Should State banks continue outside the purview of the Ministry of Finance?

The controversial divorce of the Central Bank of Sri Lanka (CBSL) from the duties and functions falling within the Ministry of Finance and transferring it to a new Ministry under the Prime Minister has become a hot subject of discussion. 

Both legally and operationally the CBSL remained as an institution directly linked to the Ministry of Finance since its inception. Due to the haphazard and makeshift provisions during the 100-day Government (which was generally accepted as a transitional period), several ministerial portfolios underwent drastic changes in a rather unorthodox manner with regard to the distribution of duties and functions. The country has already witnessed the consequences of this maladjustment during the Central Bank bond scam. State-owned banks which remained attached to the Ministry of Finance were allocated to a new ministry outside the Ministry of Finance. 

This state of affairs continued without a change even after the formation of the Coalition Government (claimed to be a National Government) following the General Election in August 2016. We are now aware that the Government has had reasons for downsizing the Ministry of Finance before the Ministry was assigned to the former minister because even with the severe limitation of the subject area the former Minister failed to deliver and maintain the expectations of the public. He was finally removed. 

In the context of the recent Cabinet reshuffle it is pertinent to review the current status of state-owned banks and to consider whether it is prudent to continue these outside the purview of the Ministry of Finance anymore.

Generally the entire banking industry has to function with a very close relationship with the Ministry of Finance. Credit supply to the local economy, accessibility to state guaranteed funds and the openings they have to several credit lines and income subsidies are factors that indicate that state banks should be positioned to liaise directly with the Ministry of Finance. 

In fact they will have to participate in most of the budget-related plans and development activities. Financing of infrastructure projects could be best undertaken or handled by the state banks at relatively lower costs. We are aware that a significant component of project costs comprises the interest element. Even if a higher interest is charged, such income will eventually flow back to the Treasury when the projects are financed by state banks. All these point to the fact that they would be better positioned functionally under the Ministry of Finance than being under another ministry.

State intervention

The funds and the capital of state-owned banks are provided by the Treasury. We are aware of several instances of State intervention to bailout the banks when they were confronted with capital and liquidity problems. 

In 1992 the then Minister of Finance stated in Parliament that the two state banks, Bank of Ceylon and People’s Bank, were insolvent. In simpler terms they were declared bankrupt. Following a big commotion, the Government of the day decided to recapitalise the two banks with state funds instead of the alternative then proposed to privatise the banks. 

Events such as this confirm the need for the banks to be under the control of the Treasury rather than some other ministry. When we look at the operations of the two state banks in retrospect we observe that they are constrained due to binding statutory provisions in acquiring the capital adequacy requirements compared to the private sector commercial banks. They cannot issue shares or raise capital by debenture issues as freely as the private banks. 

As the fund requirements of the state banks can only be fulfilled by the Treasury and such financial involvements are of a very high range, Treasury intervention becomes compulsory. Furthermore, when the state banks need additional capital infusions a financial evaluation has to precede any new allocation of funds. 

The Treasury and the Ministry of Finance have to do this task. The Bank of Ceylon, by virtue of the Act of Incorporation, has the right to raise debentures while the People’s Bank Act has no such provisions. Such issues are best decided at the Treasury level. There can be no doubt that this could best be achieved by having state banks under the Ministry of Finance.

We can take a case in point to illustrate this further. At the time of recapitalisation of the two state banks in 1992, the two banks were required to enter into an agreement with the Treasury where several conditions were stipulated with a view to improve the performance of the banks and to permit them to operate as commercially viable units with autonomy, and the Treasury was required to monitor the operations of the recapitalised banks under the same conditions. 

It must be borne in mind that these agreements are still in force and the Treasury is crediting the banks with annual interest at the rate of 12 % per annum for the value of the bonds issued for recapitalising. This monitoring exercise is facilitated best by keeping the banks under the Ministry of Finance or Treasury. 

Unlike the Bank of Ceylon, which has the right to issue debentures at times of need, People’s Bank had to be supported now and again to meet the capital adequacies required under international norms as well as under the CBSL regulations. Since the restructuring exercise in 1993, People’s Bank had to be provided with funds to meet capital ratio standards on several occasions. These were done with conditions attached. Such conditions too were to be monitored by the Treasury.

Careful scrutiny of the events that followed clearly shows how important it is to continue a vigilant regulatory control of the capitalised banks by the Ministry of Finance. The autonomy granted to the state banks under the restructuring program in 1993 was to provide the banks wthe freedom to perform their operations in a commercially viable manner including the meeting of the required regulatory compliance standards. The recapitalisation exercise was carefully designed to prevent the bank from falling into a similar mess in the future.

