Ceylon Chamber proposals for financial sector and capital markets

• The Ceylon Chamber of Commerce recently launched a working draft of ‘Sri Lanka Economic Acceleration Framework 2020-25’ towards building a $ 135 billion economy by 2025. Today we feature the Financial Sector and Capital Markets Working Group proposals from the document.

Lead:

Candor Equities Group CEO Ravi Abeysuriya

Overall:

John Keells Holdings Chairman Krishan Balendra

F J and G de Saram Partner Ayomi Aluwihare

PricewaterhouseCoopers PPP and Deal Strategy Director Ruvini Fernando

Members of the Banking Group:

National Development Bank CEO Dimantha Seneviratne

Hatton National Bank Chief Strategy Officer Rajive Dissanayake

HSBC Country Head of Commercial Banking Stuart Rodgers

DFCC Bank CEO Lakshman Silva

Sri Lanka Banks’ Association Secretary General Ravi de Silva

Members of the Capital Markets Group:

Calamander Capital Director Mafaz Ishaq

Colombo Stock Exchange Research and New Products Head Nishantha Hewavithana

Independent Private Equity Investment Advisor Nissanka Weerasekara

NDB Zephyr Partners Lanka Managing Director Senaka Kakiriwaragodage

The Unit Trust Association of Sri Lanka President Ruwan Perera

Colombo Stock Brokers Association President Prashan Fernando

Fitch Ratings Lanka Country Head Maninda Wickramasinghe

Members of the Non-bank and Financial Institutions Markets Group:

The Finance Houses Association of Sri Lanka Chairman Roshan Abeygoonewardena 

The Finance Houses Association of Sri Lanka Immediate Past Chairman Krishan Thilakarathne,

The Finance Houses Association of Sri Lanka Member Romani de Silva

The Finance Houses Association of Sri Lanka Member Brandon Morris

The Finance Houses Association of Sri Lanka Member Rohan Tennakoon

The Finance Houses Association of Sri Lanka Member Ravi Yatawara

The Finance Houses Association of Sri Lanka Member Chaminda Hettiarachchi

The Finance Houses Association of Sri Lanka Member Ravi Tissera, 

The Finance Houses Association of Sri Lanka Head of Secretariat Denzil Mallawa Arachchi 

Banking sector

1. Lending to priority sectors

Interventions

• Reduce the negative impact on the banks’ liquidity, credit risk and administrative difficulties in lending to the priority sectors and encourage the banks to lend to the priority sectors.
• Currently, interest subsidy schemes and other sector reforms are implemented by multiple government authorities and banks are eligible to receive interest subsidy for the loans granted by them through a relevant interest subsidy scheme. Dealing with multiple government authorities with different operating procedures and objectives increase the operational complexities for banks.
• The interest subsidy is provided only for the preforming facilities and in the event of default, the banks are required to absorb the total credit risk.
• These interest subsidy schemes are implemented to compensate the cost of funds of banks while encouraging them to grant loans to the specific priority sectors of the economy. However, unusual delays in receiving the interest subsidy increases the operating cost of the banks and discourage banks to participate in such schemes.
• The banks are required to classify lending to Government-sponsored projects due to delay in payments by the Governments, discouraging banks from lending to Government-sponsored projects and priority sectors.

Implementations

• Introduce a new framework for all interest subsidy schemes and other sector reforms to minimise the operational complexities of dealing with multiple authorities and delay in recovering the interest subsidies. To achieve this objective, all interest subsidy schemes should be coordinated, facilitated and implemented through CBSL.
• Implement credit guarantee schemes with a view to mitigate credit risk of the loans granted by the banks for specific sectors under these schemes.
• Possible relaxations to the NPA classification requirements for the loans granted to Government sponsored projects.

2. Financial laws

Interventions

• Reduce the high cost of bank intermediation by addressing the delays in the legal system and introducing the required bankruptcy laws.
• Facilitate evolution of the financial services industry based on regional/global trends by passing requisite legislation.
• Recovery and arbitration proceedings tend to be very time consuming, expensive and protracted with delays.
• The most significant impediment seems to be the willingness of judges to grant postponements on basis of ‘personal reasons’ of lawyers representing litigants. This delays proceedings with commercial loss to parties and great disrepute to all concerned.
• Implementations
• Re-examine the recovery laws and enactment of legal reforms for efficient implementation of recovery laws such as

1. Courts to complete commercial cases within set time limits.

2. Expedite resolving of commercial disputes through a smoother and more effective arbitration process.

3. Introduce a mechanism for speedily restructuring of companies facing financial difficulties and strengthen debt-recovery laws by plugging the loopholes that allow the defaulters to obtain restraining orders from courts and drag the commercial cases for long periods.

