At the global level, we are living at a time of recovering but weak demand, slow economic growth and declining price pressures. Many of our euro area neighbours are going through a period of correction in prices, wages and work habits that will eventually restore their competitiveness. The resilience of the Maltese economy will continue to be tested by weak demand for our exports and heightened competitiveness abroad. We have to safeguard and promote the engines of our economy – producers of goods and services, consisting in large part of SMEs.
In pursuit of its mandate, the European Central Bank has introduced various measures that also serve to support sustainable economic growth. It is for this reason that the ECB cut policy rates to historically low levels, with the added assurance that the rates will remain low for as long as necessary. This growth-friendly policy is meant to reduce the cost of investment, raise productivity and stimulate economic growth. We are now seeing some steady, but uneven, progress towards economic growth and financial markets stability.
Unfortunately, a number of countries, particularly those with stressed economies, have been unable to benefit from this low interest rate scenario because bank lending rates to businesses, particularly to SMEs, have remained high. There remains a disconnect between the ample low-cost liquidity and the actual flow of credit. Indeed, the gap between the rate at which banks can borrow from the ECB – the Main Refinancing Operation (MRO) rate – and the rate at which banks charge to SMEs, has been stubborn in the case of stressed countries. The situation is different in the remaining countries, where lending rates are significantly lower and have generally followed the downward path of the MRO.
The situation in Malta is quite odd. We should really be in the same boat with the non-stressed group of countries, including Austria, Belgium, France, Germany, Luxembourg, and so on. Remarkably, lending rates in Malta are not only higher than those of our peer group, but also higher than those of the stressed group. In fact, average lending rates to Maltese businesses exceed the five per cent mark, compared with 4.6 per cent in the stressed country category and 2.8 per cent for the non-stressed.
Certainly, looking at Malta, these are not credit conditions that sustain economic growth. Meanwhile, it is interesting to note that bank deposit interest rates in Malta are in line with the euro area average.
It is hard to justify lending rates in Malta which are even higher than those in, for example, Spain, an economy with an unemployment rate of over 25 per cent and a generally higher level of risk. Malta’s lending rates are similarly higher than those in Italy and Ireland. Certainly, the overall risk in the corporate sector of these countries is elevated, and still their lending rates are lower than ours.
An important issue is the profitability aspect. Although Maltese banks are predominantly funded by retail deposits, they are among the most profitable in the EU with a return on equity of nearly 20 per cent when compared to 5.8 per cent for the average of EU banks. Also, the ratio of net interest income to total assets is significantly higher than on average in the EU.
The Maltese banking sector has been a major contributor to the growth and resilience of the economy. Not only are Maltese banks among the most profitable in the euro area, their level of liquidity is also very high. Still, the growth rate of aggregate credit turned negative in 2013, driven mainly by weak lending flows to the non-financial corporate sector. Negative credit growth has been observed not just in the deleveraging sectors such as in construction, but also in other business areas including accommodation, wholesale and retail and manufacturing. In fact, the household mortgage market has been the only sector to register a positive performance.
It cannot be claimed that weak credit growth is due to insufficient demand by borrowers. Indeed, the success of the Jeremie programme – which had to be topped up by additional funds on several occasions – proves the contrary. Moreover, recent information from the Bank Lending Survey suggests that demand for credit by small and medium enterprises has been positive. There may be cases where businesses are discouraged from planning future investments and applying for credit, because of the prospect of high-cost borrowing.
As mentioned, a number of stressed countries are going through an internal devaluation, including wage cuts, that strengthens their external competitiveness and as a result they have already experienced a modest export-led recovery. Going forward, the Maltese economy needs to retain its competitive edge by continuing to diversify the economy into high value added economic activities. Certainly, lending rates represent a major component of the business costs and we need to ensure that the cost of investment is not excessively high.
Josef Bonnici is the Governor of the Central Bank of Malta.