Central Bank doubles its foreign financial assets in a decade
The Central Bank of Malta is entrusted to manage the country's official financial assets (more commonly known as Reserve Assets) consisting of both foreign currency and euro denominated financial assets, which were valued at €2.1 billion at the end of 2021.
The composition of the Bank’s financial assets has evolved over time. For example, the Bank’s fixed income holdings are now more geographically diversified, while new asset classes, such as equities, have been added to the Bank’s more traditional financial assets, like bonds and gold. This increased diversification was also necessary to respond to a prolonged period of ultralow interest rates that negatively affected the Bank’s interest income. It also aims to improve the Bank’s risk adjusted returns over the medium to long term, whilst ensuring an adequate level of liquidity and capital preservation in line with pre-established risk parameters.
The largest part of the Bank’s assets is held strategically with positions built up gradually over time and held for a longerterm basis. This is especially the case for interest bearing assets. However, a smaller portion of the Bank’s financial assets are traded on a tactical basis, and thus holdings can increase or decrease depending on the short to medium term view of financial market conditions.
While the Central Bank generally seeks to maintain some exposure to certain assets like gold over time through various instruments, it also engages in profit taking when it has a view that the price has risen significantly, and gradually rebuilds the position by taking advantage on episodes it views as dips in the market.
For example, in 2020 the Bank took a view on gold by buying a significant quantity and subsequently selling it making a record profit as shown in the accompanying chart. This year, the price of gold in euro terms had risen significantly in early March due to the RussiaUkraine war, but subsequently dropped by more than 10% as major central banks continued to hike rates to bring down inflation, exerting downward pressure on its price. While gold is viewed by market players as a safe-haven asset, it has remained under pressure despite recessionary concerns. Gold is also being undermined by a stronger US dollar. In such environment, it would be prudent to adopt a cautious approach when investing in such asset class.
Gold holdings, for a long time, have constituted a very insignificant portion of the Bank’s total official foreign assets, which also include special drawing rights, the Bank’s reserve position in the International Monetary Fund (IMF), foreign currency assets originating from non-euro area issuers, as well as financial derivatives . As shown in the accompanying chart, holdings of such assets are at their highest level in more than a decade as the Bank continued to increase its stock of securities originating from non-euro area issuers. Meanwhile, the return generated on gold has in general contributed to only a very limited extent, excepting in 2020, to the Bank’s profits over time as shown in the chart.
Despite the low interest rate environment, which has provided significant challenges to the Bank in maintaining its return on such holdings for several years, the Bank, by putting aside part of its profits before being distributed to its shareholder (the Government of Malta) has progressively built a stock of provisions, as well as its capital and reserves. These serve to provide cover during a rainy day, and such buffers are currently also at their highest level in more than a decade.
During the past two years, environmental sustainability has featured high on the Bank’s agenda in the management of its financial assets, alongside safety, liquidity and return. The Bank is seeking to reduce its longer-term risk on its balance sheet coming from exposures to issuers that could in time become stranded should they fail to address climate risks, whilst at the same time invest in issuers who are actively seeking to have a positive environmental and climate impact. As a result, the Bank started to invest in equity mutual funds and exchange traded funds that track a sustainability or low carbon index. During 2022, the Bank also began investing in funds whose underlying investments aid the transition to low carbon economies, whilst continuing to invest in green, social and sustainability bonds. The Central Bank of Malta aims to publish its first climate disclosure report in 2023, while it remains committed to hold and manage its financial assets as established in the Central Bank of Malta Act.
Alexander Demarco is Deputy Governor of the Central Bank of Malta