Banks have found themselves in an unenviable position, trying to maintain an impossible balancing act between the European Central Bank (ECB), their shareholders and their clients.

The ECB want banks to have ideally have clean balance sheets with no skeletons but it also wants more lending to entities like SMEs – who have high potential to turn into skeletons.

Shareholders want profits which will raise the share price and generous dividends and they do not want to see these eroded by impairments.

Clients want loans so that they can get on with their business, either slogging it out until times get better or seizing opportunities now that “creative destruction” has weeded out the competition.

Unfortunately for the main Maltese banks, they are being caught in a net which has been cast to catch foreign banks which either failed outright or have not been profitable.

Over the past decades, local banks made huge improvements to their risk management, and the ratio of non-performing loans has been slowly but very steadily falling. It was a painful process: there was time soon after the take-over of Mid Med by HSBC when the Government Gazette carried pages and pages of court auctions against defaulters who had been arrears for a considerable amount of time, assuming that no bank would ever dare to take action. Just as the banks were more careful about who they loaned money to, customers became more aware of their obligations.

Banking relationships became more about mutual respect and less about conflict-averse, ‘head in the sand’ approaches from both sides.

Banks in Malta also took a more prudent view many years ago with regard to the loans for speculative property development, as supply skyrocketed.

But the ECB’s asset quality review has forced them to accept a totally different view of their loan books. Bank of Valletta was found to have an underprovision of €16 million and HSBC Malta of €30 million.

This forced the banks to transfer would-be profits into undistributable reserves, having a material impact on their bottom line. In fact Bank of Valletta Group registered a pre-tax profit of €104.1 million, compared with €115.8 million last year, with an impairment total of €19.4 million.

HSBC Malta reported a 42 per cent decline in their profits to €52.1 million, with impairments standing at €22.5 million.

Shareholders want those impairments to be reduced as soon as possible – but clients whose accounts have been flagged as being in any one of the fifty shades of ‘doubtful’ need banks to show forbearance, one of the cardinal principles of banking relationships, and one which has contributed in no small part to the success of the local banks’ business models.

Forbearance is defined as both tolerance and restraint in the face of provocation, and the act of giving a debtor more time to pay rather than immediately enforcing a debt that is due.

Banks face a dilemma. To make the numbers look better as quickly as possible for the sake of the ECB and their shareholders, they can send out their big sticks, even though this will probably mean recovering only part – perhaps a very small part – of the amounts due.

But doing so would probably mean the kiss of death for their clients, right at a time when what they most need is forbearance: breathing space and hand-holding.

The short-term gains would whittle away the long-term relationships. What will we have gained if we have banks with a squeaky clean loan book trying to operate in a graveyard of foreclosed businesses with no newcomers encouraged to take risks?