At the Bank of Valletta Annual Public Lecture
‘Financial Services: A Key Element in Malta’s Economic Development Strategy’
30th May 1997
Towards the next Millennium: Malta’s vision for addressing the challenge |
As Malta approaches the next millennium it has confidence that the economic policies it is pursuing will continue to contribute towards the realisation of its national development strategy. Amongst the principle objectives of economic policy are the attainment of a sustainable level of growth which is backed by stable prices, an equitable distribution of wealth and a high standard of living. Financial institutions have a major role to play in addressing this challenge as they constitute the indispensable intermediaries between consumers and producers, between savers and spenders, thereby facilitating investment and promoting trade flows.
Malta is in the process of transforming itself from an offshore jurisdiction into a tax efficient international financial centre. In so doing, it builds on the strength which is derived from a central and strategic geo-political location, quality human resources, a supportive infrastructure and a flexible operating cost base. As the country continues to develop into a hub for financial services and an international business centre, it also benefits directly from a sound regulatory framework comprising modern legislation in the fields of banking, insurance and investment services.
Together with the Central Bank and the Malta Financial Services Centre, the government is particularly cautious against money laundering in order to sustain the integrity of the financial system. This requires continous vigilance to ensure that our reputation is not tarnished in any way nor the future of the financial services industry jeopardised.
Such a framework is essential for the maintenance of international investors; confidence in the domestic economy. Malta may indeed boast of having a well developed financial system with a strong institutional structure. Of utmost importance, however, is the fact that the setting up of a financial centre and the required amendments to the legislative framework in financial services have been unanimous, indicating a commitment of both sides of the House to show the world that there is continuity and project the island as a secure international financial centre. Only in so doing can a financial centre seek high repute and promise a stable future so crucial to sustaining the confidence of international investors, guarding against the adverse consequences which might arise of a slight indication of instability.
Legislation provides the framework for financial services, but it must in no way remain static. On the contrary, the recognition that monetary and financial matters are central elements supporting the rapidly evolving economic scenario brings with it the need for the regulatory infrastructure to dynamically adapt itself according to changing circumstances. This is why a number of amendments have recently been proposed: to further rationalise the existing framework, correct any irregularities and boost activity in the markets while contributing towards the improved efficiency of financial institutions.
Allow me therefore to give you a brief overview of the current discussion insofar as it relates to the proposed amendments. The computation of final withholding tax on investment income is proposed to be altered by virtue of amendments to the Income Tax Act. Issues in Malta of securities by international bodies of repute would be eligible to final withholding tax as an option for the investor resident in Malta. This would directly contribute towards the development of an international dimension for the local capital market and is particularly applicable to boosting secondary market trading in fixed income securities.
Amendments have also been proposed for the Treasury Bills Act so as to induce a greater degree of flexibility in the form and manner in which treasury bills are issued. Issues of notes would be possible in addition to issues of bills. Such changes should result in an enhancement of short term investment possibilities and trading of treasury bills as bonds on the Malta Stock Exchange.
Proposals for changes have also been directed towards the operation of monetary policy. As you know, the monetary authority operates policy guiding short term interest rates through open market operations in short term financial instruments on the money market, particularly with the advent of the interest rate liberalisation. Amendments to the Central Bank of Malta Act are intended to empower the Central Bank to provide short term advances to banks and financial institutions, including those which are not incorporated in Malta. As a result, the Central Bank will be also be able to enter into repurchase and reverse purchase agreements with non-bank corporate bodies and local branches of overseas banks as well as with banks incorporated in Malta.
Capital markets have been provided with a package of modern financial legislation as well as with a set of listing rules and regulations designed to strike a balance between the swift processing of applications and the satisfaction of world-wide standards of investor protection. Amendments to the Malta Stock Exchange Act should serve to widen the definition of securities in line with that contained in the Investment Services Act, and to enable the Stock Exchange to quote funds of overseas institutions.
