By Rusiripala Tennakoon –

The controversial divorcing  of the CBSL from the duties and functions falling within the Ministry Of Finance and transferring it to a new Ministry under the Prime Minister has become a hot subject of discussion. Both Legally and Operationally the CBSL remained as an institution directly linked to the MOF since its inception. Due to the haphazard and makeshift provisions during the 100 day government (which was generally accepted as a transitional  period), several ministerial portfolios underwent drastic changes in a rather unorthodox manner with regard to the distribution of  duties and  functions . The country has already witnessed the  consequences of this step during the Central Bank Bond Scam. State Owned Banks which remained attached to the MOF were also allocated to a new ministry outside the MOF. This state of affairs continued without a change even after the formation of the coalition government ((claimed to be a national government ) following the General Election in August 2016. However, from what transpired at the Ministry it is now confirmed  that the government has had reasons for downsizing the MOF before the Ministry was assigned to the former minister. He was finally removed.

In the context of the recent cabinet  reshuffle it is pertinent to review the current status of the State Owned Banks and to consider whether it is prudent to continue these outside the purview of the MOF any- more. Generally the entire banking industry has to function with a  very close relationship with the MOF. Credit supply to the local economy, accessibility to state guaranteed funds and the openings they have to several credit lines and income subsidies, are factors that indicate that the state banks should be positioned  to liaise directly with the MOF. In fact they will have to participate in most of the budget related plans and development activities. Financing of infra- structure projects could be best undertaken or handled by the State Banks at relatively lower costs. We are aware that a significant component of project costs comprise of the  interest element. Even if a higher interest is charged such income will eventually flow back to the treasury when the projects are financed by the state banks. All these point to the fact that they would be better positioned functionally under the MOF than being under another ministry.

The funds and the capital of the State Owned Banks are provided by the treasury. We are aware of several instances of  state intervention to bailout the banks when they were confronted with capital and liquidity problems. In 1992 the then minister of finance stated in the parliament that the two State Banks , Bank of Ceylon and Peoples Bank were insolvent. In more simpler terms they were declared bankrupt. Following a big commotion the government of the day  decided to recapitalize the two banks with state funds instead of the alternative then proposed to privatize the banks. Events such as this confirm  the need for the banks to be under the control of the treasury rather than some other ministry. When we look at the operations of the two state banks in retrospect we observe that they are constrained due to binding statutory provisions in acquiring the capital adequacy requirements. They cannot issue shares or raise capital by debenture issues as freely as the private banks. As the fund requirements of the state banks could only be fulfilled by the treasury and such financial involvements are of a very high range the treasury intervention becomes  compulsory. Furthermore when the state banks need additional capital infusions a financial evaluation has to precede any  new allocation of funds. The treasury and the MOF necessarily  have  to do this task. The Bank of Ceylon by virtue of the Act of incorporation  has the right to raise debentures while the Peoples Bank Act has no such provisions. Such issues are  best decided at the treasury level and this could be achieved by having the State Banks under the MOF.

We can take a case in point to illustrate this further. At the time of recapitalization of the two state banks in 1992, the two banks were required to enter into  agreements with the Treasury where several conditions were stipulated with a view to improve their performance and to permit them to operate as  commercially viable units with autonomy, while  the treasury was required to monitor the operations of the recapitalized banks as another condition attached. It must be borne in mind that these agreements are still in force and  treasury is crediting the banks with annual interest at the rate of 12 % per annum for the value of these bonds issued for recapitalizing. Such a monitoring exercise is facilitated best by keeping the banks under the MOF/Treasury. Unlike the Bank of Ceylon which has the right to issue debentures at times of need the Peoples Bank had to be supported now and again to meet the capital adequacies required under international norms as well as under the CBSL regulations. Since the restructuring exercise in 1993, the Peoples bank had to be provided with funds to meet the capital ratio standards on several occasions. These were done with conditions attached. Such conditions too were to be monitored by the Treasury.

A careful scrutiny of the events that followed clearly show how important it is to continue a vigilant regulatory control of the capitalized banks by the MOF. The Autonomy granted to the State Banks under the restructuring program in 1993, was to provide the banks the freedom to perform their operations in a commercially viable manner including meeting of the required regulatory compliance standards. The recapitalization exercise was carefully designed to prevent the bank from falling into a similar mess in the future.

In April 1993, the Treasury provided government bonds to the value of Rs.10.541 Billion for the following purposes:-

I .  Rs.1152 Mn. To achieve the capital adequacy requirement

ii.  Rs.1700.5 Mn. To write off loans granted to S.L. State Plantation Corpn. & Paddy Marketing Board

iii. Rs.4355 Mn. To finance accumulated Pension liabilities as the bank has failed to do this

iv. Rs.3231 Mn.to provide for loan loss provisions on a realistic basis

v.  Rs.102.5 Mn. For loans to be transferred to a special recovery agency

The agreement underlying the issue of bond stipulated inter-alia the following conditions.

