Restoring credibility of Central Bank: What ails the system?

Monday, 19 February 2018 00:00 -     - {{hitsCtrl.values.hits}}

Persistent breach of fiduciary responsibility by errant licenced finance companies 

We are today, and have been indeed for the past two years, in the throes of a classic case of regulatory failure on the infamous ‘Bond Scam’. In its aftermath, the Bond Commission Report demands accountability at various levels of management at the Central Bank in particular. It is evident that no single person can be held responsible for actions or decisions taken in a hierarchical bureaucracy that has been firmly entrenched within the Central Bank and which prevailed since its inception.

Therefore, regulatory failure and accountability go hand-in-hand and are consequential. If regulators act with responsibility within the framework of the law and are held to account if they do not, we can be confident that investor and depositor confidence in the country, particularly in our financial system, will be at its peak. Sadly, the Bond Commission report shows that this has not been the case.

Accountability: The Bond Commission report is an indictment on the serious lack of professionalism and accountability of the staff of the Central Bank at the highest level, as a result of which this sad state of affairs took place at this august institution, at the pinnacle of the country’s financial system and which has brought it to so much disrepute. 

It is imperative therefore that the credibility of the Central Bank and its pristine position in the financial system must be restored at any cost. For instance, basic office procedures which prevailed, such as the minute file, an age-old system providing a clear trail of accountability from the origin of an operation to its final execution and which records the sequence of actions taken along the hierarchical line, is not evident. 

Largely the testimony is based on oral evidence which is not supported in the files. This whole saga would have been far less complicated if a system of accountability had prevailed at the Central Bank. It is thus imperative that the Governor and the Monetary Board should give this their urgent attention in their commitment to restore the credibility of the Central Bank and to reinstate its primacy in the financial system.

Failed finance companies: The focus of this commentary, however, is not on the hackneyed bond saga and the alleged loss of government funds. Enough has been said, over an inordinate period of time, and we must now move on to setting things right and addressing the obvious frailties of the system in operation.  

It is to do with something much more fundamental to financial stability and market confidence – the persistent instability and consequent failure of licensed deposit taking non-bank institutions – the finance companies - (FCs) over the last two decades where there is a lot more at stake than meets the eye and where the Central Bank is again under public scrutiny. 

“That this country has suffered several rounds of finance company collapses is a published fact. Each time one falls, and thousands of families are left in the lurch, the role of the Central Bank of Sri Lanka (CBSL), which purportedly regulates these institutions, comes under intense scrutiny. The problems in this industry run deep. The Central Bank, for all its excuses, is found wanting in its role as the watchdog of the people’s purse. As the ordinary folks are left to ravenous wolves, partly due to their own misjudgement, nothing much seems to be done to the modern day Emil Savundranayagams who perpetrate these white collar crimes, seemingly, with impunity,” states The Sunday Times’ editorial of 22  September 2013.

“Sri Lanka has a rich history of finance company failures. During 1988 to 1990, 13 registered finance companies failed…..In 2009 eight Ceylinco group related companies had liquidity problems when Golden Key, an illegal Ceylinco-owned deposit taking firm collapsed. In 2013 CIFL – a finance company - collapsed. None of these finance company failures were a result of difficult economic times. They were due to a combination of bad governance, weak internal controls, fraud and weak regulatory oversight. The symptoms haven’t changed. Attempts to consolidate finance companies have revealed the ineffectiveness of their oversight in the past and the chilling disregard for good governance at some firms,” according to the Sunday Times.

The above news items are quoted in the context of the recent report that the Central Bank was taking over the management of ETI together with a negative net-worth of Rs. 19 billion. This announcement was preceded by a very sensible decision taken by the Governor and the Monetary Board to liquidate three long-insolvent, smaller FCs. A case of deja vu where, over the years, many finance companies have acted recklessly and fraudulently in breach of their fiduciary responsibility to depositors. That was over 20 years ago where, due to gross financial mismanagement and regulatory forbearance as well, the Central Bank had, perforce, to bail out depositors and recapitalise some of these companies and in the case of others, merge them with stronger entities.


