19th December 1999

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IMF wags finger at bank provisioning

By Mel Gunasekera

The International Monetary Fund (IMF) has expressed concern over the financial condition of the local banking sector. The Fund also noted that the domestic banks are provisioning at about half the rate of non-performing loans compared to the provisioning ratio of foreign banks.

In a report titled Sri Lanka: recent economic and policy developments, the Fund says that the financial condition of the banking sector is a cause for concern. The results of portfolio analyses on the two state owned commercial banks accounting for more than half of the banking system show them to be weak and options are now being considered to improve their financial conditions.

The private commercial banks as a group are in better financial shape, but a sharp drop in provisions relative to non performing loans suggests increasing fragility.

Steady improvements are being made in banking supervision and regulation and in the public disclosure of banking sector performance.

Despite recent progress, a number of weaknesses remain both in the regulatory environment and in the capacity of the banking supervision department to effectively supervise the banking system.

As noted, provisioning requirements are not up to international standards. Plans for raising them are facing strong resistance from banks, which anticipate problems in making additional provisions. Also the domestic banks and foreign currency banking units (FCBU) are exempted from almost all requirements under the Banking Act, including capital adequacy rules, other prudential regulations and reserve and liquidity requirements.

Furthermore, bank supervision so far concentrates on credit risks and neglected important market risks, such as foreign exchange exposure and maturity risks. The Banking supervision department is in the process of surveying banks foreign exchange exposures in preparation for setting appropriate limits. Finally the Central Banks authority in dealing with errant institutions is rather limited, a weakness that is being addressed with amendments to the Banking Act.

The financial condition of the banking system has not significantly improved over the past year. Banks have been adversely affected by the economic slowdown, the disruption of the tea trade and intensified competition, especially between the private domestic banks. To some extent the worsening trends reflect the stricter enforcement of prudential regulations.

The ratio of non performing loans (NPL) to total advances continues to be high for all three categories of banks.

The state banks are the worst off, with a ratio of 19.3% (Bank of Ceylon does not include suspended interest among its non performing assets, recording it as a memorandum item instead, which reduces its NPL ratio), followed by the private domestic banks and foreign branches with ratios of 14.7% and 11.3% respectively.

Over the past year, the state banks recorded a slight improvement, thanks to government guarantees for some NPLs, but for the private banks the ratio deteriorated.

For the foreign banks it deteriorated and then improved thanks to significant write offs and recoveries. The ratio of net non-performing loans (NNPLs) to total advances also increased for the private banks. NNPLs continue to exceed capital for the state banks, and now equal capital, for the private domestic banks presenting a risk to solvency and suggesting an urgent need for an infusion of new capital.

Domestic banks are provisioning at about half the rate of foreign banks as shown by the ratio of provisions to NPLs .

This ratio has dropped steeply since 1997, indicating increasing problems in absorbing loan losses. Assuming that foreign banks face the same losses on their NPLs as domestic banks and that their provisioning is in line with the international best practice, this large difference in ratios suggests that the domestic banks are seriously under provisioned. If as is suggested, domestic banks lend more against collateral than do foreign banks, this could explain part of the difference in ratios, but not the trend. Most foreign branches, at the instance of their home supervisors, make general provisions against performing loans, while Sri Lankan banks do not.

Domestic banks, both state and private, are experiencing an erosion of their capital base. Their risk weighted capital adequacy ratio (CAR) based on core capital has been declining since 1996.

Though the Central Bank has proposed to the banks an increase in the minimum capital adequacy standards to five percent for core and 10 percent for total capital the timetable is unclear.

The foreign banks strengthened their capital adequacy and reached CAR of 14.7%. Last year the private domestic banks took the novel step of raising tier two capital by issuing subordinate debt, increasing their CAR based on total capital. Since the subordinated debt is tradable, the differential prices quoted, offer a market assessment of the soundness of the banks in question. In fact most of the issued debentures are presently trading below par,an indication of what the public perceives its worth, banking analysts say.

SLT gets top grade

The recently set up rating agency DCR Lanka gave its first rating of AA+ to Sri Lanka Telecom (SLT) last week. The AA+ the highest rating for a company, will be a pluspoint in selling their Rs. 1.5 billion debenture for its proposed expansion project, SLT Chairman Hemasiri Fernando said.

The issue awating CSE clearence will be the largest, listed and rated debenture in the local bourse. The five year debenture will carry a fixed coupon rate of 14.5 percent interest payable annually, a 14 percent interest payable quarterly or a floating rate tagged to the six month TBill + 1.25 per cent payable semi annually. (The floating rate is subject to a floor of 13 percent and a cap of 16 percent). A consortium of financial institutions which officials refused to disclose will underwrite the issue.

