Eleven years after the collapse of Lehman and the resultant banking and financial crisis, banking regulators are not only concerned with issues of financial stability but are giving equal importance to the problem of money laundering, whose definition has been broadened from the traditional ‘cleaning up’ of the proceeds of crime to also include tax evasion.
Money laundering has today become a major concern. For banks, it carries reputational risks which have caused a substantial withdrawal of correspondent banking services across the globe. Correspondent banking is the ‘financial plumbing’ that allows money to be transferred around the world between payers and beneficiaries.
The major banks have become increasingly reluctant to offer correspondent banking because of the risk that they might end up processing illegitimate funds, and thus become an unwitting party to money laundering. This applies particularly to small jurisdictions like Malta where the volumes are not large enough to produce the returns that justify the risks from the point of view of the correspondent bank provider.
The consequences of the financial crisis, as well as the more recent concern with money laundering, has led to a drive by banking regulators to force a reduction of the risks inherent to the industry.
A new watchword – de-risking – came into use. As the name implies, de-risking is all about making banks safer, in the sense that they are rendered less vulnerable to future loss events which could have financial and/or reputational consequences.
This is the context within which BOV’s de-risking strategy was developed and is being executed.
At the heart of the strategy lies the bank’s risk appetite framework. The risk appetite, which is an articulation of the risks the bank is willing to assume in the conduct of its business, has been revised in consultation with supervisory authorities and has become more restricted. As a consequence, certain risks that the bank used to assume as part of its business now lie outside the revised risk appetite.
Certain risks that the bank used to assume as part of its business now lie outside the revised risk appetite
The consequence: BOV must close relationships that lie outside its revised business model, even if such relationships are profitable and command a good history.
BOV’s de-risking strategy seeks to address both financial and reputational risks. It is a strategy that is based on three pillars: (1) the assurance of long-term financial stability through the building of a strong capital base; (2) exit from business areas where the return being made is not justified by the risk being assumed; and (3) the termination of relationships with customers that are deemed to carry a level of risk that the bank is no longer comfortable with.
Pillar 1 is aimed at financial risk. Pillar 3 concerns reputational risk. Pillar 2 addresses both. Together, these pillars form a strategy that has the approval and backing of BOV’s supervisory authorities, both local and international.
The BOV of the future will be a smaller but more robust, lower risk and stable institution
The Bank has been working on the first two pillars for the last three years. I have, on a number of occasions, explained our stance of always giving priority to long-term stability and sustainability over short-term gains. This vision was the driving force behind our capital management strategy, which saw an aggressive push to bolster capital buffers.
Group Core Equity Tier 1 (CET1) ratio – the benchmark ratio which relates capital to risk-weighted assets – rose from 11.3 per cent in September 2015 to 19.1 per cent in June 2019 – an increase of 69 per cent in less than four years. The average European CET 1 ratio stands at 14.2 per cent.
This significant strengthening of capital over a relatively short time came at a cost – shareholders were asked to forego both interim and final dividends for 2018, and the interim dividend for 2019.
This is not a situation we are happy with, and our intention is to return to paying dividends as soon as we are satisfied that capital buffers are adequate to see the bank through all future foreseeable challenges. This is another case where we are sacrificing short term benefits for long term sustainability.
The second pillar of our de-risking strategy is the discontinuation of businesses that are deemed to carry risks which are not justified by return. We are closing down our Trust Services and Custody businesses.
BOV is returning to its roots, shedding peripheral high-risk business that developed over the years to focus on its core competence of plain, vanilla banking.
The third pillar is the exiting of customer relationships that no longer fit within BOV’s revised risk appetite. The ‘internationalisation’ of the Maltese economy, accompanied by the shift in local demographics, has galvanised economic activity and produced wealth.
But, from an anti-money laundering viewpoint, it has resulted in new challenges which must be faced in order to protect the reputation of the bank, of the financial sector and of the wider jurisdiction.
BOV is currently reviewing all its customer relationships to evaluate their fit with its risk appetite. The cornerstone of the bank’s Customer Acceptance Policy is clients’ nexus with Malta.
Customers will only be on-boarded or retained by BOV if they demonstrate a substantive link to the Maltese economy or, in the case of personal customers, if they reside or have strong parentage links on the island. Persons or entities with no link to Malta should have no business opening an account with a local bank. All such relationships are in the process of being terminated.
Nexus with Malta is the acid test, but it is not the only criterion used in deciding on whether to retain a relationship or not.
The bank is also reconsidering relationships with customers that operate in economic sectors considered as high risk. Corporate customers with multiple layers of ownership are also under the microscope, as are those originating from high risk jurisdictions.
The bank is also reconsidering relationships with customers that operate in economic sectors considered as high risk
Such relationships will only be retained if the bank is comfortable that the inherent risk can be well mitigated, and if it makes commercial sense. Relationships where the risk being assumed is not adequately compensated by return will be exited.
In this de-risking context, the termination of a relationship does not imply that a customer has not conducted its account to the satisfaction of the bank. Indeed, relationships with a considerable number of long-standing and loyal customers are being exited.
Termination is not a judgment of customer conduct but it is a necessary measure whenever the risk-adjusted return on the relationship no longer makes economic sense.
BOV is at an advanced stage of reviewing its international customer relationships, whether corporate or personal. It has now embarked on the review of its much larger local customer base. There will inevitably be a number of account closures that will regrettably cause inconvenience or distress to certain customers. But the long-term sustainability and prosperity of Malta’s largest bank demands such measures.
The BOV of the future will be a smaller but a more robust, lower risk and stable institution for the benefit of all its stakeholders. It will also be a bank that international correspondents will be more comfortable doing business with.
With this article, I have tried to explain the rationale behind BOV’s current de-risking programme and the context within which it is being conducted. In a future article I will delve deeper into BOV’s strategy for the future, including the review of its network of distribution channels.
Mr Mallia is CEO of Bank of Valletta.