When will the financial markets sort themselves out? No sooner is one bank bailed out of its insolvent state than another finds itself in difficulties. After Cyprus there already looms on the horizon the Slovenian banks which seem to have taken excessive risks in the property sector. And after Slovenia?

How could the failures escape through this supposedly rigid regime of controls?

How could mortgage corporations in the US like Freddie Mac and Fannie Mae grant millions in house loans that from day one were obviously incapable of being repaid?

How could rogue dealer Nick Leeson make Barings Bank bankrupt singlehandedly?

How could the Libor scandal happen in what London still wishes to believe to be the capital of financial probity? And one could add Lehman Bros, JP Morgan and HBOS apart from a number of other bank failures.

In my view there are two main causes for these failures: the deregulation of the banking sector and the lack of adequate supervision.

The deregulation that took place in recent years opened the doors to unprecedented volumes of dealings in derivatives, hedge funds, non-performing loans and high exposures to single countries or business sectors which eventually produced the mess some banks abroad are in today.

Take the case of the Cypriot banks. Though what they did was unwise, or even reckless if you wish, yet so far it is not clear what definite directives were broken. One therefore appreciates the feelings of the Cypriot President Nicos Anastasiades when he publicly claimed that the Central Bank of Cyprus failed to supervise the banks effectively.

Again, the recent case of the Monte Dei Paschi di Siena shows that while the MPS chiefs acted most irresponsibly, the present set-up allowed them too much leeway in their dealings in derivatives. Similarly, in the case of the huge exposures to the property and construction sector, although governed by directives to individual borrowers, their cumulative effect as a component of the total assets of the banks was the cause of many banks abroad coming to grief.

Aware of the funding mismatches in the maturity ladder of commercial banks, the European Commission for Internal Market and Service is thinking of introducing net stable funding ratios requiring banks to match their assets by sources of funding (deposits) with similar maturities. This will hopefully prop up better the banks in case of bank runs, while bringing a measure of better governance to the banking sector.

The lesson to be learnt from these experiences is that the Basel and other directives, although excellent in themselves, were not enough to prevent the crises that hit the banks.

The interest of the depositors dictates that regulators would do well to stipulate some form of capping of exposures to various sectors by way of ratios to balance sheet footings.

This can only enhance the stability of commercial banks and if Basel does not do it there is nothing to stop us from doing it here if it is a good thing.

When it comes to supervision, there are four standard lines of defence built in the banking sector against a bank’s failure. Foremost is the Board of Directors that lays down the internal discipline and policy of the bank.

The board also monitors the executives to ensure that its directives are in fact being implemented. The second is the bank’s own internal auditor, usually a no-nonsense experienced banker who is familiar with the bank’s internal procedures and banking in general.

He is chosen by the board and reports directly to it on a regular basis. There is additionally the external auditor who annually spends a number of weeks in the bank itself inspecting the books while overseeing its operations at close quarters. Then of course there is the regulator who for good measure carries out his own surveillance and also visits the bank on the ground from time to time.

Do we not all know this? Perhaps. But then if so, how could the failures mentioned above escape through this supposedly rigid regime of controls?

The truth is that as stated by the High-level Group Report on Reforming the EU Banking Sector, “in broad terms the severity of the crises indicates that regulation and supervision were inadequate”. Indeed one can add, how is it that nobody saw the crisis coming?

As far as Maltese core banks are concerned, there is general agreement that they have weathered the financial storm admirably. They remain strong and profitable.

If banks abroad followed the Maltese model the world would be a happier place to live in. But let us not be too smug about it.

The National Bank of Malta saga, for one, is still awaiting a court decision after all these years. Unfortunately, the four defences mentioned above have failed to save the bank and its shareholders.

Besides, the core banks there are other institutions and a few other smaller banks licensed in Malta, which tout for local depositors’ funds.

If we wish to maintain our good name and the high ground in the financial world as a financial centre we have to remain vigilant.

And the best way to do this is to have meaningful regulations and effective supervision.

Joe Pace Ross is a former director at APS Bank.

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