Passing banks through the ECB wringer

PKF is conducting research on the banking structure in Malta with a view to collect empirical data on the way risk is recognised when lending to SMEs. The purpose is to assess if this interest rate is competitive and does not exceed the indicative rates announced by the European Central Bank.

Talks were held with the two main banks to discuss this issue and as can be expected very little – if not nothing – was divulged as the respective CEOs claim that the only information they can impart is media releases and the standard information released to Registry of Companies.

There is no data in the public domain showing the amount lent to SMEs. Therefore another meeting was held with the Central Bank of Malta and the Malta Financial Services Authority to discuss whether the well-kept secret concerning the perception that SMEs are charged at a premium is true or false.

The feeling among banks is that SMEs are considered a higher risk and therefore carry a heavier burden as reflected in loan charges and repayment conditions. The regulators were very conscious that such a study could result in verifying the views of the Chamber of Commerce, that lending may be shrinking in Malta compared to previous years but this may not necessarily be attributed to the higher interest rates and charges by banks.

It is pertinent to question why the Midas touch displayed by banks persisted for a number of years during which they have succeeded to report superior profits even during the years when the island’s economy was in recession.

Obviously this is a complex issue and warrants a proper assessment away from any emotional attachment and has to be based on proper econometric studies. With this in mind we approached Silvio Schembri, MP – himself an economist and chairman of the joint finance committee in parliament. Media reports indicated that Mr Schembri had taken note of the issue of high interest rates as part of an exercise discussed within his influential committee and PKF was hopeful that when this important task is completed it will shed some light on the enigma why the economy is rallying but lending is stalling.

PKF wanted to gather a closer view on how SMEs are coping when applying for extra credit to help expansion of their businesses so we discussed the issue with the SMEs’ chamber, the GRTU, and they agreed to circulate to their members a professional survey designed by PKF.

The dilemma needs to be solved as it is important for the competitiveness of the economy and readers may agree that it falls under the remit of the Malta Competition and Consumer Affairs Authority – the government agency funded to oversee the state of play where the level of competition of banking services is concerned.

Naturally a grey cloud hovering over the issue adds to the mystery. Yet more will be revealed next month in the context of developments at EU level, particularly the recent change of view towards tighter regulation taken by the European Banking Authority (EBA). One of the responsibilities of the EBA is to ensure the orderly functioning and integrity of financial markets and the stability of the financial system in the EU.

To this end, the EBA is mandated to monitor and assess market developments as well as identify trends, potential risks and vulnerabilities stemming from the micro-prudential level. To start with, it is encouraging to note that one of the primary supervisory tools to conduct such an analysis is an EU-wide stress test exercise which of course has started to be conducted on banks in Malta.

The EBA Regulation gives the authority powers to initiate and coordinate the EU-wide stress tests, in cooperation with the European Systemic Risk Board (ESRB). It comes as no surprise that the aim of such tests is to assess the resilience of financial institutions in Malta to withstand future adverse market developments, as well as to contribute to the overall assessment of systemic risk in the EU financial system.

It is common knowledge that global banks had their share of criticism when the recession hit in 2007/8 and governments had to bail them out of their parlous situation – mostly out of taxpayer monies.

A lot has been written discussing the causes of the demise of powerful banking institutions – cynics were quick to attribute this to lax regulation and political patronage. Now the penny has dropped and the ECB will formally take responsibility for bank supervision under the Single Supervisory Mechanism (SSM) – expected to be from November 2014 – when it will conduct a thorough review of the assets of the Malta banks that it will directly supervise.

The comprehensive assessment, as it is called, nominally has three goals: to deliver greater transparency on balance sheets; to prompt the repair of impaired balance sheets; and to rebuild confidence in banks.

More fundamentally though, the ECB considers the exercise essential, so that it can begin its supervisory confident in the knowledge that the major banks are on a sound capital footing. Bankers are silently complaining that the pendulum has swung too much since following the demise of Lehman Brothers bank in USA, the authorities have been tightening the screws on regulations. Everyone has heard about the evolution of Basel 11 rules and how they developed into a complex and tight Basel 111 model.

The latest 2013 report covers a sample of 174 banks, which submitted data for this exercise, and comprises 43 Group 1 banks and 131 Group 2 banks. The monitoring exercise is carried out assuming full implementation of the Basel III framework. As mentioned earlier the ECB is engaged to take on oversight of about 130 of the euro area’s biggest lenders by next  November as the political consensus is hell bent to prevent a repeat of taxpayer-funded bank bailouts.

Naturally banks in Malta are being scrutinised for their compliance and a thorough assessment of their non-performing loans by locally appointed big four audit firms. Some bank directors may be silently complaining about the additional cost of such a heavy regulation including one-time costs for the ECB’s test and the additional fees for the ECB regular supervision, but one cannot blame the ECB in making sure that before taking over full responsibility for regulation of Malta banks it gets the true picture of their assets and liabilities.

One hopes that such costs are not passed to customers by way of hidden charges and heavier interest rates. Can one blame the ECB for taking such a draconian approach before assuming its role as an EU banking regulator when only this month one reads about the collapse of a major bank in Spain – Banco Espirito Santo SA’s. Its fall from grace is having one unintended consequence in Portugal’s equity market as shares of the bank that once was Portugal’s largest lender by market value slumped 67 percent last month.

As can be expected regulators have a habit of closing the barn door after the horse has bolted. The bank’s problems started  in May, when following an audit ordered by the Portuguese central bank it found irregularities in the accounts of its parent, Espírito Santo International.

The scale of the losses came as a nasty surprise to the central bank, which has spoken of a “fraudulent funding scheme” run by Espírito Santo companies outside its jurisdiction.

Surely we cannot blame the regulators who only recently uncovered potential losses on loans to other firms linked to the Espirito Santo family as the bank shares plunged and caused the PSI 20 to go down 30 percent?

Eventually the taxpayer had to foot the cost of the bank’s collapse as Portugal’s central bank took control of Banco Espirito Santo, investing in a 4.9 billion-euro bailout. In a novel move to sort the chaff from the wheat the Portuguese Central bank created two separate entities – one taking over the toxic assets and the other, Novo Banco, taking the rest. The cost of the bailout was not cheap – a total of €4.9 billion is being injected into Novo Banco from Portugal’s bank-resolution fund.

To conclude, PKF wishes to appeal to the stakeholders to help it compile a study on banking practices when lending to SMEs. The financial crisis itself, and the problems and challenges discussed above, point to a need to upgrade significantly the governance and risk management of banks in general and perhaps of SMEs in particular.

Work by the MFSA is already underway on this, but much more needs to be done. As banks get to grips with their business strategy, risk appetite, risk culture and management they will need information on the risk profile of SMEs which happen to be an important component of Malta’s business community.

Only a scientific study can unravel the truth behind the lingering perception that SMEs borrowings are charged at premium interest rates while as a general comment lending to the big firms is shrinking.

As if in a fairy tale the Mandarins running banks retain their Midas touch and continue to report exemplary results.