NEWS | Wednesday, 11 March 2009

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As BOV and HSBC put an end to further interest rate cuts, is printing more money the next step against the onset of recession? By MATTHEW VELLA

Malta’s two main banks have declared they will not be following suit in the latest interest rate cut by the European Central Bank, which announced a further cut of 50 basis points from its reference rate, from 2% to 1.5%.
Since October 2008, the ECB has implemented a 275-point cut from 4.25% to 1.5% in a bid to keep banks lending out money, at cheaper rates, and keep investments on track to sustain demand in the market.
Bank of Valletta and HSBC claim they have reduced their interest rates sufficiently, saying they are already very competitive by European standards when it comes to home loans.
Both have sent out cautionary measures that further cuts in interest rates would further endanger their deposits, the source of capital which they loan out.
“All banks have both sides of their balance sheets to manage, and a further reduction in loan rates would necessitate a corresponding reduction in the rates of interest paid on deposits. Deposit rates have fallen sharply over the past few months, and BOV believes it is appropriate that it should hold the rate of interest paid to its many depositors at the current rates at this time,” Bank of Valletta said in a statement.
There is of course, another underlying constant in this dance of interest rate cuts and recession worries: banking profits.
As one financial observer tells MaltaToday, interest rate cuts ensnare banks in a dilemma over whether they should either appease their clients or their shareholders.
On one hand, reducing interest rates makes the cost of borrowing cheaper for clients; on the other, it cuts into one of the bank’s principal revenue streams.
With Bank of Valletta and HSBC having declared themselves not eager to go on reducing interest rates, it would seem the Maltese banking sector has reached a floor.
HSBC Malta itself forewarned the general public in a press commentary by its marketing department, that it was “no longer possible to pretend that interest rate cuts alone will bring this economic crisis to an end.”
Even before Malta has seen the blurred horizons of a zero-interest-rate-policy, our banks are telling the ECB it can no longer keep on prescribing further cuts in interest rates and it’s time to pump in money into the system.

Printing more money
Uncomplicated as it sounds, actually printing more money (or increasing the supply of money) is not as straightforward as it seems, and carries with it inflationary fears because of the perception that increased cash in hand can tolerate higher prices.
The big daddy of monetarism, Milton Friedman, argued that the Great Depression was caused because the money supply was reduced dramatically. Now if interest rates fall so low as to make it to zero (you can’t take interest rates below zero), households may as well start stashing their money underneath their mattresses because it no longer pays to keep money inside the banks.
As HSBC argued, when prices and wages have fallen too far, they need to go back up again. ‘Printing money’ would mean getting the Central Bank signing off cheques to the banks, increasing the supply of cash to be loaned out. Banks would in turn be ready to supply more money (since they have been given it) to borrowers and businesses, keeping planned investment on track.
Mark Lamb, MaltaToday’s financial correspondent, says the biggest problem facing economies is in fact not the price of money, but its availability.
“Banks need to make money out of fewer loans while also taking into account the ‘risk premium’, that little bit extra which is charged to compensate for the money which they may not get back, when they consider passing on rate reductions or not. Whether the banks in Malta have now hit the floor past which they will not reduce further is difficult to tell, but with money in short supply banks are in a better position to dictate terms.”
Lamb adds that savers who have seen interest rates plummet will have little incentive to continue saving with the banks if interest rates fall below the rate of inflation.
“Fewer savers will of course mean less capital for the banks to lend and the supply of credit in the economy would be further squeezed therefore, the cutting of interest rates is a delicate balancing which has repercussions for us all.”
Economist Edward Scicluna uses a medical analogy: “it’s like using tourniquet in first aid to stop a haemorrhage, but it comes with dangerous side-effects.” No wonder printing of money sends shivers down central bankers’ spines, Scicluna says, but it seems they might have no choice. “Soon the central banks have to do what the Japanese did in their decade long recession – quantitative easing” – in layman’s terms, creating new money out of thin air.
Lawrence Zammit makes reference to the stringent credit available to business. Too much caution on lending from the banks, and you end up denting business confidence. “Unless this issue is resolved the way out of the recession will be tortuous.”
HSBC says its deposits must grow if it has to sustain ongoing lending. “HSBC primarily funds its business by raising customer deposits and, like the HSBC Group, always ensures it has more deposits than loans. Deposit rates are already very low and to reduce them further would disadvantage the majority of the Bank’s customers who are savers. A number of European banks are offering higher credit interest rates and it is, therefore, important for HSBC to remain competitive for its customers.”

Public wants cuts
Financial considerations apart, there is also a general public sentiment, one heavily dependant on borrowing, that calls for more cuts. Alternattiva Demokratika has urged all other banks to immediately pass on the complete decrease in interest rates.
“It is not acceptable that whilst banks don’t think twice to immediately decrease interest rates on clients’ savings, the opposite happens when clients are to benefit from interest reductions. Such reductions can make a big difference to people who find it difficult to cope with the cost of living. One would expect more social responsibility from institutions which, after all, make profits from clients’ deposits,” spokesperson Michael Briguglio said.
“The State should adopt a strong role in the banking sector so as to protect society from unnecessary shocks, but also to give a more sustainable and socially just direction. The fall of irresponsible neo-liberalism and the current financial crisis clearly point towards this direction.”
They sound like tough words, and many laymen probably agree. But this game of cards is played by two banks alone, and for now, it seems like nobody’s going to buy in their game.

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