ECONOMYNEXT – Sri Lanka’s cabinet has given the nod to borrow 150 million US dollars from the World Bank to strengthen the financial sector and bolster a deposit insurance fund, Transport Minister Bandula Gunawardana said.
Sri Lanka has discussed with the World Bank a liquidity support fund and deposit insurance scheme.
The 150 million US dollars would be used to strengthen a deposit insurance scheme and institutional capacity of the financial safety net.
The cabinet had given the nod for next steps to borrow the 150 million US dollars from the World Bank. The agency is supporting a series of reforms under an International Monetary Fund plan to stabilize Sri Lanka, including the financial sector.
World Bank is expected to give around 1,750 million US dollars in policy based lending to Sri Lanka alongside the IMF program.
Sri Lanka’s banking sector has ended with a large volume of bad debts after large volumes of money was injected to the banking system under flexible inflation targeting cum output gap targeting, triggering the worst currency crisis in the history of the agency.
The IMF gave technical support to Sri Lanka to calculate a ‘potential output’ an controversial econometric tool, during a time when money printing became a fad in the West, despite the central bank going for bailouts 16 times.
Soft-pegged or intermediate regime central banks typically inject large volumes of money to maintain an artificially low policy rate and then sterilizes interventions with more liquidity, allowing banks to give loans without deposits.
The mal-investments then trigger bad loans after rates correct upward. Sri Lanka’s ‘Stage 3’ bad loans which includes, Coronavirus pandemic impact was 10.9 percent of loans, from mid single digits earlier.
Usually after a panic in the currency is triggered with a combination of flexible exchange rate and flexible inflation targeting or similar impossible trinity regimes, steep rate hikes are required to bring back confidence by smashing credit, critics say.
The bonds bought back or kept as security for liquidity injected to maintain the artificially low policy rates are not classified as ‘claims on commercial banks’ but ‘claims on government’, making people believe that budget deficits are the problem and not the policy rate. (Colombo/Apr25/2023)