Why regulatory failure? 

No financial institution becomes insolvent overnight. The signs of instability and financial mismanagement were evident in the numbers relayed through the supervisory system to the regulator periodically, in the market behaviour of these entities and in that great purveyor of ominous foreboding – the network. 

Thus it is expected that the operation of an early intervention policy to deal with these signs of financial stress in the short, medium or long term would have averted many of these failures. This is the raison d’etre for financial regulation – timely intervention. 

The enemy of timely intervention is without doubt undue regulatory forbearance which, unfortunately, may have been the preferred option, even when it was apparent that there was no commitment to fundamental reforms by these entities. Whilst it is the hapless, innocent depositors who ran the gauntlet as a result, the burden of the Central Bank increased substantially.

It is noteworthy that all deposit and investment-taking financial institutions, banks, finance companies and the primary dealers are licensed by the Central Bank to be custodians of public deposits and investments. It is in ensuring that these institutions uphold the trust placed in them that the Central Bank, as the financial regulator, regulates and supervises these institutions within the legal framework established for this purpose.  It is paramount, therefore, that this accountability must, perforce, be inculcated in the professional conduct of the officers and the management entrusted with this responsibility. 

These are the lessons for the future from the bond fiasco at least, if not from the long history of failures in the industry itself, over the last two decades.

Periodic crises in the sector over the last two decades or even before saw the legal framework being strengthened and with the introduction of higher capital requirements, in an attempt to consolidate the sector, the number of finance companies were greatly reduced. This was when most corporates thought it fit to operate a finance company to service their business empires – the misuse of depositors’ funds for their own purposes – referred to as self-aggrandisement. The introduction of the Finance Business Act to replace the Finance Companies Act and the simultaneous tightening of the regulations saw greater empowerment given to the regulator to deal with, and resolve problems, in a timely manner.

An imprudent market entry policy that followed again saw the proliferation of finance companies, many of which may not have met the stringent fit and proper criteria as was evident in the instability that was evident in the sector. 

“There was never a market for this many finance companies, it was a political circus,” contends an industry analyst speaking to Echelon Magazine about the number of finance companies increasing from 35 in 2009 to 48. Many specialised leasing companies were granted finance company licenses too.

A mega Consolidation Plan presided over by a strong team of officials from the Central Bank, the external auditors and the FCs, under the overall direction of the Governor, was formulated to restore stability and reduce the sector to a viable number, based on capital strength and size. However, with the change of administration, the plan was aborted midstream and, in hindsight, is thought to have been ill-conceived, in that in certain cases, an element of coercion was alleged to force apparently weak finance companies to take over even weaker ones. 

It is also reported that the due diligence reports done by some accounting firms with a “no liability” clause built in, were done more to meet deadlines and could not be relied on. This led inevitably to dubious accounting practices being resorted to by certain FCs to mask their financial ill-health as was apparent in the published accounts of some of these entities. 

“Experienced finance company directors, a chief executive and senior managers who spoke to Echelon said ‘ever greening’ is easy, and practised at firms facing high dud loans. To prevent a large loan falling into default, firms divert cash settlements from other loans as payments to the defaulted loan. They can also create fictitious small loans – grant a facility and create a stream of inflows to the non-performing loan,” states the report in Echelon magazine.


Regulatory forbearance


With a strong regulatory and supervisory framework in place for the non-bank sector with the introduction of the Finance Business Act and the considerable legal empowerment provided to deal with problem resolution in a timely manner, there is no justification for the magnitude of the financial problems that continue to plague this sector.

Undue regulatory forbearance over prolonged periods of time only aggravate the problem of any ailing FC and should be strictly limited to not more than three months the most, during which time the remedial action undertaken must be closely followed up against a plan of deliverables to be achieved within specific timelines. Where there are no signs of adherence to the action plan, punitive action should be taken to restrict the FC and for more drastic action within the framework of the law.

As reported in the Sunday Times of 13 October 2013 by Namini Wijedasa in an article titled ‘Faults and frauds of a failed finance firm’, the Central Bank saw CFSL’S Ponzi deals and other irregularities way back in 2011. However, CIFL was allowed to canvass for and take deposits till recently, when its liquidity crisis came to a head and forced the regulator to appoint a managing agent.

