By the end of 2003 for example, the domestic banks’ assets amounted to over 277% of GDP, compared with a euro area average of 273%, while the ratio of domestic bank credit to GDP stood at 155%, as against 143% in the euro area. More significantly, spreads between short-term lending and deposit rates in Malta, at 2.41 percentage points in 2003, were even narrower than the euro area average of 3.48 points. This suggests that the local banks compare favourably in terms of efficiency with banks elsewhere in the European Union. Furthermore, despite the global economic slowdown and the recent weak performance of the Maltese economy, the profitability of banks in Malta, as evidenced by the return on assets, has been fairly stable at around 0.8%. This compares with an average return of 0.6% recorded by European banks in 2001. At the same time, bank liquidity remains very high, with the domestic banks’ holdings of liquid assets as a share of short-term liabilities, just under 50% at the end of 2003, consistently exceeding the 30% prudential requirement. Maltese banks are also strongly capitalized. Their aggregate capital adequacy ratio, defined as the ratio of own funds to risk-weighted assets, stood at 16.7%. On the other hand, the banks’ loan portfolio still tends to be concentrated on a few sectors, reflecting the structure and small size of the Maltese economy. Furthermore, they still rely too heavily on property as collateral.
In particular, the banks were unable to adjust lending rates according to the perceived creditworthiness of borrowers, and resorted instead to significant collateral requirements and to credit rationing. Furthermore, because the scarcity of land in Malta seemed to guarantee that its value would never go down, property has always been considered a safe investment, so that Maltese banks relied heavily on real estate as collateral, attaching insufficient importance to the viability of projects. As a result, many potential customers were denied access to credit. This, together with the absence of a capital market, meant that savings could not be channelled effectively into productive private investment and tended to flow instead either into inefficient Government-owned enterprises, into the property market or, despite exchange controls, into overseas assets. This situation created imbalances in bank balance sheets, which, when the economy was liberalised and exposed to market forces, came to represent a potential threat to financial stability. For example, the changes in relative prices that occurred in the wake of liberalisation tended, in some cases, to result in a deterioration in loan quality. Furthermore, bank balance sheets included a large number of Government-guaranteed loans to public corporations and utilities that were largely shielded from competition. Despite these distortions, however, no major bank collapse or financial crisis was experienced. A major change occurred in the late 1980s and early 1990s when a programme of financial liberalisation and privatisation fundamentally transformed the economic climate. For a start, the Government’s shareholding in the banks was reduced.