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President Anura Kumara Dissanayake – Reuters
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By Neomal Soysa
Much was spoken about setting up a development bank in Sri Lanka by almost all main Presidential candidates during the run up to the recently concluded Presidential elections. We understand that a blueprint was also in the process of being prepared for setting up a new development bank. Whilst acknowledging that a development bank is a timely requirement to support proactive development strategies required for economic transformation, particularly after the turmoil our economy has gone through in recent years, this letter is written to draw the President’s attention to whether a new development bank is really necessary. In order to evaluate whether a new development bank is really necessary we need to first look at the history of development banking in Sri Lanka.
Our experience with development banking
In its 2005 annual report, NDB Bank Chairman S.K. Wickremasinghe had this to say, “Development banks in the Asian Region have been moving over from traditional project lending into universal banking. In Sri Lanka, NDB has been the first to move along this path.”
NDB Bank CEO N.S. Welikala had this to say in the 2006 NDB Bank Annual Report, “It is well known that the project lending model of development finance institutions globally, was crucially dependent on the availability of long-term funding from multilateral agencies, often at concessionary borrowing rates. When this source of funding dried up generally as a matter of global policy, DFIs were forced to diversify their business activities to become commercially viable or rely on Government support for their survival.”
In 2009, Lankaputhra Development Bank General Manager/CEO Ravi Dassanayake had this to say, “The primary focus of most of the developments banks in the country has now shifted away from the small and medium sectors, where blue-chip companies and other mega players has now become their main areas of attention. In addition to this, with most of the development banks moving into commercial banking, the development lending aspect has also been curtailing, thereby creating a lacunae in the small and medium sectors in the industry (Sunday Times June 28, 2009). In 2019 the Central Bank cancelled the license of Lankaputhra Development Bank after it merged with Pradeshiya Sanwardhana Bank.
Availability of concessionary funding
On 1 July 2017, Sri Lanka officially graduated from the International Development Association (IDA). This meant that, based on World Bank rules, we lost access to concessional finance (loans and grants) from IDA together with decreased access to concessional finance from other donors as well. In this situation the very existence of development banks in Sri Lanka was threatened.
At present Sri Lanka has been once again de-graduated to be eligible for cut-rate International Development Association credits. In such a situation a development bank capable of disbursing these concessionary funds is required. However, once again graduating to a middle-income country in the medium term is very possible. It is unlikely that the government will be in a position to provide the necessary funds to a development bank to continue its activities. In such a situation would we once again go along the path NDB Bank did in 2006 and convert this new bank to a commercial bank? Will this be in the best interest of the banking sector? After all it is a well-accepted fact that Sri Lanka is already overbanked.
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Existing banking institutions with development banking expertise
The manner in which the thinking about development banking has evolved, clearly shows that more thought must be given to setting up an entirely new development bank. This is not to say that development banking is not required. What we need to think about is, can we not look at the existing banks with development banking competence before looking at reinventing the wheel? The two development finance institutions that fulfilled Sri Lanka’s development banking needs, very successfully in the past, are National Development Bank and Development Finance Corporation of Ceylon.
35% of National Development Bank’s shareholding is held by Government controlled institutions. Sri Lanka Insurance Corporation, Bank of Ceylon, Employees Provident Fund and the Employees Trust Fund. The bank’s largest shareholder is Norfund, whose goal is to create jobs and improve lives by investing in businesses that contribute to sustainable development. This mandate comprises four investment areas, with Financial Inclusion being the largest. National Development Bank’s shareholding together with its development banking expertise, makes it an ideal candidate to be the development banking arm of a bank set up to support capital formation in the Micro, Small and Medium sized Enterprise (MSME) sector.
Development banking must be supported by savings
The next aspect that needs to be considered is whether by merely reverting to its former role as a development bank, the operations of National Development Bank can be sustained. The statements by NDB bank Chairman and CEO, show that National Development Bank decided to convert to a Commercial Bank because the concessionary funding lines previously available to the bank was drying up. This shows that the sustainability of the National Development Bank, if it reverts to its former role of carrying out development banking activities alone, will depend on the availability of low-cost funds.
A report prepared by the unit on economic cooperation and integration among developing countries, division on globalisation and development strategies, UNCTAD refers to a survey done by the World Bank that shows 41% of national development banks surveyed took deposits from the public. This shows that funding structures of development banks are taking different forms. Relying on Government transfers and concessionary funding from multilateral agencies alone may not be optimum in the medium-long term.
A development bank set up to provide project finance to MSMEs to support Sri Lanka’s growth will need to be funded through other sources as well. It is an accepted fact that savings are a prerequisite to maintain a high level of investment to achieve economic growth. In order to achieve this, a development bank with savings mobilisation as one of its core strengths should be considered.
Consolidate to create a National Savings and Development Bank
Sri Lanka’s banking sector has an institution that can be considered for consolidation to form such a development bank. The National Savings Bank presently has 9% of Sri Lanka’s time and savings deposits with 13.0 million active accounts. With its strong brand image and network of 262 branches and 4,006 post office customer service centres, the highest in the Sri Lankan banking sector, it is best placed to mobilise savings than any other financial institution in Sri Lanka.