The supervisory framework: A strong and effective, fully computerised, web-based, off-site surveillance system (OSS) to capture the early warning signals and raise the ‘red flags’ on impending and imminent concerns, if any, on every one of these FCs, has been in place for over two decades, during which time, as a result of many crises in the sector, the prudential and operational provisions were strengthened. 

A team of dedicated offsite officers is assigned to each FC to monitor their performance on a daily basis so that a continuous watch is maintained over the financial health of the FCs assigned to them. The OSS is supplemented by onsite examinations carried out at least once a year, on every FC and even more frequently, whenever such an on-site visit is felt to be necessary.  

This two-pronged supervisory system is augmented by a continuous dialogue with the management of these FCs and with supervisory communications being sent on matters requiring their attention and remedial action to deal with examination findings within a definite timeframe. This then is the essence of the supervisory framework that has been, and continues to be, in operation, at the relevant department. 

It is as good, or even better, than any system in operation in the region or elsewhere and has been developed by our very own human resources without any assistance from foreign experts.


What are the checks and balances in the system in operation?

i) Regulatory responsibilities: It is incumbent upon the Governor and the Monetary Board to ensure that the supervisory and surveillance system in place is used effectively, by a committed team of examiners who can identify the ‘red flags’ thrown up by the system, in a timely manner and take the prompt corrective action (PCA) necessary to deal with impending problems at first sight. The findings of onsite examinations of statutory violations and imprudent accounting practices must receive the urgent attention of the Monetary Board. This is an imperative and cannot be overemphasised.  Enforcement of the regulatory framework is key to reforming the sector. No extraneous influences can interfere with the application of the law and the regulatory staff do not run the risk of victimisation or harassment if they carry out their duties, however politically influential the regulated entities may be. It is heartening to note that this assurance has been given by the incumbent Governor in recognition of this phenomenon as the chief contributory factor for the failure of several finance companies and the considerable regulatory forbearance exercised by the Central Bank as a result. Several newspaper commentaries can be quoted about the Central Bank intervening only after the damage has been done – virtually to close the door after the horse has bolted.

ii) Early regulatory intervention: How does this work? Early intervention demands that, for instance, when the capital adequacy ratio (CAR), a key prudential ratio imposed on regulated entities, is steadily declining, the entity is required to infuse capital or to curtail the growth of risk assets (credit). The numerator or the denominator in the equation requires prompt corrective action. The provisions provide for a deposit freeze as soon as the mandatory CAR is breached. Automatic punitive action in the form of penalties can be imposed under the law. These checks and balances are an integral part of the regulatory framework to insulate depositors against signs of potential insolvency and instability in the FC.

iii) Disclosure - Published Information: Successful fraud is about creating false confidence and making people believe in something that does not exist echelon. The audited accounts of licensed deposit-taking financial institutions are mandated to be published entirely in the interests of safeguarding depositors and investors, who immediately have access to reliable information on the financial health of these entities. They are then able to take informed, conscious, decisions on these entities. The format for disclosure is also prescribed to ensure the publication of key financial stability indicators.  It is imperative therefore that full disclosure should be made of the true state of the FC and non-compliance with prudential ratios must be given full publicity and the corrective action taken by the regulator to mitigate the resultant risk exposure, explained for the benefit of the public. The threat of public disclosure also serves as a disciplining force on errant FCs. From the information in the public domain in the recent past, it is evident that some of the weak FCs have even resorted to changing their names, using arbitrage opportunities provided by IFRS to mask their losses and convert them into profit in just one year and no mention is made of their former name in the published accounts. Strangely, the auditors too seem to have gone along with this camouflage. The gullible public are none the wiser. 

Credibility of published accounts: If the published accounts do not reveal the true financial condition of an entity and apparent signs of financial duress thrown up by deficient prudential ratios, are not revealed, then publication serves no useful purpose and can only result in deliberately misleading the public. 

