A mechanism for sanitising toxic assets of credit institutions

As if by stealth, last week in the advent of St Maria national feast, a new law was born which may have escaped the attention of many corporate managers, some trying to catch up with much-needed rest.

For the lucky few, they indulged in the hedonistic pleasure of high heeled parties including swimming in Comino’s crystal waters, while their partners imbibed chilled cocktails onboard foreign-flagged, powerboats.

What is the prognosis of experts about this law?  It is simply an act to provide for the establishment of a Residual Balances Fund and a framework for action that shall be taken in respect of the residual balances of a credit institution which meets the criteria set out in this Act.

What is the motto for this mechanism?  The easy answer is that it shall facilitate the dissolution and winding-up process of such a credit institution (meaning banks among others) whilst allowing for a controlled release of residual balances transferred from that credit institution.  Its motive includes the prevention of money laundering and the funding of terrorism.  Such liabilities shall be transferred to a Fund: itself a body corporate.  It shall be directed and managed by a Committee established under Article 7.

Powers include, inter alia, a novel approach to effect the closure and orderly winding-up of a deposit liability portfolio.  It is empowered to override rights of shareholders and, or the officers of the transferring institution, including the requirement for approval by shareholders and, or the board of directors (or other similar governing body) of particular transactions in order to permit a disposal of the transferring institution’s deposit liabilities and deposit assets.

Why do we need such a maverick law (Indiana Jones type) when we hear regular announcements assuring us that all our banks have passed rigorous stress tests by ECB? Perhaps, the naughty pandemic has opened a Pandora’s box and now after a severe lockdown, we need to separate the wheat from the chaff.

At this juncture, we note how both BOV and HSBC in Malta reported poor results over the first six months of this year.  Not to worry, say the pundits as there is nothing fundamentally wrong in the prowess of management.  All is well, they reply in unison, since one can really and truly conveniently blame COVID-19, for the shameful results.

Sadly, for the first six months of 2020, the Bank of Valletta Group is reporting a profit before tax of €13.8 million, a severe drop from previous year when it posted a respectable €54.3 million.  BOV humbly reports that its annualised return on equity (pre-tax) is just 2.6%.  Apart from the COVID-induced business shrinkage, BOV has woken to a number of skeletons in its cupboard.

One salubrious case is the trust it holds on behalf of the Deiulemar group - a defunct Italian shipping company, claiming €363 million from BOV to which recently it pledged an out-of-court settlement of €50 million.  This was rejected.

Last November, the ECB reported that the number of high-risk foreign customers had actually risen and, in many cases BOV had no information about the origins of their wealth.  ECB remarked that the bank had no unit to identify bribery and corruption among international clients and did not keep a record of those who had payments blocked due to money laundering risks.  The report said ECB investigators also identified a lack of checks over accounts held by Pilatus Bank, which was shut last year after its Iranian owner Ali Sadr Hashemi Nejad was arrested in the United States (recently acquitted) on money-laundering and sanctions violation charges.

Following the issue of this ECB report, BOV’s de-risking exercise has taken on a much wider dimension.  The bank this year is engaged in a priority process - to deal with the legacy issues highlighted by the report. The bank claims it has made strong progress in addressing the specific issues within the relevant timelines.  HSBC has also reported a difficult trading result for mid-2020.

Profit before tax was down from €19.1m to €1.8m due to higher expected credit losses and lower revenue reflecting the impact of the COVID-19 outbreak.  Revenue was down 16% largely driven by revaluation losses within the Life Insurance subsidiary (‘HSBC Life Assurance (Malta) Limited’) as a result of adverse market movements.  Ideally, we take a leaf from the Irish solution to their problem of a collapsed property sector which in 2007 saw the collapse of the property bubble. Then, it risked sending its main banks to the bankruptcy register.

A brilliant Irish solution is to set up an SPV – special purpose fund – to buy and manage the debts.  This took the form of a bad asset agency called NAMA.  This mechanism served as an international example of successful management of bad assets.  The Fund facilitated the assessment of capital shortfalls emphasizing that they should be comprehensive and bottom-up.

The empirical Irish success story in its recovery fable saw taxpayers acting in unity to shoulder the full costs of recapitalising the Irish banking system.  Naturally, as part of the resulting stability in Ireland, benefits accrued to the wider European banking system.  The banks in Malta are challenged by the pandemic which has slowed down drastically the hospitality and food services sectors.

It also took the wind from the sails of a galloping property market.  All banks have tightened lending conditions (the irony is that lately Malta Development Bank has offered a 100% guarantee to selected banks for fanning post-COVID lending).  With the hindsight of three small foreign banks (Pilatus, Satabank and Nemea) that had their license removed after extensive FIAU investigations, one may be tempted to point fingers to a soft- touch banking supervision.

However, during a post-COVID induced slowdown, one must at all costs resist the imposition of arbitrary new lending restrictions, for example aimed at reducing banks’ loan-to-deposit ratios.  The domestic economy needs all the help it can get not to be starved of essential cash flow support and to sustain high employment levels.

In conclusion, one observes that these are difficult times for all credit institutions caused by the onset of the pandemic yet the government has borrowed extensively to create a recovery fund.

One hopes it takes the advice of the Chamber of Commerce to lower VAT rates in the embattled sectors.  Studies in UK and Germany proved that lowering fiscal drag will revive subdued domestic demand.