HNB says some CB guidelines on provisioning too harsh

HNB CEO, Rajendra Theagarajah in an interview last week with The Sunday Times FT says some Central Bank guidelines on specific provisioning is too harsh.

Excerpts from the interview:

Despite persistent interest rate volatility, in 2006 HNB’s net interest margins appreciated to 5.4 percent from 4.3 in 2005. How did this come about?
It is because the portfolio is not concentrated on any particular segment like corporate banking loans which is perhaps more under threat, but any increased pressure on foreign currency lending and high end corporate banking would have more than compensated by our foray into direct remittances and the personal financial services which gives a more than adequate balance.
Also compared to some other competitors, we are into credit cards and we possess a Rs 12 billion portfolio in pawning. This gives an above average spread which compensates for any upward pressure on margins.

Why is your growth in non interest income such as foreign exchange profit lower than your peers?
There is a 23 percent growth from 2005 and it has not been as much as some of the others, but we are not concerned, because this growth was in line with our plans for 2005. We said that we will stick to basic ‘bread and butter’ foreign exchange and will not get into any activities such as derivatives trading, options and futures, which involve uncertain volatility, because we needed to get certain risk parameters within HNB into place. This year too we will follow this strategy where the core banking strategy hinges on foreign exchange rather than getting into anything ‘exotic’ in a market such as ours, because it is not deep enough. So we will ‘chew’ what we can.

Your cost to income ratio has risen from 67 percent in 2006 compared to 63 percent in 2005. Compared to your competitors this is high. Why?
This 67 percent includes financial sector value added tax (VAT). in 2006, the financial sector VAT by HNB was Rs.900 million and in 2005 we had only Rs.200 million. This is an increase of about four fold and I am not comfortable with this percentage because core banking activities have not contributed to this chunk but what is important to me is post provision more than pre provision. I consider all operating expenses such as premises, staff, VAT and provisioning which are all expenses. When comparing 2005 to 2006 this is an 11.5 percent growth and the way I see it is that this is nearly six percent below inflation. I am pleased with this performance – but this is not to say that I am complacent and there is more room to work on.

What are your thoughts on the one percent general provisioning on total performing and overdue loans by the Central Bank?
Wouldn’t this strain your margins?
It will strain margins. Either you bring down your margins or factor into pricing, but there is a more important aspect to creating a general reserve of one percent. In an environment where prudential supervision appears to be stringent depending on how to classify non performing loans, there are some specific harsh guidelines on specific provisioning. When the bigger and better managed banks are providing aggressively for specific provisioning despite fiscal pressures, to cover that with a general reserve is creating a horizon for a secret reserve.

Today we are openly saying that we will join the world and embrace IFRS (International Financial Reporting Standards). IFRS frowns upon creating a general reserve. I feel it can be counter productive towards the development of the industry. Apart from prudential regulations, we are publicly listed institutions to attract international investors who will compare apples with apples. When you have this sort of challenges, it causes more problems for them. Perhaps there could be a bit more harmonisation between monetary policy, coordination and fiscal policy.

HNB loan portfolio was Rs.121 billion in 2006 having appreciated by 19 percent. How did this happen?
In 2005 our return on assets was below one percent we even failed to qualify for concessional funding from Asian Development Bank, World Bank, Japan Bank for International Cooperation and such for small and medium enterprises (SME) banking. The main barrer was that the minimum threshold of one percent had not been achieved. We had to address achieving more productivity before considering the bottom lines and in 2005 we grew the asset base consciously by about six percent and in the process managed to increase the top line by 70 percent. Now that we have crossed the stipulated threshold and our portfolios have been stabilised to an extent with a clean up, we wanted to accelerate the portfolio but selectively. Our target was 15 percent, but we achieved 18 percent. The main contributor was our Maldivian exposure. This year as well we hope to sustain the portfolio by 15 to 20 percent this year.

Don’t you feel that the competition is intense especially for loan products?
All you need is creativity and the will. I do not see a saturation point, because customers in time will be spoilt, because of the intense competition and demand more convenience and competition will be pricing driven. There will be demand for more products at your fingertips.

Have you seen the lines blurring between your middle and high end customers?
There is further clarity. I feel that we need to focus more and give a defined support to the SME segment because it is a segment prone to the danger of getting cluttered with the lower end of the corporate banking or the upper end of micro finance. This year we have got into some structural initiatives to do defining of SME sector such as evaluating credit worthiness differently, developing different credit scoring models, increasing the competency of staff to evaluate credit managed relationships which are different from corporate banking so that the mindset of an SME is less on the balance sheet and more on the story. This will help to have more understanding on the business sense rather than the balance sheet.

What are HNB’s plans to strengthen the capital adequacy ratio this year?
It is already strong enough. At Tier I we are at 9.7 percent. Tier II is at 11.23 despite the Central Bank increasing some of the risk weightages last year, which we feel is above the regulator's requirement and also our retained earnings are good enough at the rate we are going and if there is a need we will come to the public.

What are your thoughts about consolidation in the banking industry in the country?
In the Sri Lankan perspective consolidation is important, because weaker institutions can be supported by stronger ones. This will create importunities for mutual benefits such as a complementary advantages and better value. However issues of ownership and governance should not be confused with consolidation. If the business case is strong, it should be encouraged.

The governance and ownership issues should be managed by prudential regulation, supervision and direction. These two aspects should not inhibit the other. Also one should see it in terms of financial services consolidation popular in countries such as Japan and Taiwan where financial services holding companies emerged. Here consolidation is done in the form of banking, insurance and securities industries – it has become a capital market consolidation and non banking sector one, because you see a non banking side playing a far greater role in financial intermediation. Eventually, the benefit would be for customers to have better value preposition and cheaper pricing.