23 October, 2020

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Sri Lanka May Need A ‘Bad Bank’ To Drive The Post-Covid Restructuring Of Businesses

By Arjuna Mahendran

Arjuna Mahendran

‘You never know who’s swimming naked until the tide goes out.’ (Warren Buffett)

In late 2019, much before the Covid-19 pandemic started wreaking havoc on the global economy, the branches of two key Indian banks closed their business operations in Sri Lanka. ICICI Bank and Axis Bank are two of the larger privately owned banks in India. In terms of their stock market capitalisation they are among the biggest companies listed in India. Even from a pan-Asian perspective, ICICI Bank which has an asset base of close to USD 200 billion, is huge. To put it in perspective, ICICI Bank’s asset base is more than double the annual GDP of Sri Lanka. The Bank of Ceylon has assets of USD 13 billion by way of comparison.

The reasons behind the closure of the two Indian bank branches were never revealed. Apart from a curt statement from the central bank of Sri Lanka that it had approved a request for closure from the parent banks of these branch banks, there was no explanation given in the public domain. A clue may, however, be derived from the fact that the central bank announcement of the closure of these branches was mentioned (albeit relegated to a mere footnote) in a press release mandating that banks reduce their rates of interest on loans to prime customers.

The main body of the regulator’s press release referred to an ultimatum issued, earlier in 2019, by it to banks to reduce the rates of interest they charge on loans to their prime customers by two and a half percent. This press release sought to name and shame those banks which had not complied with the regulator’s ultimatum. It can thus be surmised that the two Indian banks simply found it unprofitable to continue with their business operations in Sri Lanka under a regime of controlled interest rates. No doubt the 2018 coup and the unfortunate Easter bombings, events which dealt a body blow to confidence in the political stability of the then government and ensuing uncertainty in the general business climate, would have also contributed to the decision by the Indian lenders to quit this market. The cap on lending rates was very likely the proverbial straw that broke the Indian banks’ will to endure in Sri Lanka.

Sri Lanka can ill afford to lose these sorts of linkages which connect its economy and businesses with the wider world. When I last checked, the government is still promoting the Colombo International Financial City within the new Colombo Port City. This proposed offshore financial centre will presumably attract the rich and famous from our subcontinental hinterland to park their wealth here on a no-questions-asked basis. The presence of foreign banks, and indeed other global intermediaries, in Sri Lanka provides a valuable conduit for Sri Lankan businesses to connect with opportunities in the vast Indian market, and the wider world, so as to link-up with global supply chains producing everything from teabags to fancy jewellery. And more.

Throughout 2019 repeated press releases from the central bank bemoaned the alleged higher lending rates of interest charged by Sri Lankan banks when compared with bank lending rates in neighbouring countries. Regrettably no data was proffered to validate this charge. But in an environment where Islamic terrorists ran amok blowing up churches on Easter Sunday and the ex-President loudly disparaged his Prime Minister’s alleged mismanagement of the economy, there is some justification in bankers attaching a higher risk premium to their assessments of the likelihood of borrowers defaulting on their loans in Sri Lanka in 2019. And that higher risk premium translated into higher lending rates. As a consequence, bank lending collapsed and loan delinquencies soared in 2019 long before the covid-19 pandemic hit Sri Lanka’s shores.

The allegation that Sri Lanka banks are resorting to fixing the interest rate at exceptionally high levels to gouge their unsuspecting customers is a familiar political trope peddled to great effect in attracting votes at elections. While taxes are reduced for businesses and residents, they are routinely increased for banks, on the presumption that banks are getting a free ride at the expense of the public. But this begs several questions. Can it realistically be said that over 30 banks operating in Sri Lanka don’t have to compete with each other on price, viz. rates of interest offered, to attract business? One of the banks named and shamed by the central bank was the Peoples’ Bank, a major government-owned bank; does this imply that government-owned banks are fleecing their customers and undermining the economy?

