While the last 5-10 years have seen a period of pronounced instability in the banking sector in many countries, there is something about APS Bank that is reassuringly traditional. While some banks experimented with innovative new business models, and managed to test them, at times with dire consequences to the global financial system, others took a more conservative approach.

The traditional banking model relates the bank’s deposit base to its lending; it brings together the savings of many people and channels them to specific sectors after accounting for duration of loan, the risk of the undertaking as per country, sector, economic activity and borrower.  This could be achieved through a process of expanding the bank’s capital base through direct cash injections and the retention of past profits, extending the branch network, upgrading human resources and work practices, and adopting new technologies.

However the process of accumulating retail deposits is rather slow, certainly for an ambitious new breed of bankers distilled not in an older more patient spirit of community banking, but instead steeped in a more volatile cocktail of higher risk and higher return international banking.

When asked how the culture of banking has changed over time, APS’s Chairman, Professor Delia explains changes in banks’ behaviour are generally preceded by the emergence of new financial and economic models of behaviour which are introduced in one particular financial-economic environment and, in turn applied elsewhere.  Since the cultural and regulatory milieus differ from one country to another (or from one economic bloc to another), the impact of applying financial instruments tend to be regionally different.  Besides, with the emergence of globalisation of trade and a freer capital movement worldwide the direct and indirect effects of such decisions will induce several unforeseen effects. 

 This happened, for example, with the securitisation of loans (mortgages, car loans), or with the emergence of hedge funds, or computer trading or, in Malta, with bartering as a form of funding for property development.  Individual banks discover the impact such products can have on their balance sheets and profit and loss accounts and act/react accordingly.  Add to this, the decision to tie executive pay to performance or to exempt certain financial products from income or capital taxes (where applicable), and a matrix of potential bank behaviour will emerge.

Historically, there were different institutions to cater for different needs of finance, matching the duration of borrowing with lending.  But over the past several decades, financial institutions became ‘hybrid’ addressing various borrowers’ needs from a ‘common’ pool of resources.  In part this process emanated from a rapidly growing global capital need as many countries expanded simultaneously their economies at rates of economic growth which were quite impressive. So new instruments had to be created to generate the resources in time, and, at the same time spread the risk.  This became possible with the emergence of institutional investors, who had command over a large volume of funds.  ‘Wholesale deposits’, that were short-term located with the possibility of being renewed, grew in importance and gave rise to new models of finance and, so, financial behaviour.

 

 

In practice, as financial products become ‘complex’, the collateral which supported a loan in the traditional banking transaction gets further removed with every new product that is devised.  For example, securitised loans would affect the profitability of a particular financial institution, in the process affecting the price of its shares.  If these shares, in turn, are included in a fund, the price of its unit will be conditioned by the bank’s profits performance.   But this performance is not directly reflected in the underlying security that provided the collateral in the first instance.  In the context, the difficulties faced by regulators become evident.  But, of course, one has to balance the need to sustain economic growth in its various ramifications without, ideally, seminating those factors that could create instability, at worse major upheavals, in the future.

One of the advantages that APS bank has in Malta is its understanding of the local market. If the sub-prime bubble and its subsequent bursting was in part due to the disconnect being created between the borrower, and the counterparty, in the case of APS “we have a better feeling of the respective markets in the sectors we are active in, and so we can discuss their performance with our clients.’’ This dialogue is mutually advantageous; it enables our clients to fine-tune their marketing strategies in the process.  Professor Delia points out that “Since we operate in a small country we can target our business help more directly and customise our solutions.”

A question posed by a number of business stakeholders in the local economy is why bank lending rates are comparatively higher than the rates in Eurozone countries in mainland Europe. Mostly people seem to jump to the conclusion that the problem is the lack of competition in the local banking sector. However, Professor Delia, sees this answer as being simplistic “We have managed to give stability to both depositors and borrowers by creating an interest rate structure that fits the local economy” he explains.  ‘’It has been government policy to attract foreign institutions to operate from Malta.  They can raise capital at a price and utilise those funds elsewhere.  We have to account for this fact, while continuing to support the drive to raise capital in these Islands.’’

 As alluded to earlier, borrowing from the international financial markets, by securitizing a bank’s assets, is actually cheaper than borrowing from thousands of individual savers, with whom you have a known relationship. Maltese banks borrow and lend locally and while this makes them more expensive, this high degree of reliance on domestic depositors explains why Malta, and its banking sector, managed to ride over the global financial meltdown comparatively unscathed.

One can explain the diversion of behaviour in the Eurozone – different interest rate regimes and the re-emergence of exchange controls, for example – as a facet of a system still in transition.  Namely, a currency union, a banking union, a fiscal union, and a political union.  There is still a long way ahead, but in the meantime one has to do whatever possible to support economic restructuring and sustainable long-term growth.

With regards negative interest rates [which were implemented by the ECB subsequent to this interview] Professor Delia points out that the logic of “negative interest rates is to punish banks for not lending, but negative interest rates will encourage banks to charge savers.” The concern, he feels, is that “This will change society’s perception of savers” adding that Maltese banks do not want to charge negative interest rates and thus penalise savers.  Anyway, such strategy could encourage even more barter in trade and the outflow of capital to currencies where interest rates are positive.  The Maltese may be described as being ‘coupon sensitive’.

One of the main responses to the global banking crisis was to tighten up significantly banks’ “Tier 1 capital” requirements to a ratio of 6%. (Tier 1 capital essentially refers to common stock plus premium, retained earnings, funds for general banking risks, accumulated other comprehensive income and other reserves, divided by the risk-weighted assets.) How has this affected APS? Professor Delia points out that in 2009 APS had €15.6 million ordinary share capital out of €59.1 million total own funds (26%), whereas four years later, in 2013, the bank had €57.6 million out of €81.7 million total own funds (70%). This indicates not just an increase in APS Bank’s total own funds, but also a more than tripling of its levels of core capital.   APS Bank’s total capital adequacy ratio as at 31 December 2013 was 16.71%. “That is why we have a very prudent dividend policy.”  Very reassuring.