29 February, 2024

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CB To Launch A Diagnostic Audit Of Sri Lankan Banks; “Physician, Heal Thyself”!

By Rusiripala Tennakoon –

Rusiripala Tennakoon

This phrase is reported as spoken by Jesus in the Gospel of Saint Luke. We tend to recall such proverbial phrases when encountered with similar situations. Some critics in their skepticism, satirically commented, “he saved others, himself he cannot save”, while referring to the crucifying of Jesus. The news appearing in a daily newspaper on 10th October, about “CB to launch study to assess banks’ need for fresh capital’ came amidst conjectures and apprehension about the critical situation the Central Bank itself is  facing, reminds us of this. 

Outlook of the banking industry became a hot topic after President Ranil Wickremesinghe announced the need to issue 20% of the stock of State Banks to depositors and employees in presenting his revised budget to parliament sometime back. While we are not aware whether the Central Bank’s reported initiative is in consequence to the budget proposal OR who follows whom, the contemplated action plan of the CB  to launch a Diagnostic study centered around the big banks including the State Owned, is in the cards now.

The CB is the Banker to the Government, Banker to Banks, Custodian of the Monetary Policy, Regulator of the Commercial Banks and the Economic Adviser to Government. Associated with these roles the CB is responsible for the discharge of several vital functions related to issue of currencies, Exchange Control, Bank Supervision, Banking development including Rural Credit and Rural Banking among many others extending into a wide spectrum in the social web of the country. Of these the most relevant to the topic of our discussion is the Bank Supervision role of the Central Bank.

From its very establishment, Bank Supervision has been recognized as an important function assigned to the CB among other mandatory duties specifically provided for in the Monetary Law Act. The MLA provides for continuous supervision and regular examination of all banking institutions including non-bank financial institutions. The Monetary Board has to fix the duration of the periods for such tasks from time to time and the Director of the Bank Supervision Department nominates examiners authorized by Law to scrutinize books and accounts of every commercial bank. Specific provisions in the MLA empower the Director Bank Supervision to call for detailed information from any bank in the course of such examinations. The CB is authorized to call for further information and clarifications directly from the Auditors of Commercial Banks. 

Bank deposits have assumed vital importance in the national economy of the country due to their role of money supply to all sectors of the economy like commerce, industry and agriculture. The Department of Bank Supervision of the Central Bank is required to take steps to safeguard the Public Confidence in the financial institutions and protect Depositor interests. As we are aware the existence of the banking system depends heavily on the public confidence in their stability. The Central Bank is duty bound to perform this role of creating and maintaining of public confidence in the financial institutions of the country.

Our banking industry comprises of State-Owned Banks, Indigenous Banks and Foreign owned International Banks. All these banks fall within the regulatory and supervisory purview of the Central Bank. In keeping with the international norms applicable to those banks engaged in cross border operations, the Central bank from time to time issue directions to update the regulatory standards to match the changing and developing International regulatory frame work. This is achieved  under the directives issued to meet the standards stipulated by the  Geneva based Bank for International Settlements (BIS) from time to time called BASLE accordss to be observed and adhered to by all internationally active banks. BIS is the Bank for Central Banks and today it has developed a global supervision framework applied as mandatory regulations that should be followed by all banks exposed to international business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

Accordingly, the supervisory role of the CBSL is guided and regulated by such BASLE accord directives adopted periodically. To fulfil this requirement as well as to promote development as the economic adviser to the government, the CB issues directives, determinations and circulars to Licensed commercial banks in the country and one of the responsibilities of the bank Supervision Department is to ensure the observation and adherence to these by the LCBs. Thereby to ensure that the Banks perform their functions prudently safeguarding the public confidence. This is essential and mandatory to protect  depositors interests and the CB has to take  necessary steps to eliminate any possible weaknesses in their operations affecting their financial stability.

In this background let us take a look at the Launch initiated by the CB. The objective of this so called ‘Diagnostic study’ is to assess the extent of the implications arising out of insufficient loan loss provisions and losses incurred on forex-denominated financial assets.

Looking at the published Financial Statements of all the Big Banks there appears to be no cause for  alarm because quite contrary to what is happening in the business circles banks are showing huge profits. Most of the businesses including the export oriented are in a dire state mainly due to the forex crisis the country is facing. Some engaged in Import of electrical items etc. have made unprecedented profits by adjusting and revaluing their previously imported stocks in hand while some others in local production have gained substantially due to import controls imposed. Those associated with businesses operated with borrowed funds have fallen into big trouble due to unprecedented interest hikes.

All these debacles are the result of economic policy stands taken by the government from time to time while the banking industry has posed a survival of the pressure externally, when the other business activities faced the down fall. This is an aberration which should have been focused on by the CB long before. Among the arbitrarily identified critical factors contributing to a projected breakdown of the Banking Sector quite carefully shielded by qualifying statements such as, “although there aren’tany imminent concerns about their stability, Sri Lanka’s banks are currently undergoing their most painful stretch of stress……..”,are several either initiated or overlooked by the Economic Adviser to the Government. Some have been spelled out such as, loan defaults due to repayment difficulties, soaring interest rates, runaway inflation etc. The most critical not mentioned in the list is the sharp and precipitous fluctuations of the exchange parities for which the Central bank is directly responsible.

The Global impact due to the Pandemic and the resulting plight of the domestic adversities cannot be disregarded but the attribution of these as entirely responsible to the current situation is an illusive justification ostensibly resorted to by those who have failed in their performance. History shows us many similar instances of how bloated window dressed statistics have finally deceived all of us. Let me quote the 1990’s experience of subjecting the two State Banks to a ‘Diagnostic Audit’  directed by the World Bank. Ironically these banks were showing a good balance sheet on the face of it when this International Intervention was made. The revelations were alarming so much so the then Finance Minister declared that the two State Banks, BOC and PB were insolvent. This lead to a huge catastrophe  spread over to a country wide debate culminating in the levelling of a no-confidence motion against the FM. We still remember how the current President, then Chief Whip of the Government, Ranil Wickremesinghe ably defended the FM clearly illustrating how the Banks have been cooking the accounts to show bloated profits without adequate provisions for loan loss, employee benefit schemes and writing off bad loans. Finally the two banks were rescued by the provision of Capital to support their liquidity shortfalls to the tune of about 24 billion by the issue of long term interest bearing bonds.

The Central Bank’s current  prescription reminds us of these historic realities driving us to reaffirm the phrase, “history repeats”! To the best of information available and from the various disclosures that were being made about the questionable lending operations of the State banks from a long time before the onset of the pandemic we are reluctantly compelled to conclude some one has shirked the responsibilities bestowed on them by ignorance, neglect or callous disregard. 

Therefore we await with our fingers crossed to see the outcome of this proposed launch belatedly though. The declaration of bankruptcy ,resorting to default loans, manipulation of exchange rates, failure to meaningfully address the causes for diminishing forex inflows, precariously decided loans granted by hired contractors in the State banks during 2015 -2019 period are among the several skeletons that may come out of the cupboards during this diagnostic exercise to be effected at a critical time when the patient is in the ICU.       

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