Out of the voluminous European Commission’s assessment report on the Maltese economy, released a few weeks ago, the only thing that has attracted attention locally is that the prevalence of “higher interest rates on loans could reflect a lack of competitive pressure” and that our banks could be following “anti-competitive behaviour“.

This has unleashed a number of articles calling on local banks to lower their lending rates. Banker bashing, which was very popular in the major industrial countries just after the financial crisis, has also finally reached our shores.

However, most of these articles did not scratch below the surface or try to look at this question in an objective manner by just focusing on the facts and trying to look at the European Commission’s report holistically. One of the exceptions is David Curmi, the president of the Maltese Chamber of Commerce, who did that in his article of The Sunday Times of Malta on Easter Sunday.

I understand that the MCCAA is conducting an investigation into this matter and no one should try to pre-empt its results but should leave it to work diligently and independently. I am a bit disappointed that none of these media outlets contacted any academic from the Department of Banking and Finance of the University of Malta to offer an academic opinion on this debate. I hope that the MCCAA will invite us to contribute in some way.

I invite all those who are serious and have a genuine interest about this question to look at the European Commission’s report in its entirety. They will see that the picture is much more nuanced and, as most often, the devil is in the detail.

First, the European Commission mentioned that higher interest rates could possibly be explained by lower competitive pressure but never concluded that this was necessarily the case. At the same time, the European Commission offered other possible explanations in the form of different funding costs, higher pricing of risk or lower cost-efficiency. The latter one was disregarded when comparing the efficiency of our banks with the average of European banks. Let’s explore in detail the other two possible sources of higher interest rates.

When looking at funding costs, the European Commission pointed out the high intermediation margin. This is the difference between the interest rate that borrowers pay on loans and what depositors get on deposits. This is calculated for loans amounting to €1 million and over. This threshold is very high by Maltese standards and does not reflect Maltese SMEs’ lending requirements but I will come back to this point later on.

If we look at Maltese banks, we notice that the intermediation margin has remained stable over the period June 2008 to June 2013 (period of study in the report). We also notice that in June 2008 the intermediation margin of the Maltese banks was marginally higher compared to the eurozone average. What has happened is that following the crisis, the average intermediation margin of the eurozone banks has dropped significantly.

Mr Curmi and the local banks have been giving a good explanation for this by referring to the funding model of the local banks based on retail deposits rather than borrowing from the interbank markets. As a result, while benchmark interest rates used for interbank lending have declined towards 0 per cent, the deposits offered by local banks to savers have not declined so much in order to remain sufficiently attractive to maintain the banks’ funding model.

I would like to remind readers that it is this prudent funding model that has enabled our banks to emerge unscathed from the financial crisis. At the same time, all banks relying on such a funding model have been the most exposed during the crisis. I do not think that it would be wise to change such a system.

You cannot look at the interest rates being charged in isolation of the level of risk banks are taking

The European Commission’s report also shows that the interest margin on loans has also declined from an average of 6 per cent in 2007 to around 4.5 per cent in 2012. It also notes that the interest margin dispersion has narrowed which could be interpreted as a sign that competition is working. Furthermore, it is the big banks that are driving the lower interest margins whereas before they used to be in the higher end of the dispersion. This evidence alone would suggest that things are – after all – not that bad.

One of the criticisms that has also recently been levelled at the banks is that they do not lend enough to SMEs. The European Commission’s report offers some hindsight on that topic as well. The EC’s report mentioned that “over 75 per cent of the participating SMEs did not apply for financing in the preceding six months because of sufficient funds or other factors”.

The report also mentioned that “the ratio of SMEs that applied for financing, particularly bank loans and trade credit, increased, confirming that there is increasing appetite”. However, and I think that this is at the origin of the criticisms, “the ratio of SMEs that successfully applied for bank overdraft and trade credits dropped significantly compared to 2011 when a similar exercise was carried out”.

This is explained by “tighter risk-assessment practices by lenders” given that the SMEs themselves mentioned that “the overall lending conditions, such as availability of instruments, collateral requirements, interest rates and other costs, have improved”.

If we put it in the context of the €1 million mentioned earlier and that a number of such loans would be linked to projects involving property, it is understandable that the banks have tightened their lending given the higher risks of these projects in a subdued property market. Once again, this would point out that our banks have been following prudent practices . In fact, the EC’s report also mentions that the “high lending rates have to be seen in the context of a highly-leveraged corporate sector, in particular SMEs” and the report even mentions that “countries with similar corporate leverage are charging even higher interest rates”, although they mention that this could also be explained “by more difficult economic conditions”. This means that the lending rates would just be reflecting risk, in particular “concentration risk which is higher in Malta compared to other eurozone countries”. After all, this is what the situation should be according to banking theory.

Risk is one thing that was almost never mentioned in those articles calling for lower lending rates... I always tell my students that you cannot look at the interest rates being charged in isolation of the level of risk banks are taking. Indeed, part of the interest rate is compensation for the risk taken.

Mr Curmi’s Sunday Times article alluded to the factor of risk as well. The EC’s report does not go into this aspect, rightly so, as it was meant as an assessment of the Maltese economy and not an investigation of interest rates.

In academia, one of the first things that we look at when we make comparisons is to make sure that we are really comparing like with like. I suggest comparing Maltese SMEs to the average euro SME in terms of size, age, survival rate/failure rate, collateral, profitability, leverage. I suspect they are not similar and this could possibly explain a lot of the difference in lending rates. Furthermore, cross-country comparisons are rendered even more difficult as one has to take into account additional country-specific aspects which affect financing, such as the development of the financial markets, institutional and legal systems, etc.

In fact, the EC’s report also commented on the suggestion of the governor of the Central Bank of Malta to set up a development bank that it “could improve the efficiency of financial intermediation…. but should be equipped with sufficient risk assessment capabilities to prevent it from mopping up lower quality projects” and end up as a bad bank which would have to be bailed out by the taxpayer.

I could also add other points based on my knowledge of the local and foreign banking markets. For example, one should not just focus on the difference between lending rates but also take into account all the other costs and fees when taking up a loan as these tend to be higher abroad compared to Malta.

I also think that the clients themselves should shop more around before taking up a loan; are they ready to shift banks? Do they make use of the Moneybox tool of the MFSA? Although the latter is more for retail clients, I am always amazed as to the very low level of awareness about it.

The EC’s report also points out that the banking market is very competitive for the retail market. For example, compare interest rates on credit cards charged by local banks with those charged abroad (credit cards are often used to launch SMEs). It could be that local banks subsidise retail clients by charging higher rates to corporate clients. Even when considering the profitability of our banks, these are not excessive compared to banks abroad when considering return on equity measures.

To conclude, I would invite the local authorities to consider very carefully tinkering with the local banking sector as this could unleash unintended consequences.

Remember, the financial crisis started with the US government trying to encourage low earners to take up residential debt, a good thing per se, but we all know where that led us. I agree that SMEs are at the heart of a healthy economy and are essential to create new jobs but there are other innovative financing mechanisms that can be used to facilitate SMEs’ access to finance. The BOV’s Jeremie initiative and the HSBC Malta Trade for Growth Fund are some of these.

Robert Suban is a full-time lecturer within the Department of Banking and Finance at the University of Malta.