ECONOMYNEXT – Small depositors of Sri Lanka’s ETI Finance who are owed up to 600,000 rupees could be repaid if the firm is liquidated but assets and deposit insurance may cover only up to 65 to 70 percent of all liabilities, the government has said.
ETI Finance owes about 33 billion rupees to depositors but there is a big hole in its balance sheet.
Illegal Accounts
A central bank probe in 2012 had found that Swarnamahal Jewelllers Pvt Ltd, a company, which had no license, was taking public deposits illegally, State Minister for Finance Eran Wickremeratne told parliament.
The probe had also found that ETI Finance, which was a licensed finance company, was keeping a second set of books and taking public deposits which were not disclosed to the central bank.
The illegal and undisclosed deposits had totalled 13.68 billion rupees.
The directors of ETI had asked the central bank to amalgamate the deposits with the licensed firm. The monetary board had permitted it.
On September 14, 2015 the Monetary Board had directed the firm to transfer privately held companies, and asset of directors to cover the liabilities, Wickremeratne said.
Though some assets had been transferred complying with the directions of the central bank to some extent, the directors had failed to fully revive the firm.
Insolvent
On May 22, 2017, the chairman of ETI Finance had informed the central bank that the firm was unable to repay all the money that depositors were demanding back and asked for a state managing agent.
The central bank had then audited the firm and its subsidiaries to see whether a state managing agent can revive the firm.
On January 02, 2018, the monetary board had appointed three retired senior bankers to monitor ETI Finance. The search for a strategic to revive the firm had failed.
The directors had then found a buyer for the related companies. The monetary board had approved the sale of assets for 75 million US dollars.
About 32 million US dollars had so far been received which will be used to settle 10 percent of the deposits from June 05. Another 10 percent will be repaid when the balance 43 million dollars are received.
Swarnamahal Finance will be taken over by the new investors, Blue Summit Capital Management (Pte) Ltd, a Singapore-based investment firm, who will present a business plan to revive it.
The monetary board had ordered directors of ETI to inject another billion rupees to the firm by June 15.
Deadline
The directors have been given time till September 30 to bring in new capital or investors to fill the remaining gap in the balance sheet and business plan to be submitted by June 15.
The central bank had also directed directors not to sell or transfer any private asset without their approval.
If no new investor is brought ETI Finance will have to be liquidated under existing law.
In a liquidation all depositors will get back up to 600,000 rupees of their deposits.
The deposit insurance may bring about 9.0 billion rupees.
Action will also be taken against officers of the firm, who had engaged in illegal activities.
Shortfall
The firm had about 33 billion rupees of deposits. The investor will bring about 11 billion rupees (75 million US dollars). Another two billion may come from selling residual assets.
"It may be possible to raise 65 to 70 percent of the money," Wickremeratne said. "There may be about 30 to 35 percent shortfall."
"The balance will have to be sought from the directors through court proceedings. Since that may take a long time, decision will have to be taken whether balance is repaid by through the taxes raised from other people."
"There is also a view that it is not suitable to take the taxes from other citizens to bailout these companies."
Regulatory Forbearance
While it is not possible for any regulator to eliminate business risks and bank failures, analysts say Sri Lanka’s problem is due to discretion and regulatory forbearance where automatic liquidation is not mandatory when assets fall short of liabilities or the erosion of capital.
In the US the problem of regulatory forbearance was solved by the Federal Deposit Insurance Corporation by instituting mandatory liquidation as soon as regulatory capital fall short of a pre-determined floor.
In Sri Lanka finance companies generally have a bigger capital buffer of about 15 percent of risk assets, compared to about 10 percent for banks.
A mandatory liquidation when capital falls below 10 percent will give no discretion for the central bank to delay liquidation in case some assets go bad, and the shortfall to be met by any deposit insurance will be limited to the capital deficit and losses in the forced sale of performing assets.
However due to leverage, the when liquidation is delayed, the capital deficit tends to go up exponentially with each month resolution is delayed. The firm may also have to offer excessively high rates of interest to retain deposits further compounding the problem. Sri Lanka has the additional problem of depositors chasing excessively high rates and not distributing their risk.
Risk and Reward
Old pensioners, who are the people who can take the least risk are among the biggest investors in finance companies. There is lack of awareness that chasing high rewards (high interest rates) also carries more risk.
Sri Lanka started international rating agencies to show risk but despite Fitch Ratings giving a ‘CC’ rating and withdrawing it new depositors continued to place money in the firm which no longer had a rating.
Janatha Vimukthi Peramuna leader said a businessman he knew had sold a hotel last year and deposited 50 million rupees in ETI last December.
Analysts say rule of rating may also need to be reformed.
No firm that had either public deposits or rated bonds should be allowed to terminate a rating agency unless another agency is also brought in at least a year earlier, they say.
This will bring double scrutiny on any company that is engaging in ‘rating shopping’ (Colombo/May25/2018)