Pandemic Banking

By David Curmi

Over the last few weeks we have been given a glimpse into the initial impact the Covid-19 virus has had on local banks as APS, BOV and HSBC all reported their half yearly results.  It’s been a tough few years for banks. It has got a whole lot tougher!

Ever since the 2007 financial crisis, local banks have faced the combined challenges of negative interest rates, growing customer deposits, an economy that is becoming less dependent on capital intensive activities and a regulator that is increasingly more draconian on the risk positioning of banks, most especially the systemically important banks.  They now face a new challenge in the form of Covid-19.

This is leading to a crisis like no other.  Fortunately, the 2007/8 financial crisis had little impact on domestic banks as this was largely a funding driven crisis.  Banks were borrowing from other banks to lend into risky activities.  Local banks did not take part in such activities.  The Covid-19 crisis is different.  Not only did it disrupt supply chains but more significantly, consumers have been placed in a fear conundrum.  Fear of losing their savings, assets and in some cases their lives or those of their loved ones.  And when consumers are fearful the natural instinct is to take cover. This means protecting ourselves and our assets.  In times like this, even post lockdown, consumers spend less. In fact savings ratios have increased substantially recently..

This creates multiple issues for banks.  It increases the level of customer deposits at banks.  In the first six months of 2020, APS, BOV and HSBC reported, on aggregate, an increase of almost €800m in customer deposits, versus an increase of €581m for the whole of 2019. In the main (except for APS), these additional customer deposits were placed on deposit with Central Banks, where interest rates are negative.   More painfully though the combination of the lockdown and the fear of contracting the virus has reduced consumer demand substantially in any industry that requires physical interaction between people, most notably the hospitality, retail and related industries, which in 2019 accounted for some 22% of GDP. With operators in such industries trading at a fraction of their peak capacity, even in the traditionally fatter summer months one cannot but begin to think about what is in store in the months ahead. 

Government action has so far been critical at helping companies survive throughout the pandemic.  The contribution to wages as well as the popular voucher system have supported job retention, household income and spending to an extent. The various financial initiatives to support businesses together with the government guarantees on working capital financing and the moratoria on interest and capital repayments of loans have enabled companies to stay afloat.  Yet the profitability of APS, BOV and HSBC for the 6 months to 30 June 2020 has been already severely impacted (see table below). 

Source: Company announcements, Curmi & Partners Ltd

Whilst the health crisis is being seen today, the wealth crisis will be a secondary effect.  It will become evident in 2021.  The combination of the leaner winter months and the prospect of a potential withdrawal of government subsidies on wages will probably lead companies, especially those in the hospitality sector, to close rather than remain open at reduced capacity.  This is likely to lead to job losses and potentially missed loan repayments.   Question marks will also inevitably be raised on the direction of the property market.  We are already seeing weakness in prices, both rental and sales. This is a critical sector as a significant proportion of the population have become part time landlords.  Government is going to have to keep its financial taps open beyond September to avoid a brutal outcome.

Yet we are fortunate that local banks have been managed soundly. They have the capacity to absorb credit losses and see through this crisis.  A strong and sound banking sector is a critical pillar for any economy.  The question one must ask though is how sustainable is local banking in its current form? The signs are there to read. With no top line growth banks need to re-dimension.  Costs are being cut through branch reduction.  After all high street banking is no longer needed to the same extent in today’s digital age.  Furthermore an overly high dependence on interest income as a main source of income has left many banks exposed to the volatility of such earnings.  A stream of high quality non-interest income is an attractive diversification tool.  

Post pandemic banking is likely to look somewhat different to what we see today.  Less branches, more technology are a given.  Will the brand names we see today also remain the same or is consolidation likely to take place?  At such low returns on equity(APS 5.5%, BOV 1.9% and HSBC 0.5%) questions are inevitably going to be asked.  The risk here is that the will to pack up and leave, where possible, will become more attractive, especially when one considers the jurisdiction risks.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.