One thing most financial analysts agree on is that this year will continue to be characterised by high volatility in the equity markets. The rising price of oil, the return of inflation and persistent political risks affect the equity markets negatively even if global economic fundamental remain better than they were for the last decade.
The low-interest rate scenario has driven many investors to look for better returns by tapping into the equity market. Last year was a good year for equities even if in Malta the MSE Price index showed a decline of 2.63 per cent with major financial services equities suffering more than most. Many may be asking themselves whether investing in equities and, particularly, in financial services is still viable at least in the long term.
Very much depends on the risk tolerance of every investor. Those who cannot risk losing even a small proportion of their capital in the short to medium term may be better off waiting until interest rates start to edge up again as the European Central Bank introduces tighter monetary policies as a result of growing inflation and strengthening economic fundamentals in the eurozone.
Others who can tolerate what should be temporary downturns in equity prices in return for capital gains in the long term may want to take more risks when equity markets undergo a price correction as we are experiencing at present.
The next consideration is whether the financial sector is still worth investing in following some headline scary news about some European banks needing government support following the financial crisis of a decade ago.
Many argue that the local equity market provides a good hedge against the more pronounced volatility that usually characterises European equity markets despite its lack of depth, diversity and liquidity. My views on the local financial services sector remains upbeat in the long term. I believe that the comment made by the outgoing chairman of HSBC Group, Stuart Gulliver, who said that his bank is simpler, stronger and more secure than it was at the beginning of the financial crisis of 2008, applies to most European banks that are now supervised by the ECB.
The three major banks in Malta are now under the direct supervision of the ECB. This recent development has helped to strengthen the governance of these banks to a great extent. When announcing their results for 2017, HSBC Malta confirmed that the fall in profits last year is partly attributed to the continuation of the restructuring programme initiated a few years ago.
My views on the local financial services sector remains upbeat in the long term
The bank also confirmed that it had mitigated the risks of a contingent liability in its balance sheet resulting from ‘a legacy remediation failure in the bank’s brokerage business’ by raising a provision totalling €8 million. Most banks have to deal with outstanding legacy operational issues that drag on for years and at some stage have to be concluded at a cost.
This approach is sound business logic that should reassure investors that despite short-term volatility in results and share prices, the tight regulation on banks is suitable for investors. HSBC decided to reward the loyalty of its shareholders by declaring a special dividend of €20 million despite a fall in profits.
BOV may have a different business model from that of its competitors but it shares the general trend in European banking developments in de-risking its business. The successful share issue that BOV completed in late 2017 will help the bank to accelerate this process by resolving some long-standing legacy issues.
The bank has already declared that it wants to control its operational costs and discard less profitable and riskier business while investing in its human and technological infrastructure to exploit the abundant business opportunities that the well-performing local economy is offering.
The restructuring of a bank’s business models takes time to complete. It invariably involves financial and operational measures like cleaning up balance sheets, withdrawing from unprofitable business lines and the reskilling of staff to meet the challenges of a changing market. It also involves the revamping of business processes to make them more cost-effective and customer friendly. This restructuring is a painful but necessary exercise that every company has to undergo from time to time to remain relevant to its customers and its shareholders.
The regulator’s insistence on de-risking of banking models is good news for investors with a moderate risk appetite who take the long-term view of where to put their money despite market volatility.
The author of this article is a former BOV chairman. The contents of this article should not be construed as financial advice.
johncassarwhite@yahoo.com