14) - The MFSA is currently revising the financial reporting systems for off-site supervision. - Insurance companies are required to submit their audited financial statements to the MFSA not later than six months following the end of the financial year. - Many license holders are also required to submit detailed monthly or quarterly management accounts. - The data are not yet stored in a database that could complement the on-site inspection system. - The MFSA intends to conduct visits to all license holders on an annual basis and has visited all insurance companies and intermediaries at least once since the beginning of 2001. - On-site visits are usually conducted on a priority basis depending upon the perceived risk areas. - The MFSA has the power to take remedial actions where problems involving licensed companies are identified. - The MFSA is in the process of finalizing the revision of the detailed business forms complementing the financial reporting statements, which form part of the off-site reporting system. - The MFSA pointed out that it already adopts a risk-based on-site compliance system; however, it will study what steps are necessary to further improve on-site inspection programs in this regard. - Steps have already been taken to allocate more resources for on-site inspections by employing a new inspector and dedicating more resources of the insurance unit for on-site inspections. - Recommended actions (from Table 6): - Finalize the revision of the detailed business forms complementing the financial reporting statements, which form part of the off-site reporting system. - Move to risk-based on-site inspections. ### Cross-border operations, supervisory coordination and cooperation, and confidentiality (CPs 15–17) - The MFSA cooperates closely with most foreign supervisors. - In the case of foreign insurers and reinsurers coming from jurisdictions with a supervisory regime acceptable internationally, the MFSA relies largely on the supervision carried out by the home supervisor. - Even though the MFSA exchanges information with foreign insurers’ home supervisors, the information exchange is not formalized and the frequency and scope varies across countries. - The MFSA deals with all documents and other information in its possession or under its control, or otherwise coming to its notice, concerning authorized companies and enrolled persons, as secret and confidential. - These obligations extend to the members of the Board of Governors and the Supervisory Council and to all officers and staff of the MFSA. - Moreover, the MFSA, its officials, and its agents are bound by the provisions of the Professional Secrecy Act. - Recommended actions (from Table 6): - Widen the exchange of information agreements with all home supervisors of foreign insurers, and regularly exchange information. - In case of Malta’s EU accession, separate agreements with EU countries are not needed, but focus instead on signing MOUs with those non-EU foreign counterparties where the cross-border exposure is most significant. - Develop instruments to assess and ensure the solvency of foreign insurance companies. ### MaRIS and CPSS Core Principles (payment systems) - The assessment of the Malta Real-Time Interbank Settlement System (MaRIS) against the Core Principles for Systemically Important Payment Systems (CPSIPS) was done as part of the Financial Sector Assessment Program. - In August 2002, the CBM introduced a sophisticated RTGS system (MaRIS) that handles large-value interbank and customer transactions and is operated and supervised by the CBM. - MaRIS handles a daily average 140 transactions for a value of Lm 50 million. - MaRIS is a SWIFT-based system with fully automated transactions processing and a queuing facility that collects payment instructions waiting availability of funds and allows participants to send payments to the system outside the opening hours. - Normally, MaRIS is open for transactions from 8:00 a.m. until 2:30 p.m.; however, for customer payments, the closing time is 1:30 p.m. - The CBM may provide intra-day credit against adequate security to banks and financial institutions in Malta. - The MaRIS system exhibits no major weaknesses and most of the CPSS core principles are observed. - Three areas for improvement identified: - The recovery time is relatively long—at least four hours—in case of a system breakdown and at the moment there is no remote back-up site. - The CBM should aim to complete the draft contingency plan and test it. - The CBM should publicly disclose the access criteria for participants to MaRIS. - MaRIS operational details: - A settlement is deemed final when the participant’s account is credited on same day of value. - A payment instruction is deemed to be unconditional and irrevocable at the moment when the sending participant’s account is debited in the CBM Settlement Accounting System. - The MaRIS Operating Rules is the key document, signed by all participants, specifying responsibilities, general rules and procedures. - The MaRIS Operating Rules refer to the extension of the business day under abnormal circumstances but lack clear decision and notification procedures; a draft contingency plan is being discussed. - The MaRIS Operating