Banking foresight – Shaping integrated development

By Cassandra Mascarenhas

With the Sri Lankan economy poised at a historic juncture, the Association of Professional Bankers’ flagship event, the 23rd anniversary convention which was held last week, explored the theme ‘Banking Foresight – Shaping Integrated Development’ in order to determine what role banks will play in public and private development in the economy.

The forum was inaugurated amidst the presence of Central Bank of Sri Lanka Governor Ajith Nivard Cabraal as Chief Guest and Bank of America Merrill Lynch Managing Director and Head of the Financial Institutions Group for the Asia Pacific Region Michael Tan as the Guest of Honour.

Day two of the convention consisted of four technical sessions and a panel discussion which hosted key personalities from both the public and private sector, each of whom delved into the different aspects of the economy that would affect banks and detailed how the banking sector is expected to play its pivotal role as a key driving force.

Private-Public Partnerships

The first technical session for the day, titled ‘Changing the Economic Landscape – Private-Public Partnerships,’ featured ADB Country Director Sri Lanka Rita O’Sullivan as session chairperson and Senior Minister of International Monetary Cooperation Dr. Sarath Amunugama as session presenter.

“In the ADB’s 2020 strategic long-term document, we identified that private sector development and operations will be the driver for change needed. The fundamental principles of PPPs are quite universal but as always it depends on the detail and how you apply PPPs in practice is a very critical challenge. They must be tailored to the individual needs of a particular sector or project and based on the individual needs, resources and constraints that you’ve got,” explained O’Sullivan in her opening remarks.

Amunugama used the opportunity to express what the Government has in mind when talking of development in this decade and thereafter. He revealed that the last week saw the greatest figures coming in which indicated that like 2010, this year too would experience an eight per cent plus GDP level.

“Firstly how did we come onto this growth trajectory over the last two years? Prioritisation of our resources was determined by the war, we couldn’t rationally allocate resources but now we can move on to a more rational approach of budgeting, utilising our material and other resources and with that we are on the eight per cent growth trajectory. However, due to the economic crisis, growth is very sluggish and so-called developed economies are inching towards crisis,” he said.

He pointed out that investors went out on a limb and lent money to Greece but because of irrational allocation of resources; Greece now cannot repay its debts. Unless an outside party can help those banks which have now outstretched themselves, the Greek crisis will hit the banks but while this is going on, Amunugama noted that it is the Asian economies that are doing well.

India and China had to scale down their double digit growth so now we are among the leaders, he added and urged that we now move on from talking about growth and talk about sustaining that growth over the next five to six years.

“We need to hit that growth consecutively for a couple of years; if you don’t have continuity there then of course we have to restart operations every now and then. As economists, bankers, citizens, how do we maintain this eight to nine per cent growth that we have established?

“We have many factors working for us – the northern and eastern economy is getting integrated with the mainstream economy. Every one of the banks represented here are opening branches in the north and east.”

Amunugama noted that the world is also facing a huge global food crisis, just as much the oil crisis, where the world is now divided into self-sufficient countries and importing countries – Sri Lanka is now a good self-sufficient country and stated that we should aim to be a rice exporting country by avoiding post harvest waste.

Our services sector is expanding very fast, which the Minister said is contributing to our growth but it is also creating changes in our financial and aid structures.

“Aiming to double the current per capita income of $2,400 by 2016 will have tremendous implications for our external financing because multi lateral agencies particularly World Bank have a lot of concessionary credit for low income countries and in the past Sri Lanka has made use of this but can’t do so any more. That puts a certain limitation on our borrowings. We need to look at how we are to get the increasing amount of funds necessary to maintain this growth trajectory,” he said.

“We have many assets, in addition to that our main task now is to emphasise infrastructure, which is where we come to the issue of PPPs,” he went on to say, warming to the topic at hand.

The Government, he said, has made a paradigm shift with its commitment to the rapid expansion of infrastructure in the country. The country is strategically placed and this must be exploited. He added that in another 10 years, India will have the world’s biggest middle class, which comes up to 500 million people and even in India the growth centres will be in the South – Chennai, Hyderabad and Bangalore – and with all these changes taking place, Sri Lanka needs to build up its infrastructure to make the maximum use of it.

