Malta’s commercials banks have so far failed to lower their home loan and commercial lending rates following the decision of the European Central Bank (ECB) last Thursday to cut its key interest rate by a quarter of a percentage point to a record low of 0.75 percent. This was intended to boost a Eurozone economy weighed down by the government debt crisis. The cuts coincided with action from other major central banks on Thursday, with the Bank of England adding another £50bn in stimulus money and the Bank of China cutting its key interest rates.
The ECB also cut its overnight deposit rate – what it charges banks for depositing their money with the ECB overnight – to zero. Cutting the rate to zero eliminates already paltry returns and increases the incentive for banks to lend money to each other or to businesses, rather than park it with the ECB. However, cutting the rate to zero does not necessarily make the banks keener to lend to each other, if they fear that other banks may become insolvent and not pay the money back.
The ECB also cut its deposit rate, from 0.25% to zero. A cut in the ECB's deposit rate is designed to stimulate lending between banks, as funds placed with commercial banks overnight are currently receiving 0.3% in interest. Surveys released earlier this week indicated that the Eurozone's service sector had continued to shrink in June and that business confidence had fallen.
The rate cuts could mean lower borrowing costs for banks, businesses and consumers. Some economists, however, say it may have only a symbolic effect, since rates are already very low. Lending activity has remained weak because businesses are not asking for credit due to the slow economy and out of fear that the Eurozone may suffer a further financial calamity.
In announcing the rate cuts – the third since he became president late last year - the ECB's president, Mario Draghi said the Eurozone was likely to show little or no growth in the second quarter of the year, but should recover somewhat by the end of the year. Mr Draghi said the eurozone economy faced risks, but that inflation did not appear to be a threat, even though the inflation rate is running above the 2% target for the single-currency zone. But the rate has been sliding recently and is expected to fall to an average of 1.6% next year.
An interest rate below inflation is meant to discourage saving and promote investment, as it means that the value of money on deposit is eroded, and theoretically makes it more attractive to put money into capital projects. But IMF Chief Christine Lagarde has questioned the wisdom of cutting rates further and urged the ECB instead to buy sovereign debt bonds of the most distressed Eurozone nations.
It is probably too early to say whether the commercial banks will follow suit and adjust their lending rates. They are not obliged to. Some banks have already said that current pricing levels mean that some of their lending remains loss-making, and therefore further rate cuts would threaten a sustainable economic return.
The Maltese banks have similarly failed to adjust their home loans and commercial lending rates so far. This is not the first time that the Maltese banks have not followed through on ECB key interest rate cuts. But their failure to do so is difficult to understand, given that they are not stressed like many of their European counterparts and that they continue to make healthy profits.
According to the latest Banking Lending Survey, just five months ago, the Maltese banks intended to keep credit standards applied to households unchanged, as they expected demand for mortgages, consumer credit and other lending by households to remain unchanged. Consumer spending has been weak and has even fallen in certain months at a greater rate than in the rest of the Eurozone. The Government does not seem particularly keen to stimulate consumer spending, probably because most of this spending would be on imported goods and would jeopardise the improving visible trade balance.
In the last quarter of last year, credit to the non-bank private sector decreased by just half a percentage point to an annual 4.4 percent. Loans, which accounted for 97 percent of all credit, grew at a slower pace than in the previous quarter, expanding by an annual 4.2 percent.
Household loans, which are the largest single category of bank borrowing, expanded by around 4.0 percent in the last quarter of 2011 – well below previous quarters’ levels. Mortgage lending, which makes up around four-fifths of loans to households, expanded at a higher rate however.
But what is striking in the bank lending figures is that loans to private non-financial firms grew at around 1.5 percent – the lowest level in the last three years. It is surprising that, according to the BLS, banks were expecting credit standards to non-financial corporate borrowers to tighten at the same time that demand by enterprises for loans was expected to remain unchanged.
Analysts say that it is difficult to understand why the Maltese banks should not pass on at least some of the interest rate cuts. It is known that defaults in mortgage loans are not worrying, and therefore any alleviation in interest burdens would be a boon to consumers, particularly since the banks are so prudent in their home lending. The same might not apply to commercial real estate, where some signs of distress are evident.
The biggest question, however, is why the commercial banks should not assist businesses through lower rates, when the economy is in recession. There is no doubt that lower interest rates would be greatly welcomed by hoteliers and manufacturing industry that have been under great pressure in recent months.