Rules do not have procedures regarding the pledging of the collateral on the settlement accounts held with the CBM; consequently, such procedures fall within those established by the CBM. - Security and operational reliability (CP VII): - Recovery time for the primary computer based system is a minimum of 4 hours. - Participants’ system recovery could spill over to the next day. - There is no remote back-up site. - Contingency plans are still in draft form and have not yet been tested. - Efficiency (CP VIII): - Annual membership fees and transactions fees should cover the operational costs. - Fees are based on estimated costs for the next five years and are adjustable annually. - The day-to-day volume is very low compared to the capacity of the system, which should be able to handle at least 15 transactions in one minute. - Criteria for participation (CP IX): - Membership for banks is automatic when they have a settlement account with the CBM and are a SWIFT member. - For financial institutions, membership would depend on the CBM’s decision to establish settlement accounts for them. - There are directives that address minimum capital requirements for credit and financial institutions, but no provisions for capital ratios for other potential participants. - Risk rating, minimum payment volumes, or other quantifiable criteria are not utilized for considering access to participants. - Present access rules could be publicly disclosed; there are no detailed exit rules. - Governance (CP X): - Governance arrangements appear effective, accountable, and transparent; strategic objectives and plans, reporting lines, control, oversight and risk management responsibilities are still being formulated. - At least once a year, financial accounts of the system will be approved by the Association of Participants and distributed to all participants. - A self-assessment will be carried out every two years to assess compliance with the core principles. - Central Bank responsibilities: - The CBM is still in the process of formulating and organizing its role and policy objectives with respect to payment systems. - Policies and responsibilities are not publicly disclosed, except for enabling legislation and legislation on consumer protection and prevention of money laundering. - The CBM has undertaken a first self-assessment of compliance with the core principles in respect of MaRIS and plans to develop and initiate an appropriate work plan. - Recommended actions for MaRIS (from Table 7): - Reduce the recovery time from currently minimum four hours. - Consider the possibility of creating a distant backup site. - Finalize and test contingency plans. - Complete the contingency plan and consider the information needs of potential new participants. - Formulate explicitly the participation rules for financial institutions and eventually other participants. - Disclose publicly access and exit rules. - Implement the drawn-up governance arrangements for the new MaRIS as planned. - Make the pricing policy publicly available, such as on the CBM web site. - Address oversight and supervision in a Memorandum of Understanding between the CBM and the MFSA. - Define and publicly disclose role and policy regarding oversight. *Source: IMF staff report text provided in the content unit.* ### 142. The issuance of the Financial Market Act, which became effective in October 2002, ### _cr03264 - 142. The issuance of the Financial Market Act, which became effective in October 2002, ### Financial Market Act and Regulatory Reorganization - The issuance of the Financial Market Act, effective in October 2002, removed all regulatory functions from the MSE, changing its status to a Recognized Investment Exchange (RIE) that is licensed, regulated, and supervised by the MFSA. - The MFSA has assumed regulatory authority for stockbrokers, RIEs, listed entities, and market conduct. - Principal objectives of the new legislation include: - (i) to remove exclusivity of the MSE as the marketplace for trading of securities in Malta; - (ii) to rationalize licensing, investigation, and sanctioning; - (iii) to merge the jurisdictions of the MSE Tribunal and the Financial Services Tribunal; - (iv) to provide a clearly defined right of appeal to an independent and impartial tribunal. - Relevant regulations regarding listing authorizations, related processes, and actual listings by the RIEs are being drafted by the MFSA. ### Domestic Capital Market Structure and Key Statistics - Market capitalization of outstanding securities at June 2002 totaled Lm 1,565 million (92 percent of GDP). - Composition of market capitalization: - Government bonds: just over half of Lm 1,565 million. - Equities: 13 equities; 39 percent of market capitalization. - Corporate bonds: 16 corporate bonds; 7 percent of market capitalization. - Other market characteristics: - No securitized instruments or derivative products traded. - MSE lists collective investment schemes (CISs), but these are not traded on the exchange. - Market is small and turnover is very low. - Market intermediaries: 19 stockbrokers and stock brokerage houses. - MSE by-laws prohibit trading on their own account; consequently, there are no dealers or market makers on the MSE. ### Mutual