Where mandatory audits of annual accounts are not adhered to, it is imperative that disclosure should be made to the public as this is a sure sign of financial disarray and mismanagement. This will serve to warn the public that they should be cautious about their dealings with these FCs. This is the essence and spirit of mandatory disclosure. 

For this purpose, draft financial accounts should be perused at a tri-partite meeting between the regulators, the statutory auditors and the FC, to ensure that all regulatory concerns have been given due regard before the accounts are published. 

Where there is a mandatory, prescribed, format and where auditor guidelines have been issued, it becomes incumbent on the regulator to vet the draft accounts before they are published. Here too weak regulators, shirking their regulatory responsibility, will claim that it will be seen to be tantamount to regulatory approval. However, if all regulatory concerns have been addressed and the prescribed format has been complied with for disclosure, what is there to fear? 

This responsibility cannot be shirked and attempts to close the door when the horse has bolted are invariably futile when it is found that the published accounts are found wanting in mandatory disclosures and the public are misled even though the law provides for the accounts to be republished. Has this ever been done? This is where market implications will undoubtedly prevent regulatory intervention and can be avoided if the draft accounts were scrutinised before publication.


Misplaced confidence?


“There’s more the media know than that is in print. They are confronted with a dilemma. Do they report the facts as they are and risk a run on these institutions that will precipitate their collapse or exercise restraint in informing the public of the pitfalls? Do they keep quiet in the hope that the situation will right itself? Or do the media wait till a company crumbles and report the gory details after the fall? The last option — not the ideal one — was what happened in the case of CIFL to the detriment of the depositors,” a Sunday Times editorial stated. This begs the question of whether misplaced confidence serves the purpose in the long run.

The fear of market implications should not be used to avoid full disclosure, which will then be contrary to the principle and indeed to the spirit of mandatory disclosure. If this state of affairs was permitted to arise in the first place by reckless financial mismanagement, this should be evident to the public, instead of being deliberately suppressed from the public. 

I would urge the Governor and the Monetary Board to give full disclosure their urgent attention. Then if depositors continue to transact with these FCs when there are obvious signs of their instability, they do so at their own risk. This is the least we can do and with a safety net mechanism in place in the form of the Deposit Insurance Scheme, we should be able to still maintain depositor confidence. 

This is the public awareness that it becomes imperative must be built into the system and which is the responsibility of the Central Bank to develop and put into practice. We cannot forget the case of Pramuka Bank where just before it collapsed, its name was published, without any qualification, together with those of all other licensed financial institutions for which the Central Bank was severely criticised. This was almost 15 years ago – but nothing seems to have changed. We have to learn from these failures in our regulatory responsibility to the public. 

ETI Finance says on its website that it “is one of the leading and strongest finance companies registered under the Monetary Board of the Central Bank.” However, financial statements and a credit rating could not be found in the public domain. 

In 2013, Fitch Ratings downgraded the firm from BB- to CC and withdrew the rating a few months after. Its sister company, Swarnamahal Financial Services, is listed on the stock exchange so its financial reports were available. The company had a Rs. 1.2 billion rupee negative net worth. However, no credit rating is available. The silence of the rating company is indeed deafening. One wonders why?

The Finance Company Plc, another company without a published rating, describes itself on its website as the “premier finance company of the country in the non-bank finance business” with an “illustrious 74-year journey”. This company has a Rs. 9.7 billion negative net book value.

The above two examples make it seem as if negative net worth companies are the norm in Sri Lanka, so as to flaunt their gross financial mismanagement with such impunity in the public domain, making a mockery of healthy balance sheets! 

The depositing public, the majority of whom are not financially savvy, are thus deliberately misled by these publications. This is where the Central Bank should intervene to cut out the blatantly false, grandiose pronouncements. The importance of prior approval for published accounts is clearly vindicated here.


The right to information 


The public have the right to know if there are any regulatory concerns about any deposit-taking financial institution and the regulatory authority must be able, convincingly, and with authority, to allay any fears the public may have by disclosing the steps taken to restore the financial condition of the relevant FC to health. 