The infrastructure is thus in place for the growth of domestic capital markets. Considerable progress has been registered in the prevention of speculative activity and the reduction of risk in the market place with the integration of the trading system with the Central Securities Depository and the Clearing and Settlement System. The Exchange may now boast of full automation with end-to-end integrated technology covering the entire. transaction life cycle providing technology solutions for trading, surveillance, clearing, settlement, depository and registration.
The establishment of a collective investment scheme holding a local portfolio of securities and the introduction of specialised financial intermediaries augurs well for the continued development of activity on the capital markets. Although a critical mass of equities, corporate and government bonds and investment funds has been achieved, the number of private sector companies seeking a listing of their shares or bonds remains small. It is therefore the government’s intention to encourage companies to raise equity and longer term finance on the Exchange with a review of existing legislation so that unnecessary legal obstacles to such participation are removed.
The wide ranging reform of the legislative framework governing the financial sector is to you all very familiar. As you know, the Banking Act and the directives accompanying it provide for limitations on large exposures, the satisfaction of own funds ratios and liquidity requirements and the operation of the Joint Banking Committee which is responsible for monitoring the soundness of the banking system and for formulating supervisory policy together with the Competent Authority.
The gradual liberalisation of the business of banking, with the effective removal of the ceilings on interest rates and the limitations on loan maturities brought about a higher degree of competition between domestic credit institutions, both on the lending side and in terms of deposit taking.
Competition is also encouraged with the arrival of new international banks on the market, including those licensed to operate in foreign currency banking services destined to non-residents. Foreign financial institutions pose a challenge in terms of the quality of service which they provide, their cost effectiveness and the degree to which they meet the expectations of their customer base. They positively contribute to the upgrading and modernisation of the domestic financial sector with the technical expertise and the knowledge which they impart to the local market from their experience in their country of origin. 11 credit institutions are now licensed under the Banking Act and a further 5 under the Malta Financial Services Centre Act.
The government is determined to give the enactment of insurance laws the priorities which they so rightly deserve. It is my intention to introduce new legislation this year in order to bring the insurance sector more in the line with international standards and practices, encouraging the establishment of new indigenous insurers without excluding the participation of foreign companies on the local market. Complemented with the new legislative regime enacted through positive consensus in Parliament, this will further contribute the promotion of Malta as an international financial centre of high repute.
Discussions are currently underway for the new Insurance Business Act to be supplemented by the Insurance Brokers and Other Intermediaries Act.
The objectives of the new Act are to eliminate different regimes governing onshore and offshore insurance business so as to create the concept of one authority as the sole regulator of insurance business and to upgrade Malta’s insurance regime to European standards. In conjunction with this, the Insurance Brokers and Other Intermediaries Act is designed to regulate insurance brokering and other intermediary activities, whether onshore or offshore under one law, distinct from the Insurance Business Act.
It also provides for the registration of individual insurance brokers and the enrolment of insurance brokering companies, as well as for insurance companies to appoint and register their own sub-agents for whom they are responsible.
Legislation in this field seeks to achieve a balance between the stability of the financial services sector, through the regulation of insurance activities, and the efficiency of the market, by promoting free and fair competition. A proper regulation of activities of insurance brokers and other intermediaries is necessary in view of asymmetric information and the need to protect the users of insurance services. Following the liberalisation of maritime and aviation classes of insurance, the government has expressed a strong commitment towards the creation of a competitive and effective tax environment for insurance and reinsurance companies operating in and from Malta. With more than 25 companies operating in the general business, competition already prevails, and it is government’s clear intention to promote private enterprise. A strong insurance sector will strive towards the achievement of best practice standards and an equitable pricing structure which together ensure the stability of the market and the security of policyholders within an environment of fair trading.
