The governor of the Central Bank of Malta Josef Bonnici wants banks to reduce their interest rate margins and has been saying so since last autumn – to no avail. Bank of Valletta chief executive officer Charles Borg argued last week that SMEs were borrowing – but that the bank could not afford to reduce its interest rates because of the risks associated and without having an adverse impact on its liquidity. Times Business asked two other experts for their opinion.

Joseph Zahra

Lowering interest rates is one monetary policy tool used by central banks to boost the economy. The ECB has been using this tool (besides others) since the start of the financial and economic crisis. Lower interest rates are generally expected to make it easier for prospective investors to borrow money for their projects, be they small or large. It also encourages consumers (for example, first-time pro-perty buyers) to take up mortgage to buy their homes.

The ECB expects that its decision to lower rates will be reflected throughout the economies of the eurozone. Interest rates in Malta move much faster downwards on the bank deposit side but move stickily on the lending side, mostly because of the margin that a bank retains to cover its processing and overheads costs and its consideration of risk. Of course, the intensity of market competition between banks is another influencing factor.

A number of factors are keeping lending interest rates high in Malta compared to other countries in the eurozone. The fact that there are two big banks that between them have more than 90 per cent of the local credit market is a strong contributory factor. We should be seeing more competition in the future as the new commercial banks operating the market take up larger market shares and therefore put more pressure on the bigger banks’ margins.

The crisis in the banking sector in Europe in these last years has also prompted the ECB to run a comprehens-ive assessment of the banking sector in the form of asset quality reviews, besides the stress tests that were running for some years. This has imposed on banks (including those in Malta) the need to take a more serious look at their credit exposures and provisions, and the quality of their collateral. This makes them hesitate at this point to push down interest margins, not knowing the results of the asset quality reviews, which could mean increases in capital and higher provisions.

Shareholder pressure on the two big banks to increase further their profitability also has an influence on changing their interest margin policy. The question arises: does this mean that the banks make better use of their earned income than businesses? Which of the two have a stronger accelerator effect on the economy? It seems that the underlying assumption being made here is that bankers are better investors than business.

It is good to keep in perspective, however, that the demand for credit by business is not influenced only by price (interest rate). The composition of this demand depends on cultural factors – how strong is entrepreneurship in Malta? Is demand mostly coming from a few sectors, e.g. construction, property and tourism? A concentration of credit risk does not encourage the lowering of interest rates.

It is only with increased competition in the banking sector, with the big banks improving their efficiency, and with a more diversified demand for credit, that interest rate margins can be pushed down. If we were only to extrapolate the present situation to the future, we would be living with high interest margins for quite some time. The governor is right in challenging the status quo.

Joseph Zahra is a former Bank of Valletta chairman.

Francis Vassallo

I am not going into the causes of the financial crisis; however, the bottom line was that some banks had to close down and others were taken over either by the State or by larger banks. Still others were bailed out using billions (if not trillions) of euros, dollars and pounds injected into these banks by the various states.

Simultaneously, in a coordinated programme, the ECB, the Federal Reserve in the USA and the Bank of England reduced to practically 0 per cent the rates at which banks could borrow from their respective central banks in order to finance their balance sheets. Troubled banks had virtually unlimited access to funding from their central banks. This was necessary because credit in the market had dried up almost completely. Many troubled banks relied almost entirely on central banks for their funding.

This programme of providing unlimited funding to banks and pumping liquidity into the economy, colloquially known as ‘printing money’, lasted for several years. Even now, the rates at which banks can borrow from their central banks are still extremely low (less than one per cent). A side effect of lower interest rates is that commercial banks have also been able to reduce the deposit rates paid to their customers. This further reduces the overall borrowing costs of commercial banks.

One of the principal purposes of keeping interest rates this low is to allow commercial banks to lend to their customers at reduced rates. The aim is to use commercial banks to inject liquidity into the economy and to cause the wheels of economic activity to start turning again.

The availability of lower interest rates on loans would make it economically feasible for entrepreneurs to initiate new projects that they would otherwise not be able to enter into profitably, thus creating jobs. New jobs create higher demand for consumer goods, resulting in more economic activity, more jobs and more profits for businesses to reinvest.

Overseas, banks have passed on lower rates to their customers, resulting in increased economic activity and the beginnings of a sustainable economic recovery in countries such as the US and the UK. In contrast, in Malta the commercial banks have taken a completely opposite approach. They have taken advantage of lower prevailing interest rates to reduce interest rates paid to depositors, but they have stubbornly refused to reduce the lending rates to companies. The Central Bank of Malta cannot force banks to lend at lower rates and can only use moral persuasion to convince them to reduce lending rates. This attempt to convince commercial banks that they are morally obliged to pass on lower rates to their customers has not worked at all. It seems that these banks have created a sort of ‘lending cartel’ and have ignored the governor’s plea to reduce lending rates.

This is not just the governor’s wish, but a serious economic imperative for Malta. The result of this refusal is that the banks have been generating extraordinary pro-fits, substantially in excess of historic levels, without giving something back in the form of lower lending rates. In general, a profitable banking sector is a good thing, as it helps to ensure healthy and sound banks. However, equally important is a growing economy that produces new pro-jects, jobs and a thriving business sector.

The attitude of Maltese banks is rather shortsighted, as the economy is managed through a combination of fiscal and monetary policies. While the ECB has created a very lenient monetary policy, Maltese banks have not followed through by passing the advantages of low rates to their customers. If Maltese banks continue with this stubborn and counter-productive attitude, there is a risk that the government might impose special temporary fiscal measures in order to achieve the desired result of a growing economy.

Francis Vassallo is a former Central Bank of Malta governor.