Funds and Collective Investment Schemes (CIS) - Mutual fund business composition: - 57 locally based schemes and 300 foreign-based schemes. - Of the 50 CISs with a primary listing on the MSE, about two-thirds are managed by a fund manager directly associated with a bank. - Fourteen CISs are denominated in Maltese lira. - Locally managed CISs control approximately 10 percent of the total market capitalization of the MSE. - Historical net asset values and listings: - Primary listed CISs increased from 12 to 50 between 1998 and 2002. - Net asset value of such schemes increased from Lm 138 million to Lm 218 million between 1998 and 2002. - The Lm 218 million figure represents a sharp decline from end-2000 figure of Lm 331 million. - Legal framework: - Licensing framework for CISs established in 1994 under the Investment Services Act. ### General Preconditions and EU Alignment - Maltese market regulations are being adapted to EU Directives as part of the proposed EU accession process. - Adopted regulatory policy has adopted European standards; barriers to entry and exit largely abolished. - For central securities depository (CSD) and central securities settlement (CSS) functions, there is a need to clarify any entry barriers. ### Main Findings — Observance and Institutional Capacities - Observance of IOSCO Objectives and Principles for Securities Regulation is good, but too early to assess enforcement track record under the October 2002 reforms. - Regulator (Principles 1–5): - MFSA responsibilities and objectives are clearly stated in the MFSA Act. - MFSA is operationally independent; appointment/removal process for Board of Governors is clearly stipulated. - Serious uncertainties surround regulation and supervision of CSD and CSS functions and related institutional arrangements, including the role of the CBM — a significant weakness. - Self-regulatory organizations (Principles 6–7): - There are no functioning or stipulated self-regulatory organizations in the Maltese capital market. - Enforcement (Principles 8–10): - MFSA has comprehensive inspection, investigation, and enforcement powers and may adopt administrative and other measures against license holders. - Remedial action by license holders is required within set time frames to rectify breaches, including financial resources requirements. - MFSA conducts both on-site and off-site monitoring and compliance testing; an on-going compliance-testing program is in place. - No procedures yet established regarding surveillance, enforcement, and compliance of RIE’s and their operations under the Financial Markets Act. - Cooperation (Principles 11–13): - Amended financial sector legislation facilitates exchange of information with foreign and local authorities. - MFSA can assist foreign authorities in regulatory concerns and criminal matters; MFSA contacts foreign counterparts as part of due diligence. - MFSA is expanding MoUs or similar agreements with foreign regulators to facilitate timely two-way communication. - Issuers (Principles 14–16): - Listed companies must provide the Exchange with information “likely to materially affect the price of its securities.” - Listing requirements and semi-annual reports, in line with IAS standards, enable investor assessment. - The six months lag allowed for issuance of audited annual accounts is long by international standards. - Company Act and MSE by-laws provide minority protection; by-laws require disclosure of shareholding above a five percent interest and prohibit trading by directors in some instances. - Collective Investment Schemes (Principles 17–20): - Legislation and regulation for CIS is well developed: terms of entry, legal form, segregation and protection of client assets, disclosure, and asset valuation/pricing. - Scope for enhancement: regulate potential conflicts of interest of fund operators (e.g., use of affiliated brokers or soft commissions) and explicitly define minimum “fit and proper” standards. - Market Intermediaries (Principles 21–24): - Standard license conditions and Investment Services Guidelines underpin supervision. - Investment services license holders required to satisfy minimum financial resources requirements for net tangible assets and liquid capital pre- and post-licensing. - No risk-related ongoing capital requirements; guidance on risk management may not be sufficiently detailed. - No failure of market intermediaries since 1994; MFSA procedures for dealing with failures have not been tested and more detailed principles/procedures should be established. - Secondary Market (Principles 25–30): - MSE is the only authorized exchange though legislation contemplates multiple exchanges; such exchanges require MFSA approval. - New regulations for RIEs under the Financial Markets Act were issued beginning of 2003. - Under new legislation: - RIE must report any suspicion of insider dealing or market abuse to the MFSA. - MFSA has authority to appoint an inspector to investigate suspected insider dealing and market abuse and report results to the RIE. - MFSA must report any insider trading and market abuse to the Commissioner of the Police. - Currently market surveillance is undertaken by the MSE’s Compliance Office. - Implementation details of