Can Sri Lanka Bank on Banking? 0 1313

The Sri Lanka banking sector is a vital cog in the economic wheels of the country as it accounts for 37pct of the stock market capitalization (Table-1). A shock in the banking sector could spell deeper repercussions.

The Sri Lanka Banking Report published by the Central Bank indicated that the banking sector is in a dire situation with non-performing loans (NPL) rapidly rising given the shift in monetary policy towards a tightening stance. Businesses across all sectors have therefore seen their cost of debt increase by 100% as interest rates shifted from 7pct to 14pct during the three year period. The data therefore indicates that the large blue chips and SME sectors are running into significant difficulties in meeting their loan obligations, such actions could have an adverse impact on bank risk capital (Figure-1). The bad news is that apart from the SME the other sectors too will find it hard to manage their working capital with payments been delayed and their financial costs escalating.

Tighter monetary policy

The Central Bank of Sri Lanka has continued its tight monetary policy stance for almost 3 years. The 2018 year end inflation points to real interest rates of around 10 pct. Private sector credit growth has slowed down to 13pct over around 22pct two years ago.

The decline in banking sector profits is widespread and is reflected in the negative business sentiments. The spill off is also visible in the banking sector NPLs which increased from 22pct in Q1 to 27.4pct in Q3 and is of great concern, for banks will be forced to cut out lending to interrelated sectors until such time balance sheets are re-structured and the profit story materializes. The Central Bank has highlighted that the overall gross NPL ratio of the banking sector increased to a three year high.

High adjustment costs on the economy

On top of tighter monetary policy (Figure-1) NPLs too have significantly risen due to the lower and slower growth rates in the economy since 2015, higher fuel price adjustments, and lack of credit being extended by banks, while the 19.5pct rupee depreciation has negatively impacted real sector profits. The rupee depreciation has not had much of a positive impact on the export sector as it too is badly impacted, given higher interest rates needed for working capital. Trading companies and SMEs too have found no respite to the declining rates of profits. The use of foreign supplier’s credit for the import and export business has lost its attraction, given higher and volatile exchange rates. Similarly, the agricultural sector continues to struggle as it was hampered due to inadequate fertilizer supplies, adverse weather conditions witnessed until 2018, Q3 low producer pricing and marketing related issues.

Construction worst hit

The construction sector was particularly affected due to the government lagging on its loan repayments for most of the ongoing construction projects, which is estimated to be LKR 80 billion. On top of the delays in payment by the government, the rupee depreciation of 19.5pct has pushed raw material prices higher, eroding profits further. Therefore the bad news for the banking sector in the coming months would be the NPL’s continuing to follow the rising trend, along with contraction in banking sector profits.

Taxes suppress demand

Ironically profits earned by banks too will be subject to an effective taxation 57pct, thereby making any concessionary funding to the struggling economy even more remote. Due to these challenges faced by the business environment, consumption related loan exposure impairments and regulatory implications, banks, and with it the real economy will face significant head winds in the months ahead.

Provisioning challenges

The banking sector is facing two other challenges, namely, the new accounting standards on loan loss provisioning (IFRS-9) and the introduction of new capital adequacy regulations by the Central Bank.

The new capital regulation ties in both credit loan loss provisioning (IFRS-9) and capital requirements (Basel -3) have made it compulsory for banks to provide for credit losses, and calls on banks with assets less than LKR 500 billion to maintain a capital i.e. common equity, Tier 1 (CET1) of at least 7.0pct, an increase by 21pct from its previous 5.75pct of their Risk-Weighted Assets (RWAs), while banks with an asset base above LKR 500 billion would be compelled to maintain a minimum Tier 1 capital of at least 8.5pct, an increase of 36pct from its previous requiring of 6.5pct. These credit provisioning and capital requirements must be in place, thereby adding more to the stress on to the total cost of capital as capital i.e. Tier 1 and Tier 2 capital, should at least be 12.5pct. The rules of credit and capital requirements should in place by January 2019. Similar to the rest of the economy the banking sector also sees higher associated costs due to the credit risk factors, and the higher default probabilities impacting the balance sheets of banks.

