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by Ravi Abeysuriya

For the first time in Sri Lanka a finance company was subjected to an independent evaluation according to international standards. Senkadagala Finance Co Ltd, which has been operating since 1968 was given a SL BBB rating last week by Fitch Ratings Lanka.

This step is a milestone in the future development of the finance company industry in Sri Lanka. The finance companies play a vital role in mobilising deposits from the public. Presently finance companies hold over Rs. 21 Billion in public deposits. Pensioners who need a monthly income on their life savings, comprise a major proportion of the finance company depositors. The ratings issued by Fitch Ratings will fulfil a long felt need among depositors of finance companies, who have been looking for an independent source of advice on the financial stability of finance companies and the likelihood of getting their interest payments on time and principal on maturity. This need was highlighted during the crisis faced by the finance companies in the late 1980s but has not been fulfilled until now.

In giving the ratings, Fitch Ratings Lanka carries out a comprehensive analysis of the finance company and takes into account all credit risks the finance company is exposed to. Few of the main criteria considered in such an analysis are discussed below.

Capital Adequacy

Capital adequacy measures the amount of equity capital available for a financial institution to absorb any unexpected losses without eroding the monies due to depositors. The main source of losses for a finance company is its lending activities, where some of the borrowers default.

The best indicator of capital adequacy is the amount of equity contributed by the shareholders of the financial institution compared to its risk assets. Risk assets consists primarily of loans and advances granted by the finance company and other investments. However it excludes cash and investments in government securities which are considered to be of lower risk or risk free.

The capital adequacy ratios of some selected finance companies computed by Fitch Ratings are given below.

Finance Co.	  Capital Adequacy	 Public Deposits
			 (Tier 1)	 (31.3.2001) Rs.
Senkadagala Finance		38%		  305 Mn
Mercantile Investments		26%		1,045 Mn
Sinhaputhra Finance		15%		  535 Mn
Central Finance			12%		6,408 Mn
LB Finance			11%		1,160 Mn
The Finance			10%		6,863 Mn

Source: Published Annual Reports

According to the new Capital adequacy standard formulated by the Central Bank in 1997 the minimum capital (tier 1) percentage recommended is 12%. However this new standard is yet to be formally implemented. As stated however this is only a minimum requirement. In general a high level of capital adequacy is desirable from a depositor's perspective, as it will result in a lower risk of loss to the deposit holders, due to the equity cushion available to absorb any losses.

Liquidity

Liquidity looks at the amount of liquid resources available to a financial institution. Liquid resources are assets which can be readily converted into cash such as government securities, and bank deposits. Liquid resources will enable a financial institution to meet any unforeseen and sudden withdrawals by the depositors.

The liquidity levels of some selected finance companies computed by Fitch Ratings are given below:

Finance Co.				Liquidity
				 (as at 31.3.2001)
Senkadagala Finance			24%
Sinhaputhra Finance			21%
Mercantile Investments			17%
Central Finance				17%
LB Finance				16%
The Finance 				16%

Source: Published Annual Reports

The Central Bank requires all finance companies to maintain a minimum liquidity level of 15%. A higher liquidity level will provide greater comfort to depositors.

Operating Efficiency

Operating efficiency indicates how efficiently the operations of the financial institution are being carried out. Operating efficiency is generally measured using the cost-income ratio.

A low cost-income ratio would generally mean that a financial institution is efficiently managed, whilst conversely a high cost-income ratio could imply inefficiencies. The cost-income ratios of some selected finance companies computed by Fitch Ratings are given below:

Finance Co.		Cost-Income Ratio
			  (Y/E 31.3.2001)
Senkadagala Finance		   34%
Mercantile Investments		   34%
Sinhaputhra Finance		   63%
Central Finance			   71%
The Finance			   93%
LB Finance			   96%

Source: Published Annual Reports

An efficiently run financial institution is sustainable in the long run, whilst for obvious reasons an inefficiently run financial institution is not sustainable and would risk the depositors money.

In the future other financial institutions are likely to follow the precedence now set by Commercial Bank of Sri Lanka and Senkadagala Finance Company and obtain a rating. This will enable depositors to have access to an objective, third party assessment of the risks involved before investing in financial institutions. Unfortunately many depositors get attracted to high interest rates and intensive promotions offered by various institutions and fail to understand the risk associated with such investments.

The full analysis report on Senkadagala Finance Company could be viewed at www.fitchratings.lk

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Copyright 2001 The Associated Newspapers of Ceylon Ltd.
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