We are in the reporting season when banks announce their half-yearly results to the market. Malta’s banks BOV and HSBC published a mixed bag of results that need to be interpreted in the broad context of the transformation that the banking industry has been undergoing in the last few years. Failure to relate these results to the operational context may lead to mistaken conclusions on the way ahead for our major banks.
The headline figure, of course, is always the banks’ profit before tax. This figure indicates whether banks are still solidly profitable despite the de-risking strategy that inevitably affects profit negatively. In the first half of 2019, BOV registered net profits before tax of €54.3 million compared to HSBC’s €20.9 million.
These more than adequate profits indicate that BOV still has substantial core income streams despite its withdrawal from the riskier business lines like trusts, the handling of accounts for customers who have no business connections with Malta and custody business. HSBC is in a more advanced stage in its de-risking process and is now pursuing revenue growth.
A significant divergence in the results of the two banks is their cost profile. The cost-to-income ratio of BOV is currently 59.6 per cent while that of HSBC is 72.9 per cent. This divergence is mainly attributable to the income element of the ratio. BOV’s operating income amounted to €127 million while that of HSBC was €68 million. The challenge for both banks will be to keep income flowing while managing inevitable restructuring costs judiciously.
The Maltese economy is now attracting economic activities that no longer depend so much on bank borrowing
The costs of BOV amounted to €81 million while those of HSBC totalled €54 million. This divergence is partly explained by the fact that in the last few months, BOV had to finance the cost of international consultancy relating to the de-risking of its business model. The process of restructuring a business is ongoing. The costs involved often have steep peaks and deep troughs. BOV is experiencing one of these peak expenditure periods while HSBC has probably passed this critical stage.
The loan books of both banks remain substantial. BOV has €4.5 billion outstanding lending while HSBC has €3.2 billion. BOV’s deposits amount to €10.6 billion, while HSBC has €4.8 billion deposits. The low-interest-rate scenario is affecting BOV more adversely than HSBC since BOV has substantial excess liquidity that has to be held at the ECB with the adverse interest of -0.4 per cent. This should motivate BOV’s management to seek lending niches that will improve its gross loans-to-deposits ratio.
Shareholders who take the long-term view need to look beyond the declared dividend, even if this is an important performance indicator. BOV will announce its dividend policy for 2019 at the year end. HSBC intends to pay an interim dividend of €0.17 per share. BOV’s return on equity is a significant 7.5 per cent while those of HSBC is 5.8 per cent.
There are other similarities in the challenges that both banks face in the coming months. BOV has Tier 1 capital of 19.1 per cent, while HSBC’s Tier 1 capital amounts to 16.2 per cent. The European Central Bank’s Single Resolution Board will be indicating the requirements that will apply for new minimum required eligible liabilities. Put simply, both HSBC and BOV are likely to have to increase their capital to meet regulatory requirements aimed to make banks safer.
The banking industry has undergone more transformation in the last five years than in the previous decade. Tighter regulation, new competition from technology companies, a prolonged low-interest-rate environment and increasing geopolitical risks have inspired new strategies and business models.
The lite-touch regulation is a thing of the past and this has affected banks’ ability to generate extraordinary profits. The Maltese economy is now attracting economic activities that no longer depend so much on bank borrowing. Banks need to work harder to improve their return on assets as their loan books are relatively less prominent in their balance sheets. They also need to invest more in technology – a development that is on the priority list of both BOV and HSBC.
Regulators also need to understand the socioeconomic context in which Malta’s significant banks operate. Both BOV and HSBC have large numbers of small shareholders that trust their local banks to remain stable in the long term as their earnings depend on the return they get on their investments.
Regulatory decisions on what amount of dividends profitable banks are allowed to pay should also be based on this critical consideration.