Confusing banking sector

It has been a confusing fortnight for investors, depositors and borrowers in the banking sector, with interest rates and profits as the causes. Underlying the developments is the fact that competition is working but in unequal measure.

On the profits front, some of the smaller banks performed much better than the big guns. Whereas the latter signalled or reported reduced profits, the former achieved record levels. Investors will ask how can there be such divergence.

Technical answers can be given. Pertinent comments would be more useful from the big banks themselves. That can and probably will happen at their annual general meetings, which are, however, months apart.

On the interest rate front, a table (not attempted in this short article) setting out how Malta's banking community responded to the latest half-a-percentage-point cut in interests by the European Central Bank's would show further divergence.

Some banks, our two big ones included, did not follow the ECB's lead. Had they done so deposit and lending rates would have come down further, with the former becoming more negative after allowing for inflation. The banks, which held firm, attributed their decision to the interest of depositors. Another reason put forward was that borrowing interest rates in Malta compare well with those in the rest of the eurozone.

There is much to say for the banks' arguments on both counts. It should also be observed, however, that by not changing interest rates again on both sides of their balance sheet banks safeguarded their profit outturn. Because of term deposits, banks are tied to continue to pay interest at an unchanged rate, in contrast to earlier reductions in lending rates when debit interest rates are also changed.

In further contrast, several of the smaller banks did go part of the way to changing their lending rates but were careful to keep away from deposit rates. Again, there are technical reasons for this, including the comparative sizes of loans and overdraft portfolios and of the deposit base. Not least in view of the implications to profits, further elucidation by the banks would be in order.

The most contentious factor in a fortnight of contrasts came about in regard to the way banks price for the risk they take when lending. Risk exists and varies with each borrower and in different general situations. The banks must cover it, in the interest of both their shareholders and their depositors, to whom they are also liable for the good running of their business.

At a time when interest rates have been heading downwards and just before the ECB came up with its latest cut in order to try to stimulate economic activity in the context of a deepening recession, HSBC Malta shocked a considerable number of its borrowers. The bank moved to raise debit interest rates, increasing by one per cent the margin it charges above its base rate. Thereby it began charging a margin of at least 2.5 per cent instead of at least 1.5 per cent and, in some cases, less.

Affected borrowers cried out in pain and disbelief. One can understand why. We are living in riskier times. Yet, that is not to say that all risk has increased by some two thirds as the rise in HSBC's margin implied. In fact, not all the banks acted as HSBC Malta had done, adding to the contrasting developments.

There is a widespread suspicion that the increase in the lending margin above base rate is not merely related to higher risk within the unfolding situation but is also intended to restore lost profitability. The way bank charges have also tended to go up supports that view.

It's a free market and banks can act as they feel suits them best. It is also a competitive market and borrowers can move if they want to, though they would have to take into consideration the not inconsiderable cost of doing so. Nevertheless, given the tight economic situation and the efforts to cushion it made by monetary authorities and governments, our own included, banks are not necessarily helpful with their priorities.