The Acting Governor of the Central Bank of Malta, Alexander Demarco, discusses the CBM's role in monitoring financial and monetary stability, and beyond.

1.    The CBM has a very active research unit. Why is that important for Malta?

The Bank has been for many years very active in conducting economic research, especially on issues relating to Malta. Unfortunately, economic research in Malta is somewhat limited, and therefore the responsibility of the Bank infilling such void is even greater. In recent years the Bank has not only filled such void, but its staff has been producing very high-quality research, that sometimes finds its way in prestigious international journals.

However, the Bank is mindful of its limited resources, and hence the need to prioritise on their use. As a result, the primary aim of the Bank is to direct its research in activities that support our responsibilities in the decision-making process of the Euro system monetary policy.

All research output forms the basis of any policy decision, whether in respect of monetary policy at the Euro system or in our role of economic advice that we may be requested to give to other policy makers. Research provides the analytical foundation for policy formulation and implementation, as well as the tools required to explore different choices behind each policy decision. This is why the production of economic analysis and research prominently features in the Bank’s Mission Statement as one of its main tasks.

To this end, the Economic Research Department conducts research on a variety of topics ranging from inflation and monetary policy, fiscal policy, housing and real estate, and more recently, also in view of its increasing importance in policy circles, climate change and the green transition. To further aid in its research and analysis, the Bank also develops its own economic models. Economic models are an essential tool in helping the Bank’s economists to articulate the relationships between economic variables, and in their application to the forecasting process and scenario analyses undertaken by them. While in-house model development entails significant investment in terms of resources, developing economic models in-house ensures that the models used at the Bank are well suited to capture the specific characteristics of the Maltese economy and to provide reliable projections of various economic variables. This is particularly important in view of the Bank’s role in the Broad Macroeconomic Projection Exercise at the Euro system level, where projections by each national central bank are consolidated to produce projections for the whole euro area, which are a key input to the Euro system monetary policy decision making process.

Apart from informing policy decisions, the Bank’s research output also contributes to stimulate discussions and debates within the research community, particularly among central banks, creating very useful links between economists, policymakers and other stakeholders. In fact, despite conducting most of its own research, the Bank collaborates frequently with both local and international academia, as well as with other national central banks. These collaborations do not only help to broaden the skillset of the Bank’s researchers, but also serve to encourage policy-based research in academic circles, thereby expanding the economic research base across Malta. This, in turn serves to further promote fruitful discussions across national and international for a which ultimately lead to amore evidence-based policy decision process. However, in recent years, despite the high technical content of our research, through local media we have been also seeking to reproduce such work in non-technical language that enables the public to understand the key messages of our research.

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2.    What role does the CBM have when it comes to the financial services sector?

The Bank has two key roles that are at the core of its business which directly impact the financial services sector.

Firstly, the Bank has a seat on the ECB’s Governing Council, which is the decision-making body in respect of monetary policy. As a member of the Euro system, the Bank actively participates in decisions on monetary policy, which include setting interest rates and use of other tools to impact liquidity with the aim of achieving the2% inflation target, which in turn is conducive to economic stability. These are key elements for a healthy financial services sector.

Secondly, by virtue of Article 5(1) of the CBM Act, the Bank serves as the Macroprudential Authority, entrusted with safeguarding financial stability. A core aspect of this responsibility involves continuous monitoring and identification of risks that could impact the domestic financial landscape. As an example, the Bank closely examines data on credit growth, asset prices, and debt levels to assess vulnerabilities to detect any early warning signs of potential dangers to the financial system. Moreover, the Bank also regularly conducts stress tests to evaluate the ability of local banks to deal with adverse events, such as sudden recessions or sharp declines in asset prices. These assessments help identify vulnerabilities and quantify any additional capital needs that banks may require to withstand shocks.  The findings of these analyses are published each year in the Bank’s Financial Stability Report and Interim Report.

In view of the growing importance of macroprudential policy, the Bank has established an office dedicated to macroprudential research. This is primarily tasked with developing a tool kit, including models, to aid in the assessment of risks and vulnerabilities.

Recent experience has shown that the role of macroprudential policy of the Bank has become even more relevant given the recent limited transmission of monetary policy. When domestic interest rates do not respond to monetary policy action, this weakens the Bank’s capacity to steer domestic credit conditions through the traditional monetary policy tools. Consequently, the Bank would need to employ macroprudential measures to address financial risks that may arise from such limited monetary policy transmission to ensure financial stability locally.  The Bank has various tools at its disposal and activates those it deems more appropriate to the situation at hand. For example, in the absence of sufficient interest rate response from domestic credit institutions, the Bank in recent years has implemented targeted measures, such as the sectoral systemic risk buffer and borrower-based measures to tackle very strong credit growth related to residential real estate. By doing so, the Bank seeks to impact the behaviour of credit institutions in away that ensures that the financial system remains resilient and can continue supporting sustainable economic growth.

