Borrowers increasingly taking on larger loans compared to their income

The Central Bank of Malta is publishing its eleventh Financial Stability Report in which it evaluates developments within the domestic financial system in 2018.

A special feature focused on banks’ exposure to the real estate market, found that whilst house prices picked up recently, the monthly average repayment compared to the average wage was much more contained and below the levels reported in 2006-2007, when house prices grew at doubledigit rates.

The composition of the core domestic banks’ exposure to the real estate market shifted considerably in the last 10 years, away from construction and real estate towards mortgages, which grew by 8.8% in 2018 or 0.6 percentage points faster than in the previous year. Despite this increase, growth was still significantly lower than the double-digit growth rates recorded in the pre-2008 boom period, and it was still proportionate to nominal GDP growth.

With regards to housing affordability, almost half of loans are concentrated within three to five times gross income. However, the share of loans within the 5-6 times gross income category increased throughout the period assessed in the Report. This indicates that some borrowers are increasingly taking on larger loans compared to their income, resulting in higher loan repayments, and possibly indicating increasing pockets of vulnerability in case of a downturn.

The Central Bank of Malta issued Directive No. 16 earlier this year as a way to safeguard borrowers and lenders against cyclical fluctuations. These could be exacerbated if credit standards are eased during an upswing – thus encouraging risky behaviour which could lead to a deterioration in the resilience of both borrowers and lenders to potential future shocks.

Studies conducted by the Central Bank of Malta indicate that the Directive will only impact 2.7% of those buying their primary residence and 13.2% of all buyers of residential property. However, the Directive gives lending institutions sufficient discretion to enable, where appropriate, some borrowers to provide lower upfront finance than the minimum prescribed in the Directive.

Looking at the wider picture, the report establishes that buoyant domestic economic activity continued to buttress the resilience of the financial system. Credit growth by core domestic banks accelerated whilst asset quality improved further on the back of lower nonperforming loans. Although still in line with other European peers, bank profitability weakened, largely reflecting increased provisions.

Despite the low interest rate environment, net interest income from intermediation trended upwards owing to a larger loan book. The capital position of banks remained sound and within regulatory requirements, even following rigorous stress tests, and they continued to operate with ample liquidity.

The Central Bank of Malta remains vigilant for any emerging systemic risks, recommending that banks and other financial institutions continue pursuing prudent business models whilst at the same time preserving profitability through cost containment and the exploitation of technological enhancements.

The Financial Stability Report can be downloaded from www.centralbankmalta.org or obtained in printed form from the Central Bank of Malta.