ECONOMYNEXT – Sri Lanka is improving the process of dealing with failing banks and finance companies and which will prevent contagion in to the broader economy, Central Bank Governor W D Lakshman said.
“A robust resolution framework is an essential part of a healthy financial system,” Governor Lakshman said delivering an annual policy roadmap for 2021.
“The Central Bank has already taken measures to put in place such a framework with the aim of maintaining overall financial system stability.”
When banks or finance companies run out of capital, early resolution means depositors can be repaid with small compensation payments and other agencies would be more willing to take them over as capital deficiencies are small.
Sri Lanka’s regulatory forbearance (delay in taking action) has been blamed for large capital deficiencies in finance companies.
In many jurisdictions large banks are bailed out as being ‘too big to fail’ and others are liquidated quickly.
The Central Bank had also started designating domestically systemically important bank (D-SIG), long before the current Coronavirus crises erupted. However the Coronavirus crises had led to relaxation of some rules and thresholds to help tide the situation.
Under then-Governor Nivard Cabraal, a deposit insurance scheme was started.
Governor Lakshman said it is being further improved.
“We have already commenced revising the Sri Lanka Deposit Insurance and Liquidity Support Scheme (SLDILSS) Regulations to ensure an efficient and effective compensation payment mechanism in the event of financial institution failures,” he said.
“The Central Bank will also take measures under the Resolution framework to mitigate the contagion effect of any failure of a financial institution and to stem spillover effects on the real economy.”
Analysts say in better functioning markets, ‘failing or likely to fail’ banks are liquidated or if a recovery plan is not accepted. In the US the Federal Deposit Insurance Corporation has mandatory capital thresholds for action and will usually deal with a bank over the weekend.
Other jurisdictions have different arrangements, which are triggered at different points.
Action had already been taken on several finance companies. Licensed Finance Companies (LFCs) and Specialised Leasing Companies (SLCs) sector had also slowed due to the Coronavirus pandemic and bad loans had gone up.
“The Central Bank continued to monitor key prudential indicators, while considering how companies with weak financial positions could be revived and how measures could be introduced to clean up their balance sheets,” Governor Lakshman said.
“To safeguard depositors and to ensure long-term stability of the financial sector, necessary action has been taken to cease or limit finance business operations of those finance companies, which have continued to display weak performance.
“Further, several measures were introduced providing flexibility to LFCs and SLCs in order to facilitate their operations in supporting businesses and individuals affected by the COVID-19 pandemic.”
A legal frame work to regulate money lending activities for Micro finance institutions will also be introduce in the future once the approval of the cabinet for the presented draft.
“The Monetary Board has approved the draft of a Microfinance and Credit Regulatory Authority Act (MCRA),” Lakshman said.
“The approval of the Cabinet of Ministers for this is awaited. Once enacted, this will be helpful in further strengthening financial system stability and improving financial inclusion in the country.
“Enactment of a legal framework to regulate unregulated moneylending activities, thereby creating a better and more effective regulatory environment for moneylending institutions, is of utmost importance.”
He warned that in a low interest environment, depositors may go for risky investments chasing higher returns.
“All stakeholders in the evolving financial system have an important role to play, especially in times of a low interest rate environment, where high rewards are often associated with high risks,” he warned.
“As such, depositors should always be cautious in investment preferences, balancing risks and rewards, while the financial institutions are required to take calculated risks and offer competitive returns so that the financial system becomes efficient and sound.”
If interest rates are below market, when rates return to normal or go up due to currency trouble, the underlying businesses fail, triggering bad loans.