Financial Times

Basel II has been embraced by regulators the world over, as an effective piece of prudential regulation for a sound capital framework that measures the risk exposure of banks accurately and allocates capital accordingly.

We need to exploit the incentives provided by Basle1 I in areas such as SME lending to pass on the benefits of lower capital in the pricing of SME credit to the consumer.

The lower capital allocated to SMEs will offset the risk premium normally attached to such lending by the Banks, access to finance by SME s was identified as a significant gap in the financial system resulting in a dedicated SME Bank being set up to serve the sector.

A strong capital base is the last line of defense for a bank, and we need to recognize the importance of strongly capitalized banks together with, sound systems and procedures, effective internal controls and good corporate governance which will continue and encourage international best practice, Basel II is not a challenge but as an opportunity, to enhance access to credit at a cost that is affordable and beneficial to the banks, consumers and to the economy, noted Ajith Nivard Cabral, Governor of the Central Bank in his key note address at the” Basel II Implementation and challenges seminar” recently held at the Institute of Chartered Accountants auditorium and jointly organized under the Institute of Chartered Accountants (ICASL) of Sri Lanka and Microsoft Sri Lanka partnership.

Basel Accord is an established mechanism providing protection of depositors by laying down the rules for measuring Capital adequacy to ensure efficient use of capital.

The Basel Committee of Banking supervision based in Basle released the final version of the new Basel Accord in 2004. Banks globally are expected to complete compliance of the Basel accord by 2007.

Dr S. S. Sathchidananda, Research Director and Professor of Banking and Finance at the Center for Banking Information Technology, Bangalore and Sai Saresh, Strategist at Asia Pacific Banking & Capital Markets Microsoft Singapore made technical presentations on Basel I Journey-Implications & Implementation and Results Of Basel II implementations Benchmark research study in Asia Pacific, respectively.

Joan de Zilva, Director Bank Supervision of the Central Bank representing the banking regulator, in agreeing with the sentiments expressed by one of the country’s eminent bankers Edgar Gunatunga that the banking industry is already over regulated, justified the regulatory actions by asserting that financial markets require stabilizers as almost 80 percent of a bank’s assets are financed by depositors’ funds and the share of equity is less than 5 percent and this highly leveraged situation makes the regulatory function critical. She further added that Sri Lankan banks enjoy a free run and quoted the Indian regulatory climate where banks are subject to priority lending and caps on interest rates etc.

The regulatory environment in Sri Lanka is therefore comparatively, very flexible. Even their decision to liquidate a failed bank such as Pramuka, had been challenged. The bankers also showed concern about the Basle II implementation costs that may far outweigh the benefits from implementation they said and increase their operational costs.

Ms de Zilva elaborating further added that Basel II would be implemented in Sri Lanka on a two-year parallel basis with Basle I, which commenced this year and would pave the way for efficient credit risk management. Quoting her own experience in Bank supervision, De Zilva was critical of the credit assessments made by some of the commercial bank credit officers and did not hide her feelings in stating that credit decisions have sometimes been based on improperly prepared accounting statements and asserted the critical importance of sensitive financial information.

Basel II implementation benefits would accrue through improved lending decisions and resultant price competition, she also confirmed that legislation is now being drafted to exempt loans below Rs 5 million (the SME sector) from the parate execution mechanism in keeping with the government policy.

Veteran Banker Ranjith Samaranayake airing the views of the banking community was of the view that Basel 1 implementation was treated more as a financial accounting affair confined to the Accounts departments, however he asserted that Basel II implementation is more complex and needs a corporate approach with involvements from all sections of the Banks.

Elaborating the challenges faced he identified staff education and awareness, active involvement of credit and branch management, credit rating agencies, proper financial management, IT issues and credit risk mitigation as key issues.
Agreeing with the Director of Bank Supervision Samaranayake too was of the view that more credit rating agencies would be required for successful implementation of Basel I, as at the moment only two agencies are in operation in Sri Lanka. Speaking to The Sunday FT he added, given that only a few of the leading companies have obtained credit ratings a credit rating culture has to be developed in Sri Lanka. Credit rating may also add to the costs particularly to the SME sector whose financial disciplines are yet at a developing stage.

Sri Lanka has already seen two bank failures namely the impact of BCCI failure in the eighties and most recent Pramuka issue which put many depositors into financial difficulty.

In this regard Basel I is more flexible and permits banks to adopt multiple options to measure the credit risks. The Basel I accord is structured on three pillars – Risk appraisal, Risk Control and supervision of assets and monitoring of Financial Markets (Market Discipline). Sri Lanka has already set a migratory target at 1st January 2008.

Offering assistance to SME’s by way of exempting them from parate execution is thoughtful but it will be a challenge to the banking community in their efforts to contain defaults to keep the lending costs low.

Despite diversification of banking products lending continues to be a priority profit centre for banks. In this regard credit risk management becomes critical and successful implementation of Base 11 is undoubtedly a priority.

Thoughts for the Week

While the economists speak of resource rich western province and neglected other provinces, the National Cricket team continues to be dominated by outstation cricketers while the National Rugby team is dominated by players from the central province. Last weekend another colourful sports spectacle was witnessed at the historic Bogambara grounds when two of the country’s oldest schools Trinity and Kingswood met for their 100th Rugby encounter before a capacity crowd. It was yet another grand show in the hill capital displaying sportsmanship, culture and tremendous enthusiasm.

This is the required spirit we need all over the country to put an end to on going conflicts. Even the visitors from Australia and New Zealand, the two global Rugby giants were thrilled at this exhibition of sporting display. Sports is now a integral part of the international economy.