Michael C Bonello: The challenges facing Malta's banking system Speech by Mr Michael C Bonello, Governor of the Central Bank of Malta, at the Second Annual Conference of Finance Malta, Valletta, 29 May 2009. *  *  *  Introduction This conference about Malta’s financial services industry is being held in the midst of the most severe global financial crisis since the Great Depression and whose consequences for the real economy in terms of output and employment losses are proving to be the most devastating in living memory. It is a crisis, therefore, which cannot but have repercussions on a small, open economy like Malta’s that is highly integrated with the world economy through trade and finance. These circumstances present challenges for the domestic banking system, and in addressing them it is important to recognise the implications for the economy at large. A sound, adaptable and innovative banking system is a prerequisite for sustainable development. The birth of a modern banking system Malta’s recent banking history has indeed tended to mirror policy shifts in the broader economy. The nationalisation of the major banks in the 1970s was itself recognition that the centralisation of economic activity could not be achieved without state control of financial resources, including credit flows. Lending rates were set by the minister of finance while the central bank controlled deposit rates. Nominal interest rates were kept artificially low, often resulting in negative real interest rates.
The tests carried out by the Bank should, however, be complemented by parallel tests conducted by individual institutions. In particular, banks should make an in-depth, bottom-up assessment of the potential implications of critical events to identify potential weaknesses at an early stage so as to be in a position to take early corrective measures. This would also serve to reduce the pro-cyclicality of such measures. In recognition of the need for a strong risk management framework, the Central Bank of Malta, in cooperation with the MFSA, has been working with a number of banks on their contingency funding plans and stress testing capacity. A new supervisory regime The lessons that are emerging from the financial crisis will almost certainly change the shape of financial regulation and supervision as we know it. The globalisation of financial institutions and markets, and the associated interdependencies, imply that a regime that has only a narrow institutional and geographic focus will prove inadequate. There is now a heightened recognition of the importance of the macro-prudential dimension of supervision and of the need to have mechanisms in place to address systemic risks, within and across national borders. In this regard, the recommendations contained in the de Larosière Report constitute an excellent basis for action. The Report distinguishes between micro-prudential supervision (the supervision of individual institutions) and macro-prudential supervision (the limitation of the distress of the financial system as a whole to protect the overall economy from significant losses in real output).