It was reported in the Daily FT that Jonathan Alles, CEO and Managing Director of Hatton National Bank, sounded an alarm on the consequences of proposed consolidation of the financial sector.
According to the newspaper, he said: “It is not that I am negative and don’t see this as an opportunity, but I’ll just say that at the end of the day we will mess it up right royally.”
On the following day he made a statement emphasising the fact stated in the above statement as well that he and the bank are supportive to the consolidation initiative and have been actively involved in preparatory work.
Can Alles, who is a paid employee, go against the main shareholder of his bank, the regulator and the Government, three in one represented on his Board by none other than the Chairperson? No he can’t. Looks like even constructive criticism is also not encouraged, which is a must in this type of massive project.
In addition to the Government banks, Bank of Ceylon, People’s Bank and National Savings Bank, the Government is the major shareholder of major private banks in Sri Lanka. Considering the shareholding of Government entities, Bank of Ceylon, National Savings Bank, Insurance Corporation of Sri Lanka and Government-controlled entities Employees’ Provident Fund and Employees’ Trust Fund, the total Government shareholding in the major banks is given below:
- Hatton National Bank: 28.87%
- Commercial Bank: 19.17%
- DFCC Bank: 20.63%
- National Development Bank: 23.58%
- Sampath Bank: 12.64%
- Seylan Bank: 32.40%
It is appropriate to note that these percentages are well above the minimum allowed percentage of any one person and related entities can hold of a bank, which is 10%. Total collective voting rights in Hatton National Bank, of Milford Exports (Ceylon) Ltd., Stassen Exports Ltd. and Distilleries Company of Sri Lanka, which collectively hold 18.24% of the voting shares of the bank, are limited to 10% based on the said rule.
Conflict of interest
The Central Bank, being the regulator of the commercial banks and being the controller of the investments of the Employees’ Provident Fund, bought shares of commercial banks using EPF funds. As pointed out by many, there is a conflict of interest here. The EPF purchased little less than 10% of all the six banks above. Isn’t it appropriate to limit the shareholding of the Government to 10% in these banks considering its own rule since all the Government entities are related to one another?
The origin of the practice of acquiring shares of the commercial entities using funds of the Government entities goes back to the time of President Kumaratunga. When the current President was the Minister of Labour in the Government of President Kumaratunga, he purchased Salt Corporation with the funds of Employees’ Trust Fund Board and later he had sold it off.
Advantages of consolidation
Consolidation of banks and non-banking financial institutions has its advantages, which were pronounced by the Central Bank. Mainly there will be stability so that there is a remote possibility of a failure of a bank or a financial institution which is under the supervision of the Central Bank.
The Central Bank says that there is no urgent necessity for consolidation now. If consolidation is done now when there is a necessity, such as hardships of the economy in the future, we do not have to rush through. Let alone the mergers of the financial sector, any merger has its own merits and demerits. As Alles pointed out, we have to identify and cautiously face those situations.
Sri Lankan banks by and large lend on collateral and the ability of the borrower to pay and the prospects of the project are secondary. There are capable entrepreneurs of this country who do not have adequate collateral to offer and there are persons with ulterior motives as well. It is the capability of a bank to identify these persons and treat accordingly.
This is not an easy task as lending with the comfort of collateral and this is the way that the banks can contribute to our economy positively. It is great if we can achieve this with consolidation. Furthermore, as the Secretary to the Treasury points out, banks should move from credit card lending to long-term lending in order to have a lasting impact on the economy.
"When the country takes important policy decisions, there should be an adequate debate over pros and cons and then only should we take a decision. As Alles said, no one who argues against the consolidation is negative. What we should avoid is one-sided information and decision flow, which is prevalent in the political field today, and the ‘yes sir’ mentality"
Interest rate spread
It is widely believed that the interest rate spread of Sri Lankan banks is high. It was reported that one main reason for this is inefficiency, one main reason of which is political influence of the two giant State sector banks, Bank of Ceylon and People’s Bank.
Other commercial banks take the cover of these two giants and keep the spread high. Therefore, with consolidation, it is very much appropriate if the Government can consider seriously real restructuring of the two State sector banks. Then and only then will consolidation be effective.
Although the interest rate spread, which means the difference between the lending rate and the borrowing rate, of our banks is high, the margin which means net interest income over gross interest income is comparatively reasonable compared to international banks.
Over the last two years the margin of interest as explained above ranged from 33% to 46% of the above six banks. However, the same of HSBC Global and American Express, of which the main income is not interest, is around 65% to 70%. Their spread is low since the interest rates are low and hence it is not felt very much. Since our interest rates are high, the higher spread is felt very much.
The Central Bank is of the view that with consolidation, the interest rate spread will also be lowered with efficient utilisation of assets by the banks. However, the customers of the banks should be very cautious of this statement considering the present behaviour of the banks. Probably with fewer and stronger banks, competitiveness in the market would be affected. Especially if there are no reforms in the State banks, there would be a higher probability that customers would be affected.
Banks at the top
In the Business Today rankings, among the top 10 companies there are four banks: Commercial Bank, Hatton National Bank, Sampath Bank and the National Development Bank. DFCC bank is in the 14th slot whereas the country’s leading exporter Hayleys is in the 12th slot.
There are different reasons for this. But I believe in a developing country like ours, although the Governor of the Central Bank places the country a bit higher, top slots should be occupied by the manufacturing and exporting companies, not the banks which are just depending on the industry.
Banks should support the industry and not the other way around. This situation is not prevalent in any other country, if I am not mistaken, other than in China. The high profitability of Chinese banks is rooted in a large extent in the guaranteed high net interest margin and lower personnel costs advantage.
Among the top 10 highest profit making companies in the world there are two Chinese banks, Industrial and Commercial Bank of China and China Construction Bank, and those are the only banks among the Top 10.
In the above six Sri Lankan banks, the net profit margin, which means profit before income tax over total Income including gross interest income, ranges from 10% to 33%. Although these are not comparable, considering the profits of a manufacturing company, these figures are very lucrative. With the consolidation, if it works well, this trend would probably continue a bit aggressively.
Adequate debate needed
Finally this question of consolidation was triggered when the Secretary to the Treasury wanted the banks to borrow in foreign currency from foreign entities. The Government probably wanted to ease its foreign borrowings and wanted the country to borrow continuously with an eye to maintaining the exchange rate as well.
Banks were unable to borrow the expected amounts and one reason is the comparative smaller size of the local banks. With the consolidation, this intention can be achieved. However, it should be noted that with the still higher Sri Lankan interest rate in the international markets (it may not be able to reduce it further in the short run), the Sri Lankan Rupee should depreciate in order for our export products to be competitive in the international market. It would be a mistake if the exchange rate is manipulated with borrowed funds.
When the country takes important policy decisions, there should be an adequate debate over pros and cons and then only should we take a decision. As Alles said, no one who argues against the consolidation is negative. What we should avoid is one-sided information and decision flow, which is prevalent in the political field today, and the ‘yes sir’ mentality.
(The writer is a Chartered Accountant by profession and holds a Master of Business Administration degree awarded by the Postgraduate Institute of Management of University of Sri Jayewardenepura.)