Focus on compliance at cost of relationship building

It is not surprising that under these stress conditions and compression in net profits Sri Lanka’s banking sector is now more focused on compliance and less focused on banking relationship building (i.e. managing the business cycle), as they are forced to consider supplementing their capital base further with the existing loan/risk assets and clients. The general perception is that banking will shift from relationship building to compliance building with the new capital rules and provisioning rules of accounting (IFRS-9).The end result is that these rules would be that customers will merely be a numeric value as tighter credit rules require banks to inject incremental capital in a highly costly monetary environment and not be seen as a business cycle/human activity.

Relevance of development banking

Sri Lanka does not have a development bank to help out in long term capital formation, and this shortfall is widely felt by industries. Both DFCC and NDB are now modeled in the traditional banking mold and has shied away from providing development assistance. Sri Lankan born Prof. Howard Nicholas was in fact critical of the government for privatizing both development banks (DFCC and NDB). He voiced his displeasure at the Sri Lanka Inc. economic forum where he stated, “One of the worst things that was ever done in Sri Lanka is the privatization of the NDB & DFCC. And the reason is that all these countries, all the successful countries I mentioned, had one policy and one policy only, that was development banking, state development banking”. For development banks are more accommodative in their credit assessments and more balanced in their shareholders objectives, thus development banks are able to balance growth needs and business cycle outcomes.

Thus the high cost of capital will only negatively impact banking sector earnings/net profits(Figure-2) and will make credit growth impossible with the new loan loss accounting standards forcing banks to move away from Knowing Your Customer to unknowing their customers. It is therefore safe to say that further loan impairments would only increase due to the reluctance by banks to restructure loans of ailing businesses that are already hemorrhaging from higher debt servicing. While their own operating costs are escalating, and stringent accounting rules push them to a point of freezing new credit. It is therefore safe to say that higher cost of capital, fear of credit and the weakness in the economy is making banking on banks extremely remote under these conditions. The final assessment is that it is plausible that the banking sector could manifest into one destructive force if the current trend of risk averse banking takes place unaddressed and slips past the government’s attention, which could eventually increase the NPL ratios in 2019 beyond that of 2018.

By Dr Kenneth De Zilwa


Leave a Reply

Your email address will not be published. Required fields are marked *

Bilateral Free Trade Agreements: Are we on the Right Track? 0 719

The process of Sri Lankan policy reforms of liberalisation since 1977 has been predominantly unilateral. These reforms were undertaken in a global context of multilateral trade and tariff reforms under the guidance of international organizations like GATT and WTO. In addition, Sri Lanka joined in the efforts of liberalisation at regional level, e.g. the South Asia Free Trade Agreement (SAFTA) under SAARC initiatives. Multilateral and even regional trade negotiations however, have proved very slow and cumbersome. Bilateral and preferential trade agreements have become attractive globally, as well as in Sri Lanka.

The first experience of post-independence Sri Lanka in bilateral trade agreements was the well-known Rubber-Rice Pact of 1951 between Sri Lanka (then Ceylon) and the People’s Republic of China. It was a simple bilateral bartering agreement which provided a win-win solution to the two participating countries. The recent Sri Lankan interest in pursuing bilateral and preferential trade agreements can be traced to the 1990s. Three FTAs have been signed and implemented since then. The India-Sri Lanka Free Trade Agreement (ISFTA) was signed in 1998 and entered into force in March 2000. The Pakistan-Sri Lanka Free Trade Agreement (PSLFTA) came into force in June 2005. The Sri Lanka Singapore Free Trade Agreement (SLSFTA) was signed and made effective in 2018.

The ISFTA and PSLFTA are simple agreements covering the trade of goods between the respective partner countries. The SLSFTA in contrast, is a comprehensive agreement covering trade in goods, sanitary and phy-to-sanitary measures, and technical barriers to trade, customs procedures and trade facilitation, trade in services, telecommunications, E-commerce, government procurement, foreign investment, competition, intellectual property rights, transparency rules and matters of economic and technical cooperation. Sri Lanka may choose to negotiate its future FTAs in the same format as that of the SLSFTA. The new FTAs would then be comprehensive/deep agreements. Such ‘deep’ FTAs influence border-related policies as well as beyond-the-border policies. Liberalization through bilateral FTAs is being given priority with multiple objectives.

