By Fazeel Najeeb
On Monday, 18 March SME Development Finance Corporation, a 100 per cent government-owned (including 5 per cent each owned by the three City Councils, Malé City, FVM City, Addoo City) company dedicated to lending to SMEs opened its doors for business in Malé. The MMA issued a “financing business licence” to SDFC on 28 February.
For decades small entrepreneurs, startups and enterprise-minded individuals have lamented on a lack of access to, and high cost of finance in the Maldives. Is SDFC addressing such issues? What added benefits is it offering SMEs?
According to SDFC its focus is on lending to four sectoral segments: (a) local tourism development, (b) business support – short-term working capital and trade finance, including for purchase of inventory, (c) agriculture development, and, (d) long-term capital asset purchase for firms in construction, fisheries, ICT and manufacturing (Table 1).
Three of the four segments that SDFC is focusing on are offered credit at an interest rate beginning at 6 per cent. This must be compared with existing interest rates in order to ascertain if this level of interest rates is an improvement on the existing rates, and what added benefits which the government is endeavouring to offer SMEs through SDFC.
How costly is borrowing from banks in Maldives? How does it compare with domestic and international benchmarks?
In the last decade interest rates in international benchmarks hovered near zero for many years following the 2007/2008 global financial crisis. Between 2009 and 2015 USD Libor rates were below 1 per cent throughout the period averaging 0.5 per cent for the 6-month Libor, and except in 2011 and 2015, also below 1 per cent for the 1-year Libor, averaging 0.9 per cent (chart 1). Domestic foreign currency lending rates to the private sector, benchmarked on the Libor, ranged 8.3 – 8.9 per cent, averaging 8.5 per cent for the period 2009-2015.
The spread between Libor and domestic lending in foreign currency averaged 7.3 percentage points for the 6-month Libor and 7.0 percentage points for the 1-year Libor. The reason for high foreign currency interest rates therefore do not appear to be due to high Libor rates.
Sources: MMA; Libor. Charts by Maldives Economic Review.
Lending in domestic currency in many economies is normally benchmarked against central bank policy rates and treasury bills. In Maldives, auction-based t-bills for 180 days ranged 5.5-10.0 per cent between 2010 and 2014 and averaged 7.8 per cent (chart 2). Auction-based 1-year t-bills were launched in 2012 and ranged 7.9-10.5 per cent and averaged 9.1 per cent. But commercial bank lending in MVR during the same period were above t-bill rates, and ranged 10.2-11.4 per cent, averaging 10.8 per cent. T-bill auctioning was abandoned in 2014 and t-bill rates were fixed at 8.5 per cent for 180-days and 9.0 for 1 year. These were further lowered to 4.2 per cent for 180 days and 4.6 per cent for 1-year in 2015 and remained at this level at the end of 2018.
The spread between 182-day t-bills and lending rate to the private sector in MVR ranged 1.4-5.0 percentage points, averaging 3.0 percentage points during the 2010-2014 period when t-bill auctions were conducted. The spread between 1-year t-bills and lending in MVR during this period ranged 0.9-2.7 percentage points, averaging 2 percentage points. The spreads increased after auctions were abandoned in 2014; at the end of 2018 the spread between lending in MVR and t-bills was 7.2 percentage points for 180-day t-bills and 6.9 percentage points for 1-year t-bills.
An important objective of a central bank is to increase or reduce the amount of money circulating in the economy by influencing domestic interest rates on lending. A successful monetary policy, which is a set of tools that central banks combine at varying indirect grips on the money supply, succeeds in influencing domestic interest rates through the application of its policy instruments. In the Maldives, the main interest rate policy instruments are the overnight deposit facility and the overnight Lombard facility (chart 3). The MMA website (http://mma.mv/#/monetarypolicy) mentions an indicative policy rate of 4%; but this is not reflected in its monthly statistics publication. The minimum reserve requirement (MRR) is a non-interest rate instrument that has an immediate impact on the money supply.
Source: MMA. Charts by Maldives Economic Review.
In 2014 the overnight deposit facility was lowered from 3.0 per cent to 2.5 per cent and remained at this level at the end of 2018. This is a stand-by facility that banks use to earn an interest overnight for funds they hold in excess of the day’s requirements. Overnight Lombard facility was also lowered from 12.0 per cent to 10.0 at the same time. This is also a stand-by facility that banks can access to borrow funds for overnight from the MMA for shortfalls in their daily requirements. MRR was lowered from 20.0 per cent to 10.0 per cent in 2015 which would increase the total amount of money supply and credit. An MRR of 10 per cent means banks must maintain on average with the central bank this percentage of their total deposits for the reserve maintenance period.
How did lending institutions respond to MMA policy rate changes? Lending rates remained above MMA’s interest rate policy corridor with the overnight deposit facility at the bottom and the overnight Lombard facility at the top. An effective monetary policy should succeed in balancing interest rates within the interest rate corridor. Between 2013 and 2018 local currency lending rates averaged 10.9 per cent, 90 basis points above MMA’s upper policy rate, the overnight Lombard rate. It does not appear that banks were responsive to policy interest rate changes, i.e. passed policy benefits do not appear to be passed on commensurately to borrowers.
Irrespective of policy rates, credit to private sector appears to have grown year by year with only a slight change in lending rates (chart 4). But the lowering of MRR from 20.0 per cent to 10.0 per cent in 2015 resulted in a 12.3 per cent increase in credit that year. In 2014 the growth was just 2.7 per cent. Credit growth averaged 11.2 per cent between 2015 and 2018 but lending rates remained high averaging 10.7 per cent. The response by lending institutions to the lowering of MRR appears to have been more significant than their willingness to follow MMA’s policy interest rate changes.
Apart from interest rates, anecdotal evidence suggests that in addition to the high cost of borrowing, the required high contribution by owners as equity, excessive security demands, short repayment periods and the long and cumbersome approval process, sometimes taking months, all compound problems that borrowers face, in instances effectively prohibiting their access to finance.
Government intervention in market failure, or is there more to it?
It appears that the government has stepped in to address a number of issues that the free market and the central bank may have failed to resolve. The main issue appears to be the high cost of borrowing, particularly for SMEs in relative terms.
By focusing on certain market segments, the government also appears to want to address the problem of underserved sectors. For example, between 2013 and 2018 loans and advances to agriculture totaled a meagre MVR 29.2 million and averaged a paltry MVR 4.9 million per year. This does not compare with the MVR 44.2 billion loaned to the tourism sector during this period, averaging MVR 7.4 billion per year.
SDFC also brings in additional competition, something that the MMA acknowledged in their press release following the issuance of the licence to the company.
On the other hand, relaxed requirements for borrowing could in instances manifest in moral hazard, a reference to a situation where (in this case) borrowers may conduct themselves (business) irresponsibly assuming risks are more to the lender. Such behaviour may lead to non-performing assets and could raise sectoral stability issues, matters that the central bank must keep a check on continuously.
Overall the entry of SDFC into the market may be described as a welcome development. But for SDFC to succeed and to sustain into the long run, their decisions must be based solely on economic and business considerations, and should not be influenced by other pressures.