The perils of cheap money

Falling rates: A high-end apartment near the Petronas Twin Towers that used to fetch a monthly rental rate of RM15,000 is now going only for RM8,000. Even apartments with lower rental rates of between RM4,000 and RM5,000 per month are coming down fast.

The Alternative View column THE banks in Europe are literally sleeping on money, no thanks to the negative interest rate policy of the European Central Bank (ECB).

Under normal monetary conditions, banks earn a small return from excess cash they place with central banks. However, in the case of a negative interest rate regime, commercial banks are charged a levy for placing the deposit.

In the case of the ECB, the rate it charges the banks for placing their excess cash is 0.4%.

Since 2014 when the ECB imposed negative interest rates in a move to force financial institutions to lend more hoping that it would spur growth, banks have forked out some 2.64 billion euros to keep their excess cash with the central bank.

The negative interest rate regime has taken a toll on banks’ profitability and valuations. The irony of the negative interest rate environment is that it has not spurred more lending by banks.

Instead, European banks are looking at ways on how they can store the excess money in vaults or secured places as hard cash. There are some insurance companies that are looking at insuring the cash stored. But the problem insurers face is to assess the risk in the face of the unexpected happening such as theft, earthquakes or floods.

This is not the only problem that has come about due to the cheap money.

Banks are pressured to lend more to grow the business. However, there are not many places where banks are comfortable to lend their balance sheet.

The fact that earnings of banks are under pressure is already a clear case that lending is not growing. Loans growth is slow even in countries that have not adopted a negative interest rate policy such as Malaysia.

To keep up their earnings, banks have cut down on cost to maintain profitability.

The cautious approach of banks is underpinned by the slowing underlying economy and upheaval in some sectors such as oil and gas (O&G).

Oil prices started to fall in the third quarter of 2014 and hit its nadir of less than US$30 per barrel early this year.

Most O&G companies have taken the hit in the balance sheet. However, only now the difficulty of servicing the loans is beginning to show up.

In Singapore, Swiber Holdings Ltd, a company that provides services for the O&G industry, filed for liquidation under the weight of debts reported to be US$1bil last week.

The Swiber incident has caused a knock-on effect on all O&G stocks and banks that have disbursed loans to the sector.

Another iota of evidence of banks finding it increasingly difficult to grow their business comes in the form of a sluggish property sector.

Most developers complain that their sales are stagnant because banks are not lending. Banks, in turn, say that they cannot find worthy customers to disburse loans to.

The cautious lending activities of banks to the property sector is supported by the growing proportion of housing loans compared to total loans disbursed by the banking sector.

In 2008, the proportion of housing loans to total loans in the Malaysian banking system was 24%. At the latest count, which is as of June this year, the ratio was closer to 30%.

Loans tied to high-end condominiums are the most at risk – more so if the loans are to be serviced through rental income.

A common story among friends is how the falling rental rates for condominiums around the city centre are forcing them to put their property up for sale – at a loss.

A high-end apartment near the Petronas Twin Towers that used to fetch a monthly rental rate of RM15,000 is now going only for RM8,000. Even apartments with lower rental rates of between RM4,000 and RM5,000 per month are coming down fast.

Bankers, using their sophisticated risk-assessment models and mathematical computations, fear that lending more to the property sector would cause a financial bubble in later years.

But try telling that to developers. They contend that bank branches should be given the leeway to disburse loans to suitable lenders, as the officers on the ground know their customers well. They feel that the risk-assessment process of prospective borrowers should not be subjected to a “one-system-fits-all” kind of process.

In Europe, pressure from customers has already led to one casualty. A community bank in Sweden replaced its chief executive last week because they felt that the person was not suited to lead the bank.

Sweden’s Handelsbanken replaced its chief executive who was known to decentralise the decision-making process from branches on whether to approve loans to mortgages.

The chief executive closed down branches in a bid to reduce cost, as lending became increasingly difficult.

The move to remove the cautious chief executive has stirred debate.

The supporters feel that the removal of the chief executive was the right move because lending is the core business of a bank.

While the detractors say that the risk-assessment process of borrowers has been distorted because of the ultra-low interest rate policies of central banks. Hence, it would be better for banks to turn cautious until the underlying economy improves.

The same applies to Malaysia. Banks are under pressure to lend to the property sector when the underlying economy is still weak. Banks are right to resist because it could lead to them being saddled with a load of loans not being serviced a few years down the road.

All this is happening only because of the cheap cost of funds. The low interest rate regime is supposed to be accompanied by fiscal stimulus. The Government has embarked on major projects but it has not caught on to the broader economy, which explains why lending to sectors such as manufacturing is still low.

Until the broader economy moves, it’s best to let bankers do their job without being pressured to lend.

Source: The Star Online

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