{"id":213359,"date":"2020-09-18T15:06:41","date_gmt":"2020-09-18T09:36:41","guid":{"rendered":"https:\/\/www.colombotelegraph.com\/?p=213359"},"modified":"2020-09-23T03:03:16","modified_gmt":"2020-09-22T21:33:16","slug":"sri-lanka-may-need-a-bad-bank-to-drive-the-post-covid-restructuring-of-businesses","status":"publish","type":"post","link":"https:\/\/www.colombotelegraph.com\/index.php\/sri-lanka-may-need-a-bad-bank-to-drive-the-post-covid-restructuring-of-businesses\/","title":{"rendered":"Sri Lanka May Need A \u2018Bad Bank\u2019 To Drive The Post-Covid Restructuring Of Businesses"},"content":{"rendered":"

By Arjuna Mahendran<\/a> –<\/strong><\/span><\/p>\n

\"\"<\/a>

Arjuna Mahendran<\/p><\/div>\n

‘You never know who’s swimming naked<\/i> until the tide goes out.\u2019 (Warren Buffett<\/i>)<\/p>\n

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\u2019s 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.<\/p>\n

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<\/span><\/a> mandating that banks reduce their rates of interest on loans to prime customers.<\/p>\n

The main body of the regulator\u2019s 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\u2019s 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\u2019 will to endure in Sri Lanka.<\/p>\n

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.<\/p>\n

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\u2019s 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\u2019s shores.<\/p>\n

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\u2019t 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\u2019 Bank, a major government-owned bank; does this imply that government-owned banks are fleecing their customers and undermining the economy?<\/p>\n

The reality is more prosaic. The Peoples\u2019 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.<\/p>\n

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 (\u2018parate execution\u2019) 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.<\/p>\n

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 \u2018zombie\u2019 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 \u2018bad bank\u2019 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 \u2018bad bank\u2019 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\u2019 monies.<\/p>\n

Democratic socialism, let\u2019s 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.<\/p>\n","protected":false},"excerpt":{"rendered":"

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