MFSA’s role as competent authority are still under consideration. - Practices related to supervision of RIEs, and related CSD and CSS functions, listed entities and market conduct are being established. - Present operational arrangements for CSD and CSS within the MSE appear largely appropriate for the market’s current nature and size, but legal foundations for institutional arrangements, regulation/supervision, and dematerialization are not sufficiently solid. ### Recommended Actions and Authorities’ Response (Selected) - Mission recommendations to strengthen securities regulation and achieve full observance with IOSCO Principles are listed in Table 8; authorities committed to transition and have taken steps including: - Plans to segregate the CSD from the MSE and establish a clearer legal and regulatory framework for the CSD; oversight of securities settlement is being discussed with the CBM. - MoU between MFSA and CBM signed on February 4, 2003, refers to the broad CBM responsibility for oversight of securities settlement; a more specific MoU is being finalized. - Regulations issued in January 2003 to define standards to which the MSE must adhere as a Recognized Investment Exchange. - Notification directives issued effective April 7, 2003. - Financial resources and reporting rules for investment services license holders in line with the EU Capital Adequacy Directive have been drafted and are scheduled for adoption in 2004. - Key recommended actions summarized from Table 8: - Clarify regulation and supervision of CSD and CSS functions and related institutional arrangements; spell out MFSA’s and MSE’s applied procedures and reporting lines. - Expand MFSA’s MoUs with foreign regulators for timely two-way communication. - Reconsider exceptions to the half-yearly disclosure requirement; reduce the six months lag for audited annual accounts. - No action required for Principles for Collective Investment Schemes (per table). - Implement the EU Capital Adequacy Directive requirements; review solvency arrangements of market structure including MSE and its CSD and CSS functions. - Issue guidelines emphasizing risk management and business continuity for CSD and CSS functions. - Establish detailed principles and procedures for dealing with a market intermediary failure. - Finalize issuance of detailed directives for RIEs under the Financial Markets Act. - Issue specific legislation for dematerialization of securities and for institutional infrastructure and regulation/supervision of CSD and CSS functions. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 171. The oversight function is still in the process of being established, but amendments to ### _cr03264 - 171. The oversight function is still in the process of being established, but amendments to ### Payment Systems Oversight — status and summary of main findings - The oversight function is still being formulated and established within the CBM; amendments to the CBM Act entered into force October 1, 2002, providing the CBM with authority to oversee and regulate the payment systems. - In August 2002, the CBM introduced a RTGS system (MaRIS) which handles large-value interbank and customer transactions and is operated and supervised by the CBM. - Participants in MaRIS: the four deposit money banks and the CBM. - MaRIS handles an average daily 140 transactions with a value of Lm 50 million. - The oversight function is integral to the CBM; many transparency practices therefore follow from general CBM policies as described in the monetary policy transparency section. ### Clarity of roles, responsibilities and objectives (CBM) - Amendments to the CBM Act give CBM legal powers to regulate and oversee all payment systems in Malta. - The CBM has not yet fully explained and described to the public its objectives and role in payment system oversight. - The CBM has begun to post some information regarding the payment system on its web site and routinely reports on payment system operations in its Annual Report. - No clearly established public relationship between the CBM and the MFSA with regard to payment systems oversight and securities settlement, except for a general MoU between both institutions which has not yet been publicly disclosed. ### Open process for formulating and reporting payment system oversight policies - Role of CBM in oversight, including policy principles, reporting requirements, operating procedures, and confidentiality guidelines, has yet to be established, but the regulatory framework is in place. - CBM intends to make its operating procedures publicly available, and announce and explain changes in its policy. - CBM has introduced a procedure for consulting with participants on technical and regulative changes regarding MaRIS. - Existing directives have recently been posted on the CBM website. ### Public availability of information on payment system oversight policies - The CBM Annual Report contains a section on payment systems operations and the CBM posts some information about the payment system on its website. - The CBM provides aggregate data to the ECB Blue Book on payment and securities settlement systems in accession countries. - A more detailed account on MaRIS and the CBM’s oversight role