Radical reforms to Banking Act necessary
(The writer is a banking expert who has worked abroad and seen many bank
failures. His name has been withheld at his request).
These days newspapers are filled with reports about attempts to take
control of publicly quoted companies and banking institutions, taking advantage
of falling stockmarkets at a time when the economy is facing temporary
setbacks due to problems local and foreign. This category of investors
eagerly await opportunities like this to grab control of asset-rich institutions
at bargain prices circumventing laws and guidelines which prohibit these
Unfortunately, this is one of the weaknesses of the capitalist economic
system because it enables investors to take control by forming various
'front' companies, thereby skillfully concealing the true identity of the
These 'front' companies usually have no tangible assets or a business
record. They have only backers with deep pockets full of illegally earned
money lying in various numbered accounts in Switzerland, Bahamas, Cayman
Islands, St. Helena and other laundering centres. Even though these centres
operate very much against international laws and norms little is being
done by the IMF and the World Bank, without whose implicit approval these
centres cannot thrive.
When several 'front' companies owned by one individual get together
to take control of a publicly quoted company, very little can be done to
safeguard the minority shareholders who are affected.
One safeguard available in this country is the Takeover and Mergers Code
of the Securities and Exchange Commission which requires any party acquiring
over 30% of shares in the company to make a compulsory offer to all the
remaining shareholders at the highest price paid by the investors to acquire
the 30%. If properly and intelligently implemented, this could be accepted
as a sufficient safeguard.
Sadly, proper implementation does not happen. Those who are really committed
towards acquiring control, form front companies leaving little evidence
of the link to the true owner. What is lacking here is a mechanism to identify
these 'front' companies and their true owners, thereby unravelling the
web of tangled shareholdings which invariably lead to one party.
Dangers of total control
The dangers of one party gaining control of large public quoted companies
are many. It can become highly damaging to the society and the public at
large when an individual takes control of a company that is holding a near
monopolistic position in a country. Banks in Sri Lanka are essentially
in this category. The minimum capital required to set up a bank is over
Rs. 250 million. Approval of the Central Bank is needed and it is not readily
given. The reputation and the integrity of the original investors are looked
into carefully. All this is done to make sure banks are stable and the
interests of depositors are not jeopardised.
In the banking sector there are certain additional safeguards limiting
the percentage of shares that could be owned by an individual to 10%. The
Monetary Board of Sri Lanka (MBSL) has authority to permit this limit to
be exceeded but not beyond 15%. Thus, no individual or a corporate body
acting alone or in concert cannot exceed this 15% limit. These well-intentioned
enactments were included in the Banking Act which was a major piece of
legislation introduced by the last UNP government after much consultation
with all parties. These limitations of 10% and 15% were included specifically
to ensure that no individual could take undue advantage of one's own shareholding
in a bank by influencing the decision making of the bank. It also prevented
the directors from abusing their positions to borrow from the bank at concessional
rates by making it mandatory for their borrowing to be disclosed in the
annual reports. A further safeguard was to impose a limit on the amount
that could be lent to any "one party" known as the "Single Borrower Limit".
These provisions were included to safeguard the interests of the four
stakeholders of a bank namely, shareholders, staff, depositors and borrowers.
A delicate balance of all these four countervailing forces is essential
for the successful functioning of a bank. Any attempt by one stakeholder
to take undue advantage will impact on the whole model leading to its collapse
sooner or later, mostly sooner. The framers of the Banking Act went deep
into many cases where depositors had been defrauded by owners of banks
in the US and several South Asian countries before including the protective
clauses referred to earlier.
Capitalising on loopholes
Despite such legislative and regulatory safeguards, attempts are being
made at gaining control of banks by capitalising on the tiniest legal and
regulatory loophole. The frequent excuse given by the offenders for trying
to break the law, particularly the 15% limitation imposed by the Banking
Act, is the precedence set by the Central Bank in permitting ownership
beyond the 15% limit in the case of certain banks. For instance permission
was given to the Browns and Stassens Groups to hold nearly 40% each of
the shares of the Hatton National Bank, the Ceylinco Group and the Readywear
Groups' holding in Seylan Bank, approval given to the DFCC Bank and the
Sri Lanka Insurance Corporation to hold nearly 30% each of Commercial Bank
Governments owning 100% of state banks are also now treated as transgressors
of the Banking Act by international regulators. The principle enunciated
is the same. No individual or a group of persons, whether private or state
should be permitted to hold any equity stakes in a bank in excess of the
Empirical evidence very clearly shows that, higher the percentage shareholding
in a bank by a single party, higher will be the cases of conflicting interests,
murky dealings and unethical practices ultimately leading to a weaker bank.
The burden of operating loss-incurring state banks has now fallen on the
government as the 100% owner, the serious management conflicts that weakened
Seylan Bank and the efforts of DFCC to manipulate the Commercial Bank share
structure are some strong cases in point.
Aberrations set a bad precedence and this encourages untested entrepreneurs
to seek cover behind these precedents and try to gain control of other
banks. The attempt made by Hatton National Bank and the Stassens Group
to gain control of Sampath Bank is one such case. Competition between Vanik,
Pramuka and Samurdhi to control Pan Asia Bank is another.
Nevertheless, the recent refusal by the Central Bank to permit the holding
company proposal of DFCC and Commercial Bank has finally sent the correct
signals that it will not tolerate more such breaches of the Banking Act.
Weaknesses of the Act
The fundamental weakness of the Banking Act is its many ambiguities. It
is not clear whether the upper limit on shareholding of a bank is 10% or
15%. The discretion given to the Monetary Board and the Director of Bank
Supervision to interpret the law on a case-by-case basis is specious and
Many legal luminaries now agree that the wording of the Banking Act
does not empower the Monetary Board to permit any individual or group to
hold shares in a bank in excess of 15%. It must also be remembered that
the 15% limit was originally contemplated because it was felt that anything
higher would unnecessarily complicate the running of a bank, impair its
decision-making and finally endanger depositors' interests.
In order to ensure the long-term stability of banks in Sri Lanka it
is high time the Central Bank directs all banks having shareholdings in
excess of 15%, whether in the name of an individual, company or state corporation,
to divest these shares and bring down holdings to be within the maximum
of 15%. Even if implementing, such a directive would take at least two
to three years it would ensure the long-term stability and competitiveness
of the banking sector in Sri Lanka.