BANKING SECTOR
Compiled by Shirley Candappa
RESPONDING TO THE CRISIS
Russell de Mel explains how the banking sector can aid economic recovery
Q: Since the economic meltdown, Sri Lanka has been facing fiscal disaster and sky-high inflation… So what role can banks play in combatting inflation and reviving the economy?
A: Banks play the role of intermediaries; they mobilise funds from shareholders, depositors and lenders, as well as multilateral agencies, to borrowers and investors.
Through this process, banks derive a margin that’s deployed to cover their overheads, capital, possible provisions, taxation and returns to shareholders.
They also have to contend with fiscal policies set by the government, and operate within the Central Bank of Sri Lanka’s monetary management policies and guidelines – including those introduced to curb inflation.
The high interest period did address rapidly spiralling inflation, and encourage savings through restricted investments in capacity expansion, new projects and so on.
During this period, most banks focussed on managing liquidity rather than asset expansion by strategically moving their products such as trade finance, import substitution and exports, which are conducive to economic growth.
A bank that follows the principle of sound risk management essentially focusses on responsible lending. This entails effectively managing cash and liquidity, changing gears to curtail rapidly expanding consumer and retail lending, being vigilant in identifying early warning signals and changing focus to the quality of its bottom line.
These measures helped banks withstand market pressures, and enabled them to remain strong and support the revival of our economy.
Q: How badly has our default in repaying outstanding foreign debts affected the banking sector – and are banks in a perilous situation as a result of this?
A: The closure of many business units, mounting arrears and carrying unsettled debts over a very long period due to diverse moratoriums have to some extent disfigured and disguised the banking sector’s performance.
Banks that were disciplined in making timely impairments linked to cash flows had no view of – leave aside control over – cash flows for a long time. But when the moratorium period ended, banks had to contend with reality and make prudential adjustments to impairments that affected their bottom lines.
Overall, the banking sector’s profits suffered a dip of approximately 11 percent year on year on account of building up prudential impairment provisions. A substantial share of loans moved to high-risk ‘Stage 3’ on account of worsening macroeconomic conditions.
Since the timely plan to seek IMF assistance was in the backdrop of this disclosure, the downgrading of the country’s sovereign rating didn’t adversely impact the banking sector too much.
Banks depend heavily on their overseas correspondent banking chains for trade finance and cross border transactions. Tariffs are mostly contingent on a structured process linked to ratings. We were also most fortunate not to be impacted by a reduction in limits by correspondent banks.
However, the significant exposure of banks to international sovereign bonds and uncertainty on the ‘haircut mechanism’ of the external debt restructuring process, as well as having to market these investments, have necessitated substantial impairments that adversely impacted the bottom lines of many banks in the country.
Fortunately, banks have been able to ride out the storm.
Q: What guidance would you offer the banking sector to aid the recovery of SMEs in particular, which have been affected by the financial crisis?
A: Banks can assist by adopting and embracing the philosophy of responsible lending, which begins when banking institutions start to simulate their business strategies based on the environment around them.
There are three very important aspects to the successful continued growth of a product of any business. These entail choosing the right product, market and technology.
Good businesspeople need to know where a product stands when it is being launched. Unfortunately, most SMEs tend to launch products of their choice without considering market expectations.
Today, the milieu is predominantly a creditors’ market. It’s ‘purchases in cash, sales on credit.’ With high rates of interest, the rising cost of energy and distribution, and lengthy periods of credit and possible defaults, it is only a matter of time before these SMEs fail in the game of competition.
However, experienced bankers who believe in relationships can outsource their much needed advisory services to SMEs, structure products to suit the cash cycles of such businesses, and bring about supplier-dealer financing schemes where entities that are under franchise produce for larger corporates and are marketed under the latter’s brand names.
If bankers move out of the three main tunnels of business divisions – i.e. corporate, retail and SME – a clear path for financing emerges. Banks’ corporate divisions can take the lead in setting limits to capture and control business cash flows.
Instead of lending in isolation with impractical covenants to monitor, cash flow-based lending and recovery will pave the way for healthy business revival in our country.