4. Enact the required bankruptcy laws.

5. Establishment of special bankruptcy / debt recovery courts which handle only debtor creditor cases.

6. Convergence of CBSL provisioning calculations with IFRS requirements to avoid administrative complexities.

• Appoint an official receiver whose office should be strengthened by adequate resources and independence to operate to expeditiously contain the decline of a company in trouble and to rehabilitate them where possible.

3. Development of the SME sector

Interventions

• Bring inclusive economic growth, regional development, employment generation and poverty reduction through increasing the lending to SME sector.
• Lack of information infrastructure for SMEs.
• Non-availability of a deep SWAP market to hedge the currency risk of foreign borrowing for SME lending.
• Higher risk premium in loan formulations due to lack of collaterals.
• Implementations
• Take initiatives to broaden the SWAP market through SWAP arrangements with CBSL for borrowing made by banks for SME lending.
• Permit the development of a long-term interbank SWAP market by removing the existing regulatory barriers.
• Expedite of the project on providing borrower rating from CRIB and extending obtaining credit information relating to utility companies.

4. Slow down of economic growth due to reduction in credit supply

Interventions

• Credit growth the banking sector is highly impacted by the following:

1. Implementation of BASEL III, which requires a substantial increase in capital base

2. Adoption of IFRS 9, likely to impair the capital base of the banks.

3. A substantial portion of profits of a bank will be netted by the state by way of taxes which will significantly affect the banks’ ability to lend.

4. Difficulties in attracting capital due to low performance in the capital market to meet the new capital requirements.

5. Difficulties in raising funds due to low investor confidence due to excessive taxes on the industry, highly volatile tax policies such as retrospective taxes (Super Gains Tax, introduction of new tax treatments for existing investment securities). 

Implementations

• Possible relaxation or deferment of new capital requirements such as counter cyclical buffer.
• Consistent policy framework on banks taxation and a long-term view in application of banks taxes and tax rates.
• Possible relaxations to the existing banking tax structure (e.g. Debt Repayment Levy).
• Avoidance of retrospective taxation.

5. Sector consolidation and re-capitalisation

Interventions

• Enhance the guidelines governing banking operations to strengthen the banking sector.
• Bring long-term productivity and efficiency through reduction in cost, efficiency gains, economy of scale, enhancement of consumer base and innovations.
• Non-availability of clear policy framework on voluntary consolidation to motivate the banks on voluntary mergers addressing on issues such as branch closers, implication of consolidation on employment, tax treatment, etc.
• Implementations
• Introduce a policy framework that motivates the voluntary consolidation within the banking sector addressing requirements such as ownership control and degree of foreign ownership allowed, capital requirements and capital treatments, asset liability transfers, tax benefits and tax treatments, asset liability transfers, etc.

6. Technology

• Introductions of new technology will be important as cost to income (C/I) to be a critical factor in the future in improving the profitability of banks.
• Slow adoptability of the regulator for the new technology and difficulties in obtaining approvals.
• High costs on technology due to non-availability of cloud computing.
• Non-availability of common data centres.

Implementations

• CBSL to facilitate e-KYC through Face-Recognition Apps to facilitate e-banking.
• Establish a policy framework on cloud computing, common data centres, digitalisation and fin-tech.

Capital markets sector

1. Enable the provision and regulation of demutualised exchanges

• The SEC Act has to be amended to include provisions enabling demutualisation.
• A Demutualisation Act has to be enacted.
• Provisions for civil sanctions against securities law violations.
• Licensing and regulation of derivative and commodities exchanges.
• Incorporating legal duties on auditors in respect of capital market offences.
• Enhancing of measures for investor protection.

2. Enact Securitisation Act

• Provide a comprehensive legal and regulatory foundation for securitisations in Sri Lanka.

3.Establish a Central Counterparty Clearing House (CCP) system

• Essential that the infrastructure for such a system is in place.
• To ensure the continuity of a CCP system, the SEC should take the role of being the primary regulator and enforcer.

4. Steps to increase market size in the capital market

• Listing State-Owned Enterprises which would result in better governance and its recognition to the market, thus expanding the potential of the equity market.
• Listing of minority stakes of key commercial public enterprises.
• Dollar board: Establish a dollar board for listing of foreign and domestic companies.

