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Sri Lanka public to guarantee losses, fraud in finance companies

Nov 23, 2015 07:02 AM GMT+0530 | 0 Comment(s)

ECONOMYNEXT - Sri Lanka's central bank will guarantee all deposits at finance companies from January 2016, the most risky among deposit taking institutions, and fund will be set up to bailout troubled firms, the budget for 2016 said.

Money from tax payers had already been used in a controversial move by the current administration to bailout depositors and let the directors off the hook at Golden Key Credit Card Company, an illegal finance company 

Several licensed finance companies are also in trouble because the Central Bank had not taken early action and there is no legal requirement or process to automaticallya and quickly force the liquidation of firms that fall below their capital requirements like in the US.

"To find a long standing solution for this issue, a Financial Institution Restructuring Agency (FIRA) on the lines of the Resolution Trust Corporation in the United States of America will be established shortly to help failing finance companies to be recapitalized and their troubled assets to be taken over by this agency for purposes of restructuring" Finance Minister Ravi Karunanayake said in the prepared text of a budget speech.

"The Central Bank will be entrusted to undertake strict supervision on this restructured finance companies.

"However, as a prelude to the above proposal in order to provide the depositors with a sense of comfort and security, the Central Bank of Sri Lanka will give a 100 percent guarantee on all deposits of all the registered finance companies by end January 2016."

Finance companies trade in the riskiest category of lenders and generally pay a higher rate of interest. Well managed finance companies also have a higher capital buffer of up to 15 percent of risk assets.

If the restructuring agency proposal is delayed by giving a guarantee for deposits, which is now available only to the National Savings Bank and Treasury Bills, the public may perceive finance companies to be safer than commercial banks.

Credit guarantees by the state encourages even more risk taking by finance companies.

It will also add to the contingent liabilities of the state.

Analysts also say the setting up Resolution Trust Corporation style fund is not a long term solution to finance company failure as claimed, but is a fire fighting reaction necessary to fix firms that are already in trouble.

In the US the Resolution Trust Corporation was set up to take over and liquidate over 700 entities in housing finance which collapsed after the Fed raised interest rates in 1980 ending a bubble fired during 1970s.

The long term solution was to give powers and skills the Federal Deposit Insurance Corporation to liquidate firms whose capital fell below the regulatory minimum without any discretion or 'regulatory forbearance' to delay liquidation like in Sri Lanka.

By forcing liquidation when capital falls below a regulatory minimum (such as 8 percent of risk weighted assets) and taking away the discretion to delay liquidation, early action is taken when a lender has bad loans and the cost to the public is minimised.

Most of Sri Lanka's finance companies got into trouble after 2004, when the then administration delayed rate hikes amid deficit spending and printed money firing a massive housing and inflation bubble.

The bubble collapsed around 2008, with a balance of payments crisis, leading to the collapse of several firms involved in property including the Ceylinco group.

Analysts have warned that the Central Bank, by engaging in a rate cut in April and printing money generally after that is also firing another credit bubble, which will have serious negative effects when it moves to property speculation. (Colombo/Nov23/2015)


 

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