News | Wednesday, 12 August 2009

Issuing €350 million in bonds: the pros and cons

After Business Today last Wednesday revealed plans for private firms and government to issue bonds worth in the region of €350 million, three leading economists – John Cassar White, Karm Farrugia and Lino Spiteri, share their views on the effect such bonds would have on Maltese banks and the economy

John Cassar White: The country is still flush with liquidity, but bonds could fuel inflation

Since banks are paying historically low interest rates on deposit accounts, many depositors are shifting their money into bonds. At the same time borrowing customers of banks are attracted by the availability of financing through the public and the stock exchange and are issuing bonds with varying lengths of maturities. The interest they are paying on these bonds is at times lower than that charged by banks to their borrowing customers. This is an added incentive to borrow directly from the public and avoid the bank intermediation. Of course the effect of this development on banks is that they are steadily losing deposits and at the same time they are seeing their lending being repaid in advance by customers who prefer to borrow from the public.
The country is still flush with liquidity in the sense that many people have large amounts of cash ready to be invested in whatever instrument promises the best return. Many people are weary of getting involved in property investment or even equities because they fear price falls similar to those experienced in the last eighteen months.
So the availability of bonds is a good opportunity for people to invest their money in a relatively safe instrument. By mopping up the excess liquidity, the risk of even higher inflation should in theory be averted. If money is locked up in bonds, people are less likely to spend money on consumables thereby fuelling inflation.
Having said this, the problem of our high inflation is not caused by excess liquidity but by other factors.
As long as the cash pool continues to exist, the effects of money flowing into good quality bonds are likely to be positive for the Maltese economy. Perhaps the time may have come to start grading these bond issues so that investors know what kind of risk they are taking in return of the interest they earn.

Karm Farrugia: Frequency of bond issues could be too heavy on economy

A permanent feature of our banking system has always been excess liquidity, chiefly the result of our ingrained savings habit, though recently it had changed direction with the economy heading towards a savings ‘conundrum’ - good growth in the economy resulting in a lesser rate of personal saving. The banks have perennially been flush with liquidity, more so since the orchestrated repatriation of millions of liri/euros at the time when the country decided to apply for membership of the european single currency. It is to the credit of our banks that they avoided the temptation to export our savings in search of high-yield, but very risky, bonds and other ‘ fancy ‘ securities. On the other hand it is to their debit that, in their greed to retain their margins between savers and borrowers, they disincentivised the former and, on several instances, were rather mean towards the latter. Banks in fact have been themselves encouraging bonds issues, regardless of their consequences on term deposits. They make money from commissions and management fees.
I fear the quantum/volume of recent past, current and proposed bond issues to be too heavy on our economy. Not the principle of it, but the manner and frequency with which they are being floated - the ‘ little man ‘ is being given to understand that these issues are ‘guaranteed’, which they are not. The rate of interest is attractive enough in current recessionary circumstances but the bonds’ term is often extended beyond the worst-situation time for recovery, which could well present us once again with the imperative to control inflationary tendencies, especially after 2010, with the general interest rates climbing to heights which would cause loss of marketable value to the bonds in question.
If only the banks cared a little more about the economy and a little less about their profitability.

Lino Spiteri: Banks, economy will not be negatively impacted

Should that amount be offered to the public and is subscribed by it to a considerable extent, that would probably lead to deposit withdrawals.
There should be no negative impact on the economy since the banks are still very liquid. Their ability to lend would not be impaired.

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