1st February 1998

Noritake to expand

The Japanese ceramic giant Noritake is to embark on a major expansion of its production facilities in Sri Lanka, BOI Chief Thilan Wijesinghe said.

The company will be investing US $ 12 mn (Rs. 720 mn) in its plant at Rattota in Matale.

The investment comes hot-on-the-heels of the East Asian currency crises. The ceramic industry fears competition from low priced exports from countries such as Indonesia.

The Rattota factory is believed to be the largest overseas production facility of the Noritake group.

Ceramics and glassware have been identified as one of the thrust industries in the recent budget qualifying for a ten-year tax holiday.

Local industrialists engaged in ceramics can also import plant and machinery on a dutyfree basis to modernise their factories.

Ceramic exports have grown from Rs. 259mn in 1986 to Rs. 2.6 bn 1996.

IMF wants tough controls on banks

By Asantha Sirimanne

The International Monetary Fund has called for tighter regulation of the financial sector in Sri Lanka to prevent East Asian style weaknesses taking root here.

The Central Bank has been stepping up on site and off site supervision of commercial banks in recent times.

“It has issued directives for capital adequacy, loan classification, and loan loss provisioning and is in the process of bringing these upto international standards,” IMF Resident Representative Anton Op de Beke said. “More needs to be done.”

He called for supervision to be extended to non bank financial institutions. Mr. Op de Beke was speaking at the inauguration of the Trade Finance Association of Bankers.

There has been widespread public concern at the lack of regulation of merchant banks which have proliferated in recent years. At least two merchant banks have had serious problems and had been helped by their respective parent companies. The Central Bank has however introduced new laws to bring development finance institutions and savings banks under regulation.

The IMF is particularly concerned about the status of deposit taking institutions and the two state banks. Analysts say the two state banks have a history of lending to risky projects usually due to political pressure, counting on the government to later bail them out at the taxpayers expense.

In 1993 the government injected Rs 24 bn to Bank of Ceylon and People’s Bank to make up for bad loans.

In 1996 the government inejected a further Rs 19.3 bn to Bank of Ceylon, People’s Bank and Rs. 4.4 bn to National Savings Bank making a total of Rs 47.9 bn.

“ Financial intermediaries whose liabilities are perceived as having an implicit government guarantee, that are essentially unregulated face what economists call a ‘moral hazard’ problem,” Mr. Op de Beke said.

“This means that the owners and the managers of these institutions will be tempted to take great risks in the projects that they finance and the assets they buy.”

He said the phenomenon had been well observed in East Asia.

“This practice of risky investment can be sustained as long as the balance sheet is growing fast and the price of speculative assets keep rising,” Mr. Op de Beke said.

“Once the bubble burst, falling asset prices quickly undermined the financial intermediaries in question.”

He said the regulation and prudential supervision of financial intermediaries especially deposit taking institutions should be strong enough to prevent this moral hazard.

“The potential for this problem is certainly present in Sri Lanka,” Mr. Op de Beke warned.

“The deposits are concentrated in the two state owned banks probably perceived by the public as being implicitly guaranteed by the state. Even the private banks in raising cheap deposit funds probably benefit from a public perception that the government would step in if they faced a liquidity crisis.”

He called for regulators to ensure the meaningfulness of the reported data by enforcing international accounting standards and more disclosure.

In recent times doubts have emerged about the reliability of financial results and the local audit profession after a merchant bank was asked to reverse a questionable transaction by the SEC. Though the financial statements were unaudited, critics point out that the board was represented by partners from top audit firms in the country.

“Regular public disclosure of information on financial results and the quality of the loan portfolio can help bring in market discipline to bear on the financial system,” Mr. Op de Beke said.

The cost of restructuring should be put on the owners of the banks, he said. Analysts say the Central Bank has in the past put in hundreds of millions to finance companies, like Mercantile Credit, in a failed attempt to revive them.

“Concerned about their own money private sector owners will follow this with a restructuring or re-organisation.,” Mr. Op de Beke said.

He said consideration should be given to set up a deposit insurance scheme.

“A small scale explicit scheme may be preferable over a large coverage implicit scheme,” he said.

He said financial markets were now taking a much more critical look at the soundness of a country's banking system. Conditions that were considered adequate before the crises were no longer sufficient.

“Capital Adequacy Ratio (CAR) of 8 per cent is required and most Sri Lankan banks do comply at least on paper,” says one banking analyst. “But foreign investors are looking at around 14 per cent CAR for developing countries to be comfortable.”

Continue to Business page 3 * East Asians stay away * Interest rates edge upwards again * MIND YOUR BUSINESS

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