By Tennekone Rusiripala
This is a good initiative but late! Governor of the CBSL, you are trying to close the stable door after the horse ran away. If the capital adequacy of local banks is so affected that a “diagnostic study” has become essential for “assess the extent of the implications stemming from the increase in provisions made for losses on financial assets denominated in foreign currencies and additional losses resulting from possible bad debts” that in itself implies that it’s the result of a long-standing illness and that you’re trying to assess the damage to prevent something worse from happening. All commercial banks are required to be under the constant supervision of a special body of the Central Bank, the Banking Supervision Department. But now we know that a situation has arisen which warrants a more genuine diagnosis by an audit external to the banks’ current external auditors implying that the deterioration either completely escaped notice or suffered the consequences of negligence by the authorities.
If it is alarming that our major banks are suffering the painful effects of unprecedented pressure due to the country’s critical economic conditions, it is more distressing to note the critical situation that our Central Bank itself is facing. When faced with such circumstances, we remember the adage, ‘doctor heal yourself.
The outlook for the banking sector became a hot topic after President Ranil Wickremesinghe announced the need to issue 20% of state bank shares to depositors and employees when presenting his revised budget to parliament a year ago. some time. Although we do not know whether the initiative reported by the Central Bank is the result of the budget proposal OR stems from an advance directive from the IMF, this action plan by the CB to launch a diagnostic study focusing on the big banks, including state-owned ones are on the cards now.
The CB is the banker to the government, the banker to the banks, the guardian of monetary policy, the regulator of commercial banks and the economic adviser to the government. Associated with these roles, the CB is responsible for carrying out several vital functions related to currency issues, exchange control, banking supervision, banking development, including rural credit and rural banking, among others , extending into a wide range of the country’s social network. Of these, the most relevant to the subject of our discussion is the Bank supervision role of the central bank.
Since its creation, banking supervision has been recognized as an important function devolved to the CB among other mandatory missions, specifically provided for by the law on monetary law. The LBA provides for continuous supervision and regular examination of all banking institutions, including non-banking financial institutions. The Monetary Board shall from time to time fix the length of periods for such duties and the Director of the Banking Supervision Department shall appoint examiners authorized by law to examine the books and accounts of each commercial bank. Specific provisions of the AMLA empower the Director of Banking Supervision to request detailed information from any bank during these examinations. The CB is authorized to request additional information and clarifications directly from the Auditors of the Commercial Banks.
Bank deposits have assumed vital importance in the national economy due to their role in the money supply. The Banking Supervision Department of the Central Bank is required to take measures to maintain public confidence in financial institutions and protect the interests of depositors. The existence of the banking system is highly dependent on public confidence in its stability. The Central Bank has a duty to play the role of creating and maintaining public confidence in the financial institutions of the country.
Our banking sector includes state-owned banks, indigenous banks and foreign-owned international banks. All these banks fall under the regulatory and supervisory jurisdiction of the Central Bank. In accordance with international standards applicable to banks engaged in cross-border operations, the Central Bank issues instructions from time to time to update the regulatory standards to correspond to the changing and development of the international regulatory framework. This is achieved under guidelines issued to meet the standards stipulated by the Geneva-based Bank for International Settlements (BIS); known as the BASEL Accords, they must be observed and respected by all internationally active banks. The BIS is the bank of central banks and today it has developed a global supervisory framework applied as mandatory regulations that must be followed by all banks exposed to international activities. Accordingly, the supervisory role of the CBSL is guided and regulated by these guidelines of the BASEL agreement adopted from time to time. To fulfill this requirement and promote development as an economic adviser to the government, the CB issues directives, decisions and circulars to licensed commercial banks in the country, and one of the responsibilities of the Banking Supervision Department is to ensure observance and compliance with these guidelines. by the BCLs and that the banks exercise their functions with prudence. This is essential and mandatory to protect the interests of depositors, and the CB must take the necessary measures to eliminate any possible weakness in their operations affecting their financial stability.
In this context, let’s go back to the launch initiated by the CB. The objective of this “diagnostic study” is to assess the extent of the implications stemming from the insufficiency of loan loss provisions and losses incurred on financial assets denominated in foreign currencies.
From the published financial statements of all the major banks, there does not seem to be cause for alarm because, contrary to what is happening in business circles, the banks are posting huge profits.
Most businesses, including export-oriented ones, are in a dire state, mainly due to the currency crisis the country is facing. Some engaged in the import of electrical items, etc., have made unprecedented profits by adjusting and revaluing their previously imported stocks, while others in local production have gained significantly due to import controls imposed. Those associated with businesses operated with borrowed funds have run into big trouble due to unprecedented interest hikes.
All these debacles are the result of economic policy positions taken by the government from time to time as the banking sector has imposed survival from external pressure, while other business activities have had to face the downfall. It is an aberration on which the CB should have focused long before. Among the arbitrarily identified critical factors contributing to a projected collapse of the banking sector, quite carefully protected by qualifiers such as “although there are no imminent concerns about their stability, Sri Lankan banks are currently going through their most painful period of stress…” are several initiatives initiated or ignored by the government’s economic adviser. Some of them are 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 in exchange rates for which the Central Bank is directly responsible.
The global impact due to the pandemic and the resulting light of national adversities cannot be ignored, but the attribution of these as entirely responsible for the current situation is a vain attempt at justification by those who have failed in their performance. History shows us many similar examples of how inflated storefront statistics ultimately fooled us all. Let me cite the 1990s experience of subjecting the two state banks to a “diagnostic audit” led by the World Bank. Ironically, these banks were looking good on the face of it when this international intervention was made. The revelations were so alarming that the then finance minister declared the two state banks, BOC and PB, insolvent. This led to a huge disaster that spilled over into a national debate that culminated in the filing of a motion of no confidence against the FM. We still remember how the current Speaker, then Chief Government Whip, Ranil Wickremesinghe, ably defended the FM by clearly illustrating how the banks had prepared the accounts to show inflated profits without adequate provisions for loan losses, benefit plans and the write-off of bad debts. . Finally, the two banks were rescued by the provision of capital to support their liquidity shortfalls to the tune of approximately Rs. 24 billion through the issuance of interest-bearing long-term bonds with the Treasury.
Going through various revelations about dodgy state bank lending operations long before the pandemic began, we are forced to conclude that some have shied away from their responsibilities.
We’re wishing for the best. Declaring bankruptcy and defaulting on loans, exchange rate manipulation, failure to significantly address the causes of declining foreign exchange inflows, interest rate manipulations causing serious economic repercussions are the causes of the current situation when precarious and reckless lending operations mainly resorted to by contractors hired in state banks are among the many skeletons that can come out of the closets during the exercise of proposed diagnosis.