is not yet available. ### Accountability and assurances of integrity (CBM) - CBM uses a range of transparency practices regarding accountability and assurance of integrity, but does not provide detailed information on its expenses and revenues, including those for operating and overseeing MaRIS. - As required by the CBM Act, the Governor appears regularly before parliament and a parliamentary committee to answer questions on overall performance, operations, and financial statements. - In its Annual Report, the CBM publishes its detailed audited annual accounts based on the International Accounting Standards. ### Recommended actions (payment systems oversight) — mission recommendations (Table 10) - Clarity of Roles, Responsibilities and Objectives for Payment Systems Oversight: - Complete the process of establishing a payment systems oversight function within the CBM. Formulate policies and objectives for oversight and convey these to the public. - Open Process for Formulating and Reporting on Payment Systems Oversight Policies: - Discuss with participants and other interested parties the scope, aim, methods and reporting associated with payment systems oversight. - Define the relationship between payment system oversight and securities settlement in an MoU between the CBM and the MFSA. - Public Availability of Information on Payment Systems Oversight: - Provide a detailed account of oversight policies and operating procedures once these are established. - Accountability and Assurances of Integrity by the CBM: - Disclose costs incurred in operating and overseeing the payment system. - Consider assistance from the internal auditors in the payment systems oversight function. - Authorities are committed to swiftly implement most recommended actions once the oversight function becomes more firmly established. --- ### Financial sector institutional and market structure — summary of main findings - With amended legislation entering into force in October 2002, the MFSA assumed responsibility for supervising and regulating the banking, insurance, and securities sectors. - The revision of laws and directives has incorporated EU requirements and international best practices; regulation of the Maltese securities market is not yet completed since secondary legislation still needs to be implemented. - The banking sector accounts for 90 percent of financial sector assets. - Insurance and securities sectors are very small. - Domestic banking sector comprises four banks; two large banks each hold about 45 percent of banking sector assets. - The government has a 25 percent stake in one of the large banks. - An onshore international banking segment consists of nine banks with no significant links to the domestic financial system. - The insurance sector comprises 21 insurers with total assets equal to about 15 percent of GDP; the sector is dominated by two insurers in the life insurance segment. - The Maltese domestic capital market is small (41 percent of market capitalization for equities and corporate bonds) and secondary market trading activity is currently very low. ### Clarity of roles, responsibilities and objectives (MFSA) - MFSA clearly defines its roles, responsibilities, and objectives for financial policies; broad objectives are defined in legislation and explained in MFSA seminars and public discussions. - Responsibility for regulating and supervising the CSD and CSS is not yet formalized but under consideration. ### Open process for formulating and reporting of financial policies (MFSA) - MFSA formulates and reports on financial policies in an open manner; regulatory framework and operating procedures are contained in legislation, directives, and notices which are publicly available. - Proposed technical changes of financial regulations are discussed with the industry in the Financial Services Consultation Council. - Shortcoming: lack of public information about information sharing arrangements between the MFSA and domestic and foreign agencies. ### Public availability of information on financial policies - MFSA, MSE, and CBM make available a range of information on developments in the financial sector and financial policies. - CBM to publish a six monthly financial stability article starting June 2003, which will include comments on banks’ asset quality and publish aggregate NPLs data for all banks operating under the domestic banking license. - MFSA publishes information on the insurance sector; MSE publishes about the securities market. - MFSA issues a monthly newsletter, maintains a public information service, and MFSA senior officials participate in seminars, conferences, and public meetings. ### Accountability and assurances of integrity (MFSA) - MFSA reports to parliament typically once a year and is required by law to submit its Annual Report and annual financial accounts. - The financial statements are not included in the Annual Report or posted on its website. - Internal audit and control arrangements exist but are not yet explicitly drawn up. - Legislation and staff rules are in place for the conduct of personal financial affairs and to prevent conflict of interest; MFSA Staff Handbook rules are not yet publicly disclosed. ### Recommended actions (banking