Sri Lanka warned against continuing interest price controls by IMF

ECONOMYNEXT – Sri Lanka has been warned against continuing its controversial price controls on bank lending rates by the International Monetary Fund, in the wake of a spike in overall rates in as the island’s soft-peg came under pressure in 2018.

“Caps on lending rates and the loan repayment moratorium for small and medium enterprises should be temporary, to avoid unintended distortions and inefficiencies in financial intermediation,” IMF Mission chief Manuela Goretti said in a statement, at the end of visit in February.

The central bank also slapped deposit price controls on banks which were removed.

The central bank said the controls are to be reviewed in March.

Sri Lanka’ banks and non-banks has also seen a spike in bad loans, after the collapse of the soft-peg, though they are not high by historical standards.

“The financial system remains broadly stable, although some pockets of vulnerability remain, especially among non-bank financial institutions” she said.

Sri Lanka cut rates and injected liquidity in April 2018, as the economy recovered from a previous collapse of the currency, triggering another period of monetary instability.

In formal banks, bad loans grew from 2.5 percent of total loans to 4.9 percent by September.

Bad loans in the sub-prime finance company sector which fell to 5.93 percent of total assets in March 2018 grew to 9.86 percent by September 2019.

Some non-bank lenders were also hit by a government promise of micro-lending which led to intentional defaults.

Bad debts in leasing companies grew from 2.59 percent in March to 4.47 percent.

Sri Lanka’s central bank was set up in 1951 with wide powers, by an US official at the time when semi-socialist ‘New Dealer’ mentality was still strong in the US Treasury, and just before, the Fed gained its independence from the Treasury.

“The Monetary Law also seeks to give the Central Bank of Ceylon, powers of control over the direction as well as over the quantity of bank finance in Ceylon,” an analyst wrote in the 1951 August issue of The Banker Magazine in London as Sri Lanka’s money printing central bank was established.

“Although this is intended primarily as an anti-inflation regulation it is obvious that it can be used to slow down or prevent the increase of any particular type of credit which the Monetary Board regards as undesirable,” the Banker Magazine warned.

The central bank could slap portfolio ceilings, prescribe minimum capital and minimum cash margins as cover for any letters of credit they open.
“One other control granted to the central bank, that of limiting the interest paid by commercial banks on deposits or changes on loans, is apparently intended to be used only sparingly,” The Banker noted.

“It will be obvious from this summary that the new Monetary Board is going to be given almost unlimited power of control over the banking system of Ceylon, – a power which, if misused could do irreparable harm to the island’s economy.” (Colombo/Feb10/2020-SB)