The reality is more prosaic. The Peoples’ Bank and the Bank of Ceylon, which jointly hold about 40 percent of the assets of the entire banking system, are saddled with enormous non-performing loans from a variety of state-owned enterprises, principally Sri Lankan airlines, the CEB and the CPC. They therefore have to set the rates of interest at which they lend to other more profitable customers at high levels in order to cross-subsidise the losses they incur on those large government-linked accounts. There is probably some merit to the charge levelled at smaller local and foreign bank branches that they piggy-back on these high lending rates set by the two large government banks. But when we observe the sharp rise in non-performing loans in 2019 it is clear that all banks have suffered in roughly equal measure. For the first time in several decades soured loans are reported to exceed five percent of total lending by banks in Sri Lanka. While foreign investors are concerned about how the government will repay the several billions of dollars coming due in the next few years, local bankers are facing an equally daunting challenge in getting local borrowers to repay their bank loans it seems.

We have been here before. In the early 1990s, both large government banks were bleeding potential and realised losses. The JVP hartals and the ensuing collapse of several finance companies had compounded the adverse impact of the LTTE insurgency on the economy. To address this problem a raft of measures were introduced to recapitalise the two big banks, stop them paying pensions, afford their boards of directors quasi-judicial powers (‘parate execution’) to sequester loan collateral from defaulters, establish commercial courts to fast-track resolution of commercial disputes, strengthen supervision of accounting standards, the insurance sector, capital markets etc. However, one critical aspect of the functioning of banks in relation to the broader economy was neglected, i.e. the rather time-consuming procedures for resolving the problem of bad debts recovery and expediting declaration of bankruptcy.

The failure to address this issue will assume significant proportions in the post-covid world, not just in Sri Lanka but globally. Across Asia bankers are assiduously combing their loan portfolios to identify ‘zombie’ companies whose business models will not survive the drastic behavioural changes visited on their customers by the pandemic. Countries which can speedily and effectively close down such companies and assist their entrepreneurs to seamlessly move onto new and more profitable ventures will collectively emerge ahead in the post-covid recovery, whenever that happens. In countries which have not streamlined their laws and procedures to facilitate companies to seek protection from their creditors, to enable effective restructuring or closure, there is the alternative mechanism of a state-sponsored ‘bad bank’ which will buy the non-performing loans from lenders and specialise in restructuring and/or disposing of assets of businesses gone bad. The idea of a ‘bad bank’ has circulated in Sri Lanka for several decades. It was embedded in a proposal in the government budget presented in November 2015 for fiscal 2016. But it never saw the light of day. More the pity since it would have facilitated the rapid restructuring of ailing finance companies and rapidly released the assets underlying their bad loans into the marketplace, aiding the rapid repayment of depositors’ monies.

Democratic socialism, let’s not forget, is a system which encourages entrepreneurs to take calculated risks but also affords those same entrepreneurs protection from their creditors when ventures fail, which they often do. In the absence of outright fraud and embezzlement, entrepreneurs should have confidence that they can pick up the pieces of failed ventures and re-invent themselves in alternative business arenas. The challenge for governments is to assist viable businesses in facing the extraordinary challenges posed by the pandemic while allowing unviable businesses to rapidly restructure or die with minimal pain to all concerned. Propping up dinosaur and zombie companies may be politically popular but will not allow countries to speedily dig themselves out of the post-covid economic hole.

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Latest comments

  • 10
    1

    “Propping up dinosaur and zombie companies may be politically popular but will not allow countries to speedily dig themselves out of the post-covid economic hole”.

    But this is just what governments (capitalist governments) have been doing world wide ever since the 2008/9 crash. This is what the Obama bail out of the auto giants, AEG, Citibank etc etc was about. This is what QE is about. The problem is more than bailing out banks; the whole business world is going to run aground in SL soon.