Action needs to be taken on both sides of the balance sheet – to restrict the expansion of credit or to impose a deposit freeze - till the FC has been able to take the necessary measures to reinstate its financial health. 

The authority of the regulator to make regulatory interventions must be recognised by the public as an imperative in the discharge of their regulatory responsibilities in the larger interests of depositor safety. Any delays in this regard would result in the errant FC having access to public deposits to fund their operations – using new deposits to service existing deposits – the most dangerous thing that any licensed deposit-taking institution can resort to and which will sooner, rather than later, result in its failure. 

This is what desperate entities do and is evident in the aggressive marketing strategies adopted to offer higher than market interest rates to lure depositors who are unaware that the high interest rates reflect the high risk premium of the particular FC.

iv) Auditor responsibility and accountability: Statutory auditors are duty-bound to have discussions with the Central Bank on the going concern prospects of a company which, it is apparent to them, shows definite signs of financial fragility. 

On the other hand to collaborate with them to use various accounting techniques at their disposal, to mask the reality and to convert significant and continuous losses over the years, miraculously into profit, is highly unethical and a breach of their statutory responsibility in terms of the law, and is unacceptable. Regulators must have the courage to take such auditors to task, even to the extent of striking them off the panel of approved auditors. This is common practice in many countries where we hear of auditors having been severely dealt with for such transgressions. The international audit firm of Arthur Andersen went off the radar screen consequent to their role in the Enron and Parmalat scandals. 

Even closer to home, in Bangladesh and in India, we hear of such action taken against statutory auditors. Sri Lanka stands out as the only country where such punitive action against statutory auditors has not been taken to date, despite the failure of financial institutions on which they have given unqualified, audit opinions. It is not too late for the Governor and the Monetary Board, in their endeavour to clean up the mess, to provide for severe sanctions against statutory auditors who have not brought their concerns to the attention of the Central Bank, as they are mandated to do in law, and to provide for auditor accountability for the failure of financial institutions on which they have expressed an unqualified audit opinion.  

We must recognise that approved auditors supplement the work of the regulator and a healthy dialogue must, perforce, take place between the regulators and the auditors, particularly where on-site examinations have revealed imprudent accounting practices which are required to be reversed and where asset and liability values have been deliberately overstated and understated. The boast of a strong, well developed, supervisory system with the necessary checks and balances, is brought to naught, if it is not enforced and the regulators empowered to take the prompt corrective action necessary to put things right, at a very early stage, against all those responsible. 

We cannot take decisions, or exercise inordinate regulatory forbearance, which would protect the finance companies to the detriment of depositor interest. Our fundamental responsibility is to the depositors – this is profound and regulatory decisions taken must, perforce, reflect that depositor interest has prevailed over the interests of the FCs. 

Even though auditors are not independent, it is expected that they would act with responsibility even at the risk of losing the patronage of their client due to the public policy implications of deposit taking financial institutions.

v.) An exit policy - invoking the safety net: A clearly defined exit policy is an imperative to ensure that depositors of insolvent FCs are not left languishing for inordinate periods without their deposits, especially where a safety net mechanism is in place in the form of the Deposit Insurance Scheme (DIS). 

ADIS is designed with the primary objective of protecting the largest number of small depositors. From intermittent reports in the press, the absence of an exit policy has meant that even the rightful claims of the small depositors were not met due to procrastination and inconclusive discussions with potential investors, which were allowed to drag on over many years and which never materialised. Misguided depositors are responsible largely for this delay, as they have been influenced by the directors of these FCs to resist liquidation and duped into believing that there were genuine investors from whom they could get a better deal.  

It is therefore commendable that the decision to liquidate the three long-insolvent FCs has at long last been taken by the incumbent Governor. This triggers the depositors’ claims on the Deposit Insurance Scheme and the majority of depositors will receive their deposits, up to a maximum of Rs. 600,000 which it is reported, the coverage will be increased too from the current Rs. 300,000. This is their legitimate right and all depositors, large and small, will receive a maximum of at least Rs. 600,000 and is the responsibility of the Governor and the Monetary Board to ensure.

vi.) Elusive Investors: To date we have not heard of a single genuine investor-interest in these companies, although valuable time and staff resources have obviously been spent in the many discussions that have taken place with these so-called investors which are reported from time to time in the press. 

