The IMF’s April 2014 “Global Financial Stability Report” examines risk factors for the global financial system. In this report the IMF has charted 28 advanced economies (including 23 from the EU) on the basis of the strength of their insolvency procedures and the percentage of non-performing loans (as a percent of gross loans). They then identify a number of countries (all EU), including Malta, that combine elevated levels of non-performing loans and inadequate insolvency procedures.
Worryingly for Malta, in their analysis the IMF has placed Malta in a group that includes Greece, Cyprus, Portugal and Italy, with a particularly weak legal system and an elevated level of non-performing loans. (More reassuringly how- ever, the IMF conspicuously does not include Malta in its list of “stressed euro area countries”.) Presenting the report, Jose Viñals, Financial Counsellor of the IMF and Director of the Monetary and Capital Markets Department, explained that “the main message… is that we have begun to turn the corner from the global financial crisis and that global financial stability is improving significantly.
But… that it is too early to declare victory because there is a need to move beyond liquidity dependence by overcoming the remaining challenges to global stability.” In the context of the eurozone, Dr Viñals explained, while the improved European and national policies implemented have increased confidence in both banks and sovereigns there remains significant progress still to be made to repair banks and the corporate sector, so boosting the economy overall. Further, in his briefing, he pointed out that while central banks have been taking measures to expand the money supply and encourage lending with low interest rates, these measures have still not manifested themselves in the flow of credit to small and medium enterprises necessary for stronger recovery (as banks instead build up capital on their balance sheets).
The outstanding problem areas that Dr Viñals identified were the stability of the EU’s banks, which he argued was best addressed through the comprehensive bank assessment exercise (or bank “stress-testing” currently being conducted by the European Central Bank), and the current levels of corporate debt. He added that recent instability in Ukraine had added an extra geopolitical risk to this mix. The report itself then highlights the need to support credit by improving asset quality in euro area banks, pointing out that current levels of non-performing loans have doubled since 2009 and now stand at €800 billion. The IMF argues that the restructuring of non-performing debt and the recovery of the Euro area remains unfinished for a number of reasons, including the lack of legal capacity slowing the rate at which bad loans are resolved. More specifically they point to “difficulties in enforcing creditor rights, impediments to the sale of collateral, and long legal delays” as hampering the banks’ abilities to address distressed assets.
In turn based on a study provided by the World Bank, the IMF identify Malta and a number of other countries as having legal and insolvency systems that are weaker than average (and so less able to address bad debt sitting on their banks’ balance sheets). Furthermore the same chart identifies that, while not elevated to the extent of nations such as Greece or Cyprus, the level of non-performing debt in Maltese banks is significantly higher than that of German, French or British banks, and close to the level of Italian banks. The IMF report notes that “policymakers now face the difficult task of accelerating the clean-up of balance sheets without disturbing the improvement in market sentiment”.
As part of the “Regulation on the single supervisory mechanism” (to be completed in November 2014) the ECB is currently in the process of its comprehensive assessment of participating EU states’ banking sectors (including Malta). The IMF comment that this assessment could be “a first step in a revolution in the resolution of non-performing assets”, before then recommending a number of subsequent measures to address the clean-up and resolution of assets including increasing the incentive for banks to provision for, and write- off, debts, and “ensuring that legal frameworks are reformed and adequately resourced” to resolve issues associated with debt promptly. If significant efforts aren’t delivered to implement policies that help address the issue of non-performing loans, the IMF warns that “some economies may find that they remain stuck in the mire of low profitability, low credit, and low growth.” Based on this report it is clear that the Maltese government needs to ensure that legal mechanisms and contingencies are put in place now in order to ensure that any shortcomings in the balance sheets of local banks, that may be found by the ECB’s comprehensive assessment, can be resolved in an orderly fashion.
To download the full report visit elibrary.imf.org/page/ec4f