‘SL banking system sound’
Response of the Central Bank of Sri Lanka to the Standard and Poor’s
Assessment of the Sri Lankan Banking System:
The Central Bank of Sri Lanka notes with grave concern, a statement
by Standard and Poor’s, issued yesterday, on the Sri Lankan Banking
System and wishes to state that the statement is factually incorrect,
illogically analysed, and is highly contradictory.
1. Soundness of the Banking System
Quite contrary to the rationale for the statement, Sri Lankan banking
system is sound and resilient with the performance of the banking
industry improving over past few years.
As indicated in the Table below, key financial soundness indicators
of the banking sector which accounts for 55% of financial system assets,
were maintained at healthy levels.
Table : Key Financial Indicators
The Key Financial Indicators display a conspicuous improvement in the
gross non performing advances ratio (NPA) from 5.2% in 2007 to 3.8% in
2011 with absolute volumes of NPA indicating only a relatively lower
growth of 25% in comparison to the overall credit growth of 69%, during
this period. This evidence is contrary to the comment on the existence
of a ‘weak payment culture’.
The capital base of the banking sector has increased nearly two fold
since 2007 with the introduction of the Basel capital standards and
enhanced minimum capital requirement for banks. Profitability of the
banking sector, which has continuously increased, has further reinforced
the level of capital. These factors have contributed to the improvement
in capital adequacy ratios despite the significant growth in assets.
It is pertinent to note that the core capital ratio and total capital
ratio of 5% and 10%, respectively, imposed by the Central Bank are more
stringent than the international standards.
Liquidity of the banking system has been well managed with the
statutory liquid assets ratio being maintained well above the limit of
20%. The growth in deposits and significant representation of retail
deposits, further support liquidity risk mitigation.
Concentration of credit exposure is regulated by the Central Bank
with Directions on maximum amount of accommodation, lending to related
parties and banks being advised to impose sector wise exposure limits.
Any concentrations to certain entities have been permitted by the
Monetary Board in consideration of national priorities and/or national
interest and the ability of the banks to withstand any potential risk
arising from such exposure. Mandatory lending of at least 10% of the
advances portfolio to the agriculture sector was introduced with the
intention of enhancing the food sustainability of the country.
2. Regulatory framework governing licensed banks Despite the global
financial distresses, the Sri Lankan banking industry stands resilient
and the regulations in force are of international standards. Licensed
banks are required to comply with the requirements of the Banking Act
and Directions issued on fundamentals such as capital adequacy,
liquidity, related party exposure, ownership of share capital,
classification of loans and advances, income recognition and
provisioning, risk management in foreign exchange business, integrated
risk management, off-shore banking transactions and assessment of
suitability of bank directors and the key management. The compliance of
banks with these regulations is monitored strictly on an on-going basis
and corrective action initiated.
A mandatory Direction on corporate governance encompassing all
aspects of good governance and transparency is already in place. All
these prudential regulations are given effect in line with the Basel
Core Principles of effective bank supervision issued by the Bank for
International Settlement, Basel and in text and action they are more
stringent than those in many countries in the region as well as
globally. Additionally, the mandatory requirement for banks to obtain
certifications from external auditors on their compliance with corporate
governance directions and internal controls on financial reporting,
which are required to be published along with the audited financial
statements provides an independent assessment for the general public on
each bank’s level of internal controls, transparency and governance.
Further, Anti Money Laundering procedures and Know Your Customer
requirements are also in place with respect to all banking transactions.
Sri Lanka
possesses a well-developed payments and settlement system to
facilitate banking transactions, which is subject to the provisions of
the Payments and Settlements Act.
Thus, the views of Standard and Poor’s that ‘the risk management
practices are evolving’ and that ‘the banking regulations in Sri Lanka
are somewhat weaker than international standards’ and specifically
‘governance and transparency are weak by global standards’ are baseless.
Importantly, this statement of Standard and Poor’s is self-contradictory
with their contentment on key regulations for Sri Lankan banks.
3. Supervision of banks
The Central Bank has a continuous supervision process which is an
uninterrupted monitoring of banks to assess the trends of banks on an
individual and a system-wide basis. This process facilitates early
identification of any potential risks.
Spot examinations of banks are carried out on specific issues as and
when required based on triggers identified through the continuous
supervision process. Thus, the supervisory process is well equipped to
proactively detect any build up in risks.
Further, the affairs of banks are assessed through on-site
examinations which are conducted at least once in two years. However,
the Central Bank conducts follow up examinations on a more frequent
basis based on the risks and significance of the examination findings.
Measures have already been initiated to increase the frequency of
conducting on-site examinations in the future.
Hence, Standard and Poor’s statement that the frequency of on-site
supervision may not be sufficient to detect risk build ups in banks is
not justifiable.
4. Mandatory deposit insurance
With a view to further strengthening financial stability in the
country, the mandatory deposit insurance scheme was introduced in 2010.
This has helped to ensure continued depositor and investor confidence in
the financial system. The deposit insurance fund amounted to Rs. 4.7bn
by end 2011. The financial safety net mechanism afforded by the above is
further strengthened and supplemented by access to the
lender-of-last-resort facility available through the Central Bank.
There have been no banking failures in Sri Lanka despite the global
financial crisis. In December 2008, a licensed bank faced a distress
situation due to a crisis in a credit card company within the Group and
not due to a failure of a finance company. The resolution framework put
in place by the Central Bank in late 2007, well before the global
financial crisis emanated, proved to be an anchor to the overall
financial system stability especially when other countries, including
ones with advanced financial systems, were struggling to protect the
financial system stability at the cost of public funds.
5. Regulation and supervision of licensed finance companies and
specialized leasing companies
In addition to banks, all licensed finance companies (LFCs) and
specialized leasing companies (SLCs) are also closely monitored and
regulated by the Central Bank. LFCs and SLCs are subject to on-site
examinations at least once in every 2 years and weekly, monthly and
quarterly reports are obtained through a web based data reporting
system. Apart from the regular supervisory procedures, spot examinations
are conducted when the Central Bank identifies an issue.
Both LFCs and SLCs are also subject to appropriate prudential
regulations which include Directions on capital adequacy, liquidity,
business transactions with related parties, classification of loans and
advances, income recognition and provisioning, assessment of suitability
of directors and key management personnel and corporate governance.
Further, the Finance Business Act, No. 42 of 2011 was enacted recently,
which provides for enhanced supervisory and regulatory powers on LFCs
and powers to curb unauthorized finance business. All LFCs are required
to list with the Colombo Stock Exchange in order to increase
transparency of financials and corporate governance.
In conclusion, Central Bank of Sri Lanka wishes to assure the public
that the Sri Lankan banking system is sound and resilient and is not
prone to high risk as indicated in the statement of Standard and Poor’s.
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