By David Eacott – Head, Banking Supervision, MFSA
The European Central Bank (ECB) recently published the outcomes from the 2021 Supervisory Review and Evaluation Process (SREP). The results show modest increases in supervisory set capital requirements in comparison to 2020.
Overall capital requirements were 15.1%, compared to the equivalent set locally of around 15.6%. The difference is generally explained by the higher impact some risks have on smaller banks when compared to the largest banks across the euro area economy, offset by lower stress buffers as Pillar 2 Guidance thresholds will be rolled out to the local banks in 2022 and 2023.
The ECB and MFSA intervened during the COVID-19 crisis to protect the capital position of banks by restricting dividend payments. It is apparent that this proved to be the right thing to do as it helped support lending into the real economy. Nevertheless, the credit risk implications of the last two years are still emerging. Some banks in Malta already had higher non-performing loans and lower provision coverage ratios than the average, which lead to higher Pillar 2 capital requirements. The ECB and MFSA are also requiring improvements in the quality of credit risk management through qualitative measures to ensure that early warnings are identified and future risks to failure or financial stability are mitigated. Today’s economic environment, with rapidly increasing asset prices and inflation, adds to the uncertainty and opens the possibility for market price corrections. This makes it necessary for banks to continually improve on their monitoring capabilities.
Banks are also having to contend with the increased risks associated with continuing negative interest rates, and cost pressures coming from IT, data capture and staff-related expenditure, some of which is required to meet new regulatory requirements. In Malta, improvements in governance and anti-money laundering technology are also being addressed. All these factors are reflected in the SREP assessments and capital requirements of local banks.
Our regulatory priority is making sure that banks emerge from the pandemic in a position to meet these challenges and remain financially and operationally resilient. Some countries are already moving to lock in more capital through the application of counter-cyclical capital buffers. These buffers are released to provide banks with room to support financial stability when economic circumstances deteriorate.
Meanwhile, changes introduced by CRD5 and CRD6 to non-performing loans provisions and reliance on collateral, as well as risk weights for loans, will feed through into capital levels over the next few years and improve the resilience of those banks where there is higher credit risk.
Banks also need to finance digitisation strategies to secure their medium-term business model sustainability and will now need more investment to analyse the impact of climate change on their business profiles.
In a recent round table with the industry, the MFSA reported that banks were making good progress on a range of qualitative measures set to improve governance, controls and business model resilience after recent SREP reviews. The uncertain outlook and the many challenges ahead further emphasise the importance of ensuring adequate capital levels in the banking system.