Mr. Fernando said that the company will initially issue Rs. 1 billion and a further Rs. 500 million if the issue was over subscribed. He said that SLT was targeting the smaller investors and hence had set the minimum subscription at Rs. 10,000.

DCR Lanka's CEO/MD, Ravi Abeyasuriya said that SLT's books looked good compared to financial institutions and that they will be able to meet debt obligations after evaluating their financial performance for the next five years under worst case scenarios.

The issue is structured and managed by DFCC Bank. DFCC CEO, Moksevi Prelis said this issue would be the forerunner of several others particularly by corporates outside the financial sector. DFCC was also responsible for structuring and managing the Rs. 50 million debenture issue of Ceylon Glass, the only other non financial institution to make an issue.

SLT is the first non-listed company to list their debentures on the CSE. However 10.5 per cent of SLT shares are scheduled to be listed on the CSE early next year. Currently NTT, Japan holds 35% and manages SLT. The GOSL holds 61.5%. The balance 3.5% is held by employees.

Selling shares in post offices

The Securities and Exchange Commission (SEC) has come up with a novel concept of using post offices to provide market information.

The SEC is tying up with a leading market information provider to set up information terminals in 47 super grade post offices, which are presently being upgraded under the postal reform project. The terminals will give out hourly market information in all three languages.

The post offices are scouting for new opportunities to offer value added services, and it is the ideal opportunity for us to create awareness of the securities market and provide access to retail investors in the rural areas, Marketing and promotions Manager SEC, Malik Cader said.

A pilot project has begun in Kegalle and Kandy. Cader says it will eventually be a self-financing project which the post office would run by selling commercial spots on the information terminals.

The next stage would provide access to investors at the post offices. The Colombo Stock Exchange (CSE) has suggested to provide broking services on site. The post office will provide a counter, and the CSE will find a stockbroker. The broker would initially provide market access via the internet.

State banks fail test

The two state banks, Bank of Ceylon (BOC) and the People's Bank have failed an operational test, achieving just one of the six targets set out for them.

The banks failed to reach five out of the six specific operational targets, namely return on assets, return on equity, staff costs to average assets, total overhead costs to average assets, and rationalisation of branch network,

The test is an attempt at a diagnostic review of the two banks undertaken by two teams of international auditors, financed by a World Bank loan and who submitted their reports in June.

The agreements required the banks to report regularly to the Central Bank, which is in charge of monitoring implementation. According to a first appraisal carried out in early 1999, the agreements had scored little success. The only target met was recovering of non performing advances. In 1998 BOC recovered Rs. 1.9 bn and PB Rs. 2.8 bn; this included loans to textile companies which the government decided to guarantee. BOC performed much better than PB, and only narrowly missed the targets for staff costs to average assets and total overhead costs to average assets. The 1999 targets were relaxed in the light of the 1998 outcomes.

Despite a gradual loss in market share, the two state commercial banks, the Bank of Ceylon (BOC) and People's Bank (PB), continue to dominate banking making up a little over half of all assets and liabilities. But it is clear from the analysis above that they are considerably weaker than the banking system on average. Much of that is due to past government interference, especially with board and management appointments, dividend policy, credit activities, investments, recruitment and remuneration.

Twice in recent years, these two banks have benefits from official support operations. In 1993, they were capitalised at a cost of 3.5% of GDP in order to meet the new capital adequacy requirements. Unfortunately, lending practices did not improve and especially in 1994 there was an upsurge in politically motivated lending, sometimes with explicit government guarantee. The guaranteed lending turned non performing, forcing the government in 1996 to support the banks by placing interest earning bonds equivalent to 1.7% of GDP.

After a thorough examination of the loan portfolios reviewing all large loans individually and smaller loans on a sample basis, and applying international standards for classification and provisioning the auditors concluded that as of end 1998 both banks were seriously under provisioned.

Privatisation of the state banks, widely recommended as the preferred approach to restoring commercial viability, is not politically feasible at present. Instead the government tightened in 1998 the performance agreements that were put in place at the time of the 1993 recapitalisation. The new state bank agreements signed in July 1998, by the secretary to the Treasury on behalf of the government and by the members of the supervisory boards and senior management on behalf of the banks, spelt out reciprocal commitments. The bank's management teams agreed to aim for specific operational targets and the government agreed to respect the bank'soperational autonomy.

