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Bank de-risking strategy

Bank of Valletta’s interim results for the first half of 2018 confirm a pre-tax profit from operations of €88.5 million, which, however, is reduced to €13.5 million because of a €75 million provision mainly because of litigation in an Italian court. The bank will not be paying any dividends this year.

The financial crisis that started in 2007 showed how vulnerable even big banks are when corporate governance failures creep in either because of inadequate risk/reward assessment of projects, incompetence or a blind obsession to maximise profits. Big international banks like Barclays, HBOS, HSBC, Danske Bank and JPMorgan Chase were all embroiled in governance failures that cost shareholders dearly and, in some cases, even affected taxpayers.

Following Malta’s accession to the EU in 2004, some local banks saw a golden opportunity to tap the European market by offering new services both locally and internationally. Bank of Valletta was among the first to provide trust services when, in 2006, it launched its Trust Unit. The board and the executives of the time must have seen an excellent opportunity to overcome the local market size limitations and aggressively marketed trust services in various countries.

In 2009, the bank set up three trusts for Italian shipping families in Naples who ran a shipping company, Deiulemar. Between 2009 and 2012 the settlors of the three trusts undertook some complex transactions that were ultimately interpreted by the Court of Torre Annunziata, in Naples as having been aimed at defrauding the creditors of the Deiulemar Group of companies.

Now the bank has to manage the fallout of this legacy incident as the Italian court has placed €363 million worth of bank assets in the hands of an independent intermediary. The bank’s board has announced it remained convinced of the “strength of its defences on the merits” of the case but that it would keep the litigation under “constant review”.

It will be the Italian courts that will ultimately decide whether the management of the trusts was efficient enough and whether the losses incurred by Italian bondholders were indeed a result of any failures by Bank of Valletta.

Many lessons can be learnt. Banks should not shy away from taking risks provided they understand what is at stake and have the necessary resources, including competent staff, to manage them. A bank’s board of directors needs to continually challenge the strategic initiatives proposed by senior executives and focus on the risk/reward trade-off of every project rather than rush into marketing and business growth strategies.

Investors in bank equities need to understand that the shares are not equivalent to deposits and dividends will fluctuate according to a bank’s performance. Regulators are unlikely to ease the pressure on banks to strengthen their capital by whatever means available to make themselves safer for depositors and, ultimately, also for shareholders.

Bank of Valletta has served the Maltese economy well over the last five decades and is likely to continue to do so. There will be significant legacy issues that will need to be managed carefully by the board to ensure the long-term sustainability of the bank’s business model. Regulators will continue to submit banks to stringent stress tests to ensure they can absorb unforeseen financial shocks well.

Bank of Valletta’s de-risking strategy is the right one for shareholders and depositors.

This is a Times of Malta print editorial

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