Colombo Telegraph

Has CBSL Facilitated Another Scandal ? – Arbitraging & Increase In Money Supply

By Hema Senanayake

Hema Senanayake

The country must be unified to stop paying homage to political leaders elected to power or thrown out of power. They must be respected for what they have done or what they have been doing for the country. The character of the nation must be to stand up against any wrong doing professes by any leader. It is because of this character that Mr. Arjuna Mahendran had to leave the office of Governor of the Central Bank of Sri Lanka (CBSL) even though Prime Minister Ranil Wickremesinghe strongly stood by him.

CBSL which is erroneously listed under the purview of Prime Minister is on the spot light again. As a result, P.M. himself is under the same spot light. It may be true that Prime Minister is clean but it has no meaning if his professional judgement is wrong in administering the institutions which comes under the purview of the Ministry. Out of those institutions which come under his purview, the central bank is the most important one. Here, in this article, we are going to investigate a serious monetary mismanagement done by the central bank under the watch of Prime Minister.

Arjuna Mahendran

Previously, it was about a bond scandal purportedly done under the watch of Governor Arjuna Mahendran by Perpetual Treasuries Limited (PTL) of which the main man was the son-in-law of the former Governor Arjuna Mahendran himself. This time it was again about PTL abusing the temporary payment settlement mechanism of CBSL in order to boost the company’s profit. There is nothing wrong if a company tries to increase its profits. But it is wrong if CBSL happens to be a partner in helping any primary dealer like PTL or even a commercial bank to make undue profits jeopardizing the monetary system. All these have now been revealed by a leaked internal document of CBSL.

In the year 2015, PTL posted a profit of Rs. 5.1 billion and it is an increase by 430% in compared to the previous year. Auditor General has once again confirmed that the government has incurred a loss amounting to Rs. 1.6 billion from the most infamous bond scandal by accepting bids of PTL with higher interest rates. In general some body’s loss is somebody else’s profit. If the government lost money, PLT would have made undue profit. Most of the rest of the PTL profits might link to the abuse of CBSL payment method set up for the primary dealers. Earning undue profit is a point that people should concern, but the nation must have a bigger concern if such practice leads to the gross mismanagement of monetary system. I think it has happened. Let us investigate it.

Colombo Telegraph has recently reported that a highly confidential document by the Department for the Supervision for Non-Bank Financial Institutions of the Central Bank has been leaked.

The leaked CBSL report says that, “PTL had a practice of bidding off-market rates.” This means they quote higher rates than prevailing market rates in bidding for bonds. This was the exact point observed by the Auditor General in calculating the loss made by the government from the bond scam. Keep this in mind and let us continue with our investigation.

CBSL operates a system call the Real Time Gross Settlement System (RTGS). Under this system all institutions that deal with the Bank’s Domestic Operations Department are permitted to maintain accounts with the Bank. Accordingly commercial banks are permitted to maintain accounts. Since, Primary Dealers (PDs) like PTL have to settle their obligations to Public Debt and settle balances among themselves and with commercial banks they too have been allowed to operate accounts. As far as I have been enlightened, only the outside body which is not a primary dealer or a commercial bank that has been permitted to operate a settlement account is EPF.

Now, settlements among these institutions are made on a gross basis. As such they should have sufficient funds in their accounts since they are not permitted to overdraw the same. If any institution finds that it does not have sufficient funds, it is given a temporary lending facility by CBSL so as to borrow against government securities which such institution pledges with CB under its REPO system. This lending facility is called “Intra-day Liquidity Facility (ILF).” Since, it is an Intra-day Liquidity Facility, they are supposed to bring money at the end of the day and settle their balances. But like an Over Draft facility, they can continue to borrow and settle it and make it a permanent feature.

When primary dealers use Intra-day Liquidity Facility, the applicable interest rate is the Standing Lending Rate of the CBSL, which rate stood at below 7.5% until last month. Therefore, primary dealers got an opportunity to borrow at 7.5% from CBSL under its Intra-Day Liquidity Facility and invest in government securities at higher interest rates at around 12 -13%. As was mentioned in the leaked report of CBSL and was observed by Auditor General, PTL had won bids quoting higher rates in buying bonds.

It seems PTL has posted a huge capital gain of over Rs. 4 billion in April and May 2016 by trading the bonds purchased from primary auctions. As was reported by Colombo Telegraph, the leaked report now explains that, “These securities were purchased mainly using Central Bank’s liquidity assistance available to market participants (borrowing from Reverse Repo and using ILF). By the memo dates 08.04.2016, Domestic Operations Department has highlighted their observation on the excessive use of re-repo facility by Primary Dealers. As informed by the Domestic Operations Department, from 1st to 8th April from the total borrowed amount of Rs. 89 billion by all PDs, out of which PTL had borrowed Rs. 66 billion (75%).”

Interesting! Isn’t it? PTL has borrowed Rs. 66 billion from CBSL at 7.5% or so, in order to pay for the CBSL for the purchase of government bonds of which interest rate is 12 to 13% or higher.

Dr. W.A Wjewardena who is a former Deputy Governor of CBSL had previously pointed out that this process of borrowing at 7.5% from the Central Bank under its Intra-Day Liquidity Facility and invest in government securities at higher interest rates at around 12 -13% is defined as arbitraging and has been happening. He pointed out that this was unethical and must be prevented. I learnt that CBSL issued a press statement refuting him. However, now the leaked report has confirmed what he had pointed out. When a learned economist who performed as a Deputy Governor of CBSL pointed out certain irregularity of CBSL, how should any Minister who oversees the institution respond? The respective line Minister might have missed the point made to media by Dr. Wijewardena but the Ministry cannot miss the press statement issued by the CBSL refuting Dr. W. Wijewardena’s allegation of arbitraging.

There is no argument that arbitraging is unethical and must be stopped. Also there is no argument that arbitraging cannot continue without at least the passive support of CBSL officials. But what I am interested most is whether this process of arbitraging leads to increase the money supply in the country. If that happens, it means that CBSL actively has involved in increasing money supply so as to facilitate the PTL and other primary dealers to make huge undue profits. This is a gross mismanagement of monetary system. This must be thoroughly investigated.

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