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Interest rates and bank profits

The Central Bank is one of the most important insitu­tions in the land, and that of governor one of the highest positions. Charged with setting monetary policy, alongside the Ministry of Finance, the bank held strong sway over the banking system. Times have changed.

Years ago supervision of the banking system moved to the Malta Financial Services Authority. At the time there was a tendency abroad to effect such a division. As a former central banker I was among those who did not welcome the move in Malta. Records, experience and wisdom concerning bank supervision resided at the Central Bank, which had passed through a lot since it was set up in 1967.

Nevertheless the move was effected. In retrospect one cannot say that it brought about negative effects. Supervision of the banking system remained strict, both in terms of banks already operating in Malta and in terms of the large number of new banks set up. A number of these, about four, were aimed at the domestic market, competing with one another and with the smaller Maltese banks and with the two banks which dominated the sector.

The rest, about 20, targeted the foreign sector and did not depend on local deposits or foreign loans for their funding and other operations.

In both cases the Malta Financial Services Authority exercised strict control, seeing to it that the banks were well funded and ran their operations smoothly.

That responsibility remained with the authority even after the biggest shift in central banking took place. That occurred when Malta joined the European Union and our central bank became part of the European Central Bank network.

That development meant that the Central Bank and the Ministry of Finance gave up to the European Central Bank a major part of monetary policy – to control interest rates.

The Central Bank still retained an important role in the local monetary set-up. It also plays an essential role in being part of policy development at the European Central Bank and reflecting its measures in Malta.

One important function which the Central Bank retained after the hiving off to the Malta Financial Services Authority was the setting of the key feature of interest rates. Although hardly ever used, the bank retained its function of lender of last resort to the banks. It also remained the bankers’ bank, offering the rest of the banking system an outlet for their excess liquidity and, mostly theoretically in view of the high level of liquidity within the domestic banking system, a supply of liquidity if required.

Finance ministers have imposed a one-off tax on bank profits. It happened once in Malta as well. It could happen again

One function which the Central Bank did lose was that of influen­cing interest rates. It reflected the basic rate set by the European Central Bank, but not the limited leverage the bank had in the past.

As a result the domestic banks, essentially the big two – Bank of Valletta and HSBC Malta – have gone their own way as far as interest rates go. They have stopped following the guidance given by the European Central Bank, which has cut rates to record lows, approaching zero.

As a result, borrowers in Malta pay a premium on their loans and overdrafts from the domestic banks, because a couple of years ago the banks stopped following the reductions in the ECB’s central rate. As a result, borrowers from the local banks pay substantially higher rates than most of their counterparts in the eurozone.

Concurrently, depositors also receive lower interest rates on their placings with the local banks. But in terms of monetary policy it is the borrowing rate which is the most important factor.

Not so long ago the Governor of the Central Bank revealed that he had tried to exercise moral suasion on the banks to nudge them into lowering their borrowing rates. Probably as a sign of respect the Bank of Valletta made some minor adjustments in deposit rates, passing to depositors a small part of the profit it makes through the margin between deposit and borrowing rates.

Not so HSBC Malta. The bank cocked a snook at the governor and, in public at least, ignored him completely. In their respective regard the Maltese banks found an unexpected ally in the president of the Chamber of Commerce, Enterprise and Industry (STOM April 20). David Curmi pointed out the obvious: that banks had to build up their reserves, not least in view of demands made and soon to be strengthened by the European Central Bank.

What the valid observation does not take into account is the level of profits made by the banks. Profits is why their shareholders are in the business of banking. But that is not the whole story. They also have social responsibility.

Elsewhere such an attitude has drawn a sharp response. Finance ministers have imposed a one-off tax on bank profits. It happened once in Malta as well. It could happen again. But a better alternative would be to give something back to borrowers and lenders. They are the people directly affected.

In the final analysis, monetary policy has to be made active again.

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