29 May, 2022


Time To Focus Attention On Risks Of Banks In Sri Lanka

By Chandra Jayaratne –

Chandra Jayaratne

Open letter to business leaders

It will be wise and timely if business leaders (and also depositors) start paying attention to the emerging potential risks across the banking sector. They should collectively engage in critical risk reviews, supported by economists, banking and finance experts and business sector leaders.

The Economic Intelligence Units of the chambers should initiate the process with a position paper to be reviewed by the chamber committees. These reviews should lead to the identification of medium term (one to three year) risks of banks and the finance sector and the likely consequential impact on the business sector and stakeholders of banks, especially depositors.
The risk mitigation strategies, strategic collective action, advocacy and communication strategies should also be developed and implemented as appropriate, in the interest of the nation, the business sector and the people.

Commercial banks and even leasing companies have initiated processes towards borrowing in foreign currency. Some of these borrowings are with State facilitation and the currency risks are swapped to the account of the State. Others may be borrowing in foreign currency, with the currency risk entirely to the account of the bank concerned.

The lack of transparency and clarity surrounding these transactions increases the associated risks. Some of these borrowings are significant in comparison with the balance sheet size of the banks concerned. Even smaller banks and leasing companies appear to have begun exercising the option of lower cost borrowings, with currency risks spared or even carrying the currency risks to its account.

Aggressive marketing initiatives

Customers and prospects are targeted with aggressive marketing initiatives by local finance companies. Banks in competition also focus their attention on depositors, offering high rates of interest, gifts, incentives and lotteries. Tele-marketing, SMS marketing, e-marketing and one-on-one canvassed marketing initiatives supplement attractive media advertising. It is clear that banks and finance houses are aggressively competing for a share of the consumer savings.

These foreign and local borrowings and local deposit mobilisation initiatives are in the backdrop of an environment where there are definite signs of changes in key economic indicators. The changing trends in future growth prospects, investments, growth of export earnings, private sector credit growth, borrowings by key State institutions, tax revenue to GDP, level of the national debt, the component and structure of the foreign debt and fiscal deficit are all indicative of weakening signs. These indicators should generate ‘amber’ lights to flash on the ‘risk assessment’ screens in front of business leaders and even depositors.

Increasing and significant levels of profits of banks, levels of foreign inflows to the stock market, the pickup of stock market indices, increasing foreign reserves, stable exchange rates and relatively lower inflation rates, all flashed with a fanfare by the monetary authorities, must be cheered only with eyes open and following diligent and wide scanning and examining all relevant economic indicators.

IMF warning

“Sri Lanka should be careful about mounting external liabilities and reserve adequacy, with national debt already on the ‘high side’ at over 80% of Gross Domestic Product,” the International Monetary Fund (IMF) said in February 2013.

The IMF drawing attention to contingent liabilities highlighted that “about 47% of that debt was foreign or denominated in foreign currency; up from 44% a year earlier and about 12% of the rupee denominated debt is also held by foreign investors”.

The IMF went on further to state: “Sri Lanka spending agencies including road and urban development agencies have started to borrow on their own account outside the budget, which tend to understate the overall budget deficit and the national debt” and “about 3.8% of GDP is sovereign guarantees issued by the Finance Ministry to various lenders, including foreign banks which have given loans to loss making entities such as SriLankan Airlines”.

These comments were made in the context of the appropriation bill increasing the 4.5% of GDP ceiling on sovereign guarantees set by a Fiscal Responsibility Act. It is in this context that the IMF stressed the need to pay attention to contingent liabilities and highlighted that “if there are either sovereign guarantees or exchange rate guarantees that are being considered that also has to be taken into consideration when one thinks about debt sustainability,” pointing out that Sri Lanka’s Central Bank had several hundred million US dollars worth of foreign exchange swaps, which are exchange rate guarantees with various lenders who were encouraged to borrow abroad”.

“Sri Lanka has to watch inflation, bank credit, tax revenues, keep monetary policy tight and avoid guaranteeing bank forex borrowings and instead create an environment for foreign direct investments,” the International Monetary Fund said in May 2013.

The IMF Director cautioned against easing of monetary policy in the near term, and said the exchange rate should not be defended aggressively. “Exchange rate flexibility should be maintained to cushion external shocks, while deeper markets and a gradual move toward a flexible inflation targeting regime would strengthen inflation control,” the IMF’s Executive Directors said in a public information notice.
It is thus timely that the risk assessments led by business leaders examine whether the contrary policy regimes now enforced by the monetary authorities will enhance the medium term risks.

