Banking regulation evolved at a fast rate in the last decade as governments urged regulators to make banks safer so that taxpayers would not have to make good for poor governance of systemically important banks.
Malta’s three largest banks are now directly supervised by the European Central Bank. BOV is the first local bank that will increase its capital by €150 million. Investors ask why there is a need for capital increase when this bank has just announced very positive financial results for the year ending in September.
A bank’s governance is all about managing risk in the most effective way. Local systemically important banks are different from most other businesses in that their operations are generally financed by depositors’ money. This sobering reality is the main reason behind the need for prudent capital management to ensure that banks have solid foundations to support their business.
During the past decade regulatory authorities were able to mitigate or remedy some of the consequences of relatively localised financial crises. Regulation typically follows the economic and market cycles. As Sergio Scandazzo says in his book Risk and Governance: “Stricter provisions and more invasive supervisory powers are enacted during, or more often immediately after, times of crisis and contraction.”
We are exactly in this stage. BOV, like all other local banks, did not need any assistance to weather the tough market conditions of the last decade. As a systemically important bank, it is bound to follow the new regulation that the ECB is introducing. This regulation is underpinned by the principle that banks should increase their capital to levels that in the past would have been considered as excessive but which today are accepted as mandatory to manage risk.
BOV was always prudent in the valuation of its assets. The bank’s provision policy for doubtful debt has become even more conservative in the last three years as subjectivity has been replaced by more objective criteria defined by the ECB. This should ensure that the new financial reporting standards that will be introduced in January 2018 should not have major effects on the bank’s short-term results.
The performance of BOV in the last few years was good and consistent. Pre-tax return of equity stood at 19 per cent in September, while return on assets reached 1.3 per cent. Of course, the future does not necessarily mirror the past. BOV’s business model is evolving to make the bank’s business less dependent on interest income. Operational efficiency is being targeted by means of an ambitious IT project that should result in a better and more cost-effective service to the bank’s customers.
The performance of BOV in the last few years was good and consistent
Investors with a long-term view would not worry unduly by short-term fluctuations in the price of shares quoted in the local stock exchange. The local stock market is small and this can at times result in price movements that do not necessarily reflect the economic fundamentals of a particular quoted company. Investing in shares of banks that are tightly regulated by the ECB is, in my opinion, an advantage as it encourages management consistency and sustainability in their profitability.
In the last decade BOV has shown that it can produce consistently good results despite any operational setbacks that from time to time can affect any business. The increase in capital over the next few weeks is yet another buffer that will ensure that any growth in business can be supported by ample capital reserves. Following the rights issue, the government’s shareholding in the bank will remain at the same level as at present. This confirms the importance that BOV has in the local economy.
Investors’ risk tolerance varies according to their particular financial circumstances. Individual investors considering whether to buy shares in BOV’s capital issue would do well to understand the risks and rewards of alternative investment options that are presently available.
Institutional investors’ strategic priorities may also differ. Unicredit, for instance, is a significant minority shareholder that has decided not to take up their rights entitlement because their investment in BOV is not considered as strategic. Understandably, the strengthening of this Italian bank’s own capital base is a higher priority for its management.
BOV’s business model is evolving into one that is based on more diversification aimed at achieving sustainable profitability through more efficient use of capital. More stringent regulation at eurozone level may affect short-term profitability but should ensure more robust risk management in the longer term.
The author of this article is a former chairman of BOV. The contents of this article should not be construed as financial advice.
johncassarwhite@yahoo.com