Malta and Cyprus joined the EU in 2004 and although the island economies share many similarities Kurt Sansone explains why the Maltese banking system is unlikely to suffer the same fate as that in Cyprus.

Why has Cyprus been brought to its knees?

The Cypriot economy was doing well and was relatively unscathed by the global recession in 2009. The problems began when neighbouring Greece faced financial and economic meltdown. For historical reasons Cypriot banks had a high level of lending in Greece and invested heavily in Greek government bonds.

However, bondholders in Greece were forced to give up substantial sums owed to them by the Greek government this was described as a haircut under the terms of a bailout package agreed last year. Cypriot banks suddenly found themselves with a gaping hole in their finances as a result of their exposure in Greece. The Cypriot government wanted to stand in for its ailing financial institutions but given the size of the banking sector it asked eurozone members for a bailout.

How big was the Cypriot banking sector?

This was a crucial question that eurozone member states, particularly Germany and other northern neighbours, were asking. The assets held by Cypriot banks accounted for eight times the countrys economic output (GDP), which explains why the Cypriot government did not want its banks to fail but did not have enough financial clout to step in and salvage them.

Russian money was often mentioned as being a problem. Why was this?

The Cypriot banking sector was awash with money from Russian investors and depositors, who utilised the favourable tax regime and rather lax rules in the Mediterranean island to park their funds there. Some of this money was derived in a legitimate way but a big concern for eurozone members was the more dubious nature of a substantial part of those funds. This money circulated in the Cypriot economy through the banks.

What happened then?

On March 16, the first bailout package with Cyprus was agreed and this shook the system. Cyprus would benefit from a 10 billion bailout on condition the Government raised an additional 5.8 billion. The Government, under pressure from eurozone members, opted to introduce a levy on bank deposits to raise the money.

All savers would lose six per cent of their deposits, with the levy going up to 10 per cent for deposits over 100,000. According to financial experts, this decision would have blown to smithereens the European deposit guarantee on savings under 100,000.

This scheme was introduced at European level and ensures that savings of small-time depositors are protected if a bank fails. Cypriot lawmakers voted against this package deal and Cyprus returned to the negotiating table.

Why were banks closed and withdrawals limited to 100 per day?

The original proposal shocked people because it meant that bank deposits, until then considered to be a very safe investment, were no longer untouchable. Not even deposits under 100,000, which were supposed to be guaranteed, were safe. To avoid panic withdrawals from banks, which would have caused an instant collapse of the system, the Government imposed strict controls that had ordinary Cypriots fuming.

How was the bailout deal revised?

In the early hours of March 25, eurozone finance ministers hammered out a final deal. Cyprus would get 10 billion in bailout money on condition that it would wind down Laiki, the second largest bank. Depositors with bank funds of less than 100,000 were spared the pain, a move aimed at maintaining the European deposit guarantee on savings. But those with amounts in excess of 100,000 stood to lose as much as 40 per cent of their money or even more.

Eurozone finance ministers, the European Central Bank and the International Monetary Fund wanted bank depositors and shareholders to shoulder part of the expense to restructure the Cypriot banking sector.

Addressing journalists after the deal was struck, European Commission president Jose Manuel Barroso said the banking sector in Cyprus had to be cut down to size because it was unsustainable.

Why were questions raised about Maltas banking system?

In the aftermath of Cyprus, some sections of the international press asked whether the banking sectors in Malta and Luxembourg were next to face the chop. They premised this argument on the fact that both countries, like Cyprus, were relatively small with banking sectors much larger than their GDP.

How big is the banking sector in Malta?

Official statistics show the banking sector is eight times the countrys GDP, almost similar in size to Cypruss.

Isnt this problematic?

Not necessarily. It is not just a question of quantity but also of quality. If size alone determines whether a country is in trouble, then most EU countries, including the UK, would face similar unsavoury prospects. The problem with Cyprus was the quality and structure of the banking sector that left it exposed.

Despite the size of Maltas banking sector, assets held by the more important banks are slightly more than twice the countrys GDP. This is half the EU average.

More importantly though is that the vast majority of deposits and loans administered by these banks are domestically derived. Maltese banks have very little exposure to foreign government bonds, have more than enough cash reserves to cover their loan portfolio and adopted over the years a very conservative low-risk approach to investment.

Which are the all-important banks?

There are five banks: Bank of Valletta, HSBC, Lombard, APS and Banif. These banks have a widespread branch network, provide a full spectrum of banking services and are core providers of credit and deposit services. In financial parlance, they are considered systematically important to the economy and referred to as core domestic banks. According to the Central Bank of Maltas Financial Stability Report, these banks hold assets that are 223 per cent the countrys GDP just over twice.

Why are these banks important to the economy?

Banks are considered to be the lifeline of an economy. These banks provide credit to individuals such as loans to buy houses, cars and to make home improvements which in turn is spent on goods and services but more importantly they provide loans through which businesses can expand, operate and create jobs. They manage to do this by using the money that individuals and institutions deposit with the banks in savings accounts. They credit depositors with interest and make money by charging higher interest rates to loans.

What about the other banks?

A second category is made up of non-core domestic banks that play a more restricted role in the economy. The volume of operations and banking services they offer to residents are somewhat limited. They hold assets that amount to 77 per cent of GDP. These banks are: Bawag, Credit Europe Bank, Fimbank, IIG, Izola, Mediterranean Bank, Sparkasse and Volksbank.

A third category is made up of 13 international banks that have virtually no links with the domestic economy. These banks hold assets that are 500 per cent of GDP (five times the size of the economy) and are responsible for inflating the size of Maltas banking sector.

Arent the international banks important to the economy?

Yes and no. They help create ancillary jobs in the financial services sector but their funds are derived from abroad and the money does not circulate in the domestic economy. This is why they are not considered to be intrinsically important and so less problematic.

I am confused. How is this different from Cyprus?

It is easy to get lost in this maze but in very simple terms the Cypriot problem affected the core domestic banks that played a crucial part in the islands economy. In the words of Central Bank Governor Josef Bonnici, any comparison with Cyprus is misleading.

The Maltese core banks are nowhere near their Cypriot counterparts: they are smaller, more conservative and generally risk-averse.

This attitude in the past has earned the Maltese banks rebuke from the business community because of the difficulty to access credit facilities. Since the global recession, banks have tightened controls when issuing loans.

Talking big

A study by J.P. Morgan in 2010 had calculated assets of key global banks as a percentage of their home countrys GDP. The data of individual banks is presented here to compare with the size of Maltas five core banks put together.