There were mixed reactions to the government’s announcement that a development bank would be set up which would be supervised but not regulated, with the Central Bank governor Mario Vella convinced that this will not mean a carte blanche but other observers had more questions than answers.
“‘It is quite normal for a development bank not to be regulated. They come into the picture because of market failure and that is a consideration that the EU has always given to initiatives of this sort: it is a justified state aid measure under EU state aid rules.
“Although the development bank is not meant to be state aid, it is there with certain social development criteria,” Dr Vella said.
“In getting EU clearance for the launch of the Malta Development Bank (MDB), researched evidence had to be submitted that there exists market failures for the provisioning of SME financing and for financing of infrastructure projects. This was to ensure that the MDB would complement, rather than compete with, normal banking operators.”
Asked whether the lack of regulation could leave loopholes resulting in cronyism and corruption, he was pragmatic: “Cronyism and corruption can infect anything, including development banks and the private sector. Just because they are not commercial banks does not mean that they can do what they like. I would argue that to some extent, the level of visible governance that a development bank has to go through is pretty tough.
“Unregulated’ essentially means that it would not fall under the same capital requirements, supervision and reporting procedures as commercial banks and regulated financial institutions. But they would still have to go by normal rules of banking and for this purpose the Malta Development Bank Act will provide for the formation of an autonomous Supervisory Council to keep oversight on the executive of the MDB.
“It is only the criteria that will be different and takes into account that the MDB has functions which go beyond normal commercial criteria and for this purpose MDB will be wholly owned by the public sector.
“The problem with the word ‘regulated’ is that it is very emotionally laden. I would invite you to look at the model of other development banks. We are not reinventing the wheel and it is a fairly well known model.”
A source from the banking sector, however, saw the potential for trouble down the line: “These statements can be interpreted in different ways. Commercial banks do not normally offer long-term financing except for home mortgages. So a development bank lending for long-term projects including infrastructure projects is a feasible objective. Commercial banks today are heavily regulated because this is what the political leaders of the EU want in order to protect taxpayers and bank depositors from having to bail out or bail in banks that are too big to fail but still get in trouble because they lend their depositors money imprudently.
“One just hopes that this political intention is supported at all times and not diluted through the use of ‘unregulated’ banks as the Malta development bank will be,” he said.
However, the concerns were not only about transparency. Another aspect is whether the bank was going to have enough of a presence to make a difference. For example, the new development bank will have an authorised capital of €200 million and aims to lend €1 billion. The initial capital will initially be of €30 million. One economist, who declined to be named because of possible conflict of interest, said the figures were not impressive when one considered that initially the bank will not be issuing loans itself but would just assume contingent liabilities in the form of government guarantees.
“Commercial banks consider government guarantees as prime collateral but will have to deal with regulatory restrictions on government guaranteed lending,” he said.
The European Central Bank has already made clear that it is not happy with the exposure that certain banks, including the two major Maltese banks, have with government debt in the form of Malta Government Stocks. To mitigate the concentration risk, the ECB is insisting that commercial banks should not have more than twice the value of their capital in government debts and government guaranteed lending. The ECB is also planning to introduce a risk weighting on government debt held by banks – which was previously considered to have zero per cent risk. This new risk weighting will have an impact on a bank’s capital requirements.
“One has to see to what extent local banks can reconcile the operating model of the new development bank and the mandatory regulatory requirements of the ECB,” the economist said.
Development banks were set up to make up for the lack of financing solutions for enterprises – especially SMEs – which required more equity capital because of their perceived higher risk.
This coincided with EU pressure at the political level for member states to invest more in their infrastructures to create economic activity that for some time stifled by the politics of austerity.
This combination of factors created a demand for investment banks with a different business model from that of commercial banks.
Development banks have different models so that of the Maltese one only became clear when the Deputy Prime Minister Louis Grech explained that it would “ have a prominent role in stimulating investment and growth, making access to finance easier and wherever possible, on easier terms”, operating primarily where private commercial banks failed to make “appropriate financing available”.
The bank is proposing a link between the development bank and the commercial banks: from the information that is available so far, it seems that the MDB will be issuing guarantees to local commercial banks for part of the lending that they make to certain entities that are considered as a priority for financing. Commercial banks will be expected to carry part of the risk as well as manage the exposures.
This will help assuage EU concerns that development banks may be used by governments to help private and public companies obtain state aid through the back doors of the financing market.
“One way of preventing this happening is for the Commission to insist that commercial banks are involved in the risk assessment of borrowing proposals as well as the sharing of risks with commercial banks. This is the model the European Investment Fund uses in schemes that support SMEs,” the banker said.
However, the issue of how the development bank would help SMEs is also not that clear as there are already EU and EIF schemes that use local banks to undertake risk assessment and partial participation in the underwriting of the risk involved. These schemes usually include the guaranteeing of a percentage of the loans by EU institutions like the European Investment fund. Another banker said it was not clear how the new development fund would be more generous to SMEs, as Mr Grech said.
“Hopefully help will be in the form of subsidised rates of interest rather than diluting risk analysis standards as ultimately it will be taxpayers who will be underwriting these risks. If the new development bank intends to provide venture capital as some development do, it must be clearly stated – as venture capital carries higher risks than normal commercial lending,” the banker fretted.
Apart from SMEs, the development bank would be aimed at infrastructure projects. The economist agreed that these projects usually require longer-term financing than other projects but said that as long as a proper risk analysis and feasibility justification was established, the development bank could be a catalyst to kick-start such projects.
“These create long-term economic advantages and generate short-term economic activity. The secret of success is that the infrastructure investment must indeed be economically and socially viable if they are worthy using taxpayers’ money to invest in.”