Sri Lanka was warned against encouraging excessive foreign borrowings and was encouraged to boost Foreign Direct Investments. Attempts to give forex guarantees to banks to borrow abroad may hurt monetary stability and economic stability in the future, IMF Directors said.

“Directors noted the long-term deterioration of the export-to-GDP ratio and growing reliance on debt for current account deficit financing.” Instead of more debt, IMF Directors called on authorities for “further improvements in the business climate to attract Foreign Direct Investment,” adding that “Sri Lanka has resumed expropriating private property and there are increasing concerns over deteriorating rule of law”.

Export earnings and borrowings

Sri Lanka’s earnings from exports declined by 2.8%, year-on-year, in March 2013 whilst the overall export earnings in the first quarter from January to March declined by 8.1% to US$ 2.36 billion. The business leaders should also assess whether the expenditure on imports which declined by 16.0% to US$ 4.49 billion creating a trade deficit of US$ 2.13 billion in the first quarter 2013 is in any way related to a significant lowering of the import of investment goods, which imports act as drivers of future growth.

Business leaders must take it upon themselves to assess the specific drivers weakening export earning and assess the consequential risks to the economy in the medium term, especially if any external issues endanger expanding in the medium term, inward worker remittances above US$ 7.5 billion estimated for 2013.

The 2013 Budget gave incentives for listed corporate bond issues and permitted DFCC and NDB, each to raise forex borrowing over 10 years up to US$ 250 million, with the Government underwriting the exchange risks and providing domestic bonds to invest the funds interim. However it appears that these bond issues have not yet come in to fruition. The detailed terms of offer of the currency hedge and associated terms and conditions are not clear to the stakeholders of banks, who require such information for risk assessment. It is most likely that other commercial banks will also put pressure on the authorities to extend similar facilities to them.

The budget also allowed local commercial banks to borrow up to US$ 50 million and corporate entities to borrow up to US$ 10 million, without Exchange Control approval. It is believed that these borrowings will not enjoy Government-extended currency swaps in mitigating exchange risks.
It is hoped that business leaders do not have short-term memory and will recollect the risks that crystallised in the past via foreign borrowings by corporate entities, especially by those without a natural hedge against currency fluctuations. Business leaders must worry significantly if local commercial banks borrow in foreign currency not against FCBU linked banking transactions, but for on lending in rupees to entities with local trade operations.  If the local banks borrow significant sums at a time when local private sector credit growth is restricted and there is heavy liquidity in the market, will it result in a lowering of credit evaluations and security cover and consequently leads to potential higher levels of nonperforming loans, risking the stability of banks?

State-run Bank of Ceylon sold a US$ 500 million five-year bond in April 2013, attracting two billion dollars in offers. In 2012 Bank of Ceylon sold a US$ 500 million five-year bond. The State-run National Savings Bank has retained the services of mangers to place an international bond sale of up to a billion US dollars.

Earlier this year the State-linked largest non-bank lender sold Rs. 6 billion in five-year bonds with a yearly coupon at 17%. A recent SMS offer from a State merchant bank offers depositors long-term deposits with 20% interest coupons. These reflect yet another example of finance houses forgetting negative lessons from their past.

Risks by State banks

Media reported that the Cabinet had approved a proposal by the President as Minister of Defence and Urban Development to develop the GOH as a five-star hotel at a cost of US$ 1 billion. It said the GOH and adjoining lands owned by the Police Department and the waterfront would also be developed while maintaining its heritage.

It went on to state: “The Bank of Ceylon has prepared a comprehensive redevelopment project proposal covering the above area. The project is to be implemented in three stages and the total investment would be around $ 1 billion.”

If the Bank of Ceylon is to invest long-term in this project, (whilst already having a significant portfolio of local and foreign currency transactions with State institutions whose debt service capacity without Treasury additional funding are in doubt), the question business leaders should examine are the risks carried by this State bank.

People’s Bank, already carrying a significant exposure to State institutions, appears to be committed to cover the funding needs and expanding risks of its leasing subsidiary. This subsidiary is borrowing in local and foreign currency to support expanding its lease portfolio. Media once reported that this leasing subsidiary had transacted 3,000 leases over a weekend at a special ‘Leasing Pola’ (market) in Kurunegala. Will nonperforming leases and interest rate, currency and mismatch risks come to roost in this subsidiary in the medium?