The government continues to consider its options as to how best to improve the financial conditions and operating efficiency of the state banks. It has publicly raised the possibilities of privatising management and selling a portion of the shares to the public.

Priority for economic affairs imperative

On the eve of the Presidential election one important expectation of the busi ness community is that whoever is elected the President would make the economy the central concern. This is imperative for more reasons than one. A country dragged down by a civil war can hardly survive, leave alone thrive, without sound economic management.

Most people view the war as the main obstacle to the economy's performance. While this is true, it is equally important to recognise that the war effort cannot continue successfully without a strong supportive economy. Since the resolution of the ethnic problem or bringing about a settlement of the war, is a thorny complex issue, making economic development dependent on a successful resolution of the problem could be a very key strategy. Instead, it is more useful to view the development of a sound economy as a pre-requisite to the resolution of the conflict.

Unfortunately the war has become an excuse for ineffective economic policies. While the war has had, and does have, an important bearing on the economy, could it be said that the government has done the most it could to develop the economy ? Could it be said that the government has played a pro-active role in the economy ? Could it be said that there has been a quick and effective implementation of declared policies ? Has the government responded in time to resolve problems faced by the private sector ? Has the government's own initiatives like the Southern Development Programme been implemented successfully ? Has the government been able to improve the economic infrastructure of the country - build better roads and improve transport systems ? Is it that the war that has prevented the successful implementation of economic projects or are there any other reasons ? We would leave readers to answer these questions for themselves. No doubt the answers would depend on the political biases and leanings as well. Whatever be the answers to these questions regarding the past, what we need are affirmative answers for the future. Once the Presidential election is over and whoever wins, there is an urgent need to get down to handling the economy seriously.

One of the important measures that need to be taken is the appointment of a full time finance minister. The portfolio of finance carries with it so many tasks that it must be entrusted to a single minister, who must have no other functions. The business community is well aware of this deficiency.

The appointment of a competent full time minister itself would inspire confidence. That is a step we must expect and perhaps the business community should be bold enough to ask. Mechanisms should be established both for listening to emerging problems and for effective implementation of economic policy. While there are a number of fora for the business community to give vent to their problems and there have been discussions with actions of the business community and business leaders, the government has not complemented these discussions with effective actions. There has been a lack of formalisation and delegation of authority for discussions to bear fruit. What is suggested is regular structured meetings with back up staff or a secretariat to follow up decisions or find out reasons for the problems. The business community too should be more precise in their approaches. These meetings should not deteriorate into ad hoc requests for concessions, but ones for formulation and implementation of policies conducive to business and economic development. May be a set of sub-committees consisting of officials and businessmen would strengthen such an approach.

Government must become more business - like. Too often officials are indecisive and decisions have to go higher and higher. Often meetings with businessmen are not punctual. Discussions range over many topics but decisions are few. Decisions taken are not implemented or ineffectively implemented. All these deficiencies should be remedied if we are to achieve rapid economic growth.

We hope the period after the presidential election would be one in which economic decision making and economic policy implementation is a priority. One way of ensuring this is the appointment of a full time finance minister. There should be new mechanisms put in place to ensure good and quick decision making and implementation of policies.

Without a prioritisation of the economy, the country has everything to lose.

World bodies called to account

In an article in the London Financial Times by Robert Chote, Economics Editor, it is said that the governance and management by The International Monetary Fund and the World Bank have been brought into question. This has happened, partly because "both institutions have been forced to adapt their roles to an evolving global economy". The financial crises which have swept emerging markets since the summer of 1997 have, he says, spotlighted the Bretton Woods institutions.

The mission of the MF, set up in 1944 to oversee a world economy of pegged, but adjustable exchange rates, was to help countries cope with temporary balance of payments problems without resorting to damaging policies such as trade barriers or competitive devaluation. The Fund, says Chote, was able to achieve this relatively modest financial support packages, capital flows being initially limited. It was also "relatively simple" to prescribe fiscal and monetary policies consistent with a country's exchange rate.

But in the 1990s, Chote points out, capital account flows came to vastly outweigh the current account imbalances on which the Fund traditionally focused. Capital flows have allowed countries to sustain big current account deficits for long periods, but rendered them vulnerable when these flows reverse.

Chote observes that foreign exchange reserves have also been increasingly inadequate to protect countries from exchange rate and banking crises. When the focus was on the current account, reserves equal to three months' imports might have been thought to be adequate; but "countries arguably now need to cover all outstanding balances of short-term liabilities or even the whole domestic money supply if there is a danger that residents might flee". Chote goes on to say that the financial crises of 1997 have seen the Fund engage in huge rescue packages, demanding far-reaching structural reforms of the countries to which it lends.