Compared to National Savings Bank, NDB Bank has a branch network of 113 branches and 16 premier centres. The potential for significant cost reduction through the elimination of network overlaps that would result from a branch rationalisation program cannot be ignored when considering a consolidation of these two institutions. As a result of the foregoing there would be a strong possibility of working with a lower interest spread that will lead to lower lending rates. This would increase the demand for credit to support capital formation in MSMEs and in turn boost economic growth. After all, MSMEs are responsible for over 50% of Sri Lanka’s GDP. The management of National Savings Bank has also highlighted the limitations imposed on business expansion through the NSB Act (microfinance, lending for SME sector) as its main weakness in its Annual Report 2023.
Merging the National Savings Bank with National Development Bank would give Sri Lanka a savings and development bank with the necessary savings and disbursement expertise to channel Sri Lanka’s savings to investments in the MSME sector.
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Size matters
The National Development Bank had “Size Matters” on the cover page of its Annual Report for 2013. The report also contains a statement that: “Today in the world of banking and finance, size really does matter. The “seed to maturity” form of growth of an entity, however healthy it may be, is still inadequate in terms of scale and scope for it to make any headway in a world increasingly dominated by larger players. It is in recognition of this fact that the Central Bank of Sri Lanka is advocating consolidation within the industry as a means to increase the capacity, stability and strength of Sri Lankan banks.” This holds true even today.
A bank created by the merger of National Savings Bank and National Development Bank will have the stature and size that will enable it to have a funding structure with diverse forms of funding in addition to taking public deposits. Funding from international financial institutions, including multilateral organisations and regional development banks; debt and equity issuance in international capital markets and institutional savings will enable it to support a broad spectrum of development activities.
We should take a cue from India
During the bank mergers that took place in 2019/20, India Finance Minister had this to say: “The large capacity of one bank, the technology driven capacity of another and the strong deposit franchise the third has, are all being brought together, so Punjab National Bank, Oriental Bank of Commerce and United National Bank will be brought together and they shall form the second largest public sector bank.”
She also stated that these mergers would give the combined entities a high CASA (Current Account Savings Account) and lending capacity and large cost reduction potential due to network overlaps and rationalisation.
The Indian bank consolidations in 2019/20 saw 10 public sector banks being consolidated to 4. This reduced the 27 public sector banks that existed in 2017 to 12. Due to the success of these consolidations, India is now considering a second round of consolidation, where 12 banks is to be reduced further to 10. India’s experience in consolidation should be an eye opener for our Finance Ministry and Central Bank to give serious thought to bank consolidation to establish a development bank in Sri Lanka to achieve our growth targets.
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Challenges faced in a consolidation
Compatibility of IT platforms and merging of cultures will need to be addressed. Bad debts which arise as part of the normal operations of a bank will be found in both institutions. There will be a risk arising as a result of asset and liability maturity mismatches. Whilst the first two issues are common in any consolidation exercise these can be managed with appropriate skills and management expertise. The same issues were very well managed during the Indian bank mergers. As for the bad debts and maturity mismatches, the following can be considered.
We understand that a new development bank is being considered to accommodate the request of funding agencies that have concerns about merging existing banks that carry bad loans. The cost of time taken for a new development bank to acquire the required skills and infrastructure to commence operations will far outweigh the cost of having to carry the bad loans that these two banks carry.
If having to carry bad loans after consolidation is not acceptable, an option to consider is the possibility of transferring these bad loans at a discount to a company specialised in recovering bad loans. Such a company can be funded by the Government or even by a placement in the stock market. In the late 1990’s the non-performing loans in China’s state-owned commercial banks were reduced through a similar mechanism. Four asset management companies were created. These companies purchased RMB 1.4 trillion of the loan balances of China’s state-owned commercial banks.
Ideally a development bank should have a funding mix in which long-term liabilities often dominate the funding base. This would enable the development bank to fulfil its mandate with minimum risk. In the absence of long-term liabilities to support long-term lending, Government guarantees, or Central Bank support can facilitate the maturity transformation activity of development banks. Such arrangements are not uncommon in development banking.
Savings in Sri Lanka are generally short to medium term. It must however be noted that a very high percentage of these savings that are in the form of deposits, are rolled over. This can be seen in the deposit base of National Savings Bank as well. Therefore, it is highly unlikely that a maturity mismatch would give rise to a liquidity issue. However, in order to comply with regulations and enable Sri Lanka’s savings to be used for development the following measures can be adopted.
Deposits placed in National Savings Bank are presently guaranteed by the government. This guarantee can be supplemented to cover the ability to resort to a Central Bank support mechanism to address liquidity needs arising due to maturity mismatches, if such a need should arise.
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Conclusion
Re-establishing a development bank by consolidating National Savings Bank and National Development Bank will not be without challenges as highlighted in this letter. Challenges were overcome during the Indian bank consolidation as well. However, when the benefits of consolidation and the effect a development bank created by merging two reputed institutions with an excellent track record will have on our economy and the wellbeing of our people are considered, these challenges are well worth facing.
The manner in which the thinking about development banking has evolved, clearly shows that more thought must be given to setting up an entirely new development bank. This is not to say that development banking is not required. What we need to think about is, can we not look at the existing banks with development banking competence before looking at reinventing the wheel?