Paying through our noses for banking services

It’s sobering to know that whether we like it or not, our sons and daughters will carry a heavy legacy of €6 billion (and growing) in accumulated national debt, which at the current GDP growth rate of 2% per annum – the highest rate in Eurozone – may take us a 1,000 years to redeem with interest.

But enough moaning, and let us look on the bright side and fully rejoice that our financial services sector is booming, and that our banks have passed all stress tests mandated by the ECB with flying colours. There are more positives considering that the 2007 recession, our banks registered double-digit growth in pre-tax profits and reported exemplary “loans to capital” ratios, as can be confirmed by a clean bill of health recently issued by Brussels.

What makes our banks so Teflon-coated? Could it be a Midas touch or the use of superior risk management techniques that has created this oasis of growth, when elsewhere in the Eurozone there has been drought?

The banking sector is divided into two distinct sectors – ‘non-core’ and ‘core’ domestic banks, like Bank of Valletta, HSBC Malta, APS Bank, and Banif Bank, which act as the main financial intermediaries providing banking services to residents of Malta. Quoting the EC’s recent in-depth review of Malta’s economy, one is surprised to read that when examining the structure of income of the core banks there are some indications that there could be anti-competitive behaviour, especially over interest rates being charged on loans.

It’s no secret that banks in Malta do not follow faithfully the ECB bank rates, such that businesses are charged 3% higher than the EU average. Central Bank governor Josef Bonnici in the past called on core banks to ‘align their margins’ with those of other European countries. “Interest rates on loans to businesses are currently around two to three per cent higher in Malta as compared to Germany, Netherlands, Finland, Austria, and Luxembourg. In contrast deposit rates offered by Maltese banks are broadly in line with those across the euro area.”

As a result, bank interest margins are higher in Malta.

A closer alignment of margins with those of our peers appears to be overdue. The recently proposed Budget measure to conduct a review of bank charges to businesses makes perfect sense to me. The IDR of 5 March on macroeconomic imbalances in eleven countries, including Malta, also examines the possibility of collusion among domestic banks to create a cartel in order to keep domestic lender rates high. The IDR’s aim revolves around the desire to keep EU economies competitive at both labour and transaction costs kept in check.

The inspections, as proposed in the IDR are another sign that competition watchdogs are stepping up their scrutiny of the financial sector as a result of the 2008 credit crunch and the European debt crisis. While not suggesting that interest rates should be lower, the Commission’s findings in the IDR show that high interest rates on loans charged by domestic-oriented banks could reflect lack of competitive pressure and without wanting to sound alarmist… it warrants closer attention.

It goes without saying that core banks have defended their interest rate margins, saying that the price of lending was based on a number of factors. Naturally if the banks face closer scrutiny and an independent audit reveals that for the past years they kept higher margins than dictated by the ECB, this may constitute a warning to reduce interest rate margins.

If a modest reduction is triggered, both the economy in general and SMEs in particular will give out a sigh of relief, but it would have a considerable impact on banks’ core operating profits, which have been hitting the jackpot since the start of recession. Ask any economist to match the return on investment by local banks to those registered in other countries and the conclusion is obvious: the profitability of Maltese banks contrasted with their counterparts in the stronger EU countries comes at the top end of the range.

The Central Bank governor has been quoted saying: “There is room for reflecting on the interest rate margins and whether they could be narrowed, which would improve the competitiveness of our economy as the banking sector provides a key input into the functioning of the economy.” The question is why has the regulator has not intervened in the past five years? Obviously, because it would affect their profitability. On the contrary, critics reply that banks could become more efficient while the whole economy will be served better by having a more competitive banking structure that nurtures growth among SMEs, and improves job creation. This is particularly relevant against the background of accelerated cost-adjustments undertaken by some of Malta’s competitor countries.

The IDR stresses that meeting the fiscal targets set by the Council under the excessive deficit procedure would put government debt on a more sustainable footing in the short-term. Obviously cosmetic adjustments of say 15 point-cuts may look wonderful in the short-term, but the real crunch comes when tackling sustainability of a full 300-point cut in the long-term.

Moving on, it is a feather in the cap of finance minister Edward Scicluna that so far the Commission has concluded that the economic challenges in Malta no longer constitute substantial risks, namely the macroeconomic imbalance procedure foresees that no further steps are necessary. In this instance Malta is among the three countries (Denmark and Luxembourg) that out of 11 countries reviewed in the IDR walks with its head high in a club of laggards suffering from symptoms of excessive macro-imbalances.

More specifically, quoting from the analysis in the IDR, one finds that our financial stability indicators remain sound.

More good news as regards external sustainability and trade performance, which both have been positive, thanks to product and geographical market orientation and non-cost competitiveness factors. Another plus is that our current account balance is in surplus. By comparison another winner in the race is Denmark, where macroeconomic challenges no longer constitute substantial macroeconomic risks. Denmark has been losing export market share due to high wage growth and weak productivity growth, although in Denmark this can be attributed to a cyclical phenomenon.

As regards public finances, Denmark like Malta has worked hard to correct its excessive deficit in 2013. The jewel in the EU crown of highly-leveraged economies is Luxembourg, which enjoys the highest per capita growth. Their success story stems from a growth model based on an efficient financial sector, which has weathered the crisis well, while domestic banks post sound capital and liquidity ratios.

Finally, the favourable position of public finances in Luxembourg is highly dependent on the sustainability of a growth model based on a buoyant financial sector and presents a high sustainability risk in the long term. In this vein, it is regrettable that the recently implemented pension reform in Luxembourg is insufficient to cope with the challenge. In simple terms Luxembourg has all its eggs in one basket. Unlike Malta, Luxembourg masks a large and steadily increasing deficit in merchandise trade, which broadly comes from disappointing exports.

In conclusion, after careful reading of the IDR. the impression given is that core banks in Malta will not rise to take action – ask any surgeon to perform surgery on himself and he will not cut deep enough. Some may complain that the banking sector may have enjoyed the status quo for many years as a quasi-duopoly and it is time the country moves on to appoint a financial ombudsman with real powers to oversee the work of the Competition Authority and in an efficient manner, suggest equitable remedies to consumers.