Financial Times

CB considers proposal to double bank share capital

The Central Bank is considering a proposal to double the share capital of commercial banks, a move that could lead to the emergence of stronger banks, Central Bank Governor A.S. Jayawardena said. The proposal, to raise share capital to around Rs. 1,000 million, from the current base of Rs. 500 million, had come from the banking industry itself, he said in a recent interview.

"That will mean banks will have to find additional capital or go into mergers," he said.
The Central Bank would like to see mergers among banks that would lead to "stronger banks not weaker banks," he said.

While countries like Malaysia and Bangladesh almost compulsorily merged banks, in Sri Lanka the Central Bank expects market developments to lead to mergers and acquisitions. "We will welcome that," he said.

"There is no rule of thumb which says how many banks are required for a country of Sri Lanka's size. You need competition in the banking system," he said.

The Central Bank allowed a few business groups to set up new banks as part of the effort to improve competition but they faced difficulties in being competitive in the market.

"So probably it may be that we have an optimum number of banks at this time," Jayawardena said.

One of the reasons commercial banks targeted high profits last year may have been because of the need to build up their capital.

"Last year the banks did make fairly large profits. They were also being asked to build up their capital," Jayawardena said. "The Basle requirement is eight percent of risk-weighted assets but we have gone beyond that and now have raised it to 10 percent.

"So how do you build up your capital? You make some profits and instead of distributing it you add to the reserves and increase your capital. Some banks wanted to strengthen their capital so they targeted high profits."

Banks also were trying to bring down costs and improve efficiency.

"One reason why Sri Lankan banks have higher costs than other countries is because of the civil strife in the country," Jayawardena said. "Banks were being robbed and required unusually large security officers.

This became a burden on them. They need security to safeguard public funds. Yet we feel that banks could bring down their costs further by improving efficiency by automation, reducing waste and rationalising the branch networks."

Jayawardena also said no amount of Central Bank regulation and supervision could detect deliberate fraud which a bank management hides, and that commercial banks must have good credit evaluation and good monitoring of lending risk.

"Banks, unlike other industries are high leveraged institutions dealing with risks. They accept public deposits which they are expected to lend prudently, not recklessly," he said. "You ensure that by having some sort of supervision and regulation."

"But no amount of control can prevent a bank from going round these limits and lending in a risky manner," he added.

"Suppose there is corruption and fraud inside a bank, where the management lends to friends and relations.

The loans are not repaid, you give them another loan and show that the loan is not a bad loan but a current asset - you have given him one loan to settle his other loan which he is unable to pay. That's called evergreening. It is difficult to spot."

"By the time we detect any irregular action - that takes about a year -within that one year things can go bad."

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