Bank of Valletta recently published their results for FY 2013. The locally quoted banks have sometimes struck some observers as being somewhat quaint, seemingly at odds with the more “progressive” and “sophisticated” banking models being developed in larger economies. It of course transpires that our banking industry captains, operating in our intergalactic banking backwater, knew a thing or two about universally applicable, sound management principles. They understood the value of knowing your customer – and that customer’s specific circumstances at a granular level. Customer knowledge and sound management principles lead to sound judgement and decision-making – and safe, but also effective, banks.

My definition of an effective bank would include a requirement that its lending capability is not curtailed by being subject to excessively prudent considerations which lead to excessively high capital buffers, reserves, provisions and so on. It would also include a requirement that its financial statements are prepared with a religiously faithful adherence to the principle of showing a truly true, and truly fair view. Any duress by (for example) European authorities to adulterate the figures by adding an extra layer of superfluous safety measures would be unwelcome. If it is not true and fair it is misleading for potential investors – and it leads to sub-optimal execution on the part of the bank, with negative consequences for the economy.

‘Excess liquidity’ ... could be conceptually defined simply as the point where the cost of the liquidity (that is, the interest payable on it as well as the management time and systems needed to consider its deployment) outweighs its value

However, we now seem to be at risk of a faintly ludicrous situation where forces from above, trying to fix a eurozone banking problem neither of our making nor a feature of our local industry, dictate highly prescriptive ‘solutions’ to problems that we do not have. The problem with highly prescriptive solutions is that sound judgement cannot override them – even if the result is counterintuitive and illogical.

One of the noteworthy items in the accounts is net impairments.

These increased by 12 per cent, from €22.8m to €25.6m. In line with recommendations from the European Commission the bank is increasing loan loss provisioning on its non performing loans. The mechanism for doing this is to take a “more conservative view of the value of collateral held on non-performing exposures”. For what reason? Local banks have historically and typically made prudent assumptions in relation to the value of their collateral. They have also been prudent as to the amount lent against that prudent collateral value.

In that context, it is as yet not totally clear on what basis one can justify a further diminution in the value of collateral, to the extent that it triggers an increase in aggregate non performing loans. It certainly cannot be justified by reference to the Central Bank of Malta’s (CBM) property index. The latest 12-month data shows an increase in the index from 167.4 to 169.2. Note that the CBM is a member of the Eurosystem and the European System of Central Banks, so presumably the European Commission would be only too happy to rely on what is effectively their own data. Perhaps they do not trust themselves, an admittedly reasonable stance based on the predictive ability of European banking stress tests.

Another noteworthy item is customer deposits. These increased substantially, from €5809m to €6220m. As a general rule of thumb, increased liquidity is welcome.

However, if deposits keep increasing faster than a bank’s ability to redeploy into the economy there must come an inflection point of ‘excess liquidity’. This could be conceptually defined simply as the point where the cost of the liquidity (that is, the interest payable on it as well as the management time and systems needed to consider its deployment) outweighs its value. Where this point lies is not easy to know, but what is relevant is the recognition that it exists. We are referring here to the value of ‘pure’ liquidity, in other words funds which are not redeployed for a return – either in the loan book or capital markets.

Specifically in respect of the latter, an argument could be put forward whereby the increased financial risk taken on offsets the value attached to the liquidity in any case. After all, even bonds previously given a risk weighting of zero subsequently proved to be far from risk free. If we go back to first principles, it can also be argued that a bank is first and foremost a credit institution. It is less than clear that a bank should actively pursue deposits in order to redeploy them in the capital markets. The economy does not need intermediation for this activity in the same way as it needs it for the provision of credit. That said, one can sympathise with banks intent on building their deposits and liquidity when a regulatory tsunami is heading their way.

One hopes that the golden legacy of our banking industry, as well as its effective and locally relevant working practices, will not be eventually subsumed under this wave. We have an economy dominated by SMEs. Confederation of British Industry head John Cridland recently called for a return to ‘Captain Mainwaring banking’. (This is a reference to the bank manager in ‘Dad’s Army’). He stressed the importance of relationship banking, which he feels has been lost. We still have it; we ought to cherish it.

This article is the objective and independent opinion of the author. The information contained in the article is based on public information.

Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.

Martin Webster is head of equity research at Curmi and Partners.

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