Opinion: Where is regulatory energy focused?
By Dinesh Perera
The Central Bank has been taking out all its
regulatory energy[i]
on the Non-Bank Financial Institutions. The current 25 percent cap on ownership
targets only the NBFI sector. The earlier guise to this regulatory movement was
the need to be compliant with BASEL
3. However, the not so subtle true purpose of the regulation is best given in
the words of the IMF[ii]
‘The CBSL’s six-fold increase in the
end-2020 minimum equity capital requirement for NBFIs is expected to strengthen
capital positions while promoting consolidation of small institutions.’ A
truism, increasing capital six-fold would invariably strengthen capital
positions, followed by the actual objective of the policy.
The identified problems with the NBFI sector
are always more true for the Banking sector. For instance issues of
concentration of control are more salient at HNB where they just changed their
articles[iii]
to allow for longer tenures of directors. The problem with the proposed regulation
and the framing of the discourse is that through abstraction the Central Bank
is avoiding the actual issue. Instead of asking whether institutions are making
good loans they are trying to debate something more within the remit of our
companies act.
This debate on finance companies is peculiar to
our nation. The notion of limiting finance companies is odd as they are
associated with the smooth functioning of specialist credit. Our finance
companies are an anomaly, they are really savings and loans institutions, in
the sense that they can accept public deposits. This pseudo banking nature of
the industry is problematic in that it calls for more stringent regulation of
the industry. This is more than semantic as the Central Bank’s classifications
have legal ramifications and there is no room for the existence of Finance
companies separate from the current definition. Here, the regulator is not
being flexible in allowing finance companies to become leasing institutions.
Our capital
markets, payments system, lending infrastructure, public debt, and monetary
policy are all weak. Our reluctance to change has left us for instance with
systems where digital documents are manually signed and then scanned and then
uploaded[iv]. All the benefits of
being digital are lost. At the very least the original digital document sans
the signature could be uploaded. This is not just symptomatic of a lack of
common sense widespread amongst institutions but also the lack of a feedback
mechanism with those in power.
Finance
companies are a fix to this weak system. They look to minimize unnecessary
processes and provide credit. They act as a shield against regulatory
harassment that would indirectly impact small enterprises. In the governor’s
world of provisioning, only the wealthy would have access to credit further
perpetuating the current lack of investment outside Colombo.
Contrary to
bank-led lobbying of public opinion[v] IFRS 9 does not change the
value of a bank. Being able to record a lower profit and thus pay a lower level
of tax is something people with money tend to strive for. A firm’s accounts
combined with regulatory directives on provisioning do not actually represent
value held. People do not trade banking stocks solely on the audited accounts. Receivables
are hard to measure especially when relying on the company to disclose values
publicly. Paying out dividends can be done when receivables are received. The
people who currently control the banks are not that patient.
A CBSL
failure recently in the limelight is the inability to control market rates[vi]. This is due to the weak
transmission of monetary policy within the banking networks. Low access to the
government securities market combined with a high concentration of deposits
amongst a few banks means that there is very little competition amongst rates.
This is made worse by a tax structure making the effective rate of return on
fixed deposits relatively high.
Within the
current market environment, people are not able to make money by trading on
large disparities between the risk-free and other market rates. Trading in
government securities due to unnecessarily high minimum purchases and the lack
of an accessible market means that trading in government securities is limited
to primary dealers or banks. Oddly people needing to hold government debt are
actually taking a considerable risk[vii]. This risk is through
poor oversight and considerable counterparty risks.
Normal
members of the public, contrary to plans made as far back as 2013[viii], are still restricted
from accessing the debt markets. Those wishing to access the debt markets tend
to do so through an intermediary many of whom have large related party
transactions[ix].
Worse are the banking institutions who sell repurchase agreements on the
treasury bills they hold as if they were actual treasury bills. Notions of
counterparty risk[x]
are foreign to our capital markets discourse in spite of already having
considerable failings.
A more
complex network of specialist lenders who are financed through risk-bearing
capital would be the actual solution to the current ‘risk aversion’ of the
banks[xi]. If the Governor wants,
there to be increased investment in the economy he should let finance companies
deal with a small enterprise. Currently, we have an LKR 2 trillion fund[xii], the EPF, made up mostly
of government debt and growing sizably every month.
As so many
savings are plowed into government securities the onus falls on the government
to invest wisely. The banks in a world of fewer finance companies and much
smaller equity positions than the fund will just be making fewer of the same
loans to the more anglicized clientele at higher margins. They would not be
forced into making the project loans that the Central Bank imagines.
Finance
companies are good in that they deal with a lot of people. People the banks
would readily shun. Consider limits on online-based fixed deposits. At
Commercial Bank the minimum for a 5-year deposit is LKR 100,000. That is about
twice the median monthly income. Finance companies on the other hand readily make
deposits. On smaller sums of money, deposit insurance makes higher rates of
return less risky.
Finance
companies need better regulation. However, limiting ownership can drive
incentives to make riskier loans or siphoning money. The central bank can
always do more thorough examinations[xiii] and wind up companies
who are committing fraud. There are actually a lot of things the Central Bank
can do in the interim period as opposed to fire sales to limit risk to the
financial system.
The Central
Bank should let the auditor be selected by the minority shareholders. The
current system of selecting an auditor is problematic[xiv]. The auditor’s interests
are aligned to being selected again by the board who are appointed by majority
shareholders. Allowing audit firms to bid their services directly to minority
shareholders at the AGM is quite feasible. This should be done for all
companies.
