Monday Nov 25, 2024
Monday Nov 25, 2024
Tuesday, 18 March 2014 00:35 - - {{hitsCtrl.values.hits}}
By Shabiya Ali Ahlam
The Government in its efforts to strengthen the local financial sector is confident that the push for consolidation will lead to a new equilibrium in the industry.
With the majority of the institutions in that sphere forced to change direction following the announcement for consolidation in the 2014 Budget, the Central Bank of Sri Lanka (CBSL) has continuously expressed and extended its support to ensure that the process is carried out in a seamless manner.
In an attempt to bring the industry up-to-date on the consolidation process and progress, Kenanga Investment Corp recently held a comprehensive forum on this topic which has been gaining much attention and emphasis as of late.
The forum, which saw senior officials of financial institutions in the audience, featured Consultant Arnold Kwan to share the Malaysian experience in this regard. In addition to Kwan, addressing the gathering was Central Bank of Sri Lanka Assistant Governor C. J. P. Siriwardena, and PWC Sri Lanka Senior Partner Sujeeva Mudalige.
Since going forward Sri Lanka will require a strengthened financial sector which can steer the country towards continued high economic growth while preserving financial system stability, essential areas of the financial architecture needs to be transformed to more efficient and productive units.
Required would be improved quality human resources to service the new financial sector, enhanced robustness and resilience of the financial sector though consolidation, enhanced global connectivity, both physically and through upgraded IT capabilities, strengthening of the sector’s regulatory processes to reach and compete at the international level, and the enhancement of the ability of banks to help their customers through effective business revival support.
The support to move towards a new vision
In that backdrop, Siriwardena pointed out that the policy of the CBSL will be forward looking and designed to balance potential worldwide sudden volatilities and to pre-empt, as much as possible, any possible financial distress or any possible failure in the future.
Adequate capital and other buffers will be put in place to prepare the local financial sector to withstand business cycles, without sacrificing investment potential during periods of global economic downturn, he said.
“The Central Bank’s role will be that of a pragmatic systemic risk mitigator, and a guide that encourages innovation in order to ensure the overall goal of financial system stability since instability in the financial sector takes a heavy toll to any economy,” said Siriwardena.
Local financial sector failures in the past
While financial sector failures in the past were costly and painful, the local industry, like many other countries, faced a number of issues within several intervals.
During 1988 to 1990, 13 registered finance companies failed out of which two such companies were revived by new investments and 11 companies were liquidated. In 2002, a bank failed and it was only in 2007 that the deposits of that institution were transferred to a new savings bank. In 2009, eight
NBFIs faced liquidity problems mainly because of the collapse of a related company in a particular group. Those NBFIs were gradually revived under restructuring processes, as agreed with the CBSL.
Not long after, in 2013 an NBFI faced liquidity problems due to certain directors of that company siphoning out funds. For this the CBSL initiated a restructuring process but was halted due to it being interrupted as a result of a stay order by Court.
Siriwardena noted that although the local financial sector is “stable” and plays an “important” role in the economy, it is highly fragmented. “Sri Lanka’s present financial system now needs some structural changes to ensure that banks and NBFIs are well positioned to meet the US$ 100 billion economy target envisaged by the Government.”
The banking sector comprises of 21 local banks and 12 foreign banks, whereas NBFIs include 49 finance companies and nine leasing companies. Banks and NBFIs account for 64% of the entire financial system assets where banks hold 57% and NBFIs 7% while only five domestic banks have asset bases of over Rs. 500 billion. 12 foreign banks account for only 10% of market share, although many have been in operation in Sri Lanka for many decades.
Proposed strategy to develop strong and stable financial system
While the pre-emptive strategy is to establish a strong and dynamic banking and NBFI sector in the future, the capital will have to be increased in order to ensure that sufficient buffers are built during good times to strengthen resilience of the financial sector. For this Siriwardena noted the banking and NBFI sectors will have to be consolidated through mergers and absorption of businesses.
To ensure financial system stability, the outcome in consolidation is expected to result in a banking sector where there will be a reduced number of banks as a result of mergers and absorptions, and at least five local banks will have assets of Rs. 1 trillion or more, having a strong regional presence.