The insurance sector is characterised by brisk business with premiums paid for life insurance growing to Lm9.4 million and general business to Lm27.4 million. New opportunities are being sought in areas such a risk management, reinsurance activities, captive insurance company formation and their management. Notwithstanding the importance of the sector for sustained economic development and a strong balance of payments position, however, one may note that the contribution of the insurance sector to GDP is low at 3% for both life and general business.
The direction of policy in the field of insurance is to favour the combination of an indigenous market with international insurers licensed to operate in Malta through agencies and branches. One must also recognise the role played by the Mediterranean Insurance Training Centre in enhancing the level of professionalism of the industry which had developed an international standing.
Investment services is another growth area in the local financial sector, comprising investment management and administration services, trustee, custodianship and nominee services, and the provision of investment advice. In the last year three legal notices relating to investment services were issued by the Malta Financial Services Centre and the existing body of legislation continues to be updated. Indeed, the Investment Services Guidelines have been revised to include a new Standard Licence Condition dealing with conflicts of interest which may arise when an Investment Services licence holder occupies a position of trust within the issuer of a listed security.
The financial sector is a major contributor to economic activity. It directly employs around 3% of the gainfully occupied population and has immense potential to generate international business and foreign exchange revenue.
A sound financial sector directly contributes to economic efficiency in the allocation of savings to productive investment. Besides commercial banks, both onshore and offshore, and other quasi-banking institutions, a number of insurance companies are competing actively for financial savings in the local economy.
The life-cycles allocation of households’ consumption is facilitated by an efficient financial system which allows an optimal allocation of physical capital to its most productive use in the business sector, making possible the efficient separation of ownership from management of the firm and allowing specialisation in production according to comparative advantage.
The global financial sector enjoys excellent prospects. With rapid advances in telecommunications and information technology, transaction costs are dramatically reduced. These lower costs, combined with a learning curve applicable to the creation of new competitive products and services, is promoting rapid innovation. Innovation can be conceptualised as a spiral with a trade-off between potential benefits and costs when considering whether to implement the innovation or not. As transactions costs decrease, the threshold for taking the decision is lowered and the pace of financial innovation is therefore likely to remain sustained.
The local banking sector is strong, with high solvency ratios, well above the internationally established minimum requirement of 8%. Banks enjoy high levels of liquidity, with a ratio of banks’ total liquid assets to total deposit liabilities of over 40% at the end of the last financial year due to increased holdings of Treasury bills and other marketable securities. A healthy spread between the weighted average lending rate and the average deposit rate was maintained during the last year. Profitability is also improving substantially as institutions become more cost conscious and take advantage of the avenues which open up as a result of the financial liberalisation process. Lending practices require caution and prudence however, with special effort directed towards the satisfaction of own funds ratios and large exposure limitations. This is especially important as the consolidated balance sheet of domestic credit institutions continues to grow. In 1996 it reached Lm2.1 billion with just under half of the total asset portfolio consisting of loans and advances.
Financial products are becoming more innovative and sophisticated, thereby giving customers a broader choice of investment opportunities. The positive economic effect of this development is that a greater proportion of the country’s savings is being mobilised through the financial system and channelled to the productive sectors for investment purposes. The continuous growth in customer deposits of the banking institutions is also accompanied to some extent by a gradual rise in the public’s holdings of other financial assets reflecting the tendency for households to diversify their portfolio in the light of the wider range of investment products available.
The importance of the banking sector is evidenced by the extent of credit advanced to the principal productive sectors of the domestic economy. A glance at the sectoral distribution of loans and advances by all banking institutions indicated that manufacturing industry (including ship repair and shipbuilding) and wholesale and retail trades were the principal recipients of bank loans and advances in the past year, with substantial credit also extended to the personal sector and the hotel, restaurant and tourism trade. Excluding inter-bank advances and credit to government, total local lending amounted to Lm1.2 billion last year with lending from publicly owned and/or controlled entities accounting for little more than a fifth of the total.
