Setting up a development bank is a positive move in Malta’s small local financial market. Financing for local projects has, so far, been limited to lending provided by two large and a number of smaller commercial banks. These banks do not normally lend on a long-term basis, except for home loans. Moreover, evolving banking regulation penalises banks that lend on a long-term basis by insisting they hold more capital and reserves because such lending is considered riskier.
Therefore, the establishment of a development bank is good news for those seeking long-term financing as well as for the government that may want to invest in infrastructure projects that have an economic and social element.
The Deputy Prime Minister, Louis Grech, has said that the European Commission has given the green light to the setting up of a development bank in Malta. This publicly-owned bank will offer financing to small and medium-sized enterprises and to large infrastructure projects. Most EU countries already have development finance institutions to stimulate economic growth, especially where financial market failure is evident.
A functioning financial market is vital to economic growth. Yet, in reality, some financial services are under-provided in a free market setting either because of tough regulation on commercial banks or because of the high-risk profile of borrowing proposals.
While stressing that the development bank will be a non-profit institution, Mr Grech pointed out that it will be expected to follow prudent banking practice and only finance projects that are commercially viable. There may be more than meets the eye there in the wake of recent reports and statements about bank lending. What matters is whether this bank will indeed fill the gaps in the local financial market without burdening taxpayers with losses caused by over-generous lending.
The Commission insists that a government-owned development financing institution should not be used to facilitate State aid to private or public entities that find it difficult to borrow from commercial banks because of weak business models. Following the 2007 financial crisis, EU institutions like the European Investment Bank, the European Fund for Strategic Investments and the European Investment Fund set up schemes to support SMEs and public infrastructure projects.
The funding model to be adopted by the new development bank relies on commercial banks undertaking due diligence and project-sustainability studies with the government providing guarantees to the lending that, at least initially, will be made by the commercial banks themselves. This model has already been adopted by the European Investment Fund that works with local banks to provide finance to SMEs on favourable terms.
It is essential that the arm’s length relationship between the development bank and commercial banks is effective. Commercial banks will be expected to carry part of the risk of any lending they approve and not rely solely on the sovereign guarantees given by the development bank. Ultimately, the lending approved by the development bank is guaranteed by taxpayers’ money. It is equally crucial that, if and when the development bank needs to raise new capital from the public, it becomes a regulated institution like all other commercial banks.
Whether the cooperation between a public investment bank and private commercial banks becomes a marriage made in heaven will depend on a shared understanding that sustainable economic growth can only emanate from commercially viable projects.