Central Bank reassures of financial system stability

Central Bank of Sri Lanka

In an effort to boost confidence levels, the Central Bank yesterday assured Sri Lanka’s financial system remains resilient and insisted license cancellations of finance companies were done to protect the interests of depositors and should not be construed as sector-wide instability.

Releasing a special statement, Central Bank Governor Prof. W.D. Lakshman said cancellation of The Finance Company license had allowed the monetary institution to resolve longstanding legacy issues and provide 93% of depositors with their payments in full.

He assured that the remaining 10,000 odd depositors would also have their issues resolved.

The Governor recalled that similar steps had been taken earlier with regard to Central Investments and Finance PLC and The Standard Credit Finance Ltd. as well and 95% of payments had already been settled. Compensation payments to TSK Finance depositors had been limited to 26% due to judicial proceedings but the Central Bank expects to settle all dues eventually.

“Corrective regulatory action taken in respect of a few institutions does not mean that the entire non-bank financial institutions sector is in trouble. We indeed observe that some licensed finance companies are on par with small or mid-sized banking institutions.

“Therefore, I would like to urge the general public not to be distracted or misled by baseless comments and malicious speculations expressing doubt about the health of our non-bank financial institutions sector as a whole,” the statement said.

The Governor acknowledged certain measures introduced recently to stabilise the macro-economy, particularly the curtailment of the importation of motor vehicles, had a disproportionate adverse impact on finance companies. As part of its financial sector stability objective, the Central Bank has availed required liquidity support for licensed finance companies, while standing ready to provide emergency support for the sector if needed, he assured.

Prof. Lakshman went on to say that an important general caveat in banking and finance business was that although various financial institutions are licensed, regulated and supervised by the Central Bank, it does not mean that all their operations are managed by the Central Bank on a day-to-day basis. He pointed out this has been repeatedly emphasised by the institution previously as well.

“Business models of these institutions are different from one another, enabling them to offer different levels of interest compensation for depositors benefitting from their investments in businesses generating higher returns. The general public must therefore take note of the fact that higher interest rates offered on deposits generally mean that the relevant institutions are engaged in more risky ventures.”

He added the Central Bank will use all available tools at its disposal to maintain financial system stability. It remains committed to keeping the deposits of the general public safe from economic and financial fallout of COVID-19 and similar future unforeseen events.

“It also must be noted that the Central Bank will not hesitate to take legal action against individuals and groups spreading false or misleading information with intentions of creating unjustified disruptions in the bank and non-bank financial sectors.”

The statement also said the banking sector remains strong with total capital adequacy ratio above 16%, net stable funding ratio above 130%, liquidity coverage ration above 175% and statutory liquid asset ratio above 32%.

The nonperforming loans ratio has shown some decline while the provision coverage ratio also picked up during the first quarter of 2020. Benefitting from the new tax regime, profits after tax of the banking sector for the first quarter of 2020 were considerably higher than in the same quarter last year.

“With these performance indicators, I do not think anyone needs an additional assurance on the current strength of the banking system, which accounts for 62% of Sri Lanka’s financial sector.”

The COVID-19 pandemic and the resultant slowdown in the domestic as well as the global economy have created a challenging environment for the operations, not only of the financial sector but also for all types of economic activities in the country.

The performance of the real economy and the financial sector are closely intertwined. The future performance of the financial sector depends on the survival and growth of domestic businesses.

The Government and the Central Bank have therefore requested the financial sector, particularly the banking sector on the back of its inbuilt balance sheet strength, to continue to support the economy in various ways, while the Central Bank is providing the necessary liquidity and regulatory support to the financial sector to meet these challenges.

The statement recalled that even prior to the onset of the outbreak, going back to 2018 and 2019, there was a rise in non-performing loans in both banks and non-bank financial institutions, particularly due to the sluggish growth in private sector credit and overall economic activity.

By the time of the pandemic impact, the Government and the Central Bank said it had taken decisive measures to revive the economy including the establishment of a more conducive tax regime and a more favourable monetary policy stance, supporting growth of the real economy.

“We are confident that, despite the temporary setback caused by the COVID-19 pandemic, the Sri Lankan economy and the financial sector continue to remain dynamic and resilient. Conditions would become stronger in the period ahead as the economy recovers.”

The Central Bank yesterday said it will use its “authority and powers” to push finance companies and smaller banks to merge as consolidation was necessary given there were too many financial institutions for an economy the size of Sri Lanka’s.

The Central Bank releasing a statement also indicated it will return to financial sector consolidation likely to be similar to what was followed during the former administration of Prime Minister Mahinda Rajapaksa.

At the time the Central Bank under former Governor Ajith Nivaard Cabraal sought to implement a program to merge companies along a specific timeline. The policy was abandoned in 2015. Cabraal is currently a Senior Advisor on Economic Affairs to Prime Minister Rajapaksa.

“In respect of the non-bank financial sector, the Central Bank message is the need for consolidation. The smaller should consider consolidating with the stronger. We have highlighted, time and again, that Sri Lanka has too many financial institutions given the size of its economy,” the Central Bank said in the statement.

“At the same time, we urge financial institutions to diversify their business models, particularly to support domestic production activity, rather than being driven purely by short-term gains through financing imports and other business activities familiar to them. The Central Bank will use its authority and powers in the future to get the non-bank financial institutions as well as banking institutions behave as suggested above,” it added.

(Source: Daily FT)