Collaboration with the Malta Financial Services Authority (MFSA) is another key aspect of our role. While the Bank focuses on financial stability and monetary policy, the MFSA oversees the licensing, supervision, and regulation of individual financial institutions. Together, we coordinate efforts to foster a stable and well-regulated financial sector. Since 2014, such collaboration is undertaken formally through the Joint Financial Stability Board, as established in the CBM Act. This forum aims at coordinating policy through consistent macroprudential and micro-prudential measures to safeguard financial stability in Malta.    

Apart from these two roles, which are the core of our business, the Bank is also tasked with overseeing payment systems operated by licensed financial services institutions, to ensure that they are efficient and secure, enabling seamless financial transactions both within Malta and across the Euro area, which are essential for economic activity. Additionally, the Bank offers regular liquidity operations to local banks, and under specific conditions, it has the mandate to offer emergency liquidity assistance to stabilise institutions facing significant liquidity challenges to prevent economic disruptions.

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3.    The CBM is currently very involved in improving financial literacy- why?

In their daily life people are constantly making financial decisions that impact their lives not only today, but in their near and even distant future. People need to be equipped with having at least an understanding of very basic financial concepts. For example, most people do understand the need to save some of their income because they would like to make some major expense in the very near future, or to have some resources in the event of a rainy day. However, very often people do not think so far in the future, like saving for the time of retirement, especially when they are of a young age, and upon retirement find themselves with a sudden huge drop in income and find it difficult to adjust toa reality of having to consume less in the absence of any financial planning to such event.

There are many who are at a loss as to what instrument best suits them for their given circumstances and objectivesthey would like to achieve. There is not much awareness of what financialproducts are available, which are the riskier ones, and what are their features and attributes. Usually, low-income groups as well as very young and older people tend to score lower relative to other segments of the population interms of financial knowledge. This does not only bring adverse consequences to individual citizens, but it may also have impacts on a country. For example, citizens who make wrong choices in their investment, be it a financial productor a real asset, may end up finding that they have incurred losses that would require them to rebuild their savings and hence cut back on consumption which could impact overall economic growth of a country. Similarly, if citizens do not care to save for their retirement period, this could result in poverty of such cohorts with pressure on governments to address such poverty and possible consequent implications to taxation, fiscal deficits, and public debt.      

As a Bank we try to equip, especially young students and their teachers, with material produced by the Eurosystem containing knowledge about price stability and the work of Eurosystem central banks. From our end, we also produce our own material to educate the public, like for example, we recently published an introductory overview of the bond market as a basic guide for investors to understanding bonds. We also organise school visits to the Bank to explain to students the role of the CBM and our interactions with the Eurosystem. As providers of bank notes and coins to the public, we also provide education to both the wider public and professional handlers of cash, such as retail shops and businesses to increase the awareness of differentiating genuine banknotes and coins from counterfeits. We also undertake presentations at schools in this regard, this year reaching out to some 1,800 students.

Of course, we are not alone in trying to improve financial literacy across the island as there are other institutions and organisations that do such kind of activity, and their efforts are most welcome and commended. Certainly, there is still much more that needs to be done in this regard and our efforts will not diminish.      

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4.    The role of the CBM with regard to the Digital Euro and Digital finance

The Digital Euro is a very important project for the Eurosystem, and the CBM is very actively involved since inception of this project. In 2021, the Governing Council of the ECB had appointed a High-Level Task Force (HLTF) to investigate the need for a digital currency and provide an overview of possible design features of a digital currency, and its implications from a monetary policy and financial stability perspective. CBM is part of that task force and work on the investigation phase was concluded in October 2023.

The aim of the Digital Euro is to provide the opportunity to all European citizens to use central bank money in all kinds of payment channels through which they transact. Currently, central bank money takes the form of banknotes and coins. While citizens can use such means to pay in face-to-face transactions or in a physical store, they cannot do so through digital payment channels, such as in online purchases. Therefore, the scope of the Digital Euro is to complement the use of cash, rather than replace it, especially given the evolution of payment trends where digital payment channels have become increasingly popular. Apart from making life easier to citizens and ensuring privacy in the same way as banknotes do, there are also other benefits from its introduction, like safeguarding the strategic autonomy of Europe’s payment system.  

