Mario Mallia, CEO of Bank of Valletta rounds up 2016 for the banking sector, whilst looking ahead at what is in store for 2017.How has the banking sector fared in 2016?
It was quite a challenging year for the sector, both in Malta and in the larger Euro area. We seem to have entered an era of long-term low-to-negative rates. The fact that Maltese banks, like most of the sector in the Euro area, have chosen not to pass on negative policy rates to deposit customers means that their interest margins, and consequently their profitability, are coming under pressure. Low rates put pressure on banks’ profitability, particularly on banks which are very reliant on net interest income.
The local banking sector is undergoing a strategic process of de-risking. Banks are reviewing their business models, and questioning why they should be undertaking certain activities which carry a certain level of risk which is not compensated by an equitable return. They are taking a second look at those sectors of the economy where they may be overly exposed, and are moving to control high concentration areas. At the same time, banks are building up their capital buffers, driven by European banking regulation. De-risking and capital build-up make for safer, albeit less profitable, banks.
Finally, the sector is highly liquid, thanks to a vibrant economy and to the interest rate environment, which entices savers to “park” their savings with the banks while searching for higher yields elsewhere. While good liquidity is an essential ingredient for financial stability, too much of it becomes yet another source of pressure on the sector’s profitability.
On a national level, Maltese banks have been reporting healthy performances overall. How did Bank of Valletta fare in 2016 and which sectors within the bank have performed particularly well, and which sectors less so?
Like all other Maltese banks, BOV encountered the challenges that I referred to – low interest rates, high liquidity, increasing costs and a good dose of political uncertainty arising from Brexit and the US presidential election. But we had also our fair share of opportunities. The Maltese economy continued to grow at a far stronger rate than the rest of the Euro area; consumer and investor confidence remained strong, while unemployment fell to record lows. We experienced solid demand for personal finance, especially for home loans an investment properties. Investment services, bancassurance and credit cards also turned in particularly strong performances.
Demand for business credit was, overall, moderate, and focused primarily on property development. Nevertheless, we continued to witness vibrancy in the local SME sector. During 2016, BOV continued to support SMEs through the launch of BOV JAIME (Joint Assistance Initiative for Maltese Enterprises) Financing Package, a new financing tool arising out of the agreement that was signed between the European Investment Fund (EIF) and Bank of Valletta. Following a competitive call between banks, BOV was entrusted with the management and administration of the SME Initiative for a total fund of €50 million. Take-up has been strong, and pipeline business interesting.
At the end, BOV reported a satisfactory profit which, when adjusted for a onetime windfall gain, was marginally above that reported for last year. Maybe more importantly, we achieved a strong level of capitalisation, with a core equity Tier 1 ratio of 12.8%, which will ensure the stability and sustainability of the Bank in the long term.
In view of Malta’s consistent economic growth, what are you envisioning within your bank and the banking system at large in 2017?
There will be no paradigm shift in the coming two or three years. Banks in Malta will continue to perform their traditional role as lenders, as intermediaries between savers and entrepreneurs. Indeed, the competition between them is intensifying in this sector.
However, we also recognise that the operators within the “new economy” – mainly IT-based services – are not as capital-intensive as the more established players. Their emphasis is on human capital, rather than financial capital. Their needs may vary from those operating in the established sectors.
The “new economy” may be less dependent on credit, but it is making new demands in the areas of digital banking, payment processing, innovative financing and other areas which, up to a few years ago, were not considered as core activities by local banks. The presence of affluent investors and of a highly skilled (and highly paid) expatriate workforce, together with a more discerning local customer base, has given a huge impetus to investment-related services, such as wealth management and stockbroking. This is all leading to a gradual change in strategic focus – you could say that banks are shifting their focus from the “liabilities” side of their customers’ balance sheets, to the “assets” side.
So we may not be experiencing a revolution, but we will be seeing a substantial drive towards digitalisation, operational efficiency and private banking.
The banking sector in Europe has come under the spotlight recently after news of Deutsche Bank’s clashes with the US Department of Justice. What are the implications of this on the rest of the banking system and does such publicity affect the credibility of banks at large?
This case is the starkest reminder yet of the extent of supervisory scrutiny of banks in Europe and the US. It is hard to argue against robust supervision – although one may certainly find issue with the proportionality of the penalty in Deutsche’s case. Commentators have argued that the fine is so large that it could destabilize the bank and provoke a new financial crisis. But the case serves to highlight that even the largest global institutions are nowadays held to account, and that banking supervisors are “strong with the strong”.
Danièle Nouy, Chair of the ECB Supervisory Board, had promised that the new supervisory regime for the Euro Area banking sector, would be “intrusive, tough, but fair.” Madame Nouy was speaking of prudential supervision – the Single Supervisory Mechanism that seeks to preserve financial stability across the EU. But her acerbic description can be equally applied to the anti-financial crime supervision, of which Deutsche may seem to have fallen foul.
The lessons of the Deutsche case for the rest of the sector is: beef up your anti-financial crime defences, As regards the fallout on the sector’s credibility, some argue that such cases actually shore up credibility, as they provide evidence of the close and vigilant supervision under which banks operate.
