Dilemma of Non-Bank Financial Institutions

From left: FHA Legal Advisor Shiranthi Gunawardena, FHA Immediate Past Chairman Krishan Thilakaratne, FHA Chairman R.H. Abeygoonewardena, and FHA Council Members Niroshan Udage and Sanjeewa Bandaranayake 

• FHA finally spoke out; what’s next? 

It is encouraging to see the Finance House Association (FHA), the apex body of the Non-Banking Financial Industry (NBFI), which is made up of all registered finance companies, finally voicing the untold concerns of the industry at a press briefing last week. 

As I have been constantly expressing, the NBFI is the industry or financial nursery which nurtures the bankable customers to the country’s banking system. They have been assisting this high-risk element of the society for the last 80 years or so with the least recognition from the authorities concerned. To make matters worse, most of the time they are being blamed for the sins committed by non-regulated financial entities that are being operated under the same industry tag in the country. 

The Non-Banking Financial Industry (finance companies to most) plays a critical role in the economy. It enables high returns on savings and accommodates borderline borrowers who are not welcome by banks. Like banks, they too handle financial intermediation processes that facilitate the flow of funds between savers and borrowers. Unlike banks, they are geared to take high risks in order to accommodate new entrants into the market. 

Though the financial industry is dominated by banks over the last few decades, the NBFI has played a major role in filling the gaps created by them in the industry. NBFI has been very effectively serving the un-bankable market segment in the rural and suburban areas. Had not been for the NBFI, most of the well-known businesses of the country wouldn’t be in existence today.

Some treat NBFI as a shadow banking application with less importance to the banking industry. However, these two segments of the financial industry have their individualisms, exceptionalities, and characteristics. Hence, comparing them doesn’t make genuine validation in economics. Further, the way the revaluation of the Information Communication Technology (ICT) is taking place, NBFI may one day overtake the banking industry as unlike the latter; the NBFI operates on emotional intelligence. 

The emerging trend of Fourth Industrial Revolution (4IR) which comprises Artificial Intelligence (AI) puts the banking industry at risk at some point. The non-banking industry which basically operates on human intervention might not be at the same risk due to its dynamics. 

The present day scenario of NBFI

With only two weeks into the COVID-19 pandemic, by 31 March, NBFI recorded an NPA ratio of 11.37%. With the amount of pandemic related issues surfacing since then, one can imagine how it would be at the end of the first quarter of the fiscal year 2020/21 that ended last month. The policy-makers of the authorities should give a serious thought to assist the NBFI in the way that they do with the banking industry. 

The NBFI which consists of loans and advances totalling Rs. 1.1 trillion and an asset base of Rs. 1.43 trillion as of 31 March 2020, has paid around Rs. 15 billion in corporate taxes in the last fiscal year ended March 2020. Their counterpart, banking industry which has a base of Rs. 7.9 trillion in loans and advances and an asset base of 12.5 trillion has paid Rs. 60 billion as corporate taxes as of their last fiscal year ended December 2019. 

Considering the comparison, there is no reason as to why the NBFI is left out from present government concessionary schemes. Similarly, seven million of the population have sought some kind of financial assistance from the NBFI out of the active population of 14 million (50%) who are in the age bracket of 18-70 years. The research statistics indicate NBFI has four million borrowers and three million depositors. 

It is published last week Non-Bank Financial Institutions (NBFIs) have appealed to the Government to include them in the Rs. 150 billion Saubhagya COVID-19 renaissance facility implemented by the Central Bank of Sri Lanka (CBSL), stating that the industry could reach out to smaller companies in need of support, effectively, considering their expertise in the sector. This is a sensible appeal as the benefit could be enjoyed by the owners as well as employees of these SMEs which is the need of the hour. 

There are nearly one million micro-businesses with less than 10 employees. They account for around 44% or 1.4 million of the labour force. These micro-businesses are engaged mostly in trading and services. Additionally, there are over 70,000 SMEs that have employees between 11-50, accounting for half a million or 17% of the labour force. Hence, the appeal made by NBFIs is highly appropriate under the present circumstances. 

A way forward

Credit Regulatory Commission with extended powers: A large number of finance companies operating in the country are not regulated by the CBSL. Hence, the effectiveness of the CBSL direction on them is questionable. These directions are applicable to the registered financial institutes with the CBSL. If laid-down procedures are not adopted, they can be penalised for not doing so. There is no procedure in place to punish the unauthorised market segment in the country. Hence, there has to be a body to govern and to regulate non-CBSL regulated lending institutes. Under such circumstances, the government could consider establishing a regulatory body similar to the proposed Credit Regulatory Commission or to approve wider powers to the same commission to regulate such companies.

Level playing field between the banking industry and the non-banking industry: The LTV direction which could have been used to enhance the quality of credit in the NBFI has boomeranged on NBFI as the banking industry moved in to capture this less risk element in the market by offering very attractive rates. It was like fishing in troubled waters as business opportunities that had been left in the market too have been grabbed by banks. In the absence of level playing field between the banking industry and the non-banking industry, for survival the Non-Banking Financial Industry was forced to move into more risky territories, forgetting their cash cow, vehicle leasing. 

e latter. 

Fixed Deposit (FD) rates: The ceiling rate laid down by CBSL for NBFI has not given adequate room for NBFI to challenge its counterpart, the banking industry. In most circumstances, negligible interest rate differences are seen between these two industries in FDs. The FD rates should be liberalised for the institutes operating without compliance issues in the NBFI to make them attractive (rates) to allow uninterrupted cash flows and also to pass part of the benefit to the Depositors. However, institutes with poor compliance records shouldn’t consider for such privileges. 

Money recovery procedure: It is prudent to empower the NBFI with necessary tools for speedy recovery action such as parate rights for selected institutes with no compliance issues. However, again institutes with poor compliance records shouldn’t consider for such privileges. 

Fraudulent deeds: There is a serious concern in the industry due to fraudulent deeds and fraud in mortgage loans. Hence, an effective mechanism should introduce to synchronise the mortgage procedure and the document authentication at government institutes such as the Land Registry and local councils.  

CBSL’s role: The financial sector regulatory framework is mainly divided into two sections at the CBSL. Those are statutory examinations and continuous surveillance. These two sections divided into four sub- sections. Those are capital requirement monitoring, risk management, good governance, and other regulatory requirements. 

The CBSL is mandated to stabilise the financial system of the country. It is empowered by the Monetary Law Act, Banking Act, Finance Business Act, Payment & Settlement act, and Financial Leasing Act. The Monetary Board of CBSL is empowered to issue directions to the industry with the view of the stabilising the financial system.

It is time to think outside the box! A challenge for the new Government. Make CBSL a more vibrant establishment. Try and shuffle some of the functions of the CBSL with the Ministry of National Policies and Economic Affairs or with some other appropriate ministry. This will make the CBSL role in the NBFI and also in the banking industry more dynamic, challenging, and effective to drive the growth of the economy in the coming decade.

Conclusion

The first step of Professor Philip Kotler’s eight-step change model, sense of urgency is blinking just around the corner for the regulator, CBSL. Heraclitus, a Greek philosopher once said, “There is nothing permanent except change.” Hence we shouldn’t be afraid to think outside the box for changes. Continuous exploration and exploration-based change is the key to success and growth.

We live in a new normal era with COVID-19 pandemic where only the innovative-thinkers could survive. Change is the only tool that makes a difference for such thinkers. New initiatives, project-based working, technology improvements, staying ahead of the challenge come together to drive ongoing changes to the way we work.