Although the European Commission had issued a legislative proposal on the Digital Euro in June 2023,which to a significant extent was in line with the design features proposed by the ECB’s HLTF, however, such legislative proposal is still at the consultation stage and no decision has been taken as yet by the European Council and the European Parliament on the approval of such legislative package. Not coincidentally, such legislative proposal was launched concurrently with a legislative proposal on the legal tender status of banknotes and coins, and an eventual digital euro. In this regard, CBM also provides its opinion and input to Ministry for Finance in their discussions at the European Council on such consultation process.

Nevertheless, the ECB has moved on to the next phase of the project, naturally conditional to the approval of the legislative framework and any eventual changes to it. The first part of the current phase essentially relates to the finalisation of the scheme rulebook, which aims to provide a single set of rules, standards and procedures to ensure a harmonised digital euro implementation and user experience across the euro area. It also comprises work on selecting service providers to develop the different components of the digital euro product.    

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5.    The role of CBM with regard to Retail Payment Strategies

An efficient and reliable payment system is essential for the functioning of an economy. Payment systems are essential for both payments between residents themselves as well as for cross-border activity which was growing very strongly at the retail level with online purchases even before the pandemic, but more so during and after the pandemic. The CBM is entrusted to oversee and regulate the operation of both domestic and cross-border payments, with authorisation required from the Bank before such institutions can operate.

However, the Bank is also a provider of payment systems itself. It operates the TARGET2-Malta, forming part of the European System of Central Banks real-time gross settlement system, currently for euro payments among credit institutions but in the coming year it is expected to be extended to licensed financial institutions in the Euro area.

As regards to retail payments, ideally this should be left to the private sector with credit institutions usually providing their services to financial institutions and payment service providers to clear their customer’s transactions. However, in2020 the Bank created its own payment solution, MTEUROPAY, to credit and financial institutions and payment service providers to clear retail payments in euro for the customers of these entities. This enabled smaller credit institutions to have a lower cost alternative to direct participation inTARGET2. The direct participation of financial institutions and payment service providers in MTEUROPAY enables them to execute SEPA transfers in euro of their customers without them needing to establish a relationship with a credit institution. Nevertheless, the CBM has a very rigorous vetting framework in its onboarding process and subsequently in transaction monitoring once they are onboarded and begin their direct participation. Currently we have 11 direct participants, with another three in the process for onboarding, and another two at the application stage.  

As you may be aware, the European Commission has this year decided that in 2025 it will be mandatory for all credit and payment institutions to process customer payments within 10seconds of the release of a payment instruction by a payer. Europe’s Target Instant Payments System (TIPS) will allow customers to better manage their finances with a system that works 24/7 and 365 days a year, allowing both retailers and their clients to be aware of their financial position in real time. The mandatory introduction of such rule was necessary as banks in Europe, including Malta, had not invested in speeding up their payment processes and the Euro area had fallen behind compared to other jurisdictions. CBM will also offer its customers, mainly government and its entities, who are accountholders at CBM, with such service.      

6.    What is planned for the coming year?

For 2025, the Bank will be engaged in implementing a number of projects. One of the most important projects will be that of providing instant payments to our customers incompliance with EU regulations, as highlighted earlier. This will be indeed also applicable to all domestic banks and payment service providers. In January, the Bank will be able to receive instant payments for its customers, while inline with the EU regulations, before September of 2025, it will also be able to send instant payments on behalf of its customers. This means that payments received or made by CBM customers, either within Malta or with other Eurosystem Member States and Sweden, will be executed within 10 seconds.

During 2025, the Bank will continue with its digital transformation process and will be deploying new payment technology, enabling dual connectivity to the Eurosystem Single Market Infrastructure Gateway whose function is to perform basic checks on inbound messages and then route them to the relevant TARGET services, as well as routing outbound messages to Network Service Providers.

Next year, together with our Eurosystem partners, we also plan to launch a European Collateral Management System that would enable national central banks to operate a unified system in the management of assets used by credit institutions as collateral in Eurosystem credit operations.

We also plan to deploy an upgraded accounting system that would improve the Bank’s resiliency and operate more efficiently, leveraging on cloud technology. We also intend to improve further our analytical tools and statistical systems leveraging on new data science practices. For next year, the Bank plans to invest to strengthen further both its physical, but especially, its cybersecurity systems to increase the ability of its staff to detect and respond to ever increasing attempts to breach the Bank’s security systems.    

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