supervision, insurance supervision, securities regulation) — mission recommendations (Table 11) - Clarity of roles, responsibilities and objectives of payment system oversight agencies: - Finalize and make publicly available an MoU that formalizes the roles and responsibilities in regulating and supervising the CSD and CSS. - Make publicly available the recently signed MoU between the CBM and the MFSA agreeing on the agencies bilateral relationship. - Open process for formulating and reporting of payment system oversight policies: - Make all MoUs publicly available. - Announce the cases for information sharing with foreign agencies even if no MoU has been signed. - Public availability of information on payment system oversight policies: - No action required. - Accountability and assurance of integrity by payment system oversight agencies: - Draw up and disclose internal audit and controls arrangements and procedures for the MFSA. - Consider making the financial statements of the MFSA and MSE an integral part of their annual reports. - Authorities were in broad agreement with the mission’s findings and recommendations and committed to make swift progress to improve transparency practices. --- ### AML/CFT assessment — introduction, methodology, and main findings - The Report on the Observance of Standards and Codes for the FATF 40 Recommendations and 8 Special Recommendations Combating the Financing of Terrorism was prepared by a team composed of IMF and World Bank staff and an expert not under Fund/Bank supervision. - The assessment is based on information available at the time it was completed on January 31, 2003. - Malta has a sound and comprehensive legal, institutional, and policy framework for AML/CFT. - Main legislation: Prevention of Money Laundering Act (enacted 1994; amended 1998, 2001 and 2002). - Complementary legislation: Prevention of Money Laundering Regulations of 1994 (amended 2000 and 2002). - Malta has ratified the Vienna Convention, signed the Palermo Convention, ratified the Council of Europe Convention on Laundering, Search, Seizure and Confiscation of the Proceeds of Crime, and has fully or partially implemented UN Resolutions relating to the prevention and suppression of the financing of terrorist acts. ### Criminalization, investigative powers, and statistics - Malta criminalizes money laundering in a manner broadly consistent with international standards and imposes criminal, civil, and administrative sanctions. - Financing of terrorism (FT) is not specifically criminalized; authorities believe existing legislation is adequate, but the report recommends enactment of a specific criminal offense proscribing FT to place the position beyond any doubt. - The coverage of predicate offenses for money laundering is broad and includes crimes specified in the Vienna Convention. - The offense of ML extends to those who committed both laundering and the predicate offense; law applies whether offense is attempted or consummated and deals adequately with accomplices and corporate liability. - Authorities have wide investigative powers and special procedural remedies, including investigation and attachment orders; after conviction authorities may obtain a freezing order and an order for forfeiture after judgment. - Strong penalties exist for failure to comply with orders or other provisions of the Act or Regulations. - Statistics are maintained on property seized and confiscated, STRs received, judicial orders obtained, investigations conducted and prosecutions brought. - The number of STRs appears low. - There has been just one successful prosecution to date for ML offenses and this is subject to appeal. - Relevant statistics are maintained on cooperation sought from and provided to other jurisdictions. ### Financial Intelligence Analysis Unit (FIAU), law enforcement, and supervised sector - Establishment of the FIAU is expected to improve the quantity and quality of STRs; FIAU needs to improve AML/CFT awareness among reporting institutions and provide systematic feedback on STRs received. - Following reorganization of police structures, creation of a Money Laundering Unit, and establishment of the FIAU, a significant improvement in effectiveness of investigations and law enforcement is anticipated. - Every STR forwarded to the police is investigated in detail; investigation files can remain open for considerable periods. - If STR numbers and quality increase, it may be necessary to strengthen the existing police structure. - Use of special investigative measures needs reexamination, with explicit introduction of all possible investigative measures on ML/FT in police work. - In international cooperation, Malta is party to the European Convention on Mutual Assistance in Criminal Matters and has signed twelve bilateral agreements with other countries within its geographical vicinity. ### Customer identification, record keeping, reporting, and supervisory arrangements - Provisions on customer identification, record keeping and reporting of suspicious transactions are broadly in line with international standards. - For nominees (and trustees, if proposed trustee legislation is enacted) customer identification requirements should be extended to require