The Minister went on to emphasise on the fact that no other country has invested simultaneously in the development of five ports, while working on two airports as there is a dire need for a second runway in the country.

Another issue is that of power; Sri Lanka is the only country in the region that can guarantee a continuous supply of power. People don’t realise that the amount we have invested in various projects will guarantee a steady supply of electricity, he said, and while admitting that the moment it is expensive, Amunugama assured that the country was moving in the right direction.

The road and railway network is also being invested in heavily. One of the biggest drawbacks in the road network is the Colombo-Kandy road, he noted and stated that the railways are being worked on.

“So we have many plans but how do we fund these plans? We have multi lateral funding but this isn’t much as we get this only from the ADB. We need to look at new ways of funding. While people criticise the Government for dealing so closely with China, It’s only China who is negotiating with us to convert a large part of their loan to us to equity. Through negotiations, the same will be done with Iran and India which is why we have chosen to go to China, India and Iran.”

Although there are other ways of raising funds such as through bond issues, PPPs become very important as we don’t get concessionary credit anymore,” Amunugama added.

He said that the development of the Colombo South Port is an excellent example of PPP and is Asia’s biggest PPP, which is a model not only to Asia but to the whole world.

“What can the banks do? Up to now this funding has come from foreign countries so our banks now need to come up with innovative ideas. They can have a development fund, and you must also be able to directly negotiate with banks abroad to get your money,” Amunugama urged.

“At the moment banks have an easy time because the Government negotiates with the banks and bring the money to you, but you yourselves can go to any bank as they prefer to work with well functioning banks in Sri Lanka. Why should we have sovereign bonds if banks can negotiate with other banks and expand capacity? We are on a policy of having more banks and banks shouldn’t depend entirely on the deposit base – you need to expand so that we are able to borrow from our own banks and look towards forming a consortium to further growth in the country.”

In response to a question posed to him on the access of land for PPPs, Amunugama stated that the Government is restructuring the investment facilities; previously there were three agencies that gave concessions, all legally valid, but this is going to change that because the BOI concessions have been abused. The Government has now brought in a strategic investment law – once a project has been identified as beneficial to the national economy, only then will the Government give them all concessions, after parliamentary assent and the BOI will become just a facilitation agency.

The people factor

The second technical session, titled ‘The People Factor is Shaping Integrated Development,’ was chaired by Hayleys Group Human Resources Head Sunil Dissanayake and was presented by Postgraduate Institute of Management Senior Faculty Member Dr. Ajantha Dharmasiri.

Dharmasiri in his animated presentation focused on the people factor in shaping integrated development with an emphasis on championing change.

“It’s all about back to basics. Simply going back to basics is not enough – you need to be brilliant on basics and build the business on basics. The reality now is change, change and more change and even the rate of change is changing. In order to make Sri Lanka an economic hub, we have to change a lot of things,” he stated.

However, he admitted that change is uncomfortable, particularly change for the better. One key driver of change across the world is globalisation. The world has become a global family because of all the connectivity; globalisation is about simultaneously shrinking and expanding. The space is shrinking but connectivity is expanding, Dharmasiri noted. The uprising seen in Egypt and other countries were facilitated by technology – it has become a key enabler in globalisation.

“We are in a capacity-thirsty world and technology has made us embrace and drive change. How can this change be relevant be us and how should bankers embrace and drive change? We have moved to a very turbulent time which is more unpredictable, risky and challenging – we need to go from safe and slow to focused, fast and flexible. You are playing a very safe game at the moment, not experimenting; speed is a critical factor,” he observed.

Change happens in three stages, he said. Stage one is unfreezing. People would have gotten used to a traditional way of doing things for a long time and they need to be shaped up to think, freely, differently and openly. Stage two is implementing and after that, refreezing the new mindset.

“The main challenge is that we are very reluctant to unfreeze, especially the banking sector and we are very proud to talk about it. People like the idea of change but they fear they experience but it’s all about survival of the fittest. You need to lead people in order to have a successful change experience. Jack Welsh is one such leader who said that three Ss are necessary when facing change – speed, simplicity self confidence.”

You got to be able to go through change with confidence and adapt to change quickly, Dharmasiri added.

