Central Bank only ‘directs’ the directors

The Central Bank of Sri Lanka (CBSL) can only advise the banks and issue directions on relevant issues, but the boards of directors need to take the responsibility to safeguard their banks and the banking sector as a whole, according to a top CBSL official.

“I hope the eminent directors of banks' boards in Sri Lanka will, first, try to understand better the credit, market, liquidity and operational risks, particularly under stressed conditions. Second, that you will focus on the importance of more effective contingency funding plans and, third, that you will support improved market functioning through better governance and disclosure,” Dr. Ranee Jayamaha, Deputy Governor CBSL said, addressing the Bank Directors’ Symposium held on Wednesday.

She noted that presently the country’s financial system comprises 23 licensed commercial banks (LCBs) and 15 licensed specialised banks (LSBs), 32 registered finance companies and 20 specialized leasing companies, two main contractual savings institutions and a large number of micro-finance institutions. In terms of markets, money, foreign exchange, government securities and capital markets are the significant ones. The total assets of the financial system at the end of 2007 have increased by 16 percent against 2006, which is 1.21 times Sri Lanka's GDP.

Dr. Jayamaha said that the banking sector, consisting of LCBs and LSBs, accounts for 68 percent of the total financial sector assets while continuing to hold a dominant position in the financial sector. “Commercial banks are the largest mobilizers and providers of funds to economic units. Banks are free to determine their interest rates and lending portfolios, subject to prudential regulations,” Dr. Jayamaha noted, pointing out that CBSL has an obvious interest in maintaining the stability of the banking industry and the financial system as a whole and to ensure that banking institutions operate in a safe and sound manner and have strong capital levels.

She said that banks themselves have to design new techniques to improve their risk management to be more effective competitors. “The boards of directors should concentrate on mitigating risks in an integrated manner as credit, market, liquidity and operational risks are inter-twined and cannot be treated separately or as standalone risks. They should also find ways to increase capital and employ such capital more prudently,” she said.

She noted that threats to financial stability need not always come from risks in the traditional banking businesses such as a deposit run or deterioration in a bank's loan portfolio, but also from banks' capital market businesses, such as secruitisation operations, engagement in asset management services including hedge funds and from rogue trades. “In general, the majority of financial crises follow the same pattern. Usually, they start when profit frenzied bankers breach the elementary rules of the game. When the bubble bursts, investor confidence withers away,” she said.

Central banks have to step in not only to prevent the system from collapsing, but also to unintentionally help shareholders and directors who have taken away the resources of the bank, leaving the depositors and creditors in the lurch.

Dr. Jayamaha noted that when the crisis begins to spillover into the real economy, governments, economists, financial analysts, market analysts, the media and the banks start the blame game. The final result would be the government requesting the regulators to create new laws or to strengthen existing laws aimed at preventing similar crises in the future.