It is surprising that it has not occurred to the senior management of the Central Bank that unless an investor has an ulterior motive in using these bankrupt entities to gain a foothold into the official financial system, with tainted funds, no genuine investor with good money will chase a bankrupt and dead FC. Moreover, potential investors in any deposit-taking financial institution, must have an impeccable track record and it is only those on whom adequate due diligence has been done to prove their bona fides, can be entertained within the portals of the Central Bank. Whoever the promoter of these investors may be, the Central Bank will find itself in much deeper trouble if their bona fides are in the slightest doubt. The legitimacy of the financial investment to be made must also be proved to avoid AML/CFT concerns. 

Whatever investor interest is entertained by the Central Bank should be limited to a definite timeframe after which the next step in the resolution process must be considered, which is liquidation. These are the steps that must be clearly defined in an exit policy which has become an imperative, in the face of the many failures of FCs and which have prolonged for over a decade. More profoundly, token investments by investors, nowhere near the deficit capital that is needed, should not be considered and is a ploy very often used by the FCs themselves to gain time for their continuance. It is also very often at the expense of depositors sacrificing part of their deposits for equity with the promise of capital gains and dividends from the proposed restructured entity, which has never materialised. 

vii.) Accountability and Legal Action: “And how many directors of finance companies that failed in the past are serving jail terms? Their families are none the worse off today. They continue to live the good life; a few weeks in remand worth the price they have to pay. They don’t go by bus, surely as the depositors must. One more infamous than others is absconding abroad, or so they say, with hardly an effort by the Government to bring such parties to book” - Sunday Times.

 The above commentary says it all. Historically, hardly any legal action has been pursued against the errant directors of these companies and wherever such action was instituted, the hopelessness of the legal system in operation and the country’s legacy of legal delays has resulted in our inability to successfully prosecute any one of them. 

From the perpetrators of the Golden Key saga and several errant FCs in the Ceylinco Empire, to all those FCs that failed during the period of the crash of Mercantile Credit, not a single director or the senior management has been made accountable. 

Wherever any legal action has been taken, Sri Lanka style, they end up in the comfort of hospital beds and that is the last one hears of them. In the meantime, some of these hapless depositors, it is reported, have even taken their own lives. Whatever assets these companies had, have either been siphoned off or have lost their value over all these years. 

It is surprising that successive governments have turned a blind eye to what is blatant highway robbery of public deposits by these companies. One can only conclude alas that the depositors of these licensed FCs are of little or no significance as those of the illegal and unlicensed Golden Key. It therefore begs the question - what is our policy makers’ and civil society’s commitment to the integrity of the country’s financial system?

Just as they have relentlessly pursued the bond saga, why has civil society not taken up the cause of innocent depositors who have lost their legitimate funds? With all the current investigations for bribery and corruption underway, it is not too late to initiate action against the errant directors of all the failed FCs who have defrauded the public of their legitimate funds. The fervour with which the bond scam was pursued is surely more profound here?

This is where the assistance of expertise from the US is needed, to initiate the necessary legal reforms in an expeditious basis, to deal with the prosecution of the perpetrators of financial crime, in the manner in which they so successfully dealt with Bernie Madoff, the former Chairman of Nasdaq, amongst others, who ran a Ponzi scheme and defrauded the US public of millions of dollars. The legal process gave him a 150-year jail term, relentlessly went after his personal assets and recovered almost $ 1 billion, even going after his son who was eventually forced to take his own life.

We have still to see anyone being pursued legally in this manner in this country. In fact the wife of the Chairman of a group of companies and who was the vice chairperson of these very companies, which were responsible for the failure of several financial institutions and who escaped prosecution by fleeing the country, has since returned, escaped the legal process on arrival by feigning ill health, but is now, audaciously, seen in the social circuit!!!! What has happened to the pursuit of justice? There has not been even a whimper from civil society and even the press continues to be the watchdog that does not bark, when it chooses not to. 

