Continuance of consolidation of financial sector: Is it the right direction?

Sinhaputhra Finance PLC, one of the country’s oldest finance companies headquartered in Kandy with branches spread across the island, recently voiced their opinion on whether the Central Bank of Sri Lanka should initiate action on consolidation of the country’s financial sector, or leave it for market forces to decide this with fiscal incentives if required.

Sinhaputhra Finance Managing Director Ravana Wijeyeratne pointed out that whilst developed countries such as the Euro Zone, has seven financial institutions per million and in the US 21 financial institutions taking public funds and insured by FDIC up to Rs. 45 million per depositor, serve a population of 1 million people, Sri Lanka by comparison has banks, specialised banks and licensed finance companies comprising of a total of 84 institutions in all. This was less than four financial institutions per million and is therefore far below the average that is required for a country such as ours to ensure financial inclusion. Hence the reason for the existence of so many unauthorised finance companies and individual money lenders could be to fill this void. This means that Sri Lanka needs to have more financial institutions spread evenly across each of the country’s geographic areas.

He elaborated, “Such facts pose the question as to why the Central Bank of Sri Lanka is keen to reduce the number of financial institutions. Is it something the industry has requested or something the regulator wants in order to make the sector stronger, or something the share market wants as mergers and acquisitions drive share prices up at least on the short term?

He quoted from Central Bank Assistant Governor H.M. Hemachandra who had stated there is little evidence to support the proposition that size by itself is a predictor or has any association with the instability of a financial institution. Instead, such collapses are broadly associated with causes categorised into three groups: macro-economic, supervisory and other.

The latter includes ten categories of factors, including loose interventionist monetary policy, global imbalances and forex manipulations, a lack of bankruptcy code and the surety of government bailouts to bond holders

As such, this process will put undue pressure on both the companies employees as well as the regulators who need to finally force the effort through moral suasion, and it is likely that larger companies who are not targeted for takeover, would find lesser competition to their advantage, and encourage the effort or even be a part of it. Since the payoffs on mergers and acquisition are astronomical sums, and these gains can be professionally engineered, it requires a collusion of many professionals who could be susceptible to financial and other attractive incentives which could make the whole effort driven to be fruitless with short term gains offset by tremendous risks to the system in the long run.” 

He further explained, “Fewer companies also means fewer entrepreneurial and senior management roles available in this highly technical sector. This also gives rise to having, less competition and fewer products to benefit the customer. Further, if the sector is turned into an oligopoly by forced mergers/consolidation it will reduce competition and innovation. 

Additionally, the sheer number of clients built up by the LFC sector as opposed to the banking sector shows their impact on the Sri Lankan population as an effective player in financial inclusion.”

Another danger in consolidation and creation of larger companies he said is well articulated by Arden Young “Understanding the Financial Crisis of 2008” that states that the biggest and longest-lasting criticism of the government bailout is that it promoted the culture of “too big to fail” among Wall Street and other financial institutions. “Many people argued that the government should have made it a necessity for institutions receiving aid to break themselves up into smaller parts. This way, they would not be essential to the economy’s survival if a future crisis ever presented itself. 

“Those who advocate that “too big to fail”, is a problem believe that banks that are so huge they require a bailout can act with this in mind. The conclusion therefore, could be that we are nowhere close to curtailing the entry of new financial institutions and certainly in no need for the consolidation of the few licensed companies that exist.