ECONOMYNEXT – Sri Lanka will act fast to resolve problems of finance companies that fall short of capital, Central Bank Governor Indrajit Coomaraswamy said, ending delayed action or regulatory forebearance which led to large holes in balance sheets and complete collapse of companies.
Finance companies in future will have to boost capital quickly when required.
"If finance companies don’t, we will have to take regulatory action. We will have to be brutal when we apply that," Governor Coomaraswamy told reporters.
In the US, the policymakers took away the discretion and the Federal Deposit Insurance Corporation, a resolution agency now acts quickly, because delays expanded the capital shortage and the gap between deposits and assets widened.
It was easy to find a buyer when the capital shortage was small, and even if there were no takers, the FDIC had to put in only a small amount of cash in a liquidation, when a lender was closed as soon as capital fell below a pre-determined threshold like 200 basis points.
The US has thousands of independent banks, dating back from its free banking era and also when branch banking was prohibited and a number of banks fail each year.
When the housing bubble fired by the Federal Reserve collapsed in 2008/2009, 140 banks coming under FDIC mandate failed, another 157 failed the following year.
At end-September 2018, the ratio of capital held at finance companies in Sri Lanka to cover risks (capital adequacy) fell to 11.1 percent from 13.2 percent a year earlier.
Because finance companies give loans to riskier clients than ordinary banks, they need higher capital buffers, according to some analysts.
Central Bank regulations introduced in July 2018 call for finance companies to have at least 10 percent capital adequacy. By July 2019, capital adequacy has to increase to 10.5 percent, eventually requiring 12.5 percent July 2021 onwards.
Analysts say Sri Lanka will need to legislate a threshold like 8 percent to effectively end regulatory forbearance.
Coomaraswamy said another step existing finance companies could take is to merge with peers to meet the minimum capital levels, since having over 40 finance companies in the country is ‘ridiculous’.
There was a spurt of new finance company licenses issued during the Rajapaksa regime. Several shadow banking institutions also failed at the time.
The current problems in firms like The Finance and ETI Finance, date back to the forbearance period.
"Non-compliance will result in restrictions on deposit and business expansion and, where necessary, winding up of businesses," Coomaraswamy said.
"Therefore, it will be necessary for finance companies to give priority to capital augmentation plans in the near future," he said.
"The change in the regulatory posture of the central bank will result in early interventions against noncompliant, distressed and high risk finance companies."
Many finance companies have primitive IT systems which are not capable of complex risk management.
Bad loans across finance companies were 7 percent at end-September 2018, up from 5.7 percent a year earlier.
Coomaraswamy’s hard hitting stance amidst concerns raised by officials that some that some finance companies are ignoring regulations, rights of depositors and risk management practices to please wishes of shareholders.
Coomaraswamy said central bank officials are closely monitoring and talking with other at-risk finance companies to stabilize them.
He said there is little risk to Sri Lanka’s economy if finance companies go bust, as they hold only 7.9 percent of the total assets in the financial sector.
"This long tail of very vulnerable finance companies are in turn a very small part of the total assets,"
Coomaraswamy said.
"Some larger finance companies are robust, and are as strong as banks."
"Having said that clearly there can be a contagion effect if there is instability in some institutions," he said.
Coomaraswamy said a deposit insurance scheme is settling what the companies owe their depositors. (Colombo/Jan02/2019)