The domestic financial sector showed strong resilience in 2021 despite challenges for certain sectors, according to a central bank report published on Monday.

In its fourteenth edition of the financial stability report, the CBM assesses developments in 2021 that are relevant for domestic financial stability.

The bank remarks, in its report, that the macroeconomic environment in the EU improved over a year ago as vaccination programmes aided the reopening of economic activity.

Geopolitical risk rose further exacerbated by the Russia-Ukraine war and its compounding effect on the already-rising inflationary pressures particularly for energy and commodity prices with potential ramifications on growth prospects, going forward.

As pandemic-related government support measures were maintained in 2021, government debt levels continued to increase with potential debt sustainability concerns for some jurisdictions.

On the domestic front, despite the high uncertainty surrounding the global economic climate, banks reported improved asset quality owing to both reduced Non-performing Loans (NPLs) and higher loan volumes.

The latter was largely driven by increased mortgages as lending to corporates was solely driven by the Malta Development Bank’s COVID-19 Guarantee Scheme, the bank notes.

Such developments, according to the CBM, reaffirm the need for continuous monitoring of increasing concentration risk in the banks’ loan portfolios for the timely adoption of targeted policy measures if the need arises.

Overall, the report finds that the domestic financial sector showed strong resilience in 2021 despite challenges for certain sectors.

"Furthermore, inflationary pressures and downside risks to economic growth could possibly impact debt servicing capabilities, which in turn, could test the resilience of the domestic financial sector. This highlights the importance for credit institutions not to engage in excessive risk-taking and set aside adequate provisions whilst maintaining healthy liquidity and capital buffers," it warns.

And with the cybersecurity landscape continuously shifting with more sophisticated threats emerging, financial institutions should remain at the forefront for the adoption of the latest technological advancements to safeguard themselves against cybersecurity risks, it adds.

The report also features, for the first time, a climate risk-related adverse scenario for the macro stress testing framework. The scenario seeks to assess the impact on banks’ capital from heightened transitional risks following oil price hikes to disincentivise its use and reach net zero emissions by 2050.

With increasing evidence of physical effects and accelerating impacts of the effort to transition to a low-carbon economy, financial regulators are rapidly integrating climate-related and environmental risks into their supervisory frameworks," the report notes.

The report also refers to the launch of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), two years after the adoption of the Paris Agreement in 2015.

Financial Stability Report 2021