“Banks will have to balance growth, profitability and focus more on risk management”
Monday, 28 July 2014 00:00
Commercial Bank of Ceylon Chairman Dinesh Weerakkody completes his nine-year term today (28 July). In this wide-ranging interview Weerakkody talks about how the industry looked like in 2003 when he joined the Board of DFCC Bank and later Commercial Bank in 2005, and the challenges facing the banking industry in 2014 and what the industry will look like in the next five years.By Shanuka TisseraQ: Can you start off by talking about the current banking landscape? A:The industry is facing unusual challenges in the form of low interest, high liquidity and low credit demand. Low credit growth adversely affects other streams of income as well such as trade finance, exchange and guarantee income. Another area of concern has been collections resulting in impairment charges putting further pressure on the bottom line. One area that is doing well is the growth in deposits, which however adds to the already high liquidity in the sector. The excess money cannot be invested at attractive returns due to the current Treasury Bill rates. However I am confident that with the expansion of the economy, especially the new sectors would create new opportunities for banks. This means the industry will have to adjust. When you get these big shifts in the economy, there are always winners and losers. The winners will be the ones that can adapt to the new environment and do the right thing in the right way. In addition, local banks will need strong tie-ups with global banks to provide access to global network to support local customers’ business expansion and for advisory, training and for flawless transaction processing. There is also opportunity for pooling of resources and also setting up shared utilities.
Q: Credit growth in the 1st half of the year has been very low; will this change in the next half?A: The conditions with regard to bank borrowing is near ideal with rates at an all time low and banks having enough liquidity to cater to credit demand. However the ‘wait and see’ attitude of the business sector remains unchanged despite the attractions of raising funds at low cost. Saying that we also need to give the business community time to take decisions relating to expansion and venturing in to new areas. We are seeing a slight movement in credit growth, which we hope would gather momentum in the second quarter. One also may have to look at the other side of the low interest scenario, which is the serious decrease of the monthly income of people who are dependent on fixed income for their monthly expenditure. This segment of the economy would have seen their disposable income reducing as much as 50% over the last 12 months and this may be having a significant impact on their spending patterns, and through that the demand side of the economy. The other factor is the confidence of the private sector on the consistency and the continuity of Government Policy, which is a sine qua non for venturing in to new projects. My view is that- the waiting game should come to an end sooner than later and the private sector should look to expand and create value. I am confident that credit growth would pick up during the remainder of the year and the industry may reach 15 percent credit growth by the end of the year.
Q: Is low credit growth due to the tight monetary regulation of the last two years?A: It is difficult to tie the current situation to the tight monetary policy which may not have been a bad option to cool down an overheated economy which was growing faster than expected, mainly driven by consumer demand. May be the sudden restrictions which came about in retail and consumer lending mostly through pawning which got affected by the fall of Gold prices slowed down the economy and had an impact on certain sections of our society. In my view good monetary policy can manage the timing and length of these cycles.
"The conditions with regard to bank borrowing is near ideal with rates at an all time low and banks having enough liquidity to cater to credit demand. However the ‘wait and see’ attitude of the business sector remains unchanged despite the attractions of raising funds at low costThe banking industry is very well regulated and the regulators have always been keeping up with the changes that take place globally. More online monitoring would be far more effective rather than the traditional audits, which are generally post event. However the long-standing conservative supervisory approach with even greater emphasis on prudence underpinned by proactive and forward looking supervisory will continue to work – Commercial Bank Chairman Dinesh Weerakkody"Q: Are you satisfied with the regulation levels currently? What would you like to see different?A: The banking industry is very well regulated and the regulators have always been keeping up with the changes that take place globally. More online monitoring would be far more effective rather than the traditional audits, which are generally post event. However the long-standing conservative supervisory approach with even greater emphasis on prudence underpinned by proactive and forward looking supervisory will continue to work. Of course, in the search of financial stability, there is always the danger of piling on a mountain of regulation upon another. The other challenge for regulators would be keeping pace with technological advances.
Q: How developed is our financial services industry currently? A: The industry though well established and stable has ample opportunity to move in to new areas especially in equity financing, long term lending which obviously has to be backed up by long term deposits and venturing in to other areas such as investment banking and offering new pension products. Do I think the traditional banking model is still valid? I absolutely do.
Q: What is needed to grow the industry further? A:A strong capital market with long-term investments and opportunity to hedge your risks. Also banks will need new skills, will need to invest in the technology that have positive outcomes for customers and also require a bold private sector. I firmly believe that banks will have to identify the future drivers of profitability and modify their business model to remain relevant in the future.