Several issues must be raised on this declared approach of expanding the policy scope of FTAs. A fundamental issue is that FTAs, particularly comprehensive FTAs, restrict the policy autonomy of the government to a significant extent. In today’s global institutional and organizational structure the policy autonomy of a small country is no doubt extremely limited. It may be for good reasons that the policy makers in Sri Lanka opt to get their policy autonomy further constrained by a series of FTAs. Here the opinion makers in the country seem to demand the following. The reasons for signing an FTA ought to be transparently shared with the public. Adequate research ought to be conducted to establish that any envisaged FTA would generate net positive benefits to Sri Lanka. Further the feasibility of the envisaged FTA should be carefully examined without rushing into signing. The planned FTAs are to be signed with countries with greater experience and equipped with better institutions. If adequate care is not taken, the signing of an FTA could produce extensive adverse effects on the country’s development efforts.

”From an overall point of view, Sri Lanka, as it stands today, is in an extremely weak competitive position in the global economic set up”

There are many needed domestic economic reforms. Some of these could lead to further liberalization. At the same time, there could also be critical intervention by the state in some fields. Before envisaging any more FTAs, priority must be accorded to domestic policy reforms based on a coherent national development framework and a widely-accepted national foreign trade policy.

There is another danger in the current declared policy of moving toward two more FTAs and a comprehensive agreement with India, in addition to the three FTAs currently in force. FTAs are not the best way to improve Sri Lanka’s competitiveness or productivity which is constrained by various structural and institutional factors. None of these factors can be resolved by entering into FTAs. In addition, operating a number of FTAs with different countries, involving multiple Rules of Origin, can make the foreign trade system extremely complicated, distorted and cumbersome.

Sri Lanka does not yet have a firmly established institutionalised procedure within which international trade agreements, particularly those so-called comprehensive agreements, can be negotiated and implemented. Strong legal, regulatory and institutional frameworks are needed if the national interest is to be safeguarded in the process of negotiation and implementation of bilateral preferential FTAs. Entered into without due care, bilateral trade agreements could turn out to be, in the long run, contractual traps with obligations, without worthwhile advantages to gain.


Millennium Challenge Corporation in Sri Lanka: Paving the Way for Land Grab by Multinational Companies Comments Off on Millennium Challenge Corporation in Sri Lanka: Paving the Way for Land Grab by Multinational Companies 1002

Article by: Prof. W. D. Lakshman

The decision of 29 October 2019 by the outgoing Cabinet to sign a compact with the Millennium Challenge Corporation (MCC) has given rise to extensive public discussion and debate. A new President has been elected on November 16, 2019, with a new Prime Minister and a new Cabinet sworn in soon after. The new government is bound to reconsider its predecessor’s decision to sign the MCC agreement.

The proposed MCC compact, once signed, would make a US government grant of USD 480 million available for expenditure in two Sri Lankan projects – a transport development project (costing $400 million) and a land project (costing $80 million). These two projects are supposed to address two binding growth constraints in the country: inadequate infrastructure of transport logistics and restricted access to land for investment purposes. The MCC grant funds will be disbursed in stages over a period of five years. Unlike other official grants, the MCC grant will not be disbursed to the Sri Lankan government. Instead, these funds will be channelled into a Sri Lankan private company specially set up in Colombo for this purpose by the MCC to be used in the implementation of the two accepted projects. This company will monitor the progress achieved in the projects concerned and grant funds will be released step by step if progress achieved in each stage is judged satisfactory. The US government reserves the right to terminate the operation of the project at any time if the MCC is not satisfied with project implementation progress.


It is good to begin this brief article about the desirability or otherwise of signing the MCC compact by placing the MCC in its proper global perspective. The “Western development establishment” led by the US has dragged increasing numbers of developing countries into the net of neoliberalism since the 1970s and 1980s. Sri Lanka has the dubious reputation of having been a pioneer to be so dragged into a neoliberal policy framework. The use of foreign aid conditionality has been the mechanism widely used by the Western development establishment to neo-liberalise developing countries.


The IMF and the World Bank have formed the institutional mechanism used in the process. Under conditionality, the countries receiving grants and loans on concessionary terms were required to gradually meet the laid down policy conditions after loans were authorized and dispensation commenced
in tranches. The grant “assistance” to a developing country1 through Millennium Challenge account of the US signifies a different way of converting the developing country victims into a neo-liberal policy framework. This method has been described as “preemptive” development assistance. It entails refusal and withholding of funds until demands made by the donor country are met.

The conditions to be met are listed under three broad headings, namely
1) ruling justly (good governance);
2) investing in people (health and education for all);
3) “economic freedom” (sound economic policies that foster enterprise and entrepreneurship)

Subscribe the BiZnomics magazine for full article