{"id":108108,"date":"2013-09-30T01:29:35","date_gmt":"2013-09-29T19:59:35","guid":{"rendered":"https:\/\/www.colombotelegraph.com\/?p=108108"},"modified":"2013-10-06T00:15:52","modified_gmt":"2013-10-05T18:45:52","slug":"central-banks-professionalism-vs-ours","status":"publish","type":"post","link":"https:\/\/www.colombotelegraph.com\/index.php\/central-banks-professionalism-vs-ours\/","title":{"rendered":"Central Bank\u2019s Professionalism Vs. Ours"},"content":{"rendered":"

By\u00a0Hema Senanayake<\/a><\/span>\u00a0–<\/strong><\/strong><\/p>\n

\"\"<\/a>

Hema Senanayake<\/p><\/div>\n

A few days ago, on September 24th, Sri Lanka Central Bank<\/a><\/span> (SLCB) issued a \u201cNotice To The Public\u201d in order to absolve it from allegations leveled at it by politicians, investors, general public and certain professionals in the financial industry, after the virtual collapse of Central Investment & Finance PLC (CIFL).<\/p>\n

If\u00a0 I remember correct, for the first time in history average people during a recent protest, held placards with writings that denounced SLCB. A placard held by a possible retired old lady says \u201cCentral Bank Plays With Retiree\u2019s Money.\u201d If it does, it would be the most immoral thing that this prestigious state institution can do. Perhaps this message was hit hard on SLCB. That may be the reason for issuing the said \u201cNotice To The Public.\u201d But the irony is that the very \u201cNotice To The Public\u201d proves the SLBC\u2019s lack of professionalism not vice versa. Hence, I am afraid that SLCB may continue to ignore the interests of poor depositors. Also, due to their lack of professionalism the country\u2019s monetary system might be at risk, at least there could be significant problems.<\/p>\n

SLCB bluntly criticize its critics. In the very beginning of the \u201cnotice\u201d it says \u201cunfair allegations that the Central Bank has not been acting are being levelled every time some weakness is displayed, in any NBFI. That reasoning indicates an absolute ignorance of the financial sector, or a deliberate misunderstanding of the situation.\u201d<\/p>\n

Critics and depositors alleged that CIFL is a failed institution but SLCB\u2019s professional view is different and blames that critics are ignorant of the financial sector. SLCB says \u201cOver the past 7 years, not a single finance company has collapsed, and consequently had to be liquidated. Although there have been some finance companies that have encountered stresses, whenever that has happened, those companies have been restructured in a gradual manner to regain financial strength.\u201d (Refer, \u201cNotice To The Public\u201d)<\/p>\n

According to SLCB, the CIFL is not a collapsed finance company which requires liquidation. It reiterates this very point again and says \u201cFurther, it must be reiterated that CIFL has not collapsed as claimed by some, and it is being restructured.\u201d (Refer, \u201cNotice The Public\u201d)<\/p>\n

\"\"<\/a>Both these views explain the \u201clearned\u201d definition of the SLCB in regard to a failed or collapsed financial institution. According to that definition, a collapsed financial company is an institution that is needed to be liquidated and what is being restructured is not a failed institution. Being true to its definition SLCB has not categorized CIFL as a failed financial institution.<\/p>\n

But the whole world has a different definition in defining a failed financial institution. According to that definition \u201cA failed financial institution is an institution which is unable to meet its obligations to its depositors or other creditors because it has become insolvent.\u201d As far as we know, CIFL has failed to meet its obligations to depositors who deposited billions of billions of rupees. Therefore, according to the universally accepted definition, we duly call CIFL as a failed finance company. But the SLCB says that calling so, indicates our \u201cabsolute ignorance of the financial sector, or a deliberate misunderstanding of the situation.\u201d Who is ignorant? I think the readers can decide it now.<\/p>\n

The legal definition of a failed financial institution is much tougher. Legally, a failed financial institution is an institution that fails to satisfy contractual payment obligations due, even under reorganization or restructuring. By this definition CIFL is definitely a failed institution even if it is being restructured because under the proposed plan some depositors claim that they have been asked to convert 50% of their deposits into non-voting shares and must be willing to accept an interest well below the market rate for the rest of the deposits. Clearly this is a violation of the contractual payment obligations on the part of CIFL.<\/p>\n

Accordingly, what the SLCB first should do is to update its definition of the failed financial institution or else they might submit financial and legal reason as to why their definition is superior to the universally accepted definitions. Then only we can determine as to the accuracy of the bank\u2019s claim which says that \u201cOver the past 7 years, not a single finance company has collapsed.\u201d<\/p>\n