Q: In your view are SL banks too risk averse?A: All business is about risk and managing risk- and particular so in banking. Given the existing market conditions one cannot say that the SL banks are risk averse. It is not possible to compare with banks operating in different economies. It is safe to say there is no “one size fits all” answer to what kind of business model banks should adopt as a universal rule. Each country must reflect and determine on its own what of kind of banking model works that would suit them best.
Q: Risk management in the banking industry, how robust is it?A: There is certainly a need for a more rigorous approach to risk management because the industry is going through such a transformation. The crucial ability to understand the business model and modify it depends on the insights that risk management provides. Therefore, managing risk requires judgment and that requires people who are financially literate but also risk aware.
Q: Then there is the question whether Sri Lanka is over banked?A:One cannot say that the industry is overcrowded. However some smaller banks may find it exceedingly difficult to compete without scale. The capital requirements for the future also may well place demands on the smaller players who would be forced either to go to their shareholders for more capital or find a partner to merge.
Q: Are you implying that the Central Bank road map for consolidation is a step in that direction? A: There is no debate that the country needs bigger and stronger banks. Therefore the consolidation of financial institutions in my view will be beneficial for the stability of the financial sector in the long term and for the country. Consolidation will enhance the size of the banks and increase their ability to source oversees borrowing and risk taking capacity to enable private banks to participate in large state and private sector projects to a greater degree than at present and derive scale benefits with regard to functioning costs and finally deliver greater value to all stakeholders.
Q: What is the rationale behind Commercial Bank investing in a finance company?A: The consolidation strategy proposed by the CBSL created an opportunity for banks to reach out to other segments of the market without changing their risk profiles. The bank saw this as an opportunity to reach out to new markets that we did not have access before given our cost structures and management structures. Therefore, once the due diligence is successfully done and verified the target company will be run as a separate entity with a different value proposition.
Q: Your views on the proposed NDB -DFCC merger?A: Both are great institutions with great traditions. The challenge and the opportunity would be to retain the best of both cultures, processes and talent to deliver a superior value proposition to their customer and contribute in a significant way to national development.
Q: The success rate of banks raising funds in overseas markets. How can this be improved?A: The success rate had been pretty decent and the rates at which some backs borrowed from overseas have been very competitive. For overseas borrowing to happen in large volumes, the banks here would need to have the size, a good balance sheet and also a good business story which the foreign banks/ investors are willing to accept and trust.
Q: To stay ahead of competition what would banks have to do?A: Broadly, keeping pace with innovation, increasing productivity, delivering great experiences across all customer touch points. With competition intensifying banks would have to serve their existing customers even better by deepening existing relationships and by adding new customers. This would require banks to analyse how their customers use their products and services, and try to identify how they can improve their experience. This analysis also needs to determine what products and services they are not offering their customers as these are clearly lost revenue opportunities. Therefore effective cross-sell strategies are critical to improve revenue per customer and to do that banks need to know their customers at a deeper level for cross selling across segments.
Q: How is Board governance in general in the financial services sector?A: Boards have a fiduciary responsibility to shareholders to ensure the long-term health of the company. The board’s job is to provide oversight and perspective to the executives running the business. They have to make sure things are done by-the-book, but they are also expected to bring their own experience, from other businesses and other industries, to the table to help the enterprise make better decisions. The trouble is, these two roles are uneasy bedfellows, so the real challenge facing a Board member is being able to move between the roles seamlessly – checking up on the enterprise one minute, and providing trusted advice the next.
Q: Why are banks so popular with stock market investors in Sri Lanka?A: I think earning volatility is one of the key factors that affect the share prices. In a bank’s business model, profitability is historically consistent and this in-turn reduces the price volatility of shares. In my view, unlikely the other sectors, the banks can quickly re-price a major part of their assets and liabilities, which reduce the main variable cost (i.e. cost of funds). This helps the banks to maintain a stable bottom line and dividend payout despite market ups and downs which is an attractive feature for an investor taking a medium to long-term view. Another factor, which contributes for stable performance, is the regulatory and governance framework surrounding the banking business. Since the banks are confined to a defined business model by the regulator, such institutions are not vulnerable to many market risk factors. This creates stability and confidence in the mind of the investors creating an appetite to buy and hold bank stocks. Bank shares would therefore be demanded by institutional investors such as foreign funds compared to shares of other industries. This consistent demand too makes the share more attractive in the stock market. In addition, banks are quick to focus on OE initiatives, invest in new technology to manage costs and also to grow new skills to grow the bottom line.
Q: How should an institution manage shareholder expectations of dividends?A: In my view it is a sign of weak leadership to say that shareholders merely invest for short-term returns. Most shareholders in my view are looking for sustainable long term, consistent returns over time. They recognise that this comes only when you have sound relationships with customers and broader stakeholders and engaged employees. So in a nutshell, I am very supportive of that stakeholder model.