One may note that net foreign assets of the banking system last year were in decline for the second consecutive year. This occurred as a result of continued pressures on the current account of the balance of payment and the requirement for banks to meet their customers’ foreign exchange needs. The banking sector remains nevertheless a fundamental source of foreign exchange.
It is government’s policy and my strong intention to give close attention to the need for banks to be run on a commercial basis. An external commentator might be alarmed that of the two largest banks, one has a public majority ownership and the government has a 25% stake in the other. I strongly recommend that this be not taken at face value however, and to the mistaken claim that government is involved in the running of the two main local credit institutions comes the response that the way the banks operate and take their decisions is purely in a business-oriented manner without the interference of the government.
The role that a government should play in the financial sector has changed radically as a result of a wave of deregulation in global financial markets in the 1980’s. Suffice to say that the negative attitude sustained by economic research towards political intervention in the financial markets is justified in view of the growing awareness of the ineffectiveness of quantity controls. This requires caution however as deregulation does not mean unregulation. Indeed, the government will continue to intervene together with the Competent Authority in the field to design rules of a protective nature so as to correct various types of market imperfection. This is necessary since the market left to its own devices may turn out to be to the detriment of the players therein. I am thinking for instance of systemic risk which may jeopardise the overall stability of the financial system, or the inadequacy of information dissemination which may undermine consumer protection.
Amongst the priorities of the regulatory framework remain the promotion of free competition and fair trade. The high priority accorded to free trade by the government is at the basis of its continued support for the implementation of monetary policy with market operations and the separation of its instruments from those of a supervisory nature.
A guiding principle in the design of new regulatory instruments is that of competitive neutrality, by virtue of which rules are intended to promote competition and support market developments, not create unnecessary rigidities in the operation of financial markets. The amendments I mentioned earlier are to a large extent guided by this principle, as they are designed to encourage a broader use of financial instruments to make the markets more efficient in terms of stability and portfolio diversification.
The strength and stability enjoyed by financial institutions world-wide as a result of the protection previously afforded by credit controls is being replaced by a greater need for equity capital as a protection against operating losses in a context of global liberalisation. Thighter capital adequacy rules were thus called for, the underlying provisions for which were drawn up under the Basle Committee on Banking Regulations and Supervisory Practices. Early capital adequacy provision for banks operating in international financial markets concentrated exclusively on risk of loan losses.
These have now been extended to include risks which may arise from movements in financial instrument prices as well as the settlement and counter-party risks to which an institution may be exposed in the course of trading. Internationally, the need to account for the complexity of such risks was recognised with the rise in capital market turnover and the increasing diversification of financial instruments. Globally, the new line in government regulation of financial operations is to make financial institutions themselves accountable for the task of controlling risk management. Of particular relevance is the possibility of using value-at-risk models to calculate the capital cover for market risk in this respect. As the global financial market place continues to evolve, developments of a regulatory nature are closely monitored by our Competent Authority in the field. I am informed that the Central Bank of Malta is carefully considering the applicability of the introduction of capital adequacy provisions for local financial institutions.
Whereas in the past competitive success could be explained by market position, the scale and scope of a firm, differentiation with respect to competitors, or cost considerations, the attainment of a competitive edge now centres on the management of a company’s most prized asset, its human resources. We are indeed faced with a growing realisation that in the financial services sector, the effective management of human resources can provide the competitive edge for an organisation to succeed in a dynamic and competitive environment.
Only by applying the abilities, talents and potential of its staff in response to the requirements of the business, is a financial institution really working towards the implementation of people-centred management. I specifically chose to use the term implementation, to distinguish people-centred management from a purely conceptual level. By this I would highlight the importance of the purpose of the organisation, as enshrined in its mission statement, and the emphasis which is therein placed on the importance of career development, the continuous enhancement of skills and staff well being. This directly affects the organisation’s strategy, or the way in which it will go about implementing its missions. A growing realisation of the importance of human resources will alter the values of the organisation at a grass-root level, changing the beliefs which are subscribed to as the distinctive way in which business is conducted. The philosophy of management, and the commitment to the way in which values are adopted in the management of the organisation, can only benefit from such a realisation.