In April 1993, the Treasury provided Government bonds to the value of Rs. 10.541 billion for the following purposes:

i. Rs. 1,152 million to achieve the capital adequacy requirement

ii. Rs. 1,700.5 million to write off loans granted to the Sri Lanka State Plantation Corporation and Paddy Marketing Board

iii. Rs. 43,55 million to finance accumulated pension liabilities

iv. Rs. 3,231 million to provide loan loss provisions on a realistic basis

v. Rs. 102.5 million for loans to be transferred to a special recovery agency

The agreement underlying this issue of bond stipulated inter-alia the following conditions.

a) tenor of 30 years where the bonds could be redeemed through the recovery of any specific loan losses identified then

b) The Committee on Financial Sector reforms in the Ministry of Finance of the Government of Sri Lanka will be required to monitor the progress of the PB and its performance after recapitalisation

The writer wishes to deal with the entire agreement and the position in the aftermath in a separate article.

It remains to be examined how these conditions are adhered to and whether the expected performance standards have been achieved. 

Again on 11 October 1996 the Government decided to issue Treasury bonds to the value of Rs. 10.0563 billion on account of the equivalent of total loans granted under the direction of the Sri Lankan Government. The agreement entered into between the bank and the Treasury contained inter-alia a schedule of the loan facilities covered under this bond issue. 

An amount of Rs. 3,724 million was for the purpose of setting off non- performing assets and Rs. 6,331.75 million to finance the State Bus Assembly project. These bonds had a tenor of 10 years carrying an interest rate of 14% per annum to be paid to the bank by the Treasury.

In 2003, the PB received long-term Treasury bonds to the value of Rs. 625 million on account of loans and overdrafts granted to the CWE.

As the bank continued to be constrained with capital shortage the following amounts were released by the Treasury for capital augmentation.

    2005: Rs. 1.0 billion

    2006: Rs. 2.0 billion

    2007: Rs. 1.5 billion

    2008: Rs. 1.5 billion

Capital infusion

These monies were released, as reported, under a special strategic plan adopted to keep the bank operations under control and develop business activities enabling the fulfilment of CAR requirements.

However, these provisions were insufficient to meet the capital shortages experienced by the bank. Therefore the PB during 2008 resorted to an internal borrowing process, circumventing the statutory restriction it had to issue public debentures by issuing special debentures to the funds of the Employees Pension Trust Fund lying with the bank. The total value of such debentures issued to the Pension Trust Fund was Rs. 15 billion. An amount of Rs. 10 billion is still outstanding on account of this debenture issue.

It is in this current scenario that the bank is given another capital infusion of Rs. 5 billion recommended to the Cabinet by the Minister in charge of the bank, Kabir Hashim. The newspaper report published stated as follows: “Sri Lanka’s second largest bank, People’s Bank, is to get a capital infusion of Rs. 5.0 billion after the lapse of nine years as the government steps up efforts to assist it to meet International Basel iii standards.”

 It sounds as if the Government is stepping up the efforts for the bank to meet CAR needs. 

The issue here is in the context of the subject we are discussing viz. prudency for the bank to continue being attached to a different ministry other than the MOF, whether all these factors regarding the performance and the failure of the bank continuously to reach capital adequacy standards on its own were duly addressed. Such an evaluation and an appraisal could best be done only by the Ministry of Finance.

According to the CBSL directions issued under banking regulations (as far back as 2015), banks were advised to improve their capital base to meet the Liquidity Coverage Ratio (LCR) under BASEL iii liquidity standards for commercial banks. It is to be noted that the BASEL Committee on Banking Supervision (BCBS) issued the Basel iii rules on liquidity risk management, standards and monitoring on 16 December 2010.

It is questionable as to whether the state banks adjusted and planned their activities and performance well in advance to fulfil these requirements. Or did they simply wait with their legs crossed because any way they knew that the Government was coming to their rescue.

An examination of the published accounts indicates a picture quite different to what the newspapers have reported in the article we are discussing.

The paper has reported that “the Cabinet paper also noted as much as 70% of the bank’s loans are extended to small and medium enterprises.”

But according to available information the total Loans and Advances position is (approximately) Rs. 1,015,544.00.

The loan breakup when analysed indicates:

Pawning advances: Rs. 112,876.00 million – 11%

Advances to State sector: Rs. 388,000.00 million – 38%

Staff loans: Rs. 24,566.00 million – 2.4%

NPL and old loans, etc.: Rs. 7,450.00 million – 1%

Total: Rs. 532,892.00 million – 52.4%

According to this breakdown total lending as private loans would be around 47% and this includes all lending including amounts granted as loans against Government guarantees under various projects. Hence the small and medium loan portfolio said to be included in the Cabinet paper appears to be incorrect.

The bank has also stepped into the highly risky areas of lending in the past such as the infamous hedging transaction and incurred heavy losses which were written off from the past profits. This is the first time a state bank got involved in derivative lending which in reality is beyond normal banking practice. The total loss written off amounts to over three billion. 

The costs and expenditure incurred by the bank for advertisement, refurbishing and many other unproductive areas too appear to be extremely high for an institution hard pressed for capital.

All these point towards one hard truth. The Ministry of Finance should closely monitor and guide the affairs of State banks under its purview as a matter of national importance. This can be best done by having the banks within the portfolio of the Ministry of Finance.

(The writer is the former president of the Ceylon Bank Employees Union and former Chairman of Bank of Ceylon and the National Gem and Jewellery Authority).