He then defined the different ways of implementing change. Participatory evolution, which consists of minor change with a collaborative effort which happens fairly often, such as a quality circle. Then there is forced evolution, the implementation of minor change with coercive action.

Dictatorial transformation is when major change in brought about through coercive approach when you enforce change upon people - it works temporarily but not in the long run.

The best way of executing change, he said, is through charismatic transformation; major change with a collaborative effort for sustainable results.

“To do all this, the people factor comes in. After the war there is a lot of development activities taking place and for change there are several aspects required - speed in what we do, predictability, consistency in what you do and the differentiator, service quality.”

He acknowledged the fact that managing a multi generational workforce is an increasing challenge. Generation Y has an individualistic nature which makes it a challenge for managers to tap into their potential and make them work as a team. However, Dharmasiri encourages a workforce with different generations in order to have a more diversified workplace.

“Seventy per cent of transitional efforts in the world fail. It is an attitude problem; we are a nation of talkers. The execution gap is one that is spreading. I challenge HR practitioners because there is a clear difference between doing and delivering. The results factor is extremely important,” he concluded.

Capital market development

The third technical session delved into the significance of capital markets on the banking industry. Titled ‘Capital Market Development – The Banks’ Role,’ it was chaired by SEC Sri Lanka’s Former Director General Channa de Silva and was presented by SEC Director Dr. Hareendra Dissa Bandara.

“Stock markets are important because it measures the health and well being of an economy. Sri Lanka has recorded three and half per cent negative growth this year. How does this look on a global platform? Sri Lanka is ranked eighth globally so it has been a very mediocre performance. The market is very volatile, however People’s Leasing closed at Rs. 7 billion IPO which is tremendous for a previously government owned entity. These all have impacts on the banking system,” stated de Silva in his opening remarks.

He went on to say that it has been a bad year globally, starting from Greece, which once a darling of the world but today is bringing the Eurozone down with their massive debt. It’s difficult times for the EU, the US isn’t doing well either and he pointed out that as a result, smaller countries like Sri Lanka are finding it difficult.

Capital market development is a hot topic in Sri Lanka at the moment, said Dissa Bandara and even though the country has enjoyed over a 100 years of share trading, he personally believes that the age of the country’s capital market is only two or three years.

“The post-war capital market is existent because of peace and peoples’ mindsets became free as a result which leads to economic prosperity. Based on this we can talk about public private investments in the economic process. Earlier, no one wanted to embark on big ventures because of the uncertainty involved,” Dissa Bandara noted.

Because of the post war era, investors again rethought the Sri Lankan capital market and its development and their level of confidence increased and at the same time, the listed companies saw their ability has increased. Soon after the war, the earnings of most of the business entities increased as well. The brokers’ facilitation saw a rise and finally the involvement of market institutions also increased.

There is a difference between domestic participation and foreign participation, the SEC Director observed, especially with the rural investors who entered the investment arena and this is a very important development within the country but unfortunately foreign participation has been reduced.

Furthermore, the country’s macroeconomic variables have been very favourable, interest rates have reduced drastically and inflation rates have come down. Even in the face of these opportunities for investment, the capital market still has very basic products such as shares, corporate bonds and warrants, although the latter is no longer very popular.

Dissa Bandara emphasised on the need to attract more investors and the SEC has been playing its part by hosting investor educator programmes in order to increase the number of CDS accounts. The SEC has documented a 240 per cent increase in CDS accounts so far.

“Foreign participation is volatile but domestic participation is very high and we have been able to maintain a good phase after the war. Although we say there is a tremendous interest among the rural people to transact in the stock exchange, less than five per cent of the population are involved in capital market activity. At the moment there are 35,000 active CDS accounts per month which is less than one per cent of the population. We see 200,000 active CDS accounts every year. 173,000 of these are worth less that Rs.500, 000. Yet a couple of people have accounts worth billions which is very dangerous,” he said.

“We must educate other people and bring them into the capital market,” Dissa Bandara added, “that’s the only way as we can’t ask the current investors to invest less.”

Sri Lanka has also failed to attract the foreign investors expected which is proving to be a big challenge but when a market is this volatile, investors are reluctant to enter. The country currently has 268 listed companies which is a comparatively low figure in comparison to other countries in the region. The number of brokers has now increased to 29 from 15.