1. a tenor of 30 years where the bonds could be redeemed through the recovery of any specific loan losses identified then
2. the bonds to carry an interest rate of 12% per annum to be paid by the treasury to the Bank
3. The committee on Financial sector reforms in the MOF of the GOSL will be required to monitor the progress …. Of the PB and its performance after recapitalization….

The writer wishes to deal with the entire agreement and the position in the aftermath in a separate article.

It remains to be examined how these conditions are adhered to and whether the expected performance standards have been achieved.

Again on 11^th October 1996  the GOSL decided to issue treasury bonds to the value of Rs.10.0563 Billion on account of the equivalent of total loans granted under directions of the GOSL. The agreement entered into between the Bank and the Treasury contained inter-alia a schedule of the loan facilities covered under this bond issue. An amount of Rs.3724 Mn. was for the purpose of setting off non- performing assets and Rs. 6331.75 Mn. to finance the State Bus Assembly project. These bonds  had a tenor of 10 years carrying an interest rate of 14% per annum to be paid to the Bank by the Treasury.

In the year 2003  the PB received long term treasury bonds to the value of Rs.625 Mn. On account of loans and overdrafts granted to the CWE.

As the bank continued to be constrained with capital shortage the following amounts were released by the Treasury for the Capital augmentation.

Year 2005          Rs. 1.0 Billion

Year 2006          Rs. 2.0 Billion

Year 2007          Rs. 1.5 Billion

Year 2008          Rs. 1.5 Billion

These monies were released, as reported, under a special strategic plan adopted to keep the bank operations under control and develop business activities enabling the fulfillment of CAR requirements.

However these provisions were insufficient to meet the capital shortages experienced by the bank. Therefore the PB during 2008 resorted to an internal borrowing process , circumventing the statutory restriction  it had to issue Public debentures, by issuing special debentures to the Employees’ Pension Trust Fund lying with the Bank. The total value of such debentures issued to the Pension Trust Fund was Rs. 15 Billion. An amount of Rs. 10 Billion is still outstanding on account of this  debenture issue.

It is in this  scenario that the bank is given another capital infusion of Rs 5 Billion recommended to the Cabinet by the Minister in Charge of the Bank, Mr. Kabir Hashim. The newspaper report published stated as follows:-

“Sri Lanka’s 2^nd largest bank, Peoples Bank, is to get a capital infusion of Rs.5.0 Billion after the lapse of 9 years as the government steps up efforts to assist it to meet International Basel iii standards.”

It sounds as if the government is stepping up the efforts for the bank to meet CAR needs!

The issue here is in the context of the subject we are discussing( viz. prudency for the bank to continue being attached to a different ministry other than the MOF),  whether all the relevant  factors regarding the performance and the failure of the bank continuously to reach capital adequacy standards on its own were duly addressed. Such an evaluation and an appraisal could best be done only by the MOF.

According to the CBSL directions issued under banking regulations( as far back as 2015) banks were advised to improve their Capital base to meet the Liquidity Coverage Ratio (LCR) under BASEL iii liquidity standards for commercial banks. It is to be noted that the BASEL Committee on Banking Supervision {BCBS} issued the Basel iii rules on liquidity risk management, standards and monitoring as far back as 16-12-2010.

It is questionable as to whether the State Banks adjusted and planned their activities and performance well in advance to acquire  these requirements. Or did they simply wait with their legs crossed because any way they knew that the government was coming to their rescue.!

An examination of the published accounts indicate a picture quite different to what the newspapers have reported in the article we are discussing  about.

The paper has reported that “the Cabinet paper also noted as much as 70% of the Bank’s loans are extended to small and medium enterprises”

But according to available information the current  total Loans and Advances position is (approximately)

Rs.1,015,544.00

The Loan break up when analyzed indicate

Pawning advances                                  Rs 112,876.00 Mn     11%

Advances to State sector                      Rs.388,000.00 Mn      38%

Staff Loans                                               Rs.   24,566.00 Mn      2.4%

NPL  and Old loans etc                           Rs.      7,450.00 Mn     less than 1%

Total                                                          Rs.532,892.00 Mn      52.4%

According this  break down the total lending as private loans including the quota for  small and medium enterprises would be around  47%.  Again this includes all lending including amounts granted as loans against government guarantees under  various projects. Hence the small and medium loan portfolio said to be included in the Cabinet paper appears to be incorrect.

Bank also had stepped into highly risky areas of lending in the past such as the infamous hedging transaction and incurred heavy losses which were written off from the past profits. This is the first time a state bank got involved in derivative lending which in reality is beyond normal banking activities. The total loss written off amounts to well over 3.0 billion excluding an amount of a deposit in foreign currency set off by the Deusche Bank on account of Oil Hedging Transactions.

The costs and expenditure incurred by the bank for advertisement, refurbishing and many other unproductive areas too appear to be extremely high for an institution hard pressed for capital.

All these point towards one hard truth. Ministry of Finance should closely monitor and guide the affairs of the State banks under its purview as a matter of National Importance. This would be done best by having the Banks within the portfolio of the MOF.

*T. Rusiripala – Former President of the Ceylon Bank Employees Union and Ex- Chairman Bank of Ceylon and National Gem and Jewelry Authority