A bank for the economy

It had to be the Covid pandemic to change the scenario and persuade people that the Malta Development Bank could play a crucial role. And it did.

National development banks (NDBs) are an under-appreciated set of financial institutions in the global economy.

At the latest count, there are at least 450 national development banks operating globally, with over US$ 8 trillion of collective assets and over US$ 2 trillion of annual disbursements. The pure scale of NDBs is something that almost no other financial institution can match. The assets of the top five NDBs is more than Bank of American and JPMorgan combined and larger than the GDP of every country in the world besides the United States and China.

Thanks to the Labour Government elected in 2013, the idea of a development bank – which had been touted since the early eighties – was revived and the government set up the Malta Development Bank (MDB) in late 2017.  Having been closely involved in its setting up as Chief of Staff for the Deputy Prime Minister, I can say that it was no easy task.  Some senior civil servants were against the idea and dragged their feet as only bureaucrats could, while negotiations with the European Commission and Eurostat were not easy at all.

Why are development banks so important?  

The theoretical foundation for development banks includes both industrial policy and social considerations.  The former addresses such issues as the reduction of information asymmetry and credit rationing, promoting latent capabilities in the economy, reducing coordination problems between investments with large spill-over effects, reducing so-called “discovery costs” (e.g. information externalities), and strategic trade (e.g. subsidising firms in costly international markets). 

The socio-economic environment includes issues like investment in regions (Gozo?) or customer segments that are not profitable for the private sector (e.g. social enterprises), supporting socially-oriented initiatives (including high employment), and investment in environmentally-friendly projects.

Those are the positives.  But there can also be negatives, when a bank is fully-owned by a government.  There are well-known examples of failures where the development banks concerned indulged in what is known as rent-seeking behaviour.  This can range from misallocation of credit (e.g. subsidised capital to large firms that do not need support in the first place) through “soft budget constraints” (supporting unproductive or failing firms), and pure “rent seeking” (provision of subsidies to firms that do not need subsidised capital).

The political risks in Malta can potentially be enormous, given the traditionally close links between politics and business, the preponderance of family-controlled businesses and their political clout, not to mention the lack of transparency in the award of contracts by the public sector.  These risks were well-known to the European Commission and they were the proverbial dark horse in the negotiations   ̶   never mentioned but always a huge consideration. 

Addressing market imperfections

In essence, development banks are tools to solve market imperfections.  In fact, in order to obtain the European Commission’s approval for setting up the MDB, Malta had to show through detailed studies that bank lending to corporate borrowers in Malta was subdued while lending remains were relatively high compared to other EU countries.  In spite of the banks’ excess liquidity, there was a perceived gap between demand and supply, particularly when it came to SMEs.

A shortfall of SME access to finance is a typical example of market failure evident in all countries. All too frequently, small businesses have a huge challenge persuading lenders that they are credit-worthy, simply because they do not have a borrowing history.  Their inability to provide sufficient collateral makes lenders perceive them as higher-risk.  

But market failures can also occur in the case of infrastructure financing.  This is probably more pronounced in a small country like Malta where the financial intermediation landscape is less diversified, and the syndicated loan market plays a tiny role.

Studies conducted in 2015 estimated the total funding gap for SMEs and infrastructure at between 29% and 39% of GDP over a five-year period, equivalent to between €2.3 billion and €3.1 billion.  The areas of the economy that appeared to hold the most potential for the MDB’s intervention, given the identified market failures, were SMEs and start-ups, sustainable infrastructure, waste management and the circular economy, renewable energy production and energy efficiency, and the blue economy.

A crucial role

The initial phase of the MDB was rather sedate, both because it had to recruit suitable personnel and develop its structure, but also   ̶   in my view   ̶   due to resistance from certain quarters.  It had to be the Covid pandemic to change the scenario and persuade people that the bank could play a crucial role.  And it did, with a variety of schemes to help enterprises in the difficult economic situation between 2020 and 2022.  It is estimated that the MDB succeeded in increasing financing to stretched enterprises by around 11.5%.

Of course, the bank’s wherewithal depends on the capital at its disposal.  Its initial capital of €30m has since risen to €80m, though I understand that a further increase in the share capital is being considered.  The bank’s own capital is currently complemented by around €130m of stand-by loans from the KfW (a German development bank) and the European Investment Bank, and an overdraft facility of €25m from APS Bank. 

The MDB, however, is not a retail bank.  In other words, it does not compete with the commercial banks in seeking deposits from the general public or to lend to individual businesses. These were crucial conditions imposed by the Commission in its approval process.  Instead, the bank’s role is to develop schemes which help the commercial banks provide more financing on the back of its guarantee of their lending.  This guarantee has to be carefully crafted to avoid a situation where the commercial banks take excessive risks because of an over-reliance on the MDB’s guarantee.  The MDB itself is guaranteed 100% by the Government.

So, the MDB comes in either with its own schemes addressed to plug certain market gaps or to sustain schemes developed by the commercial banks themselves.  Essentially, the MDB lets the commercial banks deal with the customers in terms of assessment of their projects, their viability, the loans they can extend, the term period and interest rate, and monitoring of the loans.