The World Bank too has had to adapt to a changing global environment. In the 1950s and 1960s the Bank, says Chote, had a niche for lending to developing countries all to itself. There was no global capital market on which these countries could could borrow. But now access to capital is much more widely dispersed. The Bank's standard loans have become increasingly less attractive, and the Bank has focused on technical advice to developing countries. It has successfully repackaged itself as an institution focused on poverty reduction. Meanwhile, says Chote, " the crises have seen the Bank called upon to contribute liquidity support to the huge rescue packages, a role normally confined to the Fund and in turn the Fund has been offering detailed structural policy prescriptions normally the province by the Bank".

Policy makers are taking a step backwards to look at the roles of the Bank and the Fund. Chote refers to a recent report by four leading international economists (An independent and accountable IMF - Geneva reports on the World Economy) which argues that there is a strong economic case for the Fund to continue to play an important role "Yet" says the report "its governance structure and the representation of its member countries are anachronistic and must be reformed". The report, says Chote, identifies three critiques of the way in which the IMF makes policy:

1. Decision-making is dominated by the management and staff who set the agenda for executive board discussions. IMF staff and management imposed on the Board recommendations driven by an outdated financial programming approach during the recent financial crises.

2. The IMF's management and main shareholders place a higher weight than society as a whole on monetary and price stability and less on economic growth and equitable income distribution.

3. National governments - especially the U.S. exercised a disproportionate influence over the decisions taken by the Fund. An example given is pressure brought about by the U.S. to continue to lend to Russia for strategic and geopolitical reasons when the country's economic policies did not justify further help.

Chote says that the first concern could be addressed by exposing the Fund to a wider variety of outside arguments when it comes to developing policy. The report suggests that national officials should be encouraged to address the IMF board themselves when policies or programmes directly affecting them are discussed. The report also suggests that the board should convene regular meetings of a panel of academic consultants; also regular external revisions of IMF programmes should be commissioned.

These measures would reduce the IMF board's reliance on the staff. "But" says the report "inevitably, management would retain some agenda setting power over the decisions taken by the IMF's shareholders."

The report makes, according to Chote, several recommendations to increase the transparency and accountability of the institution. The first is to ensure that more decisions are taken by formal votes on the board rather than by consensus. "Like it or not, consensus and compromise are the enemies of accountability" the author argues. It is also urged that the Fund publish the arguments and votes of individual directors so that they are accountable to the electorates of the countries they are supposed to be representatives. As regards the complaint that the IMF's decisions are driven by national political interests, notably those of the U.S. its biggest shareholder, the report notes that support for Russia has been attributed to U.S. security objectives and that the opening of markets demanded as a condition of lending to the Asian crisis victims may have been driven largely by the desire of developed countries to gain access to them.

The report proposes prohibiting executive directors from taking instructions from governments. Directors would be appointed to multi-year terms of office, but could be dismissed by a super majority vote of the " interim committee" of finance ministers which shares the same constituency structure as the board and which oversees the activities of the Fund.

G20 gathers to debate global financial future

By Janet Northcote

Top financial officials from the world's lead ing industrial and developing countries meet in Berlin on Thursday, seeking a common approach to global problems. Officials from the G20 group, who had a preliminary exchange of views over dinner on Wednesday evening, are expected to assess progress and generate ideas on solving the problems which have arisen as the world's economies knit closer together.

Yet the finance ministers, who will attend the meeting together with their central bank governors, stressed in advance of the main session that financial markets and other observers should not expect major decisions.

French Finance Minister Christian Sautter, commenting on Canadian Finance Minister and G20-chairman Paul Martin's aims, said: "The intention is not to prepare future decisions. "Rather the intention is to look at why some things that have been decided have not been developing countries," he said.

The new forum groups the G7 group of industrialised nations— Britain, Canada, France, Germany, Italy, Japan and the United States — plus 11 emerging and other economies — Argentina,Australia, Brazil, China, India, Mexico, Russia, Saudi Arabia, South Africa and Turkey. European Central Bank President Wim Duisenberg and outgoing IMF Managing Director Michel Camdessus make the group up to 20. The G20 is the latest in a series of initiatives aimed at adapting the world economy to the trend of globalisation — and particularly the concern that economic interdependency can make one area vulnerable to a crisis in another.