independent application by regulated financial institutions of full customer identification procedures as applied to customers generally. - Provisions for professional intermediaries (lawyers, accountants, etc.) should be reviewed and brought into line with the latest international standards. - FIAU is now the competent authority for AML/CFT with a statutory role under the PMLA to monitor compliance and liaise with supervisory authorities, principally the MFSA. - FIAU is still building operational capability; how FIAU and supervisory authorities will combine in practice is not yet evident. - FIAU can appoint supervisory authorities as its agent and can collect relevant data directly from regulated institutions or via supervisory authorities. - Supervisory authorities continue AML/CFT functions under sectoral Acts to ensure regulated entities comply with PMLA requirements. - MFSA is now the single regulatory authority for banks, securities, insurance and bureaux de change, and is Registrar of Companies; MFSA includes AML/CFT within on- and off-site supervision. - MFSA sectoral supervision units devote resources to AML/CFT and conduct some dedicated AML/CFT on-site examinations. - Recommendation: level of resources and specialist expertise in AML/CFT at MFSA should be reviewed and increased as necessary to expand on-site inspections, in particular to include international banks and a sample from the branch network of domestic banks. ### Coordination and industry awareness - A Prevention of Money Laundering Joint Committee was formed comprising representatives of financial sector institutions and the authorities; it had not met for some time due to structural changes but is due to meet again soon. - Industry discussions indicate strong awareness of AML/CFT risks and legislative and supervisory requirements. - Industry confirmed active role of MFSA and emerging influence of the FIAU, which was widely and warmly welcomed. *Source: _cr03264 - 171. The oversight function is still in the process of being established, but amendments to* ### 197. The Companies Registry in the MFSA is also within the domain of AML/CFT ### _cr03264 - 197. The Companies Registry in the MFSA is also within the domain of AML/CFT ### Companies Registry role and supervised entities - The Companies Registry in the MFSA is within the domain of AML/CFT implementation. - Regulated nominees (likely to be superseded by a regulated trustee regime) are responsible for AML/CFT due diligence in respect of the beneficial owners of registered companies with nominee shareholding. - Brief on-site examinations of regulated nominees are conducted by MFSA and include an AML/CFT component. ### Summary assessment against the FATF 40 + 8 Recommendations - Malta is in broad compliance with the FATF 40 + 8 Recommendations, with room for improvement and enhancement in certain areas covered by the Recommendations and the Methodology. - Table 12: Recommended Action Plan to Improve Compliance with the FATF Recommendations (high-level items extracted): - General framework of the Recommendations (FATF 1–3) - No specific recommended actions listed in the excerpt. - Scope of the criminal offense of money laundering (FATF 4–6) - No specific recommended actions listed in the excerpt. - Provisional measures and confiscation (FATF 7) - No specific recommended actions listed in the excerpt. - General role of financial system in combating ML (FATF 8–9) - No specific recommended actions listed in the excerpt. - Customer identification and record-keeping rules (FATF 10–13) - Address the following points. - Consider introducing an explicit provision requiring the renewal of identification should doubts appear regarding identity in the course of the business relationship. - Consider introducing in the law or regulations a requirement in relation to the inclusion of name, address and account number when transmitting funds. - Supplement the current Guidance Note by introducing a specific legislative requirement to include originator information on fund transfers. - Establish a requirement for graduated customer acceptance policies, and additional focus on high risk customers. - In relation to nominees (and trustees under the proposed new legislation), require financial institutions to verify the due diligence carried out by nominees/trustees, to help to minimize the reputational risk to Malta from the continuation of this category of business. - With regard to dealings by financial institutions with other professional intermediaries (as specified in Regulation 7), acting on behalf of clients, require information on the identity of the beneficial owner/client to be made available to the financial institution, in line with, among other things, the interpretative note to FATF Recommendation 11, having due regard to the provisions of the Second EU AML Directive. - Increased diligence of financial institutions (FATF 14-19) - Introduce specific provisions dealing with complex and unusual transactions and high-risk accounts by the authorities in addition to the current measures. - Establish an overall standard for the quality, coverage, and updating of AML/CFT policies and procedures documentation and check for implementation in the