We have jointly undertaken a series of “constrained” bottom-up stress tests across a number of banks and last year we participated in the EU-wide stress test stress test. This year the Bank is assisting the MFSA in the stress test exercise being conducted by the newly established European Banking Authority. Together, the Bank and the MFSA now need to build upon this positive track record. The recent changes in the nature and size of the domestic financial system and in the external environment with which it increasingly interacts, in fact, suggest that the time has come for the existing model of cooperation to be further refined and strengthened. The need to increase the effectiveness of the institutional arrangements for the preservation of financial stability is also related to Malta’s aspirations to consolidate its position as a successful financial centre. The financial services industry has grown considerably, particularly since EU membership in 2004. Today there are 25 licenced credit institutions, 14 of which with a majority shareholding from other EU countries. But the fastest growing sector has been the funds industry, with more than 400 funds registered, many having redomiciled from other jurisdictions. There has been a similar growth in the insurance business with 50 operators here today. In the process, Malta has become a very important centre for captive insurance in the EU. This increased visibility brings with it the responsibility to ensure that our financial system does not serve as a channel through which risks are transmitted to other countries.
A monetary policy that succeeds in maintaining stable prices promotes financial stability by encouraging investment and economic growth. Conversely, a stable financial system helps monetary policy achieve its primary objective by, for example, ensuring the smooth propagation of the central bank’s interest rate signals throughout the economy. At this point it is useful to dwell briefly on the meaning of the concept of financial stability. In Malta we define it as “a condition where the financial system – comprising institutions, markets and infrastructure is able to: allocate savings to investment opportunities efficiently; ensure the rapid settlement of payments; effectively manage potential risks that may harm its performance; and absorb shocks without impairing its operations.” If there was ever any doubt as to the importance of ensuring the realization of such conditions, it can surely no longer be the case after the experience of the past three years. The financial crisis has clearly underlined the vital role of central banks in safeguarding financial stability and the importance of adopting a macro-prudential approach to regulation and supervision. This thinking lies behind the many initiatives taken recently to strengthen the institutional framework for financial stability, most notably in the EU and on which Mr Fell will be elaborating later on. It is not surprising that in this new emphasis on macro-prudential supervision of the financial system, central banks are expected to play a key role.