Neighbours and Mirrors

The Malta Independent of Sunday

The argument that Banks are abusing their dominant position is often made as many wonder how Banks could return record profit growth in the context of a stagnant economy. The disconnection between the lackluster performance of the economy and the stellar performance of the main banks could, to some, be only explained by the excessive exploitation or outright abuse of the banks’ dominant position.

That the two main banks have a dominant position on the local market is uncontestable. That there is no effective competition in the local banking sector is a well founded suspicion especially since the acquisition of Mid-Med Bank by HSBC has reduced an important competitor that HSBC were previously offering via Midland Bank.

The accusation of abuse of dominant position in the banking sector has now received a strong boost as it has been made in quite explicit terms by none other than the Governor of the Central Bank who is ultimately responsible for monetary policy and financial stability. This is what he had to say in a recent interview about the Bank’s paying unrealistically low interest to their depositors.

Another factor that has undoubtedly served to encourage consumption, and even possibly investment abroad, has been the relative unattractiveness of the traditionally preferred saving outlet, the 12-month fixed deposit. The gradual reduction in the Central Bank of Malta's central intervention rate these last years was followed by more than proportionate cuts in the rates offered by banks on fixed deposits, probably because of the abundant liquidity available at the time. In today's tighter liquidity conditions, a 12-month fixed deposit rate of about 2.6 per cent may now be considered inappropriate.

While the impact of these behavioural shifts on the balance of payments is likely to stabilise over time, the Bank is nevertheless concerned about the apparent imbalance between spending and saving patterns and will be monitoring developments much more closely.

This accusation is so serious that one has the right to ask why is it that the Governor is simply complaining lightly about it rather than using the authority of his position to correct what needs to be corrected. Whilst the Central Bank is no longer the direct regulator of the banking sector, its monetary policy and financial stability functions afford enough tools to ensure that banks start giving more weight to their macro-economic responsibilities. Their size and dominant position should offer easy profit maximization opportunities but these need to be tempered by their responsibility not to damage the stability of the economy by inducing excessive consumption and discouraging savings.

Is the Governor right in claiming that in the context of a Central Intervention Rate of 3% which has been kept steady for more than a year by the Monetary Policy Council of the Central Bank, a fixed deposit rate of 2.6% for a 12 months fixed deposit is inappropriate to stimulate a sustainable balance between saving and consumption and to protect the official reserves of the country as extremely low interest rates offered to local depositors force them to seek better investment opportunities outside the country?

There is no clear case for the Governor’s contention. The overnight deposit facility that the Central Bank offers to banks is 1.5% whilst the deposit rate for 14 day deposit is 2.95%. Six month Treasury Bills yield 2.98% whilst 2 years government paper yield 3.20%. Given that banks have to make a margin on their deposits does it seem that a rate of 2.6% for 12 months deposits is out of sync with the general money market condition?

I try to shed some light on the matter by tracking interest rates paid by banks on time deposits in comparison with the 6 month Treasury Bill rate:

                                              Weighted average time deposit rate             six month T B rate          margin

1998                                                     5.35%                                          5.50%                  0.15%

1999                                                     5.43%                                          4.96%                  -0.47%

2000                                                      5.25%                                         4.94%                  -0.31%

2001                                                      4.98%                                         5.04%                   0.06%

2002                                                      4.39%                                         3.80%                  -0.59%

Dec 2003                                               3.45%                                         2.93%                  -0.52%

Dec 2004                                                2.87%                                        2.98%                    0.11%

Source: Central Bank of Malta

While it is true that in 2004 Banks have succeeding in closing the gap between the interest rates they pay on time deposits and the six month Treasury Bill rate, this was only following 2 years where this margin had widened to record level as interest rates were coming down and banks were locked in to pay higher interest on their time-deposits during 2002 and 2003 . During 2004 the central intervention rate remained steady at 3% and therefore the banks had the opportunity to renew their deposits at the lower rate catching up on previous years.

Especially if one looks at the experience prevailing in 1998 when there was more competition in the banking market, there is nothing to support the Governor’s conclusion that banks are under-paying interest on their deposit through some abuse of their dominant position. If anything it was only in 2004 that Banks had the opportunity to restore their margin to somewhere near they were in 1998 and only because the central intervention rate stopped falling.

So if the Governor is unhappy with the rapid fall in savings ratios and the loss of reserves as savers start preferring foreign investment products rather than the traditional fixed deposits, it may well be that he may have to look for the real reasons somewhere much closer to his seat.

Banks are paying low interest on their deposits because the Central Bank has brought the central intervention rate to a level that neither stimulates savings nor offers sufficient safeguard against the risk of capital leakages. At the same time the low interest rate in the context of an uncompetitive economy is not increasing the demand for investment finance so that the economy remains overly liquid. The consequences of this over-lax monetary policy is pretty well reflected in the asset price inflation we are experiencing as shown in the House Price Index published by the same Central Bank in their Quarterly Review 2004:4 and in the MSE Index which shows a strong inverse correlation with the movement of the central intervention rate.

Is the Central Bank joining the national habit of blaming neighbours before looking at the mirror?