Like this, most of the purported ten realities explained in the \u201cnotice\u201d are just rhetoric; even some statistics quoted are out of the context. In a brief article such as this, it is difficult to explain point by point. But I wish to discuss one important policy issue that surfaced after the CIFL collapse.<\/p>\n

I agree that NBFIs (Non-Bank Financial Institutions) such as CIFL play an important role even though the role is not that big. According to the SLCB, NBFIs share of the total financial sector accounts only 6.6%. Out of it CIFL\u2019s share, accounts less than 0.06% and SLCB concludes that \u201ctherefore, the liquidity problem of CIFL will not affect the NBFI sector as a whole.\u201d This conclusion is totally unprofessional for any central bank to make. The reason is that the crisis it creates in the market and in the people\u2019s lives does not correspond to its insignificance in terms of total market share of CIFL. It created a big crisis and suspicion of the stability of the sector. The reason is that the financial industry is totally depends on the trust of depositors.<\/p>\n

No bank or financial institution is too big to bring down by the depositors if the 10% of deposits are withdrawn at any one day. This is true even for the largest bank in Sri Lanka namely Bank of Ceylon. Trust and confidence are the most important words in financial sector and SLCB has the primary responsibility to ensure that depositors have the utmost trust and confidence, assuring them that all their deposits will be safe even though the SLCB is technically\/legally liable to pay only up to Rs.200,000\/= per depositor when a deposit accepting financial institution fails. This is the promise that is missing in the \u201cnotice to the public.\u201d If the SLCB truly holds that promise which it should, then the process of reviving of CIFL would be totally different than it is now.<\/p>\n

Getting back to the policy issue I want to question as to whether SLCB should allow NBFIs to accept deposits. I would say no. Let me explain why.<\/p>\n

Peoples\u2019 savings are deposited usually in banks. In general banks are of two types. One type is call \u201cdesignated commercial banks\u201d and the other type call \u201csaving or\/and development banks.\u201d The simple difference is that the designated commercial banks can create money known as \u201ccredit money\u201d when they grant loans but the rest of the banks can\u2019t do this. Due to this very nature of the designated commercial banks, they are the back-bone of the monetary system. They need peoples\u2019 deposits to do this business. In terms of the country\u2019s economic growth the system needs to create new money on demand-and-supply basis and also must be able to shrink money supply when it is needed. This can only be done by designated commercial banks. No other type of banks or NBFIs can do this. By this measure, even though designated commercial banks make profits, those banks directly perform an invaluable macroeconomic activity.<\/p>\n

In relative terms NBFIs are about making profits. So, why the country should allow them to accept deposits? NBFIs should not be allowed to compete for people\u2019s deposits with banks. And also, due to this very nature of the operations of designated commercial banks they are resilient and very unlikely to collapse if the significant portion of their loan portfolio is not tied-up with fictitious capital of the financial market. As at now this risk is very minimal in Sri Lanka because still total bank assets to GDP ratio is around 84%. In Iceland this figure was over 1200% before the collapse of the financial sector in 2008 and in Ireland the same figure was 800% before the collapse.<\/p>\n

However, NBFIs must do their businesses with equity of investors and with credit lines they arrange with banking institutions. If they get the CSE approval they would be able to mobilize capital through the issuance of shares. These should be the sources of capital or funds for NBFIs operations.<\/p>\n

Therefore, I strongly suggest that SLCB must bring regulations to stop NBFIs accepting new deposits after giving them a fair grace period of time. In the event, SLCB would not have to monitor any NBFI which has zero deposits and CSE would take regulatory actions to hold NBFIs for best business practices.\u00a0 If SLCB thinks otherwise, now it is high time to explain their professional view on this matter rather than criticizing its rational critics with rhetoric.<\/p>\n

Before I end this essay let me quote what I wrote in my book entitled \u201cIndispensable Bad Debt\u201d published in 2008 November.<\/p>\n

\u201cThe market mechanism is an essential tool to ensure the use of social resources efficiently in production\u2026Even highly sophisticated central planners cannot do it more efficiently that market mechanism. The market mechanism itself is the best planning tool\u2026 The market process gives the meaning to money and justifies its existence. In turn, the money system provides the infrastructural base for the market to function\u201d (Page 64 & 66).<\/p>\n

In brief if the financial system fails, then production system fails. The subject of monetary infrastructure comes under the purview of the Central Bank in any country. This is very reason I uphold Central Bank as the most important economic institution in any country and suggest that it should be free from politics and must be free from private sector influences. Hence in the same book I wrote \u201c\u2026 the Central Bank should be the fourth independent branch of the government\u201d (Page 97). This is what we think about central banking and its professional duty.<\/p>\n

I think the SLCB did a great disservice to itself by issuing the said \u201cNotice To The Public.\u201d<\/p>\n","protected":false},"excerpt":{"rendered":"

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