“There will be a large development bank that will provide a substantial impetus to development banking activities in the country. Domestic banks which had assets less than Rs.100 billion will have assets of Rs.100 billion or more through organic growth and merger and absorption with other banks and NBFIs over a reasonable time horizon,” he said.
Expected outcome
In this scenario, foreign banks in Sri Lanka will be expected to demonstrate a greater participation in economic activities and will be making significant contributions to the economy.
The two large State commercial banks, Bank of Ceylon and People’s Bank will be encouraged to grow and expand towards a stronger regional presence, and to operate with higher levels of capital. They will also be expected to strengthen their off-shore banking operations and be able to attract funds, as well as conduct private banking on a wider scale.
The National Savings Bank will be encouraged to broad base their banking activities to contribute to the economy on a larger scale. The Pradeshiya Sanwardhana Bank will be encouraged to serve the niche market of microfinance, targeting inclusive growth in the provinces.
The other smaller State banks will be encouraged to merge with the bigger state banks or with one another and play a more cohesive role, since at present these banks account for just 1.1% of the market share.
With regard to NBFIs, it is hoped that the number of such institutions will be reduced to 20, of which three would be specialised in micro finance. Each NBFI will have an asset base of over Rs. 20 billion over the period and will have improved loss absorbency capabilities and enhanced resilience to internal and external shocks due to the increase of the quality and quantity of capital.
Whilst they will be able to attract low cost, long term funds in the form of deposits and debt instruments, they will have improved cost efficiencies in order to be competitive, the ability to diversify their business models and be ready to deal with market volatilities, to be able to manage risks in an integrated manner, and have improved governance along with fit and proper directors and senior management.
The detailed strategy
The present NBFIs will be identified as category A, C, and C in preparation for the consolidation. Category A NBFIs are those with assets more than Rs. 8 billion, core capital more than Rs. 1 billion, and a high degree of compliance with the directions issued by the CBSL. Category B are LFCs or SLCs, or groups of such that do not fulfil one or more of the criteria of the Category A. Category C are those NBFIS where businesses are at a standstuill, and no action pertaining to the consolidation is possible dure to the stay order issued by the Court of Appeal in respect of the restruturing plan. There is only one such institution in this category.
The consolidation approach will be where local banks and category A NBFIs will discuss with category B NBFIs and identify merger partners and agree terms and conditions for mergers and absorptions. All Category B NBFIs are to merge with local banks or Category A NBFIs, or merge among themselves so that they fulfill conditions of the Category A NBFIs.
Siriwardena noted that in the event that a Category B NBFI requires a capital infusion by the acquiring bank or Category A NBFI as per a plan that is approved by the Central Bank, a matching support to the acquiring entity via the Deposit Insurance & Liquidity Support Fund would be provided.
The local banks and Category A NBFIs would be encouraged to acquire and absorb one to three category B NBFIs. He pointed out that initially the local banks and Category A NBFIs will be given a time period of until 31 March 2014 to identify partners of their choice from within the Category B NBFIs for such mergers and absorptions.
Deadlines
All banks and NBFIs will be expected to adhere to a rather focused time line. For merger of NBFI within the group the submission of the action plan to the CBSL should be done before 31 March 2014, and the target date for completion is set for 30 June 2014.
For merger and absorptions of Category B NBFIs by banks or Category A NBFIs the deadline for proposal submission is 31 March 2104 and majority of the Category B NBFIS are expected to be absorbed by December 2014, while any remaining are expected to be completed within the first half of 2015. For increase the minimum core capital of NBFIs to Rs. 1 billion and Rs. 1.5 million is set for 1 January 2016 and 2018 whereas the action plan should be put forward before 31 December 2014.
Siriwardena stressed that while all banks and NBFIs will be expected to play their role actively and effectively, local banks and NBFIs will be required to submit broad plans by the date as specified for possible mergers and absorptions, and foreign banks to submit broad plans by the dates as specified for the greater participation in the economy.
Merger and absorption plans that are submitted by banks and NBFIs would be evaluated and approved by the CBSL. The required financial, tax and HR due diligence will need to be carried out by reputable firms, preferably those with international expertise in such processes, while the purchase consideration must be based on sound internationally accepted, market-based principles, he noted.