5. Steps to increase market 

liquidity

• Continue to enforce a higher free float percentage.
• Establish a market making mechanism to ensure a continuously liquid market for listed stocks.
• Implementing “market makers” to promote liquidity in the market.
• Reforming the transaction cost structure with the objective of lowering them to an appropriate level.
• Implement a brokerage industry consolidation plan where market intermediaries deal in all capital market products.
• Sri Lanka needs to introduce minimum capital requirements for market intermediaries in the CSE.

6. Increase transparency and liquidity in Government securities

• Developing a reliable benchmark yield curve across the entire term structure.
• Practices such as private placements, partial filling of offered amounts, outright cancellation or rejection of announced auctions, etc. must be limited to exceptional circumstances.
• A more transparent and efficient trading platform for Government securities must be established.

7. Increase transparency and liquidity in the Corporate Debt market

• Increasing the size of the listed corporate bond market is vital by increasing the institutional investor participation.
• Introducing a formal market making mechanism.
• A central counterparty clearing and settlement system is an essential component to mitigate settlement risks and promote investor confidence.
• Introducing repurchase agreements (repos) on corporate debt securities.
• Introducing bond derivatives will also contribute to the development of the market.

8. Development of Real Estate Investment Trusts

• Ensure that it receives support from local regulatory bodies and authorities in formulating a legislative framework for its operations.
• Fast track the implementation of Collective Investments Scheme (CIS) code. Alternatively, enable REITs under the Unit Trust code as a first step until the CIS code is implemented.
• A stable tax regime must be kept in place to instil confidence in investors and enabling them to be tax neutral.

9. Establish derivative market (A derivative is a financial contract with a value that is derived from an underlying asset)

• Regulations for introducing derivatives products needs to be developed.
• Trading, clearing and settlement technology and mechanisms need to be developed.
• Sri Lanka needs to undertake a comprehensive assessment and prepare a realistic road map for developing derivatives products and markets.
• The SEC and CSE should also link the initiatives for increasing the size and liquidly of the stock market to the development of derivatives.
• The CBSL, SEC and CSE should explore the potential for introducing derivatives on Government securities.

10. Introduce commodity derivatives

• Assess the economic and practical feasibility of setting up commodities trading. This might involve leveraging on the existing capacities of the CSE to commodities trading. 
• The development of trading, clearing and settlement structure.
• The SEC should consider the need for a separate commodities legislation.

11. Broaden pension fund portfolio

• Pension funds should consider creating more broadly diversified portfolios.
• Pension funds should consider strengthening the capacity for in-house fund management.
• Pension industry should consider incorporating external fund management into their portfolio, by doing so, the public have a choice as to invest in the internally-managed EPF and ETF or a privately-managed pension fund.
• Setting up of a separate “Pensions Office” or regulator to formulate and monitor the framework required to enable private participation in pension fund management.

12. Increase awareness of unit trusts

• The unit trust industry needs a comprehensive plan for educating the public about benefits of unit trusts.
• Pension reforms needs to include external fund management of pension funds.
• The unit trust industry will need consolidation.
• Review the existing taxation framework for unit trusts and make appropriate changes for the operation of and investing in unit trusts.
• A SEC-mandated robust licensing framework for professionals in that industry.

Non-bank and financial institutions sector

1. Policy development

Interventions

• An apex committee should be set up and tasked with policy development and include key stakeholders and key decision makers.
• There needs to be regular (preferably monthly) forums where the committee meets to discuss policy direction and latest developments.
• Implementations
• Industry bodies should be represented in the committee in order to obtain their insights and address any concerns.
• Representatives from departments important to the NBFI sector such as Land Registration, RMV, legal system representatives should be members of the committee.

2. Decoupling the regulator and policy developer

Interventions

• Regulator looks from a regulatory perspective and not from a development approach. As such there is a conflict of interest for a regulator as they can formulate policy to make regulation easy at the cost of economic development.
• Government and regulatory policies on limiting the risk taking abilities of the industry will negatively affect credit granted to risky sectors and will simulate lending for such sectors through unregulated institutions.
• There should be consistency in policies set out for the sector.
• Implementations
• Ministry for Economic Development should drive the formulation of policies for the ultimate growth and development of the country and, should not be influenced by regulatory constraints.
• Institutions should be allowed to take on risk and manage it. 
• Minimise inconsistencies between economic policies and regulatory guidelines.