The MDB guarantees a certain percentage of the loan, which can vary according to the type of market failure, the characteristics of the lenders, as well as enables the banks to reduce their interest rate thanks to the guarantee they get from the MDB.  By the way, the MDB also benefits from guarantees provided by the European Investment Fund and the Pan-European Guarantee Fund.

The MDB’s impact

The bank’s impact on the ground is evident from the fact that over five years it reached 700 businesses employing some 40,000 workers and facilitated lending to the tune of €600m, including €15m in loans to some 400 students.  According to the Bank’s CEO, Paul V. Azzopardi, the MDB is contributing around 13% of all the banking system’s outstanding loans.

Earlier, I referred to Eurostat’s approval of the setting up of the MDB.  Complicated negotiations were conducted in the light of Eurostat’s position that interventions by the MDB should be limited so that they do not become part of the government’s debt and jeopardise the country’s obligations under the Maastricht criteria.   On the other hand, the Commission was concerned that the bank should not become a back-door to State Aid. Thankfully, the bank has managed to convince the Commission to approve the State Aid envelope available to the bank by some €423m to reach €678m.

Since its inception the bank has launched some 10 schemes ranging from family business transfer facilities through the Covid guarantee scheme and Ukraine crisis support measure, subsidised loans, liquidity support, guarantee and guaranteed co-lending schemes, start-up loan schemes, to student loan schemes.     

The bank’s impact has been felt throughout the economy. During Covid, 11 economic sectors  ̶  mainly manufacturing, food & accommodation, and construction  ̶  were supported by guarantees on loans ranging between €5m and €25m.  Its SME Invest scheme has assisted 88 micro enterprises, 53 small ones, and 9 medium ones with loans of €47.6m, but which average just over €303,000 per enterprise.

An important function of development banks is to perform a powerful counter-cyclical effect in times of economic crisis.  According to World Bank data, NDBs increased their lending by 36% to $1.58 trillion in 2009 when Covid hit.  This lending injection was far greater than the growth in private bank credit in the same countries over that period.  In Malta, the MDB leveraged a €350m government guarantee to support of nine commercial banks a commercial bank portfolio of €500m in working capital.

Leveraging ability and profitability

If there is anything that I would say has not materialised in the desired manner is the leveraging ability of the bank.  The programme’s fundamental goal is to attract new investment capital to projects capable of generating revenues through user charges or dedicated funding sources and to complement existing funding sources by filling market gaps, thereby leveraging substantial private capital for critical improvements to the nation’s surface transportation system.

In all of this I haven’t made any mention of the bank’s profitability.  It’s rather superfluous.  Normal development banks are not expected to make a profit or, if they do, is does not have to be to the same order as commercial banks.  NDBs are not driven by price-earnings and the other normal ratios keenly watched in respect of commercial banks.  This does not mean, however, that they can register large losses as if it doesn’t matter.  In the MDB’s case, in its six years of existence, it registered its first modest profit in 2022.  Prudency dictates an element of profit, if only to build some equity and reassure the institutions concerned that they aren’t acting recklessly. 

The attractiveness of a development bank lies in its ability to leverage a relatively small amount of capital to a large amount of loan capacity.  In preliminary estimates of the potential, the team involved in developing the bank’s remit had used a leverage rate of around eight   ̶   that is €800 loaned for every €100 of capital.  Analysis of programme funding in other banks, albeit more long-established, show a leverage factor of between 8 and 13.  The MDB’s leverage rate is still extremely low, by comparison with both the average worldwide and the objective mentioned in policy papers on the MDB.

All these statistics are a story in themselves, but what an analyst like me would want is a scientific study on the effect on private market performance of the MDB.  Studies abroad have estimated the impact of several development banks.  By impact, I mean additionality    ̶   that is, the difference between what happens to development bank programmes versus the counterfactual (without the programmes).  The gold standard for evaluating impact is a randomise controlled trial (RCT), though some researchers have also created artificial control groups using matching techniques.

Another disappointment has been the lack of involvement by the bank in infrastructural and social projects, with the notable exception in the latter of student loans. Mind you, though the bank can finance “large infrastructural projects that contribute to important regional or national development”, in practice it can only do so if such projects are taken on 50% pari passu by privately-owned firms and the bank.  Because large-scale infrastructural projects undertaken by purely privately owned firms are very rare in Malta, this severely limits the Bank’s ability to contribute to the Maltese economy in this way.

Much that the MDB can do

In my view, crucial functions that the MDB should support would include encouraging innovation and structural transformation; supporting projects to improve productivity in the Maltese economy; enhancing financial inclusion; supporting infrastructure financing; and promoting environmental sustainability, in particular by combating climate change.

There is much that the MDB can do to better fulfil its mission.  That seems to be the objective of the bank’s new chairman, Leo Brincat, when he told the Times of Malta in a recent interview that he intends to consolidate its inherent strengths by widening and diversifying its client base.  He appears to be working on an outreach programme to identify the needs of SMEs and community organisations and determine how it can help them. 

I would augur that he and his management team succeed to give the Bank a new impetus. 

Photo: REUTERS/Luke MacGregor

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