Financial Times

Swedish Chinthana - we fail to hear, see and practise
The Deputy Governor of the Central Bank of Sweden, during a recent talk in Colombo, recounted the many occasions beginning 1990, where he and his colleagues from the Swedish Central Bank had described the financial crisis in Sweden. He stressed that the crisis led to a considerable impact on the Swedish economy, resulting in low and during a number of years of negative growth with correspondingly high unemployment. It had also made the Swedish practise basic conditions necessary to ensure financial systems function smoothly.

Many interesting factors behind the crisis included mistakes made by commercial banks, the Central Bank and the politicians with almost a half century of a negative thinking within the financial philosophy and a regime of practices driven by negative perceptions. This is the Swedish Chinthana! - “The violin music the deaf elephants of Sri Lanka fail to hear, see and practice”.

The Swedish Central Banker believes that although conditions tend to differ between countries, financial crises usually have similar causes (including excessively rapid credit boom, insufficient credit assessment and overheating in the economy) and similar results (large currency outflows, rapidly increasing loan losses and insolvent banks).

During several decades half of the Swedish Banks’ lending had been directed to the government and provided low interest rates with long durations, enabling the government to finance ambitious housing construction programmes and finance the budget deficit that arose as a result of investment and social welfare measures. “Credit ceilings” limited the rate at which lending could increase, whilst the deposit rates and lending rates were also determined by the Central Bank. Cross border capital flows were restricted and the ability of foreign investors to raise local capital was restricted.

The forex earnings had to be compulsorily brought back and converted to local currency. The foreign banks were not allowed to establish whilst local banks’ ability to have overseas subsidiaries was limited with portfolio investments overseas by Swedish nationals controlled.

The release of foreign currency for overseas spending had to be justified. These control measures took considerable resources to administer.
The regulations applied over a long period with the intent of creating a stable market for credit and foreign currency, secure and sound banks and redistribution of wealth through prioritized economic measures resulted in the absence of incentives for banks to develop and reduced the opportunities for market competition.

Importantly with state directed lending and controlled risk taking credit assessment processes failed with little or no market competition with low incentives for effective client servicing. Banks were forced to subscribe for government debt programmes with non market prices and the banking sector itself operated with low efficiency.

Thus short term stability was attained at the cost of the long term tensions and eventually a financial crisis arose with negative growth and negative macro economic outcomes.

The resultant financial crisis negatively impacted not only the banking sector but more importantly the society as a whole, with real estate prices booming, non market interest rates and exchange rates, high inflation and high wages with higher unemployment.

The property bubble burst impacting negatively on property value based collateral security driven loan portfolios of banks. The Swedish banks had problems financing short term international debt and the central government had to guarantee existing and future obligations.

The bad loan portfolios were significant at 12 percent of GDP. The sector exposure and credit concentration on single and related borrowers were very high and ignored expected norms of risk management. The banks having been adequately capitalized was one advantage. As a consequence of the crisis one bank was closed down and another declared bankrupt

The crisis deepened due to the lack of expertise and management competences within the banks and the Central Bank to manage the credit and risks in a responsible manner and due to the wrong monetary and fiscal policies in practice.

The importance of having carefully drawn up legislation, with the supervisory authority empowered to intervene early using effective set of operating rules and having the necessary competency to diagnose impending risks and enforce market discipline without fear or favour were pre requisites.
The independence of the Central Bank regards setting interest rates according to set objectives including expectations on inflation control within targets was highlighted as a primary driver of sustainable growth and stability within a regime that assures fiscal discipline and market competitive policy regime.

Will the Sri Lankan Chinthana accept the independence of the Central Bank, the focus on inflation control, no directed lending, unbiased and effective bank supervision and regulations that assures risk based market competitiveness of adequately capitalized banks as fundamental? Alternatively does the “Unplugging from the international system” allow the freedom to the wild asses to run the financial systems and the macro economy to the ground?

(The writer is a business leader who advocates change in management for growth, social entrepreneurship for stability and new leadership paradigms for sustainability. He could be reached at wo_owl@yahoo.co.uk).

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