Tuesday, 13 May 2014

The ugly has one defect

Whenever I used to complain about anything, my late Mum used to warn me:

The ugly has one defect - it is ugly.  The pretty has many - it is pretty but this could be better and that could be improved.

This was flashed back to me upon reading the presentation given by the Governor of the Central Bank to Parliament's Economic and Financial Affairs Committee in House yesterday.  

Going through the presentation it was generally a very up-beat rendition - see link below:

Governor's presentation 12.05.2014

Trying hard to find something to fault it with, that was found in the fact that bank lending to the private sector is falling rather than growing and that this could be a bad omen for future economic growth -  see slides 22 and 23.

Firstly one should note that this is a phenomenon which is happening in the whole Euro area even in the strong core Euro area countries as is well explained in slide 22.

Secondly there are very good,and I would say positive reasons,  why this is happening in Malta.  These include the following:

1. Most of the drop is in the construction sector.   Given that real estate was suffering from oversupply the decline in construction lending will help to stabilise and improve the real estate market.

2. The drop in construction lending will be easily reversed when the excess stock of unsold real estate is digested and developers can see a ready market for their new developments.

3. Bank borrowers are accessing the bond market where they can raise long terms funds at 'cheap' fixed rates.  Often they are borrowing on the bond market to pay down their bank borrowing based on variable rates in order to lock the low interest rates for the long term.  This process of disinter-mediation is healthy and should  be encouraged as it compels banks to price their loans more competitively.

4. The economy is diversifying into  the services sector which is less capital intensive and therefore require less financing even though it has more value added - see slides 10 and 11

5. Given low interest rates prevailing many foreign investors no longer rely on local financing to execute their Malta projects.

The other point of discussion is why local banks, in spite of the falling demand for loan, are still pricing their lending to SME's higher than other Euro area countries - see slides 20 and 21.   There is a very clear reason why this is so and the Central Bank and the MFSA should blame themselves for it.

We have created a strange system where we have licensed foreign hedge funds to invest in locally licensed banks, allowing them to dip their fingers in the jam jar of the local deposit insurance scheme,  but then operating only on the liabilities side of their balance sheet, i.e. raising deposits,  but doing little other commercial operations on the assets side of their balance sheet i.e. they hardly do any lending locally.

This means that the banks are finding competition for deposits which keep them priced above what banks nominally pay for retail deposits in Euro area countries.   To protect their interest rates margins banks have to keep lending rates correspondingly high, especially as they find no competition from such foreign owned licensed banks who show no interest to grow their lending book locally.

The solution is simple.   'Force' such banks to use their license also to offer competition in local lending and the market for loans and credit to SME's will take care of itself to price itself in line with Euro area realities.

Having said that, what is pretty remains pretty notwithstanding its defects.

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