Governor, minister expect banks to pass on full rate cuts

The Central Bank Governor yesterday said he expected banks to pass on the full benefit of the recent ECB rate cuts to customers.

On Thursday, the European Central Bank slashed rates to 2.5 from 3.25 per cent, a historic reduction.

Addressing the Institute of Financial Services' annual dinner, Governor Michael Bonello referred to a recent statement issued by the ECB's Governing Council, of which he forms part, saying the council expected the banking sector to make its contribution to restoring confidence in the midst of the economic and financial crisis.

Mr Bonello quoted ECB President Jean-Claude Trichet saying that after central banks and governments had taken bold decisions to counter the crisis, commercial banks too were expected to live up to their responsibilities, especially at a time of deteriorating growth prospects.

"With bank lending rates in Malta generally set with reference to official policy rates, I would expect bank customers, particularly those whose borrowing promises most to support domestic economic activity, to benefit fully from the recent ECB rate cuts, which have totalled 175 basis points," he said.

His call was backed by Finance Minister Tonio Fenech, speaking at the same event, who said the government expected bank customers to benefit fully and unreservedly from ECB rate cuts.

"To do otherwise would betray your own customers and in my opinion would be very short-sighted," he said.

Contacted yesterday, both Malta's major banks, HSBC and Bank of Valletta, said they were considering their response to the ECB's interest rate cut.

Last month, following an earlier ECB rate cut, the Malta Chamber for Small and Medium Enterprises (GRTU) urged the government to take action against the attitude being shown by Maltese banks which, it said, were not lowering interest rates as much as they should.

Mr Bonello yesterday gave the background to the international financial crisis. As it unfolded, the Bank was in continuous contact with the MFSA and the Finance Ministry and had taken steps to obtain more frequent balance sheet data from credit institutions.

The government gave a commitment to protect financial institutions and depositors, and in the light of similar steps taken elsewhere, decided to raise the guarantee provided on bank deposits to €100,000.

Mr Fenech said this was intended to give depositors additional peace of mind and maintain confidence in the banking system and in the institutions that monitored and regulated them.

He said Malta was now ready, together with the Central Bank and the MFSA, to meet the European Commission's proposals to strengthen the Maltese Depositor Compensation Scheme by the end of 2009, but sooner rather than later.

"We have achieved a place among the 10 soundest banking systems worldwide according to World Economic Forum, and we want to improve this position in real terms. Ultimately, this is the surest signal that our systems are robust and that depositors can trust our financial institutions," he said.

Meanwhile, Dr Bonello said the crisis, so far, had had a limited impact on the domestic financial system and on the Maltese economy. While the latest data point to continued, if slower, economic expansion in the third quarter, Maltese banks continued to benefit from an approach based on traditional intermediation between retail depositors and borrowers.

"It would be naïve, indeed dangerous, to expect that the turmoil abroad will leave the Maltese economy and its financial system unscathed. Malta has a small open economy, highly dependent on trade," he warned.

"As the recession grips our major markets, Maltese exporters will be increasingly affected. As the export sector comes under pressure, this will have an adverse effect on domestic demand.

"Accordingly, the bank's growth projections for 2009 have been revised downwards to under two per cent. This, in turn, could have repercussions for the banking system as asset quality deteriorates," he said.

Moreover, he continued, partly because of the small size of the economy, bank loan portfolios were highly concentrated and domestic banks were directly exposed to the construction, mortgage and property development sectors to the extent of over 50 per cent of total loans, and in the form of collateral securing other lending.

Recent international experience showed that strong increases in property prices fuelled by rapid growth in credit were unsustainable. House prices could not rise faster than incomes indefinitely, otherwise housing would simply become unaffordable. In the September quarter, the Bank's property price index, based on advertised prices, fell moderately compared to a year earlier, said Mr Bonello.

"While domestic banks have been more prudent than banks abroad, the continuing high dependence on property as a driver of credit growth, and as collateral for other lending, remains a source of risk," he warned.

The Governor stressed that Malta needed to ensure it maintained its reputation as a sound and well-regulated financial services centre.

He said the institutional links between the Central Bank, the MFSA and the Finance Ministry could be strengthened further in the light of this current climate, adding this would be of mutual benefit.

Safeguarding the health of the financial sector in these challenging times also called for prudent behaviour on the part of the market players themselves.

"The current crisis will not be over until confidence and trust are restored and the credit channel starts to function fluidly again. This requires greater transparency and a recognition that a sound financial system is one that practises the traditional banking values of integrity and faithfulness."

Mr Fenech said there was still a lot of potential growth in financial services, especially in such high-value-added areas as portfolio management, fund administration and captive insurance.

The MFSA was currently looking into the possibility of allowing Islamic finance to be offered from Malta's shores.

"Considering our geographic proximity, existing investment links and good relationship with the Islamic world, this may prove to be a worthwhile initiative."

The financial services industry continued to increase its contribution towards economic growth and job creation in spite of the difficult international situation, Mr Fenech said.