Soaring heights of NPLs in banking

• Turning private debt into public debt

Capital inadequacy, political interference, abuse of power, wasteful and unproductive expenditure, corrupt deals, circumventions of regulatory directions, unscrupulous lending operations, imposed IMF and WB conditions for reforms, and window-dressed balance sheetsare some of the often-heard mediaspeak about our banking sector. 

While some of the local non-State sector banks do not fall into this category, the State banks are overwhelmingly eligible to be clustered into this bunch. The latest culmination is thedubiety about an attempt to privatise People’s Bank. 

This is not the first instance this impending threat has surfaced. About three decades ago during a regime of the UNP, a proposal brought to privatise both Bank of Ceylon and People’s Bank was withdrawndue to mounting pressure.Among the several reasons attributed for this move then were;

I. Comparatively low efficiency

II. Very high intermediation cost

III. The very high portfolio of Non-Performing Advances

IV. Inadequacy of capital to meet the CAR stipulated under international standards

V. Insufficient loan loss provisioning

When these issues were raised,there was no room for dispensing these observations as unwarranted or unjust. It had to be accepted that this sad state of affairs was the result of a failure to take remedial measures with an early diagnosis in respect of these long standing aberrations. Those of us, who intervened in the matter then, in the national interest,expressed the following views in defence of the State banks:

Quote: “It is an undisputed fact that the State banks are saddled with many extra overheads due to the imposition of several obligations of a social nature on them. The financial costs of such obligations weigh heavily on them as against the competitors in the market who operate without such pressures. The value of contributions towards the social upliftment generated out of such obligatory functions cannot be measured in rupee terms for either the determination or comparison offactors such as efficiency and profitability. This handicap has placed other competitors,the non-State banks, in an advantageous position to concentrate on the more profitable segments of the market.”

Alas, can we make such excuses in the current context as the situation we are facing today is much worse than what it was then? The threats, challenges,opposition and the resulting public opinion against the move to privatise the two State banks caused the Government to look at other options. The re-capitalisation of BOC and PB was accepted and implemented as the remedy. In addressing the other issues including the administrative lapses, the Government entered into two separate agreements stipulating the conditions applicable to the re-capitalisation and the proposed changes for the banks to conduct their future business without falling into a mess again. Among the proposed steps were the following:

a) To provide the necessary autonomy and flexibility to enable the two State banks to conduct their business operations by suitably amending the acts of incorporation;

b) To remove legal provisions which enable the govt. to issue directives;

c) To provide the necessary funds to meet the capital adequacy requirements and also to make adequate loan loss provisions.

These changes were proposed as an alternative to privatisation with an assurance from the Government that the two banks will be continued as Government owned institutions.

Immediately following the re-capitalisation exercise then Secretary to the Treasury,R.Paskaralingam, byCircular No.EA 02/BC/PB/01,issued to all secretaries, heads of departments, and corporations under the Ministry of Finance advised that the Cabinet has decided as follows:

Quote: “The BOC and the PB to be exempted from the provisions ofPart II of the Finance Act no.38 of 1971and from all Treasury and Public Administrative circulars.The banks will be free to approve their own budgets and determine how their profits would be utilised,to fix their own cadre requirements, determine the salary levels for their staff and handle their own tender procedures for goods and services and undertake all their administrativematters, according to their commercial needs. Simultaneously, Treasury Circulars granting special privileges to the BOC and PB are hereby withdrawn.

“The banks would, also, be allowed to open and close branches on the basis of their commercial requirements.Operational autonomy will be given to the banks to enable them to conduct their lending operations on a commercial basis.”

This circular included another very important clause, to cover the aspect of Government-directed lending by the two banks;

Quote: “If the Governmentdirects either the BOC or the PB to grant loans for public enterprises which the banks consider are not viable or lent at interest rates below the market rates to particular groups of borrowers, then the Governmentwould be required to guarantee or subsidise these loans.”

What happened thereafter is history now.

Despite the stringent conditions and the autonomy granted for the banks to conduct their operations on a commercial footing, PB performance did not improve as expected. Profit position of PB became critical once again towards the end of 1998, and following a presentation of the bank’s position to the then President/Minister of FinanceChandrika Kumaratunga by the then Chairman of the bankMano Tittawella appointed by her, a decision was taken to recruit specialists to improve its performance.

Banks were allowed to take specialists in various fields from outside on contract basis to support business activities where such expertise was required. The Bank of Ceylon continued to manage its affairs with the internal staff with the adoption of remedial measures and required policy decisions. However People’s Bank decided to recruit a number of outsiders to be engaged as specialists. 

A foreigner was recruited designated as Director (Restructuring and Strategic Development)to the CEO’s position, and this person left the bank after about two years. Thirteen other employees were taken as contract employees on negotiated terms to various other positions. They were supposed to provide expert guidance to the employees in the permanent cadre in the areas to which they were attached. These contract employees were recruited through a private company and they were paid through that company and their terms and conditions of employment were not known to the staff.

