The forgotten skills in economic management

It is clearly seen that the economic performance of the first half of the year cannot be attributed to the political crisis and the terrorist attack. The main adverse factor we faced in the first half was the slowing down of the international economy and a slack demand for exports. Even here the weaknesses of the Sri Lankan economy had an important role to play in the inability to respond to the changes in the international conditions.

Besides, internal economic factors too were responsible for the poor performance we witnessed in our exports in the first half of the year. Production in nearly all-significant economic activities declined. In the case of agriculture, weather had an important role in the low production of paddy in particular. Even here the poor performance had other factors too.

The decline in paddy production, while partly attributable to poorer weather conditions, has much to do with the high costs of production and non-viability of paddy farming in many areas of the country.

Tea production that has shown an impressive growth in recent years has been adversely affected by work disruption on the estates. Rubber production has been declining for a considerable period and the decrease in production in the first half of the year by a further 1 percent was mere continuation of this declining trend reflecting an inability to face the fundamental weaknesses in the structure of the rubber industry. The decline in coconut production after several years of increase may have been cyclical.

When we turn to industrial performance the results are most disconcerting. Industrial production in the private sector is estimated to have declined by only a marginal amount. Yet industrial export earnings have declined by 1.5 percent, with garment export earnings declining by as much as 4 percent. Consequently industrial export earnings have declined by 2.6 percent and total export earnings have declined by 1.5 percent in the first half of the year.

Probably the only bright spot was the higher tourist arrivals and earnings. In the first six months of the year tourist arrivals increased by over 10 percent and tourist earnings by 11 percent. This was indeed a very creditable achievement as it was in a global context of depressed incomes in western countries. Further, the increase was also on top of an increase in tourist earnings last year. Tragically the up-trend in tourism is likely to have been arrested by the bomb blast and the particularly harsh publicity the country has been subjected to, as well as the hike in airfares and reduced flights to the country.

The fact is that in many areas of economic performance the results have not been merely due to external factors alone. Poor economic management over the last several years has been fundamental to the results we have obtained. Unless we are realistic to accept this position it is not likely that we would take corrective action. Instead we will continue to be a nation wallowing in our bad fortune, blaming the war and terrorism and other external shocks.

If the economic performance of the first half was so poor without the major setbacks in July and August, what a miserable economic performance we are likely to achieve in the next half of the year. It is therefore vital that once the political crisis is resolved that economic management is placed in the forefront of government activities.

Deficiencies in banking laws in S L

Ownership Limits

Firstly, banks by their very nature are focal points for the concentration of economic resources. Thousands of small depositors entrust their savings to banking institutions. These deposits are, in a legal sense, borrowings by the bank. In the case of large banks, these borrowings are 50-60 times the share capital invested by the owners. While public deposits are in the nature of a loan to the Bank, it differs from any other large loan made available to the bank by an institutional lender in one significant manner. An institutional lender to the bank is able to and will most certainly impose conditionalities and covenants so as to ensure the proper end use of funds, as well as secure the safety and recoverability of the facility extended by it. However, in the case of small depositors, that control is not possible. Unlike in the case of debenture holders, there is no mechanism to appoint Trustees to act on their behalf. Although the sum total of small deposits far exceeds the capital invested by the owners, there is no mechanism to impose the collective expectations of the depositors on the owners. Accordingly, if ownership is in the hands of one group, there is the risk of a large concentration of resources being used for the benefit of the owners.

Another area of concern is the contagion effect. When a bank is held by one group it is most likely that the ups and downs of the owners would reflect itself on the bank. This may well go beyond perception via transfer pricing of services, management fees, excessive pay out of dividends etc. Despite controls imposed by regulators on lending to related parties, lending to group companies, and accommodation to directors, there is a real risk of the integrity of the credit process within the bank being in jeopardy.

While the above considerations would undoubtedly support the case for a well- diversified ownership structure of a banking institution, one must not forget the disadvantages that may arise from the absence of any single shareholder or group, who has a significant stake in the bank. The absence of a dominant shareholder may lead to a lack of direction and a weakening of the supervisory control, a Board and a shareholder body should have on management.

Section 11 of the Second Banking directive of the European community stipulates that persons in member states are required to inform the local regulator if they are to acquire a qualifying holding in a bank. A qualified holding is defined as 10% or more of capital or voting rights or a holding which makes it possible to exercise significant influence over the affairs of the bank. Further, Section 11(1) also stipulates that an investor must also notify increases in his shareholding when it crosses thresholds of 20%, 30% or 50% or on becoming a subsidiary. At these points, the regulator can prohibit such acquisition if they are not satisfied of the suitability of the person considering the need to ensure a sound and prudent management of the bank.

Material interest

For the purposes of this paragraph 'material interest' means the holding of over ten per centum of the issued capital of such licensed commercial bank."

The section imposes no absolute limit on the maximum shareholding. However, it requires the investor to obtain the written approval of the Monetary Board to invest more than ten per centum of the issued capital of a licensed commercial bank. The section is also silent as to what criteria the Monetary Board would apply in granting or refusing permission for the investment.

