A Banking Regulator’s Perspective
JUNE 16, 2022

By David Eacott - Head of Banking Supervision, MFSA

Costs for banks have increased significantly in the last two years. Regulators have required banks to invest in more capital to improve their financial resilience; to spend more on digital services and cyber resilience to improve customer experiences; and to spend more on stronger compliance standards so they comply with an increasingly complex set of rules such as those for anti-money laundering.

At the same time, the MFSA has upgraded its supervisory approach – which means they need to be more responsive to our demands –while they also faced operational challenges as a result of COVID-19.

The MFSA knows there is still a significant degree of dissatisfaction, justifiably or not, with the service banks are providing to local customers. I made a speech recently which pointed out that more change is on the way which will continue to make the challenge for banks even harder. These include changes to drive more environmentally conscious lending standards, meaning banks will need much more information from their business and retail customers about their activities or properties before being able to make a decision on lending. This is likely to mean further changes for customers of banks.

Banking regulation is governed by international and European standards. It is important that Malta does its best to meet these standards to ensure we have a good reputation. Quality regulation is also a prerequisite to a stable and prosperous banking sector and economy on the islands. International bodies, correspondent banking service providers, and international talent all look to the regulator to have set clear standards and to hold banks to them when they assess Malta, whether that’s as a place to live, work, do business, or rating it for others to do business with. We work with the Central Bank of Malta and the Financial Intelligence Analysis Unit to deliver these outcomes.

We are working with the banks where, as a result of our reviews, we have identified concerns about small compliance issues or even longstanding weaknesses in business models and governance and controls. We had a list of over 160 areas for improvement across our banks when we started two years ago. Over a year on, around half are already satisfactorily resolved. Each represents an incremental improvement in the safety and soundness of our banking system.

The MFSA has, over the last two years, also been improving the supervisory model across all sectors. We now operate a regulatory regime that examines risks in business models, robustly assesses the quality of governance and controls, and takes actions to mitigate risks in line with Single Supervisory Mechanism guidelines.

We have also integrated work undertaken by specialists on anti-money laundering (AML) risks into our assessments. We also talk regularly to banks about the AML risks embedded in their strategies and how they can ensure effective oversight of them.

What is on the horizon? I put improvements in the quality of stress testing towards the top of the ‘to do’ list for boards and management. It is a vital tool to assess the medium-term viability of a business and its capacity to lend to the real economy even in a ‘stress’ situation, as well as management’s own understanding of their strategy.

The MFSA is also now responding to the ECB’s request that national competent authorities set capital guidance for banks. The ECB calculates the level of capital depletion in a ‘stress’ situation and sets a level within parameters according to the results. We are working with colleagues at the Central Bank of Malta to calibrate our domestic framework.

We will also continue our work to ensure appropriate financial resilience of the system here in Malta. This means updating the arrangements applicable for legacy non-performing loans: there should be sufficient capital to mitigate risks posed by them, and to incentivise banks to work them out or take them out of the banking system.

It is important we do this as the core banks have told us they intend to grow their lending over the next 18 months, in aggregate, probably by a fairly modest 6-10%. At the same time, the weighted capital ratio of the domestic banking system would fall by 1% under the same plans. International bodies and central banks are gradually lowering their expectations for economic growth, but regulators are concerned this will have an impact on credit quality in the next few years. This means impairments are likely to increase. The ECB’s recent lending survey shows that much of the increase in credit demand by firms is for working capital – reflecting risks associated with supply chain disruption and the increased cost of maintaining inventories.

The MFSA has also noted that banks are planning an improvement in their cost to income ratios – largely by generating more income rather than cutting costs. It is, however, possible that economic circumstances may impact planning assumptions. The supply chain issues, war in Ukraine, and consequent second order impacts may affect how much banks are able to deliver on their plans.

If plans are adjusted downward, then it might also have an impact on capital supporting the domestic banking sector. So the MFSA will monitor the performance of the core banks’ business models against their plans to detect whether there is any risk that profits may be squeezed further than planned in the medium term. It would be a very healthy development if the sector lifted its return on assets from the current 04% to 0.7% as the combined plans suggest.

Another area that is important for boards to reflect on, and where the MFSA is seeking change, is the structure and composition of boards. It is the responsibility of the Chair of the board of any bank to have sufficient skills on the board to oversee the complexity of the operation they run. They must have skills covering prudential risk, conduct risk, AML, IT and operations, as well as experience in the local market or the market in which they operate. The Chair needs to ensure the board composition provides for a Chair of both risk and audit committees, and other committees where they have been established, and builds in succession options to ensure continuity and sustainability of their oversight. Chairs also need to evidence they have a plan to improve the level of gender and age diversity in a reasonable timeframe.

In a small jurisdiction such as this, talent at all levels is in short supply, so there is a responsibility on the Chairs of bank boards to think creatively about how to generate a pipeline of talent for their boards that delivers these outcomes.

We are also undertaking some work on funding models, particularly those models which rely heavily on platforms rather than a domestic funding franchise. With a changing interest rate environment, it is important that banks understand the risks to their business models that arise from changes in funding costs.

And of course, we are continuing our work on credit risk management to help improve the quality of monitoring and decision making so that risks are mitigated at an early stage – and ideally before the credit moves into risk territory. Our work, and that of the ECB has identified a need across all banks to generally improve the frequency and manner of client reviews, to improve early warning systems and risk identification.

Over and above all this, there are a number of structural and policy changes which will influence decision-making and outcomes in the future that extend beyond the regulatory matters already mentioned, such as climate change and the digital operability of their businesses.

The policy environment will advance in tandem with the Digital and Operational Resilience Act due to be finalised soon. And market structure changes are likely to also impact strategies when the Markets in Crypto Assets framework is finalised too.

There is a lot for boards to think about coming up, on top of the work already done. Improving customer outcomes while managing the increased regulatory demands will require continued dedication and the commitment of all involved.


This article is based on a speech presented by Mr Eacott in May 2022.