7th March 2018
On Banking Concentration
Under Indrajit Commaraswamy we are to see a major consolidation of the non-banking financial institutions in the country. We are currently also seeing a huge recapitalization of the banking industry. I have many issues with the current Central Banker but feel that on an overall balance he is doing a good job. His actions or inaction in the foreign exchange market is the correct policy for an export led growth model. His purchase of dollars from the FX market creates non-debt fueling reserves for the country. Further his movements on inflation targeting, increased risk profiling (more than just on-site examination), and policy stability are encouraging. He is old and as such is incredibly slow in terms of implementation. He also doesn’t have the political will or might to fight against corruption. His interventions on PABC are laughable especially when considering DFCC and BOC involvement. For instance, the recent fraud involving Indra Silva, the BOC, and shares in Janashakthi insurance are a matter which he is ill suited to tackle.
With regards to the financial sector I do not think consolidation is the current requirement. The NBFI sector is small and further concentrated in the hands of a few firms. Even if we assume the worst of the sector it does not pose a significant risk to the financial system. The sub sector however does boost competition with regards to rates and keeps the larger banks honest with regards to lending to underprivileged communities. Having watched most Central Bank videos I do not see the need for him to address the sector with as much focus.
By his own words there are huge failings with regards to the control of the state banks. State banks have on their balance sheet most of the subsidy the government provides in the form of electricity and petrol. Politically driven lending as seen with Perpetual is rife and a cause for serious concern with the large concentration of finance under state control. BOC, People’s Bank, and NSB are poorly run banks which are inept to handle even basic banking tasks like the opening and closing of accounts. Internal controls are poor. Staffing is politicized. These institutions are ill suited for innovation and/or the provision of financial instruments in line with the global economy.
There are also huge failings with regards to primary dealers. The failings of Entrust and Perpetual Treasuries are notable. Even after the failing of Entrust there is little mention in any of his public statements with regards to improved control over the primary dealers. First Capital has recently been put on a rating watch by ICRA Lanka and the sale of Janashakthi’s general insurance business is not a sign of strength. Further the expansion of Orient Finance is worrisome as in between 2010 and 2017 their loan portfolio has grown over 7 times with a lot of financing obtained from Banks. There have been notably aggressive financial institutions in the same period that the Central Bank should reign in.
Financial sector stability is driven by the practices of the institutions that manage the most amount of assets. The Central Bank has been wholly inactive in the regulation of these institutions. The EPF, BOC, People’s Bank, and NSB are mostly run by political interests. The Central Bank may feel that it has achieved something with regards to its actions on Perpetual Treasuries, but this is a small victory that was only really achieved due to the political value of getting convictions. The Central Bank has yet to outline reform with regards to the EPF. In most major economies individuals are given the choice to allocate their own retirement funds. This would be a huge boom to the unit trust industry and further does not require the winding up of the EPF. The Central Bank has also to answer how it is that Perpetual was able to obtain financing for its scheme.
There is also no excuse for the fear psychosis that the Central Bank is trying to create with regards to debt repayment. Most of the debt is held by the EPF and the State Banks. All institutions under state control and who would quite happily reinvest their funds into government securities. Core inflation has been negligible and headline inflation has been driven by supply side shocks. There is room for the Central Bank to print money to reduce the governments financing costs. The current real return on fixed instruments offered by the government is ridiculous and an affront to anyone who must work for a living while paying taxes.
The Central Bank’s Basel compliance is also not particularly well received. The banks will be less profitable due to it in the long run. To my knowledge we are the most secure country in terms of banking sector in South Asia. We do not need to see improved stability in this regard. The government however should continue to act to improve its financial rating. With regards to the Central Banks dream of reducing the number of financial institutions there is a simple fix. There is huge room for institutions wholly owned by the state to merge. Lankaputhra, Sri Lanka Savings Bank, and other smaller banks can be merged. There is also huge room for institutions with common ownership to merge. LOLC and Vallibel alone can account for a major reduction in the number of standalone institutions. Please, Mr Commaraswamy, do not make speculators and corrupt regulators rich by forcefully merging smaller institutions. It will tarnish your reputation and legacy.