These are politically exposed people who in AML/CFT jargon are known as PEPs and who should never be associated with licensed financial institutions. It is imperative that our Fit & Proper criteria for market entry should be expanded to include the prohibition of PEPs.

viii.) Name and shame: If no legal action has been pursued one would expect that at least these directors would be named and the Central Bank circulates the names to all public sector entities and within the financial system itself of persons who should be debarred from holding any public sector posts or be associated in any way with a licensed financial institution.  

It is pertinent to mention that while the senior George Bush was the President of the US, during the Savings & Loan (S&L) crisis, his son who was associated with a failed S&L was prosecuted and debarred from being on any financial institution for life. 

As a result of this serious lapse, many of these errant directors and senior management personnel of these FCs continue to carry on, regardless, in their business operations and one of them was even a director on the Colombo Stock Exchange until very recently. 

The first course of action should be that their names should be sent to the Credit Information Bureau. If the law does not provide for this, then an amendment to the law is long overdue. This is a decision that the Monetary Board should take as soon as it is informed of an insolvent FC. 

It is pertinent to mention that one of the biggest failures in finance company history in this country and a classic example of how a finance company should not be run, and which celebrated its 75th anniversary, had a message of felicitation from the President, who it is apparent was not informed of its track record of failure, which underscores the importance of keeping public officials of such eminence at least periodically informed of such financial failures and which would save embarrassment for those holding such high office in the country.

This is a very sad reflection on the integrity of the financial system of the country, in the same way as the bankrupt balance sheets of these entities are permitted to be flaunted in the public domain with impunity.

ix.) Market entry: It is very important that persons entrusted with a fiduciary responsibility should be beyond reproach, with an impeccable track record of financial integrity. Extraneous factors should not be allowed to influence the decisions of the licencing authority.

The accountability of the licensing authority is at stake if persons who are not “fit and proper” are entrusted with the safety of public deposits. “The Central Bank licence is consistently used in canvassing for customers. It is hard to blame the depositors for not scrutinising the balance sheets — the Central Bank’s ‘licence’ is their safety net (Sunday Times).” 

This underscores the implicit faith the public have in the integrity of the Central Bank’s license which should be upheld. Even over the electronic media “licensed by the Central Bank of Sri Lanka” is given much prominence. That’s all the public want to hear and which puts all the more responsibility on the Central Bank to ensure that these FCs are worthy of that licence and whether indeed that licence should be even temporarily suspended, particularly where they are continuously in violation of the regulatory directions. “The Central Bank observed that 38 non-bank financial institutions (which also includes a few leasing companies) had weak compliance with regulatory directions (Echelon).”

What is most profound is that a strong regulatory framework in place should not be permitted to be practised in the breach by the non-enforcement of the regulations and the punitive action that is demanded at the first sign of financial duress in these FCs which in turn should provoke the PCA and early intervention by the regulator to nip the problems in the bud.

Early intervention by the regulator is profound and is tantamount to a breach of regulatory responsibility if such intervention has not taken place and will surely subject regulators to accountability in view of their statutory responsibility to the public at large. Several articles in the print media talk of weak regulatory oversight – an allegation which the Governor and the Monetary Board must avoid at any cost.

Uneven playing fields 

Accountability of officers and management who have statutory duties entrusted to them must be enforced. No officer, however senior he or she may be, has the authority to waive the application of legal sanctions for the breach of statutory regulations by errant financial institutions, except with the prior approval of the Monetary Board. 

The findings of statutory examinations must be acted upon with swift regulatory action, without which the efforts of the examining staff to identify serious financial mismanagement will be negated and will lead to a frustrated workforce. To permit unsound FCs to operate in the financial system, on par with the strong and healthy finance companies, gives rise to an uneven playing field, particularly where there is absolutely no indication to the public that a FC is in dire straits of financial duress, permitting them to compete in the system for public deposits together with the strong and healthy FCs. 