It is with great pleasure that I note a good representation of the local financial sector in the achievement of the Quality In People Award, as an accolade to high standards of human resource management. It is very positive that in circumstances where shareholders would tend to focus on profits as the key to success, bank management still believes that the formula contributing to its achievements lies in the quality of its people, stating assuredly that without their performance, profits can neither be sustained nor improved.
In operational terms this is accompanied by a shift of the retail bank’s strategic focus. With the adoption of an increasingly sophisticated marketing approach, retail banks today seek to target specific customer segments and build relationships with them, both satisfying and anticipating their requirements. This drive to develop customer relationships based on quality of service, efficiency and loyalty effectively highlights the direct relation which exists between the quality of the service provided and the quality of the people who actually face the customer.
At a time when the leading local banks are striving to position themselves in an increasingly dynamic market, it is crucial for people-centred management to be integrated within new business procedures. The ongoing culture change will inevitably result in the alteration of a bank’s business strategy, its values, and the design and philosophy of its management so as to make its people a pillar of success. I cannot overstress the importance of harmonious relations and staff satisfaction in the attainment of productivity targets, nor the essence of pride in one’s workplace for the effective satisfaction of customer requirements.
A cursory glance at the number of work days lost due to industrial action is a powerful illustration of the cost incurred by the economy as a whole in the absence of harmonious staff relations. Although across all economic sectors 7 strikes were called in 1996 as against 13 in 1995, the total of work days lost reached 16,500 nearly three times as much as in the previous year. The disputes involved nearly 4,000 workers in industrial action, with the banking sector accounting for nearly half of the total of work days lost.
It is therefore imperative for financial institutions to pursue their efforts towards instilling a culture of communication, operating in an open environment and striving towards stable industrial relations.
The factors driving change in the financial sector are multi-directional, comprising the need to maintain and improve quality of service, increased competition for the attainment of satisfactory financial results, steady advance of information technology, and greater than ever expectations from shareholders. The need to maintain motivation, morale and direction of staff should not be viewed as a pressure in the opposing direction, instead it is a response to a competitive environment and a rapid pace of change.
The local leading financial institutions have been instrumental in the design of incentives for staff to further their studies, directly contributing to the professionalism and quality of service in the sector as a whole. Opportunities have been created through graduate programmes at the University of Malta in Banking & Finance and Computer Studies as well as in postgraduate Management studies or the recently launched Masters in Financial Services. Partnerships have been struck with leading international academics in collaboration with foreign institutes of higher education.
The number of graduates augurs well for the future of the financial services industry: 55 students are to graduate with honours in accountancy, a further 34 in management, 9 in banking and finance, and 5 in economics at the end of this academic season, in addition to 148 students who will have completed the Bachelors in Commerce degree programme. I would also like to commend the Chartered Institute of Bankers and the Chartered Institute of Insurers for the sterling work carried out in connection with their degree and diploma programmes.
With a comprehensive regulatory framework, dynamic players comprising credit institutions, both onshore and offshore, insurance companies and investment services providers, and proactive supportive bodies such as the Central Bank of Malta, the Malta Financial Services Centre, and the Malta Stock Exchange, the infrastructure is firmly in place for a strong, sound and stable financial sector, The continuous evolution of the global financial market place, as a result of rapid progress in communications and information technology, will continue to have profound consequences on business practices and the management of human resources.
The authorities, by carefully monitoring developments on the global market place, will continue to guide local financial services providers and will direct their full efforts towards strategically positioning Malta as an international financial centre of high repute. I am therefore pleased to reaffirm the confidence with which Malta is addressing the challenge of the next millennium in the field of financial services and its overall economic development strategy.