Blanket guarantee for Finance Companies questionable: Theagarajah

Nov 25, 2015 (LBO) – Sri Lanka’s Finance Ministry is to provide a blanket guarantee for finance companies which needs to be reconsidered, Chief Executive Officer of NDB, Rajendra Theagarajah said.

Finance minister delivering the budget speech said the Central Bank will provide a 100 percent guarantee on all deposits for all registered finance companies by end January 2016.

Although several countries have deposit guarantee schemes, they have been controversial for the problem of moral hazard and unbalanced taking of risk.

“As at today I don’t think any financial services industry in the world has blanket 100 percent guarantee,” Theagarajah said.

“How will you differentiate between institutions which are well managed and stable due to good governance and sound balance sheet and somebody who has just fallen back on a third-party guarantee,” he asked.

Theagarajah was speaking at the 2016 Budget Seminar organized by the Institute of Chartered Accountants.

“So that should be looked at. It must be first principle of survival of the fittest or encouragement of failure will be defeated.”

The 2016 budget has also proposed that banks should cease in engaging in leasing business from 01 June, 2016.

However, Theagarajah said it is yet to quantify the impact of providing such a guarantee as well as the real impact or the competition of it for the banking sector.

Finance minister in his budget speech said the guarantee scheme will provide the depositors with a sense of comfort and security for their deposits in the finance companies.

“To prevent undue concentration of deposits in the non-bank financial sector, I propose to impose a cap on the interest rates offered by the Finance Companies,” he said.

Even though certain state banks currently have state guarantee, it is evident that private banks are also carrying out their business activities well without such state backed guarantees.

Apart from the guarantee, a Financial Institution Restructuring Agency will also be established to help failing finance companies be recapitalized.

Troubled assets are to be taken over by this agency for purposes of restructuring and the Central Bank will be entrusted to undertake strict supervision on this restructured finance companies.

The government is to provide initial capital of 10 million rupees as equity and also issue a Treasury bond to the value of 25 billion rupees with a tenure of 5 years for the Agency.

Finance companies have been most vulnerable in the recent past and government had to provide relief to the Golden Key Depositors at a heavy cost.