Supervisors must, however, tread carefully and weigh the consequences of their decisions before actualising them. An unwanted consequence of disproportionate penalties may be the instilling of a culture of fear, where banks become exceedingly cautious in their dealings, for fear of crossing a supervisory line. Supervisors are there to keep criminals out of the financial plumbing; they now have to ensure that good, honest business is not also unintentionally excluded as a result of overly zealous policing.
Does this same scrutiny of Deutsche Bank – an established financial institution in Germany and beyond – put Maltese banks at risk?
Maltese banks are always more vulnerable than most of their Euro Area counterparts, in view of their size and lobbying weight. The risk is that disproportionate supervisory responses may prompt banks to retreat to their comfort zones, and just sit there. In such cases, the smaller institutions, in the smaller countries, are always the first to be affected, since the volume of business they generate is usually not enough to justify the actual or perceived risks being assumed by the services providers. So the latter may end up by withdrawing their services.
I am, of course, referring to correspondent banking services. Rising supervisory expectations, coupled with the threat of draconian penalties and mounting compliance costs, are leading banks to question why they should be providing correspondent banking services at all. Today, banks are not only required to carry out KYC – Know Your Customer – but also KYCC – Know Your Customer’s Customer. In other words, they may be held accountable for the sins of omission committed by their correspondents. And many are deciding that this business is not worth the risk.
Correspondent banking has become a global issue, and has attracted the attention of supranational organisations such as the IMF. I believe that the correct balance between supervisory diligence and the unhindered conduct of legitimate business has still to be struck. Supervisors must be careful not to push business out of an over-regulated banking sector into the more opaque and less regulated world of shadow banking.
Malta is becoming an investment hub for businesses and expats alike – how can this benefit the banking sector to enhance profits and encourage further economic growth? On the other hand, are banks doing enough and taking enough measures to allow businesses room to grow?
Malta’s economy has certainly been “internationalised” in a relatively brief time. As always, such a situation presents both opportunities and challenges. The opportunities are clear – we now have access to a larger, more sophisticated and more affluent market. On a national scale, we have to be careful to keep the economy well diversified, since undue reliance on one or two sectors would make us vulnerable.
The challenges are equally there for all to see – an open and booming economy, right in the middle of a region which is marked by geopolitical tensions, will attract both good and bad. In our eagerness to embrace the good, we cannot afford to let our guard down.
I can assure you that no bank will turn down a good business proposal, especially in these times of low yields and high liquidity. Indeed, competition for good business is intensifying, and banks are often cutting margins down to the bone when it comes to onboarding desirable customers. But we have to remember that banks are lending depositors’ money, and not their own, and high risk, speculative proposals will often fall outside of banks’ risk appetites.
In the case of international customers seeking to open bank accounts in Malta, we have also to ensure that such requests are legitimate. Customers with multiple and complex layers of ownership may raise concerns, as will requests by companies to open accounts in Malta when they have no economic activity of any nature on the Island. We cannot throw caution to the wind in the pursuit of short-term profit. Malta’s reputation as an international financial hub may otherwise be at stake. We have always and everywhere to thing long term.
The Malta Development Bank announced by government is a first of its kind locally. What are your thoughts on this? Do you consider this as government competing with the private sector or was there a need for such an institution?
I have always believed in the need for a Development Bank in Malta, and I certainly don’t view it as a competitive threat to the local sector. The Malta Development Bank will reach into areas where commercial banks are unable or unwilling to go, such as infrastructural projects with very long payback periods; but also in certain areas of SME financing that may be on the periphery of the risk appetites of banks. There will therefore be an extension of credit where credit has never reached before. There will not be a state-funded operator competing with the commercial banks on their own territory.
So, in a nutshell, the Malta Development Bank will complement, rather than compete with, the local commercial banks.
Financing will be provided through the commercial banks, on the strength of guarantees issued by the Development Bank. This will, in itself, serve to mobilise the liquidity held by the banking sector in the service of the real economy, without burdening the sector with undue risks. Mobilisation of idle cash, and the extension of the financial plumbing, will make for greater economic efficiency and offer higher growth prospects for the future.
What are your priorities for 2017 and which key areas are you looking to focus on?
The Bank’s strategy for the coming two or three years is one of consolidation. We cannot progress unless we have the right quality and quantity of resources, whether these be human, IT or financial capital. The market is changing rapidly, technology even more so, and those institutions that do not keep up with the pace are risking their shareholders’ investment.
And so we are focusing on taking our resources to the next level – by enriching and diversifying our internal skills sets; by introducing fresh blood at every level of the organisational structure; and by ensuring that BOV remains a model employer which can attract and retain top talent.
We will be transforming the way we do business, by replacing our core banking system and changing our processes to fit into the new architecture. On the financial front, we are seeking to strengthen our capital buffers through a variety of means, including the issue of fresh equity.
The ultimate beneficiaries of this change programme must be our customers, who are ultimately the raison d’être of BOV, as they are of any bank. Unless our efforts translate into better quality service, shorter response time, enhanced security and an improved customer experience, they will all have been a waste of shareholders’ money.