The South-East Asian crisis which broke out in 1997 almost took on global proportions, with additional fears of a spread to countries in Latin America hurting the world's biggest markets. With the agenda fairly open, attention in advance of the talks focused on a proposal from the United States to clip the wings of the International Monetary Fund, on who should head the IMF, and on currency issues.

Proposal to rein in IMF gains cautious backing

The U.S. initiative to redefine the mission of the IMF drew a cautious welcome as other leading countries welcomed its central thrust but differed on the details. U.S. Treasury Secretary Lawrence Summers launched a bold drive this week to limit the IMF's role to short-term financing— the task it was set when it was created after World War Two— and get away from long-term aid to struggling countries. Japan voiced some reservations on the idea — a government source said long-term lending was sometimes necessary — and France said it was concerned that a changed IMF focus could mean some countries that needed aid might not get it on time.

But G7 sources said there was no real disagreement on the basic idea of giving greater focus to IMF activities and ensuring the Fund does not become too free in its lending.

The issue of who should succeed outgoing IMF Managing Director Michel Camdessus, who will retire in February, is also expected to feature, although it is not on the official agenda. Germany hopes to win backing for Deputy Finance Minister Caio Koch-Weser, but has so far received luke-warm backing within Europe, with some countries subtly conveying the message they would perhaps prefer to see another candidate emerge. France's Sautter told reporters that he appreciated the qualities Koch-Weser had to offer and acknowledged that he was the only "explicit" candidate at the moment, but added that Europe must choose its candidate in a transparent manner."We still have time to reach a decision, up until Camdessus leaves," he added.Camdessus, on a stopover earlier in Paris, said however deliberations over who will replace him should be speeded up.

Currencies not on agenda

Currencies were not on the G20 agenda, but ECB President Duisenberg caused the euro to spike up against the dollar onWednesday by saying the common currency had upward potential,although he did not put a timeframe on his comment. Sautter said he had told U.S. Treasury Secretary Lawrence Summers that the euro's slip to parity current level against the dollar reflected dollar strength rather than euro weakness, and the euro should gain in value as European economies improved. Reuters

Personal information on net transactions unsafe

By Dinali Goonewardene

Personal information obtained through transactions on the internet in Sri Lanka is not safe. There are no laws or regulations protecting the privacy of personal information in Sri Lanka, said a leading lawyer and former regulator. "There is privacy infringement- sellers obtain consumer information without the consumer knowing," former Director General of the Securities and Exchange Commission and Partner, Nithya Partners Arittha Wikramanayake said at the 20 th National Conference of the Institute of Chartered Accountants of Sri Lanka. Mr Wikramanayake presented a paper on "E Commerce Legal Considerations- are we ready?" He concluded that Sri Lanka was not ready.

It is common for traders to collect personal information from their customers during routine e commerce transactions. "This information has become a valuable marketable commodity to those providing services on consumer patterns and preferences, resulting in considerable abuse," Mr Wikramanayake said. "Since the consumer is usually unaware that personal information about him is available in a data base for third party use, he runs the risk of serious harm by such information being incomplete or inaccurate," he said. Information collected is used to send e mail messages and chain letters, giving rise to privacy issues.

Under Sri Lankan law data is not considered property as it is not tangible property and as a result hacking is not considered theft.

The great divide between countries that have privacy protection laws and those that don't have given rise to the debate whether data should not be exported from countries with strong laws to those with a laissez faire attitude. This debate is fast gaining relevance as the data collected in certain countries is processed in a different country. Sri Lankan internet service providers will also be affected as information gathered in countries with strong protection laws may not be considered appropriate to pass through them.

The Organisation for Economic Co-operation and Development (OECD) has formulated guidelines on the protection of privacy and transborder flows of personal data. The OECD guidelines have served as the basis for most privacy legislation and codes of conduct that have been developed.

The OECD guidelines set out principals including the collection limitation principal which places limits on the collection of personal data and requires that it be obtained with the consent of the data subject .

Personal data should be relevant for the purpose for which it may be used and for the extent necessary for that purpose, it should be accurate, complete and uptodate. The guidelines also state that the purpose for which personal data is collected should be specified when it is collected. Personal data collected should not be used for any purpose other than those specified, except with the consent of the data subject. Personal data should also be protected by reasonable security safeguards.

The protection of personal information is considered a basic human right in Europe and a European Union Directive encompasses data protection. In the United States the government has been working with the private sector to develop and implement effective privacy self regulation. The US approach includes sector specific legislation, regulation, private sector codes of conduct and market forces. The self regulatory approach is also adopted by Australia, Japan and Canada.


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