It is widely known that in recent years the banking industry has experienced a significant shift which rendered the banking business model less attractive. Following the debt crisis of 2008, banks were faced with the new reality of stricter capital requirements, coupled with historically low interest rates, as strong intervention by central bank led to high grade fixed income assets trading at negative yields.

The uncertainty surrounding the coronavirus pandemic is presenting substantial threats to the banking industry. Banks, through their loan portfolio, are exposed to potential significant credit losses, as the economic cost of this virus and the subsequent containment measures may result in a number of borrowers defaulting on their loans. 

This is further exacerbated by the new accounting rules that financial institutions had to adopt as from January 1, 2018. IFRS 9, requires banks to account for provisions based on expected credit losses (ECL), especially when they cross key thresholds such as ‘material change in circumstances’. This requires banks to take provisions for the entire life of a loan.

Previously, banks used to account for provisions based on actual evidence of potential defaults, known as the ‘incurred loss’ framework. As a result, it is expected that Banks will need to book significant ECL provisions, which will eat up accumulated earnings and consequently, impact the banks’ capital ratios.

This might present a situation where, governments are turning to their banks to facilitate lending in order to ease the economic pain brought about by the outbreak, while concurrently banks are unwilling to provide financing in a riskier environment, due to potential increases in ECL and subsequent impact on capital ratios.

The impact of these new accounting rules started to emerge even locally, as banks reported on the first quarter of 2020.

HSBC Bank Malta plc reported that the outlook over the medium term remains uncertain and volatile, with the bank providing for €7m ECL provision to reflect the potential impact of this virus at a portfolio level. However, at the time of the announcement the bank announced that it has not experienced material increase in specific credit losses from either business or retail customers. Attributing the latter to support measures introduced by the government and the bank’s conservative risk culture.

Bank of Valletta plc did not specify any provisions taken in Q1 2020, however it did specify that the situation on impairment provisions remained favourable to date. Albeit, the bank did mention the likely requirement of further provisions given the current difficult environment. Furthermore, the bank stated that the duration of the current situation will be a key determinant of the credit losses which may arise.

FimBank plc did not report on Q1 2020, however it announced that a company with whom it has a business relationship, has recently encountered significant financial difficulties, which resulted in this company to enter into liquidation. FimBank’s exposure to this client is of $8.5 million. This news follows the recently announced Fitch downgrade of FimBank's long-term issuer default rating to B+ from BB- with a negative outlook. Fitch highlighted that the downgrade was driven by increased pressures on the Bank's business model as a result of the economic fallout from the COVID-19 outbreak.

Lombard Bank Malta plc announced that the bank has not experienced any need to increase provisions for ECLs as a direct result of the pandemic. The bank attributed this to its loans which includes facilities for medium-term projects which should not be excessively impacted by the short-term economic environment. 

Moving forward, much will depend on the uncertainty surrounding the duration of this outbreak and the extent of the local economic impact, in addition to, the continuation of measures enacted by the government to support local business. Albeit, IFRS 9 will present significant challenges to banks and may create excessive provisions, which might worsen the ability to recover once the current situation stabilises. 

Disclaimer: This article was issued by Rowen Bonello, research analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. 

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