The proposed reform package under the exercise envisaged the permanent cadres to be trained as a part of the human resource development scheme. The contract employees were expected, therefore, to be engaged as contract persons for shorter durations. But this did not happen. While remaining and continuing as expert contract employees, they were promoted to ranks in the permanent cadre and positioned to discharge duties as part of the decision makers in the highest echelons of administration while being under contract terms. 

Just to cite one specific case, the contract employee engaged to improve the performance of the bank’s Treasury Department in 2001 retired as the CEO of the PB while being a contract employee in 2019. During this periodall the contract employees recruited were holding virtually all the strategic high positions of the bank in the areas ofgeneral management, risk and compliance, human resources, corporate credit,IT,finance and marketingfor very long periods, running to nearly two decades.

Most of these so-called experts came from other banks which closed up their operations in Sri Lanka or merged with others here. Although profiled as experts,they did not possess any exceptional expertise required to turn around the ongoing operations in an established bank such as the PB. How they were recruited and whether the terms of employment matched the industry standards that prevailed and even the procedure followed for their recruitment remains apprehensive to date. It is conjectured that there was foul play associated with the company that provided the services to the extent of conflicts of interests by the decision makers involved. Some of these specialists were redundant in their former places of employment who were given golden shake hands under VRS packages.

What is relevant in the context of our subject is whether these experts made any meaningful contribution in the restructuring process. The bank was unable to steer clear out of the mess it was and today after about nearly two decades of their involvement at the highest levels in the ranks of the bank,assenior deputy general managers, deputies and heads of departments, the bank has fallen into a critical level whichhas warranted a national level consideration of converting its ownership to private from public. During the tenure of the recent past the name of PB was highlighted in the public eye over several questionable acts and there are many factors that remain in the dark.

Capital inadequacy

In several instances before, after the last major re-capitalisation exercise in 1992, PB had to be capitalised by the Treasury. After the recapitalisation in 1992 by issuing Governmentbonds of 30-year duration to the value of Rs. 10 billion, the Treasury released Rs.8 billion in four tranches between 2005 and 2008 to augment the capital shortages.

Since the PB is debarred from raising private capital under its Act, the bank resorted to borrow funds from the pension funds held by the bank as the custodian of such funds belonging to the pensioners, on few occasions after 2008 totalling to over Rs. 15 billion.The latest we heard about this matter(2018) was an announcement made by Minister Kabir Hashim that, “Sri Lanka’s second largest bank, PB, is to get a capital infusion of Rs. 5billion after a lapse of nine years as the Governmentsteps up efforts to assist it to meet international Basel III standards.”

There were many instances of unethicalmanoeuvres to circumvent the legal restrictions in order to cover up the capital shortages. The instances are too numerous to recapitulate in a short article. But just to quote one glaring instance, once, to fulfil the obligatory requirement of providing funds to the Employees’ Pension Fund, PB transferred funds from the Widows and Orphans’Fund maintained at the bank. These borrowings were repaid in instalments during a period of 10 years.

With all the inputs by the contracted experts the PB has failed to fulfil its capital adequacy requirements to remain in business accepted as eligible for international banking. Therefore the PB Act was amended as gazetted on 9July 2018 and by bill presented to parliament on 24May 2019to provide for increasing the authorised capital of the bank to Rs. 50 billion divided into one billion shares of Rs. 50 each.

The Amendment also provides for the bank to raise any sum by issue of debentures. The shares will be vested in the Treasury under the Minister of Finance and from time to time the Minister will determine the paid-up capital of the bank. If the Governmentis not funding the share issue, it will necessarily be funded through shares issued to other sources. PB, after several years of roaming around to prevent a privatisation, is back at square one and the country will have to wait with fingers crossed to witness what is going to happen.

Political interference

If we look at the available statistical information partly published and partly through whistleblowers, the Government is completely utilising the bank’s resources for political purposes than development purposes. The development that the PB is involved in now is the major partaking in‘loan melas’ sponsored by the Government with hardly any emphasis on the economic aspects, such as GamPeraliya and Enterprise Sri Lanka. With elections round the corner and with a miserable failure on the part of the Government to achieve its economic targets, they are adopting short cuts as temporary appeasements of the masses which are easily accomplished through grants in the form of ostensible loan schemes.

An analysis of the loan portfolio of PB will show the extent to which it remains throttled under this political influence. These statistics are covering up to the period ending 31 May 2019. All amounts shown are in millions.

Total non-performing position: Rs.39,851.00m

Total loans and advances: Rs.1,176,635.00m

a) Total advances to State-Owned Enterprises: Rs.477,169 m

b) Pawning, staff loans and old NPLs: Rs. 173,343 m

c) Net Loans and Advances: Rs. 526,122 m

Percentage of non-performing excluding a) and b)6.27%

It is reported that several facilities granted to SOEs that remain unpaid over long periods and have fallen into doubtful category according to CBSL directives are kept in the current section without transferring into NPL.