course of on-site inspections. Use FIAU powers in terms of collecting and reviewing such documentation in conjunction with the MFSA or otherwise. - Criminalize negligent money laundering. - Measures to cope with countries with insufficient AML measures (FATF 20–21) - Introduce a specific additional requirement in relation to countries believed to have poor know-your-customer (KYC) standards, in addition to PMLR reference. - Implementation & role of regulatory and other administrative authorities (FATF 26–29) - Increase the frequency of on-site ML/FT work, particularly for international banks as well as insurance and securities firms. Introduce a program of bank branch ML/FT inspections. To achieve this, expand specialist ML/FT resources currently available to the MFSA’s supervisory units. - Reactivate the Prevention of Money Laundering Joint Committee as quickly as possible, with all relevant financial services industry segments represented. - Complete and issue the draft consolidated Guidance Notes as quickly as possible. - VII. Wire transfers (Special recommendations) - Introduce legislative or administrative requirements addressing specifically the need to give enhanced scrutiny to wire transfers that do not contain complete originator information, although some examples of relevance are included in the list of examples of possible suspicious transactions included in the appendix to the Guidance Notes. - II. Criminalizing the financing of terrorism and associated money laundering (Special recommendations) - Criminalize FT specifically as a serious offense, making it a predicate offense for ML purposes. - Immediately implement any outstanding elements of the UN Security Council Resolutions relating to the provision and suppression of the financing of terrorist acts. ### Other recommended actions (Table 13 highlights) - Customer Due Diligence (CDD) - Make mandatory the implementation of the provisions of the Basel Committee CDD paper. - Publish specific provisions covering additional measures for private banking businesses and politically exposed persons. - Introduce an explicit requirement that, where a transaction or account relationship does not proceed, any funds accepted must be returned only to original source. - Extend the provisions for non-face-to-face business to refer to electronic methods of financial services. - Review the distribution of provisions between the Regulations and Guidance Notes, given the descriptive nature of the latter, with a view to strengthening and making more explicit the mandatory requirements of both. - Law enforcement - Consider the establishment of an asset forfeiture fund into which confiscated property could be deposited and applied for law enforcement purposes. - Consider an asset share mechanism as an addition to powers to deal with confiscated property. - Consider a legal mechanism allowing for confiscation without conviction (civil forfeiture). - Consider increasing the number and scope of training courses and related activities for administrative, investigative, prosecutorial, and judicial authorities in relation to enforcing laws to combat ML and FT. - Exchanges with foreign police forces working on AML/CFT issues would also be beneficial. - The use of special investigative measures needs to be reexamined, with explicit introduction of all possible investigative measures on ML/FT in the work of the police. - Financial Intelligence Analysis Unit (FIAU) - Consider augmenting the staff of the FIAU as the full implementation of its AML/CFT functions is achieved. - The FIAU needs to take steps to improve further the AML/CFT awareness and knowledge of the reporting institutions, particularly those institutions and sectors that may have been underreporting suspicious transactions in the past. - The FIAU needs to provide systematic feedback to institutions on STRs received. ### Authorities’ response - The Maltese authorities are in general in agreement with the positive assessment and the conclusions reached by the FSAP Assessment Team on Malta’s regime in compliance with the anti-money laundering and the combating of the financing of terrorism international standards. - The authorities accept the recommendations made by the assessment team and will take immediate measures to implement them. - The authorities note that, at times, the recommendations require the inclusion of best practice guidance into the legislation. Where appropriate this will be done. - In other instances, implementation may be made by way of mandatory directives to the industry issued by the respective authorities pursuant to enabling clauses in the relevant legislation—such as by the Financial Intelligence Analysis Unit and/or the relevant supervisory authority. - The authorities believe that financing of terrorism is already adequately criminalized under existing Maltese penal legislation as required by the Convention for the Suppression of the Financing of Terrorism. However, the Maltese authorities take note of the positive recommendation to further strengthen the criminalization of the FT. *Source: _cr03264 - 197. The Companies Registry in the MFSA is also within the domain of AML/CFT* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03264.pdf_