CB to launch study to assess banks’ need for fresh capital

By Tennekone Rusiripala

This is a good move but belated! Mr. CBSL Governor, you trying to close the stable door after the horse has bolted. If the capital adequacy of local banks is so affected that a “diagnostic study” has become a must to “assess the extent of the implications coming from higher provisions made for losses on foreign currency -denominated financial assets and the additional losses stemming from possible bad loans” that itself implies that it is the result of a longstanding ailment and you are trying to assess the damage to prevent something worse happening. All Commercial banks are required to be under constant vigilance by a special arm of the Central Bank, the Department of Bank Supervision. But now we know that a situation has come about, warranting a more authentic diagnosis by an audit outside the present external auditors of the banks implying that the deterioration has completely escaped the attention or suffered the consequences of negligence by the authorities.

While it is alarming to note is that our big banks are undergoigng the painful effects of unprecedented pressure due to critical economic conditions of the country, it is more distressing to note the critical situation our Central Bank itself is facing. When confronted with such circumstances we are reminded of the saying, ‘Physician Heal thyself’.

The outlook of the banking industry became a hot topic after President Ranil Wickremesinghe announced the need to issue 20% of the stock of state banks to depositors and employees in presenting his revised budget to parliament sometime back. While we are not aware whether the Central Bank’s reported initiative is a result of the budget proposal OR arising out of a preconditional directive from the IMF, this action plan of the CB to launch a diagnostic study centred around the big banks including the state-owned ones is on the cards now.

The CB is the Banker to the Government, Banker to Banks, Custodian of the Monetary Policy, Regulator of the Commercial Banks and the Economic Advisor to the Government. Associated with these roles the CB is responsible for the discharge of several vital functions related to the issue of currencies, Exchange Control, Bank Supervision, Banking development, including Rural Credit and Rural Banking among many others extending into a wide spectrum in the social web of the country. Of these the most relevant to the topic of our discussion is the Bank Supervision role of the Central Bank.

Since its inception, bank supervision has been recognised as an important function assigned to the CB among other mandatory duties, specifically provided for in the Monetary Law Act. The MLA provides for continuous supervision and regular examination of all banking institutions including non-bank financial institutions. The Monetary Board has to fix the duration of the periods for such tasks from time to time and the Director of the Bank Supervision Department nominates examiners authorised by law to scrutinise books and accounts of every commercial bank. Specific provisions in the MLA empower the Director Bank Supervision to call for detailed information from any bank in the course of such examinations. The CB is authorised to call for further information and clarifications directly from the Auditors of Commercial Banks.

Bank deposits have assumed vital importance in the national economy due to their role in money supply. The Department of Bank Supervision of the Central Bank is required to take steps to retain public confidence in the financial institutions and protect depositors’ interests. The existence of the banking system depends heavily on the public confidence in their stability. The Central Bank is duty bound to play the role of creating and maintaining of public confidence in the financial institutions of the country.

Our banking industry comprises state-owned banks, indigenous banks and foreign-owned international banks. All these banks fall within the regulatory and supervisory purview of the Central Bank. In keeping with the international norms applicable to those banks engaged in cross border operations, the Central Bank from time to time issues directions to update the regulatory standards to match the changing and developing International regulatory frame work. This is achieved under the directives issued to meet the standards stipulated by the Geneva-based Bank for International Settlements (BIS); known as BASLE accords, they are to be observed and adhered to by all internationally active banks. BIS is the Bank for Central Banks and today it has developed a global supervision framework applied as mandatory regulations that should be followed by all banks exposed to international business. Accordingly, the supervisory role of the CBSL is guided and regulated by such BASLE accord directives adopted periodically. To fulfil this requirement and promote development as the economic advisor to the government, the CB issues directives, determinations and circulars to licensed commercial banks in the country, and one of the responsibilities of the Bank Supervision Department is to ensure the observation and adherence to these by the LCBs and that the banks perform their functions prudently. This is essential and mandatory to protect depositors’ interests, and the CB has to take necessary steps to eliminate any possible weaknesses in their operations affecting their financial stability.

Against this background, let us take a look at the launch initiated by the CB. The objective of this so called ‘diagnostic study’ is to assess the extent of the implications arising out of insufficient loan loss provisions and losses incurred on forex-denominated financial assets.

Going by the published financial statements of all the big banks, there appears to be no cause for alarm because quite contrary to what is happening in the business circles, banks are showing huge profits.

Most of the businesses including the export oriented are in a dire state mainly due to the forex crisis the country is facing. Some engaged in Import of electrical items, etc., have made unprecedented profits by adjusting and revaluing their previously imported stocks in hand while some others in local production have gained substantially due to import controls imposed. Those associated with businesses operated with borrowed funds have fallen into big trouble due to unprecedented interest hikes.

All these debacles are the result of economic policy stands taken by the government from time to time while the banking industry has posed a survival of the pressure externally, when the other business activities faced the down fall. This is an aberration which should have been focused on by the CB long before. Among the arbitrarily identified critical factors contributing to a projected breakdown of the banking sector quite carefully shielded by qualifying statements such as “although there aren’t any imminent concerns about their stability, Sri Lanka’s banks are currently undergoing their most painful stretch of stress …” are several eithers initiated or overlooked by the economic advisor to the government. Some of them are loan defaults due to repayment difficulties, soaring interest rates, runaway inflation, etc. The most critical factor not mentioned in the list is the sharp and precipitous fluctuations of the exchange parities for which the Central bank is directly responsible.

The global impact due to the pandemic and the resulting light of the domestic adversities cannot be disregarded but the attribution of these as entirely responsible to the current situation is a vain attempt at justification by those who have failed in their performance. History shows us many similar instances of how bloated window-dressed statistics have finally deceived all of us. Let me quote the 1990s experience of subjecting the two state banks to a ‘diagnostic audit’ directed by the World Bank. Ironically, these banks were showing a good balance sheet on the face of it when this International Intervention was made. The revelations were alarming so much so that the then Finance Minister declared that the two state banks, BOC and PB were insolvent. This led to a huge catastrophe spread over to a countrywide debate culminating in the tabling of a no-confidence motion against the FM. We still remember how the current President, then Chief Whip of the Government, Ranil Wickremesinghe ably defended the FM clearly illustrating how the banks had been cooking the accounts to show bloated profits without adequate provisions for loan loss, employee benefit schemes and writing off bad loans. Finally, the two banks were rescued by the provision of Capital to support their liquidity shortfalls to the tune of about Rs. 24 billion by the issue of long- term interest bearing bonds from the Treasury.

Going by various disclosures about the questionable lending operations of the state banks from a long-time before the onset of the pandemic we are compelled to conclude that some have shirked their responsibilities.

We keep our fingers crossed. The declaration of a state of bankruptcy and the default on loan repayments, the manipulation of exchange rates, failure to meaningfully address causes for diminishing forex inflows, interest rate manipulations leading to serious economic repercussions are the causes of the current situation while precarious and reckless lending operations resorted to mostly by hired contractors in the state banks are among the many skeletons that may come out of the cupboards during the proposed diagnostic exercise.