Q: What kind of people are needed for bank Boards? A: Bank Boards that get majority of their capital from the public require people with varied skill sets, commercially-savvy and people who are independent in their thinking to ensure the Board has the breadth and depth of skills and experience to enable adequate oversight of the bank business now and in the future. When I joined DFCC in 2003 the industry was very different and the demands made on directors not all that challenging. Bank Boards now require a lot of brainpower and intellectual rigor to keep up with the mountain of regulation and technology changes that are taking place.
Q: There has been much debate about how Independent Directors should act in the boardroom. Your thoughts?A: Independence to me is not about ‘no-shareholding’; it is more about how independent the director is in his thinking and his ability to challenge proposals at the Board meeting objectively. I do subscribe to the view that non-executive directors are the ones who really perform the real role of independent directors, since executive directors are often left to defend decisions and proposals in Board meetings. Board members should properly understand the business they are overseeing; they should devote sufficient time to the work that they can get under the skin of the company and follow up on things that don’t seem quite right; and they should help to develop a culture in board meetings what Intel used to call “constructive confrontation” – which is about legitimising challenge and dissent, but in a positive way.
Q: Should sitting and retired public servants be appointed to Bank Boards?A: In my view shareholders whether public or private should have the freedom to appoint competent men and women of high integrity to look after their interest. However they should as far as possible avoid conflicts of interest.
Q: How realistic is the Banking Act Direction 11 setting term and age limits for directors?A: Age and term limits provide a painless way for people to retire gracefully and automatically. Admittedly, this is a pragmatic argument and the downside is that a director who is doing a fantastic job may get forced out early. Also limits reduce the likelihood that a few individuals dominate board decisions forever and they also help to provide periodic injections of new energy and ideas. However finding the right director is no easy task. Therefore, the shareholders acting in the best interest of all the stakeholders should decide term and age limits.
Q: What would be the challenges for the banks in the next five years?A:With margins on the decline and increasing competition Banks will be under pressure to smart size their operations for tighter performance management, centralised transaction processing, deeper relationships and also grow their fee-based revenue to ensure that they continue to enjoy the double-digit profit growth rates that they have been seeing over the past few years. Another key challenge the banks will face is implementing Basel standards while maintaining the attraction of their shares to investors. The new rules in Basel III will negatively affect the numerator as well as the denominator of Return on Equity (ROE) which ratio being the basic and widely used indicator by the equity investors. While the profitability of banks are affected negatively by reduced lending capacity, higher cost of funds, increased cost of liquid assets, the increase in equity base will pull the ROE down. On top of the above reduction in ROE, banks may need to curtail dividend payouts in the future to preserve and build capital buffers. This negative effect on ROE and dividend payouts could reduce the investor’s preference to invest in bank equity, compared to other options available in the stock exchange. But banks are smart they will learn to manage that challenge. In the long run, banks would have to broaden their delivery channels through innovative technology to cater to Gen Y and Millennials who will quickly opt for social media, tablets and demand for more sophisticated technology to do their banking. Client-centric relationships will also become order of the day. Finally, broad technology themes – such as cloud, mobility, social media and big data will impact all banks. Therefore, the challenge for the banks would be to anticipate how the technologies that are available today and in the pipeline would impact their internal and external stakeholders tomorrow. However, technology should be used to cut cost, create efficiencies and to provide a seamless user experience at the point where the customer interacts with the bank.
Q: What about competition from outside the traditional banking sphere?A:Banks are very likely to see further competition from tech companies as they explore the possibilities of providing on line banking, payment systems and money lending services. However to what extent this will affect retail banking services will depend on the regulators. In many markets regulators are still to decide whether such companies should come under their supervision.
Q: With the sector becoming more sophisticated with the infusion technology will the financial services sector have the required skills?A: Sri Lanka would need to prepare large number of people to work in the industry. Therefore the investments we make now in education will contribute significantly to economic growth and will be key to our current and future competitiveness. The Government’s ability to promote public-private partnership to invest in human capital formation would be crucial. However, the private sector must also stand ready to take advantages of the support the Government is willing to provide to promote human capital formation. The private sector cannot wait till the state invests; we need to grow our talent pools that however require sustained investments.
Q: Finally where would you like to see Commercial Bank heading?A: In 2013, Commercial Bank became the 2nd most profitable bank in the country, so the next logical step would be to become the most profitable bank in the country. The bank is well placed to serve the growing domestic market as well as expanding regionally and internationally.
(The writer is a freelance journalist, graduate in business administration from the University of Leicester and is engaged in the capital markets)