Post war initiatives carried out by the SEC include market expansion in rural areas, market development and awareness creation especially in the North and East and the human resources component is to double at the earliest moment, thereby creating more employment opportunities, revealed the SEC Director.

Market awareness in the north and east has been key and the CSE and SEC have done a lot in this regard and Dissa Bandara noted that since the CSE opened in Jaffna, the performance has been very good.

Dissa Bandara admitted that there has been a lot of criticism about market manipulation and the SEC is now carrying out investigations into this matter.

Banks’ role in the capital market

“Banks more or less deal with similar concepts and over the last 100 years, the banking sector has only thought that they should only develop their own sector but they are in the financial sector and to develop the country you need a strong financial system which can effectively contribute to the development of the nation. If the capital markets and the banks are linked together they could do a better job. The banking sector is reaching the ceiling, the next level is the capital market whether we like it or not,” the SEC Director pointed out.

He went on to say that in this financial system, the banking sector is just one component. Every market has to get together in order to build a strong financial system. All types of financial market should be taken together and not differentiated.

“We need to change the mindset of people; each person has at least one passbook and they know how to save but do not understand how to invest. So as bankers, you should be able to teach them about the savings and investment because people need to have both. Banks are very popular and capital markets are not, it is very hard to teach anything about the capital market because of the dominating power of the banks.”

Dissa Bandara also urged banks to move towards innovative products as traditional lending and borrowing will not be profitable like in the past. Banks need to further explore capital markets and invest in them in the long run, which is a challenge. It is important to invest in capital markets wisely and he stated that although people seem to think such investments are very dangerous, one rarely ends up making a big loss in the long run especially if investors go through a unit trust and he added the connectivity between custodian banks and the CDS needs to be improved.

“We didn’t become first or second in the global ranking because of the lack of foreign investors, we have failed because of the liquidity in the market one which is one issue. There is also apparent manipulation and because of this, volatility is apparently high so people may think that the market is not stable. Foreign investors don’t think about equity, they think about debt but in our market, debt is very poor,” Dissa Bandara responded when he was asked about the lack of foreign investors.

He assured the bankers that the fundamentals in the stock exchange are at such a level that banks can afford to take a risk, pointing out that large scale investors are not panicking even now because they have selected a few stocks carefully and have invested for the long run. “People are talking about apparent manipulation. Normally this can’t happen but even our chairperson explained that 14 or 15 stocks are behaving in on abnormal way and we are investigating this matter.”

“Broker fees are terribly excessive, especially internet fees and this is one thing that needs to be done and now is the time to do it. These are small markets and can be easily manipulated. The speculating element is lacking in the Sri Lankan market. The Sri Lankan growth story is a 10 year one and we are only two years in to it. We are just asking banks to look to be a very dominating force in the future,” said de Silva.

Legal and regulatory reforms

The final technical session at the forum on ‘Legal and Technical Reforms – The Way Forward’ was chaired by CBSL Deputy Governor K.G.D.D. Dheerasinghe and presented by Nithya Partners Partner Naomal Goonewardena.

Goonewardena first shared some key points highlighted during the conference’s inauguration such as the fact that size matters and banks, especially in the South-East Asian region have consolidated and also expanded regionally.

The second thing was that in the context of where the banking industry currently stands, there is the possibility of greater competition arising from the entry or expansion of foreign banks into this market.

Thirdly, there was a mention about the necessity to be strong in order to assist others, there is a need for the banks itself to be strong. There was also a mention about the fact that the banks in this country need to access foreign capital markets to obtain long term debt capital in order to be able to meet the capital requirements going forward in the context of the projected growth rates.

He noted that there was also a reference to a more inclusive banking model being brought about in this country so that things like bank penetration would be dealt with.

It is in this context that Goonewardena spoke about the legal and regulatory reforms, what has happened in the recent past and what is actually being contemplated by the Central Bank and other regulators going forward within the next year or so.

“When it comes to confidence in the banking system, I think that we are all aware of the fact that the banking institutions are involved in unrelated activities, that there are other unrelated financial institutions and the fact that those institutions are going through difficulties and this could have an effect on the banking system as a whole,” he said.

“In regard to things like risk management, it is a movement to keep ourselves abreast with international development, in order to be able to give confidence to international players who have an involvement in this market and the players in this market, it is important that we keep up to international norms both in regard to accounting and risk management practiced in this country.”