No risk review will be complete without an examination of the potential risks on banks arising from the operations of other heavily-borrowed State institutions, Ceylon Petroleum, CEB, Urban Development Authority, Road Development Authority and the combined SriLankan/Mihin Airlines.
These institutions are heavily indebted to State, local commercial and foreign banks, with some borrowings guaranteed by the Treasury and backed up by currency hedges in the Central Bank books. Here the risk profile appears to become significantly impacting on banks as the borrowing levels increase and investments made by the Urban Development, Road Development and Airlines are unlikely to release free cash flows adequate to cover debt servicing. CPC and CEB cash flows are based on politically weighted pricing formulae and the latter sensitive to available water resources for hydro power generation.

In the airline sector, the costs of modernisation of the fleet (said to involve the acquisition of nearly 25 new aircrafts in 2012 and 2013), competiveness, comparative lower operational efficiency and extra costs of operation to justify Mattala Airport will surely put these institutions into free cash flow deficit. (Whilst SriLankan is acquiring 25 new aircrafts over two years, the bigger and more network extensive American Airlines boasts in advertisements that they are acquiring one plane per week i.e. 52 per year)

External stability

Dushni Weerakoon’s article titled ‘Sri Lanka’s External Stability: Foreign Debt and Export Earnings’ must receive the careful attention of business leaders, especially:

1. Sri Lanka has been witnessing a persistent weakening of its export capacity, with the exports to GDP ratio falling to a low of 16.4% in 2012, and a declining share of the global export market. In 2012, earnings from exports contracted by 7.4%, and have continued to contract by 8.1% in the first quarter of 2013.

2. Sri Lanka’s external debt has grown at an annual average of 16.4% during 2006-12, while earnings from exports of goods and services have grown at only 8.7% during the same period.

3. The share of non-concessional and commercial borrowing rising to 50.5% of total external debt in 2012 from a share of 7.2% in 2006.

4. The imposition of an 18% ceiling on credit growth of Licensed Commercial Banks (LCBs) in 2012 was relaxed to 23%, so long as the additional funds were borrowed from overseas.

5. The uptake of foreign borrowing by State-owned banks and other private entities entail continued external sector risks for the country as a whole.

6. The most prudent strategy to insulate an economy from rising exposure to foreign debt is to ensure a healthy growth in earnings from exports of goods and services, and build-up a ‘war chest’ of non-borrowed official reserves.

It is the fervent hope that the risk review will envelop the banking and finance sector risks arising from the global and local macro economic impact, country risks, exchange rate/interest rate, mismatch and other financial risks, as well as key operations risks arising from:

1. Governance risks in the face of the State involvement in the control of banks, with stage managed board appointments made possible using the voting power of the EPF/ETF , Insurance and State Banks

2. Independence of the Board and Management being threatened leading to independent and capable directors and Senior Management exiting

3. Interference in management and state directed lending and investments and decision making controlled via non independent directors

4. Weak regulatory and oversight structures

5. Lack of independent analysts and competent media critique

Voice of business led advocacy and bold and timely strategic action can mitigate risks not only in the banking and finance sector but also across business and the nation.

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Latest comments

  • 0

    This comment was removed by a moderator because it didn’t abide by our Comment policy.For more detail see our Comment policy

    • 0

      Thanks for this Sir! You are an exception in the corrupt SL business landscape where everyone plays ball and goes along with the SPIN put out by the lying clown Nivard Cabraal rather than speaking out..

      Sri Lanka’s debt is set to sore and the Commonwealth of Clowns Circus aka. CHOGM in November will surely bankrupt the country and there will be massive financial crisis there after – unless China bails out the corrupt Rajapassa dictatorship.. China has asked for an Aid Management Agency to be set up but that’s too late. The crisis is here.. and knowing China will merely be a show of transparency.

      It is the poor who have to pay for all the SPIN and corruption..

  • 0

    The basic problem is of income vs expenditure and a country living beyond its means. Increase in consumption but no corresponding increase in value addition and export generation. We import most capital goods, raw materials and other luxury items to titillate the tastes of the masses. People are getting used to live on debt and debt instruments.

    The govt is now short of cash and is exerting pressure on the so called private banks to lend money to the state. BOC recorded a decrease in profits of 26% last year which is a whopping amount for the principle govt bank. Money being spent of huge loss making projects like MRPM and MRMA (Magampura and Mattala). All well and good as long as there are people to lend and CB is able to print money. But the crunch comes when we have to borrow to service debt which is red line we have already crossed.

    Mahinda Chinthana 1 and 2 were touted as the solution to all the problems of the nation. The end of the war was heralded as a new era, the economic war. Now the economic war has turned into a religious war against minorities. The govt is running to countries like China, Myanmar and Thailand for assistance, sources from the west and Middle East seem to be drying up. When will the bubble burst?