This is the epitome of an uneven regulatory playing field and seriously undermines the credibility of the regulatory and supervisory system in operation. It is surprising that the strong FCs which operate in the system, and there are many of them which the industry can be truly proud of, do not assert themselves to ensure a level regulatory playing field. 

The Central Bank alone cannot be expected to ensure stability in the industry – the other stakeholders, primarily the strong FCs and the auditors, also have an important role to play to restore and maintain confidence in the industry.

It is noted with relief that the Governor and the Monetary Board are taking key initiatives to change the course of things in this sector for the better. The recent pronouncements by the Governor in this regard augur well for the sector and judging from the decisions already taken to liquidate the three small, long-insolvent FCs and to intervene in the case of ETI and SFS, reflects a definite commitment to stabilise the non-bank sector. The key to success in this regard are a firm commitment for:


Timely enforcement accountability


Upholding our strong regulatory system and making it work by ensuring (1) and (2) above.

A compliance culture to ensure:

  • Good governance and compliance by the regulated entities
  • nZero tolerance by the Central Bank of regulatory non-compliance, weak governance and spurious accounting practices
  • nIncentivising the regulatory staff to discharge their regulatory responsibilities without fear or favour
  • nEliminating undue regulatory forbearance. Regulators should not be seen to favour the FCs over the depositors through non-enforcement of the regulatory framework 


This is the commitment that is expected by the depositing and investing public from the Governor and from the Monetary Board, which needs to percolate down to the rank and file and which must be seen to be discharged, to avoid allegations of weak regulatory oversight which the Central Bank, and particularly the relevant department, has been accused of from the time of the first large-scale finance company failures.

It must be recognised that no foreign experts can help to reform the sector if we are not willing to crack the whip at the first sign of trouble, which become evident on a daily basis from a well-designed and effective, off-site surveillance system which is in place and which identifies the red flags very clearly and from statutory examination findings. 

It would be very useful if foreign experts offering technical assistance found the time to study the system in place and attempt to understand the causes of the problems in this sector before they bring their own systems here. No two financial markets are the same but the characteristics of the South East Asian markets are similar in that they are predominantly still in the traditional business of accepting deposits and granting credit unlike their counterparts in the West or even in the countries in the Asian region like Singapore, which are more sophisticated and deep. 

This was the primary reason that we escaped the brunt of the Global Financial Crisis – our very strong and superior, regulatory systems and our zero exposure to the exotic and toxic, non-traditional, financial instruments of the western world, despite which we find ourselves quite audaciously being subject to their dictates.

I wish to strongly reiterate, by the same token, that the high-quality capital requirements (common equity), the capital buffers and the liquidity requirements, inter alia, only now imposed by Basel III, have been part and parcel of our regulatory systems from the inception of central banking in this country and is therefore nothing new. 

But we continue to slavishly pay obeisance to the Basel Committee for what we have had within our system for almost half a century. It is strongly advised that the regulators pay attention to more fundamental problems in the system, like overstated asset values from non-performing portfolios which are not identified, rather than concentrating on Basel III to the exclusion of all else. 

All we hear today is about compliance with Basel III – a fashionable international benchmark that it is convenient to latch onto for all concerned, and which offers an even more convenient diversion from ills more fundamental that may be lurking in the industry if one just cares to look.

In conclusion, may I suggest to the Governor and the Monetary Board that they commission a study to be made of the history of failed finance companies in this country – the public deposits that were lost – from one group of companies alone it is alleged to be over Rs. 300 billion (the bond losses pale in comparison), the action taken against these companies, if any, and, if not, the legal constraints that prevented such action and most importantly, the causes for their failure.  

It will be very apparent that nothing has changed over the last two decades and therefore a lot needs to be done to reform the systems in place to eliminate the fundamental problems facing the sector. This then would be the platform from which any reforms of the sector could be successfully launched and together with the consolidation of the sector, as a result of the enhancement of the capital requirements for FCs, where those which cannot afford to meet the new capital requirements will either be taken over by or merge with stronger FCs to make them more financially robust, will hopefully lead to the overall stability of the sector.  

A lot depends on the Governor and the Monetary Board to take these reforms forward conclusively and with conviction.

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