Borrowers taking on larger property loans compared to their income, report finds

Borrowers are increasingly taking on larger property loans compared to their income, creating economic pockets of vulnerability if an economic downturn takes place, a Central Bank report said.

In its eleventh Financial Stability Report for 2018, published on Wednesday, the Central Bank found that almost half of all housing loans were concentrated in the range of three to five times of borrowers’ gross income.

However, the share of loans within the five to six times gross income category increased through the period assessed in the report.

This, the Central Bank said in a press release, 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.

This, the Bank noted, “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.

In light of this, it said it had earlier this year issued Directive No. 16, which imposes limits on lenders with the aim of strengthening the resilience of lenders and borrowers against the potential build-up of vulnerabilities which could result in financial losses both to lenders and borrowers stemming from potential unfavourable economic developments.

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,” the Bank said.

A special feature of the Central Bank’s report focused on banks' exposure to the real estate market, finding that 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 double-digit 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.

In terms of the wider picture, the report established 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 non-performing loans. Although still in line with other European peers, bank profitability weakened, largely reflecting increased provisions, the Bank underscored.

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 added that it “remained 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.”