    It is upto the Chambers of Commerce to be pro-active and sound the alarms. The economy cannot be totally entrusted to a set of corrupt megalomaniacs.

  • 0

    I know nothing about business or economics, but I do know that there is no greater authority than Chandra Jayaratne from whom to learn something about the state of business and the economy. In gentlemanly and technical language, and in a model of understatement and restraint, he is telling us that the rosy picture of the economy painted by the political establishment and the politicized Central Bank is not only wrong, but dangerous, and that in fact we are on the verge of a precipice. Since the present regime and sanity are polar opposites, this warning is sure to go unheeded, and the economy will crumble. Depositors will line up by the banks to withdraw their money. The rich and the corrupt will be OK, but for the large majority of the citizens the Miracle of Asia will be their next meal.

  • 0

    this is great eye opener.hope to see good articles like this in future


  • 0

    Gr8 article

  • 0

    Time To Focus Attention On Risks Of Malinvestment In Sri Lanka. Wealth is the nerve center of an economic system. Therefore, the real wealth of a nation is it’s people and how they are treated and educated.

    In the pages of history there lives no city more glamorous than Babylon. Its very name conjures visions of wealth and splendour. Its treasures of gold and jewels were fabulous. One naturally pictures such a wealthy city as located in a suitable setting of tropical luxury, surrounded by rich natural resources of forests and mines. Such was not the case. It was located beside the Euphrates River, in a flat, arid valley. It had no forests, no mines not even stone for building. It was
    not even located upon a natural trade route. The rainfall was insufficient to raise crops. Babylon is an outstanding example of people’s ability to achieve great objectives, using whatever means are at their disposal. All of the resources supporting this large city were human-developed. All of its riches were human-made.

  • 0

    Dr Dushni Weerakoon has pointed out that the share of non-concessional and commercial borrowing has risen to 50.5% of total external debt in 2012 from a share of 7.2% in 2006. Chandra Jayaratne has quite rightly pointed out the risks arising from foreign currency borrowings by banks and leasing companies with the concurrence of the Central Bank, mainly during the last twelve months. The impact of these borrowings is to artificially prop up our exchange rate as shown by the following monthly average exchange rates published by the central bank for the US Dollar.

    Jan 12 April 12 Jul 12 Sept 12 Jan 13 Apr 13
    113.9 128.6 132.87 132. 87 126.85 126.03

    These figures show that the Sri Lanka Rupee has appreciated 5.2% between Jul 12 & April 13 while the inflation rate is 6.4% in April 2013. Effectively our exporters have become 10% less competitive, if not more, in the world market.

    The unavoidable electricity price hike and the impending fuel price hike will accelerate inflation, making our exports even more uncompetitive.

    Dr Dushni has quite correctly pointed out that the most prudent strategy to insulate the economy from rising exposure to foreign debt is to ensure a healthy growth in earnings from exports of goods and services, and build-up a ‘war chest’ of non-borrowed official reserves. Why are we moving in this imprudent direction?

    The answer is the mirage called a 4,000 Dollar Economy by 2016. Some of you will remember the amazement when the promoters of Hilton Hotel borrowed the Yen funds required for the construction of the hotel at a very low rate of interest. What happened? When the Yen appreciated the hotel became insolvent.

    That is what can happen in a much larger scale if we chase this mirage called a 4,000 Dollar economy without sustainable export growth. The negative impact of this unsustainable propping up of the Rupee will endanger the stability of the banks and our economy. We must learn a lesson from Cyprus and get back to a prudent monetary policy as recommended by Dr Dushni Weerakoon who is one of our most eminent economists.

    For all those who are interested in knowing where our economy is heading, please read the book ‘Devaluing to growth and prosperity – Misaligned Currencies and Their Growth Consequences by Surjit S Bhalla Ref. http://bookstore.piie.com/book-store/6239.html

  • 0

    An excellent comment on the prevailing economic conditions in the country. A Judge has just been arrested for corruption and if he is guilty let him face the consequences. But what are we to do except to twist our hands helplessly when the government begins to borrow beyond its means and lead us to the cleaners? Wheeler dealing and questionable policies are being pursued all in the name of the people’s welfare. But all we see is a rise in our debt levels. The last bastion of safety for the us middle income earners has been the licensed commercial banks. But even their management has not been spared. Where are we to lodge the meager savings we have?

  • 0

    This reminds me of Argetina

  • 0

    Sorry its Argentina

  • 0

    Take off all money out of this country, its a Land like No Other….

  • 0

    The diaspora is holding a sizeable sum in NRFC accounts and those who
    really understand the future of SL will not let their balances remain
    for long?

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