Section 13 also confers authority to the Monetary Board to withdraw the approval given under section 12 or vary the terms and conditions of an approval, with the approval of the Minister and on a report made by the Director of Bank Supervision.

Apart from the above provisions in the statute, the Central Bank has stipulated limits of ownership in the banking institutions via directions issued under powers vested in the Monetary Board as per Clause 46 of the Banking Act. In terms of these directions, the maximum holding by a company, an incorporated body or an individual in a banking institution shall not exceed fifteen per centum of the issued capital of such institution. Further, the aggregate holding by a group as defined in the direction should not exceed twenty per centum of the issued share capital. Similarly, the holding by an individual and his related parties should also not exceed twenty per centum of the issued share capital.

Subsection (2) of the direction permits one of the promoters and his associates as defined in the direction to hold 25% of the issued capital with the approval of the Monetary Board. Further, the aforementioned restrictions will not apply to shares acquired by any person, after obtaining the prior written approval of the Monetary Board, where the Monetary Board considers that such acquisition of shares is necessary or expedient in the interest of the national economy (section 4(1) of the direction).

Foreign participation

It is apparent from the above that the maximum an individual or a group could own in a banking institution is 20% of the issued share capital. This limit can move upto 25%, in the case of one promoter, with the approval of the Monetary Board. However, the limits can be exceeded with the prior written approval of the Monetary Board, provided the Monetary Board considers that such a holding in excess of the limits specified is necessary or expedient in the interest of the national economy. The direction and the Act do not specify what criteria should be applied in deciding whether an acquisition is necessary or expedient in the interest of the national economy. The section seems to impose a subjective test. However, it is not certain whether a decision by the Monetary Board, in terms of this section will not be subjected to judicial review.

Limit on ownership

If the rationale, as explained above, for the imposition of ownership limits is to prevent abuse, then it is incumbent on the regulator to examine the background and acceptability of the owners themselves, so as to ascertain the likelihood of abuse. In other words, the real test in imposing ownership limits should be whether the owners are fit and proper persons capable of managing the affairs of the bank. This is the test embodied in the European community directive. Despite the increasing trend, we see of judicial activism by way of reviewing administrative decisions via pleadings based on fundamental rights, it is respectfully submitted that the regulator should not shy away from applying the 'fit and proper persons' test when imposing ownership restrictions.

Mergers and acquisitions

In some countries, separate statutes have been enacted dealing with mergers and acquisitions of banking institutions. Canada and the United States are examples. However, there is no reason why the general code on mergers and acquisitions enforced by the capital market regulator, should not deal with mergers and acquisitions relating to banking.

There is, of course, a need to examine the provisions of the Banking law and the mergers and acquisitions code enforced by the capital market regulator, in order to smooth out conflicts if any, that may exist in the respective provisions. A case in point is, where the mergers and acquisitions code would trigger a mandatory offer to all shareholders when the share holding of a person reaches a threshold limit. This provision needs to be reconciled with the need to conform to the maximum ownership limit imposed by the Banking Act.

Section 12(1)(c) provides for a licensed commercial bank to acquire the business of another licensed commercial bank or of any branch of another licensed commercial bank. Section 17(1) provides for a licensed commercial bank to have a subsidiary company which carries on the business of providing medium and long term credit for development i.e. a licensed specialised bank, with the approval of the Monetary Board. A new section, namely section 12(1)(f) has also been proposed in the draft amendments to the Banking Act to provide for the amalgamation of a licensed commercial bank with a licensed specialised bank. The above provisions have been added in an incremental manner to a statute that was originally framed to regulate the business of commercial banking. Thus, they do not cover all possible situations that could arise in the banking industry at the present time, for example, the acquisition of a licensed commercial bank by a licensed specialised bank. It is therefore time that we re-examine the relevant provisions with a view to facilitating, as well as regulating mergers and acquisitions, which are bound to take place in the local banking industry in the years to come.

Appointment of Directors

The above would be true of a banking institution too with one significant difference. In the case of a banking institution, a large proportion of the money at risk does not belong to shareholders, but to depositors. Accordingly, should not the depositors have a say in the appointment of directors? Although, one would be tempted to answer the question in the affirmative, it would not be practical for thousands of depositors to participate in the selection of directors. Further, unlike a shareholder, a depositor can be much more transient. Giving expression to the collective wisdom of depositors, in the selection of directors, though desirable will be impractical. However, the interests of the depositor need to be addressed when it comes to the vital task of appointing directors in a banking institution. Such a role can and should be performed by the regulator.

The draft amendments to the Banking Act proposes to introduce the fit and proper person test in the appointment of a director of a financial institution. This is a welcome move. The section also enumerates criteria for determining whether a person is a fit and proper person for the purposes of this section. However, the wording in the section is not helpful in deciding whether the test should be applied objectively or subjectively. It is respectfully submitted that the test ought to be a subjective one with the Monetary Board, being vested with the decision making authority. It is appreciated that the subjective test itself may not prevent judicial review.

The draft amendments to the Banking Act also proposes to introduce the fit and proper test to persons acquiring a material interest in a banking institution. This move too is welcome.

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