The widely held belief that banks are well-oiled money-making machines is no more than a misconception. Banks are in the business of managing risk, and some of these risks are out of their control.
The half-yearly results published by Bank of Valletta and HSBC confirm that, however prudent banks are, the risk universe in which they operate is vast. There will be times when their best efforts will not be enough to give their shareholders an adequate return.
BOV saw its profits drop to 75 per cent in the first six months to €13.8 million.
HSBC saw an even more significant drop of 93 per cent when its pre-tax profits for the same period came down to €1.8 million.
Both banks commented that COVID-19 was behind these depressing results. This argument is only partially correct.
In the last few years, both HSBC and BOV have been implementing a de-risking strategy of their business model.
Under European Central Bank regulatory pressures, local banks have been shying away from economic activities that are considered high risk despite the insistence of the government to promote these activities.
The major banks’ business model is now more in line with that of domestic banks that mobilise local savings to finance traditional activities like tourism, local services, mortgage lending and trade finance. But the timing of the pandemic certainly did not help to mitigate the impact of de-risking.
The low-interest-rate scenario that has prevailed for the past several years has hit banks and their depositors adversely.
The pricing of risk has become distorted in this environment. This partly explains why provisions for doubtful debts have been increasing.
An issue that is rarely discussed is the unfair competition that banks face from the issue of corporate debt that is sub-investment grade and sold to retail investors.
While banking regulators insist on banks tightening their lending criteria to ensure that the sub-prime borrowing excesses of the financial crisis of 2008 are avoided, not much is being done to ensure that retail investors understand the risk of buying loosely regulated sub-investment grade debt.
More needs to be done to ensure that retail investors in search of yield get the same level of protection by ensuring that the sale of investment products by banks and other financial intermediaries is made in a level playing field.
Both BOV and HSBC can weather the current negative adverse headwinds as they are well capitalised and have a sound business model. It is almost inevitable that cost-reduction tactics will continue to be adopted by both banks.
Closure of more branches and reduction of staff are amongst the tactics that could be on the cards for the next year and beyond. Customers will have to get used to accessing more services by electronic means.
In the case of HSBC, the question remains as to what the medium-term plans of the bank’s corporate headquarters in London are for the local subsidiary. The dramatic reduction in HSBC’s local balance sheet does not augur well for the long-term plan of this bank in Malta.
Malta’s major banks remain sound despite the disappointing results for the first half of this year. But a return to the profitability levels of a few years ago is unlikely as their business model is no longer dependent on frothy economic activities.