How Would An Increase In Deposit And Loan Interest Rates Affect You? – Financial Services

ECB Interest Rates

In January 2023, customer inflation in the Euro location stood at
8.6%¹. In Malta, the yearly inflation rate stood at
6.8%². If it weren’t for Government’s choice
to keep energy rates repaired, this would usually be greater.

The European Central Bank (ECB) targets an inflation rate of
2.0% over the medium term to satisfy its main function of
preserving cost stability throughout the Euro location. It was for that reason
not a surprise when the ECB chose to increase rate of interest and
reverse a years long pattern of low or unfavorable interest rates.

Source: ECB information; KPMG analysis

How does increasing rate of interest reduce inflation?

The present aspects increasing inflation internationally are the
remaining effect of the pandemic on supply chains, and the continuous
war in Ukraine, which affected the supply of oil, gas, and grains,
explaining the especially high rates of energy and food
inflation.

When rate of interest increase, the greater cost of obtaining
dissuades customers from purchasing products typically gotten through
bank financing, such as property, vehicles, and equipment. Higher
obtaining expenses likewise leave less money left over to invest in
daily products such as clothes, taking a trip, and eating in restaurants. In
turn this reduces the aggregate need for items and services,
eliminating inflationary pressures. Higher rate of interest likewise
motivate more conserving and subsequently less spending.

Loan and deposit rate of interest in Malta

The ECB provides funds and accepts deposits from business banks
in the Euro location, consisting of Malta, instead of straight from
people and businesses. Nonetheless, the rate of interest used
by business banks usually relocate line with ECB rates. However,
to date, the boost in ECB rates has actually relatively had small effect
on the rate of interest used by regional banks.

As per the Central Bank of Malta’s (CBM) latest quarterly
evaluation, in September 2022 the typical deposit rate of interest stood
at 0.14%, and the typical loan rate of interest stood at 3.25%. While
there have actually considering that been some advancements, these have actually been mostly
restricted to greater deposit rate of interest specifically on brand-new term
accounts, the discontinuation of set rate of interest on brand-new home
loan items, and little boosts in loan interest margins, and
however, these actions have actually just been used by some banks.

Should commercial banks increase rates on overnight deposit
accounts – more commonly referred to as savings accounts, and
increase their loan base rate, consumers and businesses will be set
to experience much bigger differences in their disposable incomes
and cash flows.

Why haven’t interest rates in Malta increased yet?

Based on the audited financial statements for year ending 2021,
the average loan-to-deposit ratio for core banks³ in
Malta stood at 56.6%, while that for significant banks in the Euro
area amounted to 104.8%⁴. This means that generally
Maltese banks do not resort to borrowing from the ECB at the
current 3.0% MRO rate (Main Refinancing Operations), but rather
rely on their own customer deposit base, at the average deposit
interest rate of 0.14%, as at September 2022, mentioned earlier, to
fund their loan book. In turn, this arrangement allows banks to
retain the currently advantageous interest rates on their loan
products.

How long will interest rates remain unchanged in Malta?

While the average loan-to-deposit ratio for Maltese core banks
stands at 56.6%, the ratio for individual core banks ranged from
circa 40.0% to over 90.0%, based on audited financial statements
for year ending 2021. The banks with a higher loan-to-deposit ratio
will probably be under greater pressure to increase their deposit
interest rates so as to maintain, and possibly strengthen, their
deposit base.

Once deposit interest rates increase for general savings
accounts, banks will very likely increase their base rates in order
to safeguard bank profitability.

What happens if banks increase their interest rates on
loans?

Locally, home and business loans are generally sanctioned at a
fixed margin over a bank’s base rate. Each bank’s base rate
is set by the individual bank and may change at any time at that
bank’s discretion. On the other hand, the fixed margin
specified at sanctioning, cannot be altered for the entirety of the
loan’s term.

Let’s take the example of a loan with a bank sanctioned
at a fixed margin, of say 1.5% over the bank’s base rate, of
say 2.0%, corresponding to a final interest rate of 3.5%. While the
fixed margin of 1.5% will remain constant, the 2.0% in the previous
example can increase or decrease at the bank’s
discretion.

While banks can increase their interest rates exclusively by
increasing the margin on new loans, an increase in the banks’
base rates would impact all existing and new loans and overdrafts.
Amongst other, an increase in banks’ base rate would be
expected to have actually the following effects on repayments:

New home loans As per current CBM
directives⁵, the repayment-to-income on home loans
cannot exceed 40.0% at sanctioning stage and that repayment must be
based on a stressed interest rate of 1.5% over the actual final
interest rate. Higher rate of interest will increase repayments, thus
decreasing the maximum amount that customers’ can be
sanctioned. As an example, in the event of an increase in interest
rate of 1%, a prospective 32-year old customer, with a maximum
permissible repayment of €1,000, would see their potential
loan amount decrease from roughly €250,000 to
€220,000⁶.

Existing home loans Increases in interest rates
will result in higher monthly repayments. The amount by which a
customer’s loan repayment will increase will depend on the
outstanding balance of the loan and the remaining term. As an
indication, an increase of 1.0% in the base rate on a loan with an
outstanding capital of €100,000 and a remaining term of 20
years, would imply an increase in repayment of circa €50 per
month, over the term of the loan⁷.

Personal loans Similarly to home loans,
increases in interest rates will impact the amount that can be
sanctioned and increase the monthly repayments. However, the CBM
does not stipulate a maximum repayment-to-income for personal
loans.

Business loans Increases in interest rates will
be reflected in higher loan repayments impacting the cash flow of
the business. Unlike home loans, repayment amounts on business
loans are not subject to a maximum by the CBM. For instance, if
interest rates were to increase by 1%, a business loan of
€500,000 with a term of 10 years, would incur an increase in
repayment of circa €240 monthly over the term of the
loan⁸.

Overdrafts Interest rates on overdraft is
charged periodically and there is no fixed monthly repayment with
respect to the outstanding balance. Therefore, increases in
interest rates will increase the interest due accordingly.

In summary…

If, when, and how to increase interest rates, will probably be
the single most important decision for local banks this monetary
year. What each bank decides will be influenced by their current
position in the market and will necessitate a fine balancing act
between the interests of their net deposit customers, their net
borrowing customers, and their shareholders.

On a reassuring note, the Maltese banking sector has undergone
significant expansion over the past two decades and today’s
banks are heterogenous and cater for different markets –
banks vary both in terms of balance sheet characteristics, as well
as market objectives. Thus, it is unlikely that all banks will
increase interest rates in unison, allowing customers to make the
best choices depending on their own personal realities.

Footnotes

1. Eurostat

2. National Statistics Office – Harmonised
Index of Consumer Prices (HICP): January 2023
030/2023

3. The Central Bank of Malta classifies APS, BNF,
BOV, HSBC, Lombard, and MeDirect Bank (Malta) as core domestic
banks.

4. European Central Bank – Supervisory Banking
Statistics, Third Quarter 2022

5. Central Bank of Malta – Directive no
16

6. Based on an increase in the loan interest rate
from 2.94% to 3.94%, 2.94% being the typical loan interest rate for
households as at September 2022 (CBM Quarterly Review
2023:1)

7. As above

8. Based on an increase in the loan interest rate
from 3.82% to 4.82%, 3.82% being the typical loan rate of interest for
non-monetary-corporations as at September 2022 (CBM Quarterly
Review 2023:1)

The content of this article is intended to provide a basic
guide to the subject. Specialist suggestions must be looked for
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