Example:

Paddy Marketing Board: Rs.2,847 m

SriLankan Airlines: Rs. 31,008 m

Mihin Lanka: Rs. 2,533 m

Total: Rs.36,388 m

If this amount is added to the already categorised NPL shown above, the total NPL will be Rs. 76,739 m.

This is the highest among all commercial banks in the country. The last shown three amounts are kept as current loans due to the guarantee provided by the Treasury. CBSL and Government Auditor have advised the PB to transfer these amounts also to NPL. But it is not done yet.

This is the net result of the expert contribution that the PB received over a period exceeding 15 years.

The PB has paid the following amounts as remuneration for these contract employees for the period from 24 August 2018 to May 2019.

Total of salaries, insurance, bonus advances, performance bonus (inclusive of retirement gratuity to the last contract CEO of Rs.18 m) amounts toRs.119.389 m.

According to reports, this amount covers the cash remuneration package only of four contract employees for a period of 10 months.In addition they have been provided with a full range of other fringe benefits, under entertainment, travelling,car loans, overseas trips,free medical assistance , executive insurance cover, etc., which adds on to the cost of maintaining them in the bank.

According to any analysis this sounds a highly-exorbitant sum to be borne on account of four or five employees in the category of contract employees attached to a public institution, particularly when the performance of the bank in the area of lending is in such a mess with such a huge accumulation of non-performing balances. It is interesting to find out who is behind the lending, recommending and approving of these facilities and whether their performance deserves to be compensated with huge bonuses.

Questionable issues

PB is the only State bank that got involved in the infamous oil hedging fiasco. The recommendation to enter into this transaction was initiated by two contract employees. Their names came up in the international judicial proceedings. PB had to write off over Rs.5 billion on account of this deal as losses. But strangely the PB did not hold anyone responsible for this ordeal.

When the exposure of SOEs is taken out, PB shows an extremely poor market share in the area of lending to private sector. A sum exceeding Rs. 530 million is outstanding as overdue from 25 borrowers on account of temporary and permanent overdrafts granted.Five borrowers in this group also figure in the NPL category with a total sum of Rs.3,211,029,472due from them to the PB over and above the overdraft facilities outstanding.

The bank has recently made a credit proposal on behalf of a local company requesting to consider a long-term funding facility to a UAE company to partly finance the second tranche of the investment on bio energy project to be set up in Northern Sierra Leone, Africa totalling$ 15.0 million for a period of three years. At a time the country is engaged in a serious borrowing spell for the replenishment of foreign reserves, it is strange how a State-owned bank withcapital inadequacies and heavily loaded portfolio of non-performing loans could agree to lend $ 15 million to a project in Africa!

PB, irrespective of the capital shortages and the need to borrow by issuing debentures, has during the last two years spent over Rs.2 billion, most of it in terms of foreign exchange, for a digitalisation project. Sometime back there arose a big public hue and cry about these transactions and inquiries and investigations were carried out at Ministry level, COPEand the Auditor General against public allegations levelled. However, the project proceeded as planned although there were unprecedented disorientations associated with it.There are reports of several frauds, shortcomings and system failures associated with thisdigitalisation which the bank is keeping under cover absorbing the losses.

A director of the PB who was holding this position for more than 10 years under both regimes of Government was alleged to have misused his position to obtain large facilities to a company where he was serving as thedeputy chairman, running to approximately Rs.10 billion. He had to resign from theposition in the PB when there were strong allegations of conflict of interest levelled against him. His group of companies is now facing liquidation and is blacklisted by the CSE. But he is still continuing as a director of the PLC which is a subsidiary of PB. The CBSL will have to examine the suitability of this person to hold such a post in the context of whathas transpired while serving as a director of the PB.

Hemasiri Fernando, who relinquished the post of Chairman of PB, who was serving during this entire questionable period, is now the chairman of PLC which is a subsidiary of the PB. It is prudent to examine whether he fulfils the fit and proper requirements of the regulations under the Banking Act No. 3 of 2010 to hold this position.

A facility granted by the FCBU of PB to a company registered in Maldives under a hotel project amounting to about $10 m has been transferred to NPL with an outstanding balance of Rs.1.7 billion.

Another facility granted to a Maldivian hotel project amounting to Rs.1.2 billion has been transferred to NPL as there were no repayments.Both facilities were granted in foreign exchange during 2017/2018 period.

Many large facilities granted by the PLC too have fallen into NPL. A perusal of the details indicates that these facilities were granted on a favoured basis under the influence of persons serving as directors there.

A person whileserving as a director of the PLChas obtained a facility from the PB and an amount of over Rs. 240 m has been transferred to the NPL on account of this.

The manner in which the banking officials were allowed to manoeuvre in the lending operations poses a question whether the bank was deliberately pushed into such a situation by those interested inprivatising it.