Protect CB independence

Institutions, particularly independent institutions, exist for very important reasons. Central Banks around the world are empowered to be independent because they often have to take unpopular decisions to maintain the economic health of a country by ensuring financial system stability. Making inroads into the independence of the Central Bank, especially at a time when the economy is struggling with the impact of COVID-19, could have very serious consequences. 

In any country the Treasury regulates fiscal policy and the Central Bank monetary policy. The banking and non-bank financial institutions are regulated by the Central Bank precisely because there has to be non-political, data driven and consensus-based decision making, which cannot be done when there is a political stranglehold on the institution. 

Over the past few days there have been two serious charges levelled against the Central Bank. One being that it has improperly monitored troubled non-bank financial institutions and secondly it has failed to implement the Government’s refinance policy effectively. These are both serious issues but threatening to remove Central Bank officials over them is not just overkill but also problematic because it does not take into accounts regulatory and resource constraints that created these challenges as well as overall weak macroeconomics. Shrinking the expertise based democratic space for such a key institution does little to resolve these problems. 

For starters experts have long called for the Central Bank to be made more independent so it has the powers to have stronger oversight over finance companies and its other duties. In some instances licenses were given with political influence and there is insufficient legal oversight to ensure that finance companies release consolidated financial statements, update their books regularly, perform audits and maintain transparent engagement with depositors. The 2008 financial crisis triggered the Rs.26 billion Golden Key Credit Card Company going bust, collapsing the Ceylinco Group that it belonged to. This prompted the Central Bank to intervene but several finance companies remain mired in chaos a decade later. In response, the Central Bank tightened regulations on finance companies, requiring them to improve governance, management and capital structures but it still proved to be tough going, especially for family owned companies such as ETI. Firewalls across subsidiary and parents companies were not kept in place and few of Sri Lanka’s finance companies have credit ratings. It is therefore clear that a rules-based framework has to be evolved with more early warning systems and faster resolution mechanisms – an effort that the Central Bank was working on under former Governor Dr. Coomaraswamy.

As far as the refinancing facility is concerned it has to be implemented considering the different financial strengths of banks and finance companies. Top down policies in such a situation could place already stressed companies under greater pressure. Sri Lanka cannot afford to have a bank or another finance company go under when the country is already struggling.

Loosening regulatory measures too much could impact the overall health of the financial system. Moreover, the refinancing will likely be facilitated by money printing, which could result in inflation and currency depreciation that would have to be countered by the Central Bank using its precious reserves to defend the currency. Given Sri Lanka’s debt dynamics a fine balance needs to be preserved. Therefore a consultative approach is best not just for institutions but also the public.