    • 0
      0

      Mr Arjuna Mhendran @

      Those who are in power today are in the view that you have changed your name.
      :
      Is that true ?
      :
      Former President Gamaralage Joker SIRISENA added to the lanken press in a public speech lately. We perfectly know SIRISENA or the like would not care much about what they are just adding to the press. So is the nature also with MAFIA boss Mahinda Jarapakshe. When would the people dream of a better future, while all these remain similar to garbage dumps in Wanathala mulla ?
      :
      CT over to you, if AM should have changed his name, how can he become a writer to CT ?
      :
      Why doesnt incumbent GOVT take this as a serious issue if so called BOND BANK SCAM was made by GOOD GOVERNANCE govt ?
      .
      IF THIS WOULD HAVE BEEN IN EUROPE, BOTH GOVT AND AM WOULD NOT HAVE CHANCE TO CONTINUE AS BEING DONE in SRILANKA.

  • 6
    6

    Arjuna Mahendran
    “You never know who’s swimming naked until the tide goes out.”
    —————–
    Arjuna Mahendran – this applies to you – I guess?
    or were you caught with your (swimming) pants down?

  • 10
    4

    ARJUNA:
    Good … keep telling Gota’s government what to do. This will drive the Pohuttus and the monks over the edge. They think you’re teasing them that they can’t catch you. Or, is it because criminals always return to the scene of the crime? In that case, would you also offer some advice to Ranil on how to restructure what is left of his UNP ?

    • 11
      3

      Ajay
      UNP doesn’t need any restucturing as there is no structure left after ranil’s debacle. All UNP need now is for ranil to get the hell out of the party and to join SLPP officially.

  • 6
    4

    Bad Banks are created by “Bad Governors of the Central Bank.”
    reality check biting back Arjuna

  • 11
    3

    “When I last checked, the government is still promoting the Colombo International Financial City within the new Colombo Port City. This proposed offshore financial centre will presumably attract the rich and famous from our subcontinental hinterland to park their wealth here on a no-questions-asked basis”

    This will take another 25 years. By that time India, Singapore, Dubai and even Bangladesh would have leaped frogged Sri Lanka in Finance, Manufacturing, IT , Logistics etc…while Sri Lanka move at Elephant’s pace.

    In 25 years time port city would turn out to be another white elephant and part of China

    Mahinda wont be around, dead and buried….may be in the very Port City.

  • 10
    5

    This shameless man should be held accountable for the major part of the pathetic situation in the country today. Due to his highway robbery, voters retaliated to Yahapaalana Government irrationally. They voted absurdly out of retribution, resulting Pohottuwa to get unwarranted power. Voters didn’t know Mahendran’s family was looting the country during MR time too with the help of Kabraal. Only difference is during MR time nobody was there to jump up and down in the Parliament, because brayers like Booruwansa, Gommanpila too got crumbs from the loot. This man was paying all the expenditure for RW and his wife, when they were on foreign trips. This man’s son in law was in the same looting mafia with Kabraal’s family, when Kabraal was the ring leader, providing lion shares of the loot to MR family. This man doesn’t have any political party, his party is money. At least GR should get this man extradited from Singapore as promised on the political stage. But it will never happen, because they protect each other, as the same way RW protected MR family. Our ignorant voters kill each other without understanding that simple fact. Seems we will be in this hellhole eternally.

    • 3
      0

      Mr Guruge

      Dont you think that all in power are shameless today ?

      If AM is to be attacked, what about Mafia Boss, His brother (oberhaupt), His other brother Basil, His other other brother ::: and MR s sons ? …. And Buruwanas as their condom support ?

      I think if my GURU late Rev Sobitha Thero would have been alive today, we could join him for a demo, but in today s context, if people agree with the bunch of criminal why to bother anymore ?

    • 2
      1

      Well put Guruge.Do we have any hope for the country?

  • 0
    3

    Foreign sponsored terrorism can be physical and soft power too. We SL are experiencing both from not just one Nation our neighbour but from all other Asian Tiger Econolies too where Tamils live……all these countries “puppet show” is now at the expense of SL……as they all make a living from China themselves but make the world to focus on SL as a sacrificial cathode for all that is crooked/criminal they have been doing to and in SL for decades??

    Once The Hague concluded matters regard to foreign sponsored terrorism the compensation should be enough to make up for the decades of the development to come in SL.

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