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Mixed signals in Fitch’s bank rating

Rating agencies like Fitch have an important role of guiding investors on the financial strength of companies listed on the world’s stock exchanges. Although in the last few years they lost some of their prestige when they failed to recognise the risks that led to the financial crisis of 2007, they have since become more thorough in their analysis of banks, countries and major corporate entities.

The recent downgrade of Bank of Valletta, in which the government still holds a 25 per cent shareholding and appoints the chairman as well as another director, sends mixed signals to the management and shareholders of the bank.

A BBB rating is given by Fitch to “medium class companies, which are satisfactory at the moment”. This rating is at the lower end of investment grade classifications. The bank is still very pro-fitable, has passed the European Central Bank regulators’ stress tests and is still paying good dividends to shareholders. The reason for the downgrade, according to Fitch, is that the bank’s capitalisation is under pressure from increasing regulatory requirements and to due risks which are not, in the agency’s opinion, fully reflected in current capital ratios.

Banking has become increasingly regulated and, following the financial crisis, regulators decided that, in future, any EU bank facing difficulties should not be bailed out by taxpayers’ money. Instead, banks are now expected to increase their capital substantially so that, in case of a crisis, shareholders and bondholders rather than taxpayers would bear the brunt of losses.

Fitch acknowledges that Bank of Valletta has “a strong franchise in Malta” and “profitability from sound core revenue generated from its commercial business, good operating efficiency and contained loan impairment charges”. But it also highlights “concentration towards government exposure and towards the real estate sector”. These weaknesses must have been on the mind of the bank’s senior management that have set ceilings on certain types of lending while, at the same time, abandoning business lines that involved the bank in undue risk.

This prudent strategy has earned Bank of Valletta and other banks in Malta the rebuke of the Prime Minister who declared that the economy in Malta was growing despite the banks’ aversion to risk. It is not the first time that banks, especially those that have the government as a significant shareholder, have earned criticism from politicians.

Most politicians have a short-term view of the economy while banks and their regulators prefer to take a long-term perspective that is built on prudence.

It is, of course, in the interest of depositors and shareholders that politicians do not meddle in bank affairs and leave their day-to-day running in the hands of experienced technocrats who have strong independence of thought. Fitch’s decision indicates that a cultural change is needed in the mindset of all stakeholders of Bank of Valletta.

The government, as the main shareholder, cannot consider the bank as an extension of the political administration. Customers shouldnot expect light-touch borrowing conditions and employees must not rely on having a ‘job for life’ unwritten guarantee only because the bank is partly government owned.

Bank of Valletta has to compete in a tough market where clients have a choice. Its main concern has to always be safeguarding the interest of depositors and shareholders and not supporting economic growth at all costs, as politicians would want.

As pointed out by Fitch, there may also be economic sectors that present an abnormal risk. Bank of Valletta and other banks do well to steer away from them.

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