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Probe into banks’ oligopolistic position

The €15 million contributed by the government of Malta will be leveraged with commercial lending through a risk-sharing mechanism

George M. Mangion
15 February 2016, 10:05am
The European Investment Fund (EIF), part of the European Investment Bank Group, and Bank of Valletta (BOV) last month signed the first SME Initiative transaction in Malta. 

The agreement aims to facilitate access to finance for over 800 Maltese SMEs by enabling BOV to offer financing at even lower interest rates and less collateral requirements. It is expected that SMEs, including start-ups, in need of financing will benefit from €60 million of finance in Malta, which is contributing €15 million from its European Structural and Investment Funds (ESIF) to this new EU initiative.

The €15 million contributed by the government of Malta will be leveraged with commercial lending through a risk-sharing mechanism, which will result in more SMEs benefiting from European resources on advantageous terms, such as reduced interest rates and improved collateral requirements.

This financial instrument is expected to act as a catalyst for private investment and foster job creation. Definitely a step in the right direction – but critics will argue that the amount of €60 million is a drop in the ocean when compared to loan books of two major banks, which run into billions.

Thus one may say that the initiative to subsidise loans to SMEs is a welcome one but the total sum available is too little and not realistic. Sharing it among 800 applicants at an average of €75,000 each is a joke. It is true that initiatives lauded by the PL administration were touted to help SMEs in their endemic problem to raise finance but as always it is too little too late.

Naturally, party apologists wax lyrical about the need to lighten the burden on companies employing fewer than 250 workers as they face problems of limited access to finance. Talk to business managers and they all confirm how banks are risk averse when lending to start-ups and medium sized entities. It is an open secret that commercial banks apply rules that are too rigid with respect to collateral, payback time, and the interest rate.

This exacerbates problems for SMEs in their quest to grow and improve their products and services. When finance has been made available on difficult terms, SMEs have no other choice but trying to source other non-bank financing. In Malta, one seldom complains that credit providers of loans to SMEs, are a handful – actually being fairly concentrated in two main financial institutions and a large portion of their customer base tends to be of a more permanent nature, nonchalantly remaining solid customers of the same bank.

One may argue that such an oligopolistic situation could arise whereby banks would follow each other’s behaviour in the market by offering very similar products and gradually inculcate a culture of profit taking even in retail products sold over the counters.

This means that the SME loan market is a market where movement among players is limited, if not static – with some exceptions. Put simply, the elasticity is low as few SMEs shop around once they set their loyalty to one particular credit provider.

PKF’s research found that switching between banks, which ought to happen in a non-concentrated market, does not occur so often and few SMEs bother to shop around for best conditions of borrowing, due to a perceived lack of transparency of prices on offer.

For this purpose, PKF last year commenced on a long hard journey to collect empirical data on the way risk is recognised by banks when SMEs knock on their doors to seek finance. The first steps in the methodology was to assess if the interest rate is competitive and if it does not mirror the indicative rates regularly announced by the European Central Bank.

Since the passing of the Small Business Act in July 2011, under  the PN  administration,  an attempt was made to build an official classification showing separately the amounts (usually around the €1 million cluster) lent to SMEs. This classification has since stopped being collected. The general perception is that SMEs in Malta are considered a higher risk and therefore must carry a heavier burden as reflected in various sanctions letters issued with corresponding high loan charges and tougher repayment conditions.

Obviously this is a complex issue and warrants a proper assessment away from any emotional attachment and a solution based on scientific studies. This is a dilemma, perhaps with no solution. Bankers in Malta tend to point to higher costs resulting from rigid Anti Money laundering regulations when accepting clients and the ECB’s tighter regulation with a penchant of nipping the bud of any non-performing loans.

With retrospect, one may reminisce that global banks have had their share of criticism when the recession hit in 2007/8 and national governments quickly moved to bail them out of their misery –mostly out of taxpayer monies (although no banks were bailed out in Malta).

A lot has been written about the causes in the international arena leading to the demise of powerful banking institutions (eg Lehman Brothers) – bank bashers were quick to attribute this to lax regulation, cronyism and political patronage. The EU appointed the ECB to formally take responsibility for bank supervision under the Single Supervisory Mechanism (SSM) – so the ECB conducted a  comprehensive assessment of local banks.

Some bank executives may be silently complaining about the additional cost of such heavy regulation, including one-time costs for the ECB’s stress tests and the ongoing additional fees for the regular audits. One hopes that such costs are not passed to customers by way of hidden charges and heavier interest rates.

Work by the MFSA is already underway to examine bank charges and fees but much more needs to be done. It goes without saying that as banks get to grips with their business strategy, risk appetite, risk culture and management they will need information on the risk profile of SMEs which form an important component of Malta’s business community.

Undoubtedly, the lingering perception is that lending to SMEs is charged at premium rates while as a general rule lending to big firms is shrinking (banks are over liquid) yet banks remain highly profitable.

But not everything is doom and gloom for SMEs as the Director General of the Office for Competition (MCCAA) last year ordered a sector inquiry in terms of Article 11A (1) of the Competition Act to examine the prevailing competition conditions in the market, with particular emphasis on interest rates on loans to SMEs.

This report confirmed the worst fears, that lending to SMEs is at a premium. It is to be noted that more than 85% of enterprises can be classified as SMEs, with the majority of these being micro enterprises that employ fewer than 10 workers. Quoting from the MCCAA study it confirmed the view that the two main banks form a quasi duopoly since at the end of 2013, they accounted for 75-100 per cent of the market for bank loans to SMEs, highlighting the assertion that with such high levels of concentration SMEs are typically faced with low levels of competition when accessing finance.

In conclusion, the MCCAA study  says... The interest rates charged by Malta’s core domestic banks on loans to non-financial corporations are among the highest in the EU, only lower than those of Greece and Cyprus, whose economic performance suffered significantly in the aftermath of the 2007/8 international financial crisis.

The die has been cast and now there is no hiding behind the thick veil of banking probity or discreet ECB regulation as the Genie is out of the bottle that  banks in Malta are earning superlative returns on equity (one reaches close to 21%) yet SMEs in Malta have to grin and bear the cost of interest charged higher than the rate recommended by the ECB. 

Readers may obtain a copy of the MCCAA report, which was tabled in Parliament on 12th October, 2015 by the minister of finance. 

George Mangion is a partner in PKF, an audit and business advisory firm
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