3. Development of the SME sector

Interventions

• Maximum interest rate on deposits. As per the new direction the interest differential between NBFI and banks have reduce to 0.50% to 1.50%. Low interest differential has resulted liquidity strain to most of the NBFIs as the deposits are been shifted to banks as the interest premium is less considering the credit rating of each company.
• Accordingly, the credit flow to the SME sector could be limited.
• NBFIs are catering to a risky segment and the repayment behaviour of such customers are different to banking customers (significant portion of recoveries are made after 90 days). The proposed regulation on NPA classification of 90 days will affect adversely on granting loans to risky sectors such as SMEs as significant amount of current customers may have to be arbitrary classified be classified as NPAs.
• Lack of Information Infrastructure for SMEs.
• Higher risk premium in loan formulations due to lack of collaterals.
• Implementations
• Facilitate a market-based deposit rates based on the credit ratings of the respective entities or widen the spread in deposit rates between banks and NBFIs.
• Delay the implementation of the NPA 90-day classification. This is to be done on a staggered basis over a four-year period and up to a minimum of 120 days considering the sector specific operational model.

4. Financial Laws

Interventions

• Reduce the high cost of NBFIs intermediation by addressing the delays in the legal system and introducing the required changes to the recovery laws.
• Facilitate evolution of the financial services industry based on regional/global trends by passing requisite legislation.
• Recovery and arbitration proceedings tend to be very time consuming, expensive and protracted with delays.

Implementations

• Re-examine the recovery laws and enactment of legal reforms for efficient implementation of recovery laws such as

1. The laws to be introduced with respect to private money lenders and with respect to exorbitant lending rates and unethical collection practices.

2. Mortgage of leased vehicles to third parties: make it a criminal offence under a new provision to be introduced to the Finance Leasing Act, on par with section 15 and 19 of the Consumer Credit Act 29 of 1982.

3. Mediation board activities to be streamlined in a manner which would help the recovery activities to be more efficient and effective. The mediation board should compromise more financially competent members.

4. Parate execution to be introduced to NBFI mainly focusing on property mortgages.

5. Slowdown of economic growth due to reduction in credit supply

Interventions

• Credit growth in the financial sector is highly impacted by the following:

1. Implementation of BASEL III, which requires a substantial increase in capital base

2. Adoption of IFRS 9, likely to impair the capital base of the NBFIs.

3. A substantial portion of profits of NBFIs will be netted by the State by way of taxes which will significantly affect NBFI ability to lend.

4. Difficulties in attracting capital due to low performance in the capital market to meet the new capital requirements.

5. Difficulties in raising funds due to low investor confidence due to excessive taxes on the industry, highly volatile tax policies such as retrospective taxes, higher NPAs.

Implementations

• Possible relaxation or deferment of new capital requirements.
• Consistent policy framework on taxation and a long-term view in application of taxes and tax rates.
• Possible relaxations to the existing tax structure (e.g. Debt Repayment Levy).

6. Sector consolidation and re-capitalisation

Interventions

• Enhance the guidelines governing NBFIs operations to strengthen the sector.
• Bring long-term productivity and efficiency through reduction in cost, efficiency gains, economy of scale, enhancement of consumer base and innovations.
• Non-availability of a clear policy framework for the financial sector as commercial banking, development banking, leasing and finance, micro finance, etc. 

Implementations

• Demarcation of the sector as commercial banking, development banking, leasing and finance, micro finance and re-focus on venture capital business.
• Restrict issuing any further licenses for banks or any financial institutions.
• Introduction of a policy framework that motivates voluntary consolidation within the NBFI sector addressing requirements such as ownership control and degree of foreign ownership allowed, capital requirements and capital treatments, asset liability transfers, tax benefits and tax treatments, and asset liability transfers.
• Introduction of new regulations in relation to risk management and governance of the sector.

7. Technology

Interventions

• Introductions of new technology will be important as cost to income (C/I) will be a critical factor in the future in improving the profitability of NBFIs.
• Slow adoptability of the regulator of new technology and difficulties in obtaining approvals.
• High costs of technology due to non-availability of cloud computing
• Non-availability of common data centres.

Implementations

• CBSL to facilitate e-KYC through face-recognition apps to facilitate e-banking.
• Establish a policy framework on cloud computing, common data centres, digitalisation and fin tech.
• Eliminate the requirement for NBFIs to have a sponsoring bank in order to obtain clearance for issuing products like credit cards, etc. to avoid unnecessary bottlenecks and costs.