However if it is observed that any Category B NBFIs may remain unabsorbed after 31 March 2015 the CBSL may consider such a situation as a possible threat to financial system stability. In such an event the CBSL will issue directions to any bank or NBFI directing such institutions to implement and undergo a suitable consolidation process under the provisions of the Monetary Law Act, Banking Act or Finance Business Act.
Support extended
Siriwardena shared that in the merger absorption process the accounting, valuation, tax, Human Resources and other due diligence practices will be supported. Firms of accountants with international connections and the Institute of Personnel Management have been invited to provide advice and guidance to Banks and NBFIs, to assist them in this process. The payment of consultancy fees for necessary advice and guidance that will be provided by the consultants on accounting, tax, valuation of businesses, HR issues, and others in the merger and absorption processes will be met by the CBSL.
At the same time, all banks and NBFIs will be free to obtain any advice and/or guidance from any other source they prefer as well, at their own cost. The tax concessions and benefits proposed in the Budget 2014 are expected to facilitate the consolidation process.
“The seriousness of the envisaged consolidation process is confirmed by having tax benefits provided in the Budget 2014. The President in his Budget speech proposed to give qualifying payment status for acquisition expenditure of banks or finance companies if they have acquired any finance company,” recalled Siriwardena.
He added that the exact details and implementation of such benefits are now being finalised with the Ministry of Finance and Planning and the Department of Inland Revenue and will soon be notified.
While the CBSL will closely guide the merger/absorption process to ensure that it will be smooth and constructive, each bank and NBFI must form a steering committee for this purpose. The relevant banks and NBFIs must submit monthly reports on their progress regarding the mergers and absorptions to the CBSL. Banks and NBFI sectors will be expected to align their immediate future business expansion, new recruitment and other capital expenditure in keeping with the new developments, and a special unit of the CBSL headed by an Assistant Governor will liaise between all stakeholders to ensure the successful implementation of the merger/absorption process.
The CBSL will issue public notifications from time to time to apprise the overall progress of the process and will also liaise with other authorities such as Securities and Exchange Commission (SEC) and Colombo Stock Exchange (CSE) and Registrar of Companies, wherever such support is needed.
Impact on HR
The government having continuingly stressed that the consolidation process must not adversely affect the staff of the respective institutions, institutions are to ensure that no staff member is to be forcibly retrenched as a result of these merger and absorption processes, and no salary of any employee is to be reduced from that prevailing as at 31 December 2013.
Furthermore, those involved in the merger and absorption process will be encouraged to appoint competent Human Resource consultants to perform independent reviews on senior management.
Progress achieved so far
According to Siriwardena, the progress so far in the consolidation process is noted to be very encouraging and is in line with the ‘Master Plan’ the CBSL Governor announced earlier this year. Since unveiling the Master Plan on financial sector consolidation one to one meetings were held with all banks, registered finance companies and specialised leasing companies, and positive response from the financial institutions have been received.
While having met the Ceylon Bank Employees’ Union to clarify matters, the CBSL has successfully managed to maintain a close dialogue with the approved panel of auditors and other consultants. Furthermore, discussions were held with the Securities and Exchange Commission and the Colombo Stock Exchange, and the Ministry of Finance and Planning on matters related to taxation.
Started also are the independent due diligence and valuation process by auditors under the guidance of the Central Bank. “The overall response was positive, considering the need to build strong and dynamic financial institutions to preserve stability. Many chairpersons along with their respective boards and CEOs appreciated the proposed benefits of the consolidation process and echoed the need for consolidation in the financial sector for a number of reasons.”
Siriwardena noted the reasons as to strengthen balance sheets to give an impetus to growth and stability in this country have greater connectivity to regional and global markets, inculcate strong governance and risk management practice, address the contagion and spill-over effects and systemic risk and strengthening the public confidence.
Foreign banks have also expressed their commitment to grow and support the 5+1 Hubs and bring in expertise on introducing superannuation products.
Moreover, due diligence and valuation of business has been initiated. The Central Bank has requested the nine auditors to conduct the due diligence and valuation of business of Category B NBFIs and all other consultants to work with these Auditors.
Consistent scope and business valuation methods are to be in place, the Central Bank will expect independent and professional output from the auditors. These DDs and business valuations will be carried out using acceptable standards and will provide price guidance to buyers and sellers.
Pix by Upul Abayasekara