The Central
Bank should also limit the voting on directors by large shareholders. Minority
shareholders should have at least one board seat. Mandate that the CSE allows
for digitized systems via a central portal for voting. Disclose publicly the
direction of voting to prevent considerable collusion between state held funds
and extreme wealth.
As
previously hinted, the Central Bank can use the EPF to easily make the banking
system BASEL
compliant. A BASEL
compliant system would reduce risk. They can use that power then to do away
with the Colombo
socialites currently on the boards of the leading banks. This, in the long run,
will drive mergers.
The Central
Bank can force banks to wind up or prevent deposit-taking from subsidiary
finance companies. They can further close any state-owned finance company or
bank, of which there are many, which do not serve any national purpose.
It is
difficult due to the complexity of the regulatory movements of the Central Bank
to convince people publicly that this is against their interests. It is made
even more difficult by the very visceral image of failed finance companies in
the media. Why is it not imperative (by 2020) to consolidate the NBFI sector? Put
simply it is because the finance companies have an insignificant asset base and
play a vital role in credit dispersion to underbanked segments of the
population.
Take
JustPay a brilliant initiative of LankaPay. There lies a system that allows for
retail digital payments at a fraction of the cost of the current credit card
system. The system is functional and very well implemented except for a lack of
merchants and public adoption.
JustPay’s
tariff is a fraction of current merchant transaction rates[xv]. It allows for the instant
realization of funds as it is based on the CEFTS system. This and the allowance
for digital wallets could allow Sri Lanka
to follow in the footsteps of China[xvi]. Here the Central Bank
will prevent the telecommunications providers from allowing the instant opening
of digital wallets assigned to mobile numbers (Telco’s anyway collect data
sufficient to open a bank account) or allowing the JustPay system to be used
between individual bank accounts.
To further
make sure the system is not used the Central Bank has set legislation
preventing any price benefit to be passed on to the consumer. This is the same
that VISA and Mastercard used to gain dominance globally which they were later
sued for[xvii]. The rule from a
broader document[xviii]
is given below;
2.3
Merchant Acquirers are strictly advised to make sure that the merchants do not
recover full/part cost of Merchant Discount Rate from the end consumer.
This is to
prevent the price benefit from a better-processed payment reflecting in the
consumer’s choices. Why should the merchant not pass on the costs incurred in
processing the payment to the consumer? This is the same regulation applied
domestically on credit card terminals. It is now illegal in the EU. It is like
preventing companies from charging a rate different to Sri Lanka
railways for the movement of freight. Price differentials i.e.: – lower prices,
are what drive consumer choice. Anyone put through the extent of reading
economics required to work at the Central Bank already knows this.
The fiscal responsibility management act initially placed the bar too high. This made it unfeasible to implement. Why such learning can’t be implemented with the NBFI roadmap? There have been very few consolidations with subsidiary companies being sold off to monetize the ‘never to be issued again’ value of a finance company license. Why doesn’t the Central Bank reprioritize reform on the NBFI sector? Things can be done and have already been outlined to improve the sector. We have already seen it in the regulation of microfinance, the high real interest rates, the political role of banking investigations, and in payments regulation.
(– Dinesh studied at the London School of Economics obtaining a degree in management. You may contact him at dinesh@wronglk.com. The opinions expressed in this article are the author’s own and they do not necessarily reflect the position of any other institution or individual. –) [i]https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/laws/consultation_papers_20190516_Introduction_of_Ownership_Limits_of_the_Licensed_Finance_Companies_e.pdf
[ii]
2018 ARTICLE IV CONSULTATION AND FOURTH REVIEW UNDER THE EXTENDED ARRANGEMENT
UNDER THE EXTENDED FUND FACILITY—PRESS RELEASE; STAFF REPORT; AND STATEMENT BY
THE EXECUTIVE DIRECTOR FOR SRI LANKA
[iii] https://cdn.cse.lk/cmt/uploadAnnounceFiles/5661553858915_373.pdf
[iv]https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/laws/cdg/Finance_Business_Act_Direction_No_2_of_2019_e.pdf
[v] http://www.dailymirror.lk/147889/CB-may-go-easy-on-capital-if-banks-hit-severely-by-IFRS-
[vi] https://www.lankabusinessonline.com/central-bank-will-impose-lending-cap-if-sri-lanka-banks-do-not-cooperate-cbsl-chief/
[vii] http://www.ft.lk/article/516369/CB-takes-over-Entrust-Securities
[viii]
http://www.sec.gov.lk/wp-content/uploads/consultation-paper-v3..pdf
[ix] https://cdn.cse.lk/cmt/announcement_portal_prod/CTB%20-%20Grade%20Fund_7825033690575333.pdf
[x] https://www.investopedia.com/terms/c/counterpartyrisk.asp
[xi] https://economynext.com/Sri_Lankan_banks_too_risk_averse,_regulator_says-3-14867-17.html
[xii] http://www.epf.lk/
[xiii]
http://fiusrilanka.gov.lk/docs/Circulars/2017/Circular-01-2017.pdf
[xiv] https://www.reuters.com/article/us-india-il-fs-auditor/india-seeks-bans-for-deloitte-kpmg-arm-for-alleged-auditing-lapses-idUSKCN1TC1E4
[xv] https://www.lankaclear.com/products-and-services/justpay/
[xvi] https://www.visualcapitalist.com/china-digital-wallets-payments/
[xvii]
http://fortune.com/2018/09/18/visa-mastercard-6-billion-price-fixing-lawsuit/
Context
Regulatory Priorities
Who Finance Companies Deal
with?
Actual Fixes: Short Term
Actual Fixes: Long Term
Why They Won’t
It is Simpler to See in the Payments System
It is too ambitious