Amendment to the People’s Bank Act; was it much ado about nothing?

People's Bank - Pic by Shehan Gunasekara

The bill to amend the People’s Bank Act has been passed in Parliament despite the cliché ‘privatisation’ allegation associated with any change to the status quo of a public enterprise. 

The Minister in charge of the subject dispelled these allegations as an attempt to gain political mileage with elections at the doorstep. Although, the passage of the bill was once postponed due to the political pressure, it has now been passed by Parliament.

The gist 

The amendment has two main objectives; i.e. to increase the authorised capital of the bank and allow for the issue of debentures without a Government guarantee. It is the latter that caused the controversy and fed the ‘privatisation’ conspiracy theory.

The ‘privatisation’ conspiracy theory

The bank was established with the Government and the co-operative societies as its shareholders. Section 13 of the Act prevents the sale of shares of the bank other than between these shareholders. 

If at all, it is the 1986 amendment to the Act that created an ambiguity when it mirrored the powers of the Bank of Ceylon and, inter alia, included provisions for the sale of the bank or any part thereof with the approval of the Minister [section 5(1)(z)]. 

However, these provisions would be subject to or subsidiary to the more specific provisions contained in section 13. Thus, the privatisation argument seems implausible.

Implausible but not impossible

The removal of restrictions on debentures may have been promoted by the need to issue Basel III compliant debentures to meet the capital requirements of the same standard, which the other big banks have already done.

The Basel III compliant debentures carry a non-viability clause, which means whenever the Central Bank determines that the bank is not viable, such debentures must be converted into ordinary shares of the bank. However, this would be problematic in view of the aforementioned section 13. 

A seemingly clever legal interpretation could convince that the conversion into shares is not the same as a sale of shares of the bank; however there still exists a problem of an exit strategy for any potential investors of the debentures. The same section 13 provides for the purchase of shares by the Government contemplating any sale by the shareholding co-operatives. These provisions could be made use of to offload the debenture converted shares on to the Government and even profiteer in a ‘bond scam’ styled transaction!

If the above convoluted sequence of events pan out, an issue of Basel III compliant debentures could see shares of the bank vested with private investors; however, practically, it is more of a deterrent for the investors of these debentures than anything else, unless of course the investors possess the same acumen as those involved in the ‘bond scam’!

The original intention 

When perusing the scheme of the Act, it is apparent that the Government intended to maintain full control of the bank, including its funding. In addition to the capital, section 15 provides for the lending of sums from the consolidated fund to grant any medium to long-term loans by the bank. 

Further, the Government guarantee on debentures ensures that in the event the bank is unable to repay the debt, the required sums will be paid out of the consolidated fund and the creditors would not have a claim on the bank’s assets (section 21).

Depositor protection

The above mentioned channels of Government funding offer protection to the depositors of the bank. It reduces the need for funding from other creditors and in the event the assets are insufficient, the Government will honour the guarantee to these creditors leaving the bank’s assets to the depositors. 

However, with the Government guarantee removed, the creditors (other than subordinated debenture holders) will have priority claims on the assets of the bank to the detriment of the depositors.

The parallel State bank

The Government exerts comparatively less control over its other commercial bank, the Bank of Ceylon. The Bank of Ceylon Ordinance does not provide for a channel of Government funding or Government guarantees for the issue of debentures. However, the Ordinance does stipulate the Government as the sole shareholder of the bank (section 7).

The Bank of Ceylon has already issued Basel III compliant debentures and the Minister in charge of the subject used this as an argument to dismiss detractors at the bill stage as being politically motivated in the current instance. However, as contrasted above the Bank of Ceylon does not require Government guarantees to issue debentures. 

Even so, it is interesting to know how the Bank of Ceylon issued Basel III compliant debentures in view of the Government’s sole shareholding of the bank. What would be the outcome if the non-viability option on the debentures is exercised? Would the private investors become shareholders of the bank with voting rights and ranking pari passu with the Government as a shareholder? This seemingly violates the Bank of Ceylon Ordinance.

The desirable future 

In the absence of clarity on any distinguishable purpose for each of the two Government-owned commercial banks, going forward, it makes sense to harmonise the rules books of the banks to provide consistency and avoid any confusions. It is important to have strong State-owned banks for an economy such as ours and it would be counterintuitive for any economic reform agenda to weaken the state banks. Even developed economies need intervention to stimulate economic growth, let alone the developing economies. 

Although policy intervention has been the preferred option for developed economies, the prolonged economic recessions in the US, Europe and Japan have made it clear that these tools are insufficient. Even the controversial ‘quantitative easing’ failed to achieve the desired results, because private banks chose to invest the injected liquidity by the central banks in safe assets like Government securities rather than in the real economy. 

However, China managed to stay afloat during the global recession to the envy of the west because its stimulus package was channelled to the real economy through its large state owned banks and even able to target specific sectors of the economy. Therefore, it is foresightful to understand the role of a strong State banking sector in a fragile economy such as ours and focus any reforms to strengthen the sector. 

(The writer is a finance cum legal professional and is the Chief Consultant at SGBMC.)