Discussing deposit insurance which was brought into effect approximately a year and a half ago, he noted that the deposit insurance fund can also be used to grant advances to member institutions who have a severe liquidity crisis, so it’s not only the depositors who can be the beneficiaries of deposit insurance. This is obviously something that will enhance confidence in the financial system as a whole.

He then moved onto the new finance business bill which was passed in parliament on 31 October, it has not yet been signed by the speaker as a result of which it is still not yet a law but this will substitute the Finance Companies Act No. 78 of 1988. It licenses people who carry out finance business which is identical under the old act but it also mentions that no person other than a licensed person who is entitled to carry out finance business shall accept deposits. So therefore, deposit taking now is very specifically mentioned and there is a wide definition of the term deposit.

Taking into account this definition of deposit, even loans and debt instruments comes within the term deposit, subject to exceptions set out in Section 73 of the Act. The substantial provisions in the new bill deal with the management of finance companies and controls all unregistered institutions.

“These are obviously all things that are going to increase confidence in the financial system itself. In addition to that, several micro finance institutions in this country have gone through, and some of them are still going through, serious financial difficulties. The new microfinance bill which provides for the regulation of the microfinance business and it clearly says companies registered under the bill can carry on microfinance business,” he elucidated.

Goonewardena went on to say that there is a microfinance authority who is entitled to make rules and regulations with regard to microfinance business in a manner that is similar to what the Central Bank of Sri Lanka does with finance companies. In other words, it is not regulated by the Central Bank itself but a separate authority and has the same powers that the Central Bank has in relation to finance companies.

“All these additional regulations for finance business and finance companies and the additional regulations for microfinance companies I think is a step towards in the correct direction with regard to creating additional confidence in the financial system itself, which is what is necessary.”

There is a new customer charter that has been brought into effect and banks must be already complying with these things, he said. There is a role of conduct required for customer protection and in terms of the charter there is a general requirement for banks to assist customers to understand the products and services which are being offered.

Banks will be required to provide details of their agents and prevent them from acting improperly, credit cards, collections, agents these are all things that the public has some forms of concern and this customer charter is trying to deal with some of those problem areas.

“Generally at the moment, the CBSL works under Pillar One of Basel II which is a ratio based assessment of risk which prevails in a bank and they are moving towards a more capitalistic assessment process under Pillar Two of the Basel II framework and this requires an integrated risk management process so in other words, you not merely looking at ratios or regulation of certain things but you are looking at risk management on a more integrated basis. In that context there is a risk management circular issued by the Central Bank and it emphasises the integrated nature of risk management,” Goonewardena stated.

“This risk management initiative will ensure that Sri Lanka is in line with international norms which are essential if we are to access international capital markets, if we are to have extensive dealings with overseas parties.”

He added that there is also a consolidated supervisory framework being looked at by the Central Bank in connection of monitoring the affairs of debts. It seems to be that the 11 banks in this country have 60 subsidiaries as well. This Central Bank is now working towards monitoring those subsidiaries because of the effects these institutions can have on the banking sector.

Under product development, he revealed that the CBSL is looking towards setting up a regulatory framework for Islamic banking which is a relatively new product in this market.

The Inland Revenue Act of 2011 has to some extent clarified income tax treatment with regard to Islamic financial transactions; they will treat it like a corresponding transaction which will come under the normal principles by disregarding the Islamic feature of the product.

“There is an urgent need for some clarity on derivative products and especially foreign exchange related derivatives and some clarity about the Central bank would use those products because the Central Bank’s directions on derivative products is in my view vague and therefore banks run a risk, in the event of there being some difficulties, in enforcing those products,” he said.

In terms of a regulatory framework for internet and phone banking, there is a gazette notification which has been published which details how the Central Bank will regulate those transactions.

“The first year for IFRS in this country will be the year ending 31 December 2012 and I think this is obviously a challenge as well as an opportunity. Sri Lanka is going ahead with IFRS implementation whereas India has deferred it for a further two years mainly on the grounds of tax reasons, obviously from my point of view that is a great opportunity for Sri Lanka because it would be advantageous for us to say that we are ahead of a market like India.”