Monday Dec 16, 2024
Monday Dec 16, 2024
Friday, 25 September 2020 00:03 - - {{hitsCtrl.values.hits}}
By Rienzie Wijetilleke and Kusum Wijetilleke
In 2008, the housing crisis in the United States caused a global credit crunch that was felt all around the world, not just in the US and the UK, but also Russia, Ireland, Mexico and several Baltic states. The crisis was truly global, yet Sri Lanka was spared the worst effects of the crisis for various reasons. Primarily due to the regulatory structure which restricted exposure to high risk financial assets. The financial crisis did create issues for Sri Lanka’s exports and generally speaking there was a drop in both the prices of and demand for commodities. Sri Lanka nonetheless survived the financial crisis and even thrived for a few years following the defeat of terrorism.
Yet Sri Lanka may have another looming crisis, and it is not the property ‘bubble’. While the property market is currently lacking in liquidity, there is adequate room for upward social mobility from the working classes and there is demand in many sub-sectors of the property market. Perhaps there will be an oversupply of luxury condominiums sometime in the near future, but this too is a small market segment when compared to the property market as a whole. Further, the mortgage industry is also heavily regulated and banks generally discount the value of a property it is lending against.
Sri Lanka may however face more severe issues in the near future with the level of personal debt that many Sri Lankans have taken on. From the point of view of the financial institutions, unsecured credit card debt is perhaps the major threat to the stability of the system. As per a report from October 2018, Sri Lanka’s total credit card debt stood at Rs. 101 billion. A report from April 2019 showed that total credit card debt had increased further to Rs. 109 billion, that is a Rs. 8 billion increase in seven months. Since April 2019, the overall economic performance of Sri Lanka has suffered at least two major setbacks. First, the Easter Attacks which created a dramatic drop in tourist arrivals, a major income earner for Sri Lanka and an industry that employs millions directly and indirectly. Second, just as the country’s economy seemed set for a revival, the COVID-19 pandemic struck affecting not only tourism but virtually every other industry as well.
Many Sri Lankans had no choice but to resort to utilising any debt instrument available to them in order to make ends meet. There is little doubt that many Sri Lankans would have opted to utilise the available balances on their credit cards, plunging them further into debt with even higher interest rates and expensive penalties and charges.
Even if we assume that credit card debt in total would ‘only’ be around Rs. 120 billion at this point in time, we have to also consider other forms of personal debt. Most mortgages are well secured due to the discounting requirements from the CBSL, thus even in the unlikely event that there would be a crash in the property market, most lenders will be well collateralised. This is not the case with credit cards, and exposure to the credit card sector is significant across banks of all sizes, in all tiers.
Yet this is still only part of the problem. Consider personal loans, though quantums are smaller, the risk is high for the lending institution as more often than not, personal loans are unsecured and usually borrowed for consumerist purposes. Most people in Sri Lanka buy durables including televisions, washing machines etc., on consumer finance schemes - again some of this risk is taken by banks and other lending institutions. The durable item will often be obsolete in a year or two, so any default is unlikely to be covered by the value of the goods. Education loans are another instrument which many consumers use to fund their educational pursuits or those of their children. Often these too are unsecured and only linked to monthly income. Thus, considering credit card debt plus other forms of unsecured personal debt, both Sri Lankan borrowers and the lending institutions might well be engaging in an unstoppable ‘snow-ball’ effect.
Against this backdrop, it is with some consternation that we note the comments made by the Minister of Industries Wimal Weerawansa at a business conference held at the BMICH a few days ago. During the event he stated that he has “not seen such rigid policies when lending to entrepreneurs or industry like in this island,” while also alluding to the annual profits of some banks which are over Rs. 3 billion in some cases. Weerawansa did not however point out that Sri Lanka’s largest state bank, the Bank of Ceylon, reported a loss of Rs. 300 million for the quarter ended June 2020. Sampath Bank saw its profits drop by 36% for that same quarter. Cargills Bank made a Rs. 64 million loss in Q2 2019 and the June 2020 quarter also saw non-performing loans (NPL) increase to 5.3% of total loans industry wide. This is all before the worst effects of the pandemic driven lockdown can be baked into the numbers. Indeed many banking professionals expect further provisioning and write offs in the coming year.
The Minister also stated that the banks in Sri Lanka are less interested in lending to industries. What he perhaps means to say is that lending on industrial projects is restricted. However economists agree that many of Sri Lanka’s major industries – tourist hotels, hydro-power, garments and other manufacturing related projects – have all been heavily backed by bank finance. He continues, stating that the CBSL “has developed a lot of monetary policies for the benefit of the bankers and not for the benefit of the client”. This once again is a mischaracterisation of the structure of the system. Banks are run through depositors funds, the depositors are Sri Lankan citizens, it is their money that the banks lend with margins, under strict guidelines. The CBSL’s main duty is to protect the hard earned money that citizens deposit in the banks.
It is very important that we understand the current predicament in its entirety before making such comments, which are quite clearly meant to put pressure on financial institutions to lend more funds. As a veteran of the banking industry I am well aware that banks are one of the key drivers of economic activity in any economy, but more so in Sri Lanka where FDI has been lagging for many years.
The shareholders of banks do not own the funds that are being lent, these are the citizens’ deposits that are being lent. In basic terms, banks take funds as deposits; on demand, on short-term tenors and on medium to long term tenors. Banks must be cautious on lending funds even on a short term basis if their funding structure is tilted towards demand deposits. Capital adequacy will not be anywhere near enough if ad-hoc lending strategies are given priority. A lender’s major task is to identify the borrower and their risk profile verses the steps that can be taken to mitigate risk. The important term here is to mitigate risk, not to altogether absolve yourself from the risk.
In our experience, there are three broad categories of borrower:
Once you identify your customer and what category he falls into, you must then take a view on the risk proposition verses the profit motives and act accordingly. This is no easy task. At this current stage in our country’s recovery from the Easter attacks and the pandemic, increased lending even at lower interest rates can lead to serious instability in the system. In fact the worst is likely still to come, considering that moratoriums are expiring at the end of September and the country’s economy has yet to show signs of a sustained recovery. Wages have fallen due to the lack of business activity, disposable incomes are non-existent, personal debt is on the rise and non-performing loans are also increasing.
Yes, the banks in Sri Lanka have been very successful in the past and the industry is perhaps one of the most stable and dynamic in the country’s history, however this is as a result of very carefully crafted policy and strict regulations. If anyone goes back a few decades to the height of terrorism in the nation, it is the banks that guaranteed some form of economic progress to the country’s people and its industry. Thus I urge the Minister Weerawansa and his colleagues to not be so brash as to think that the country, its people and its industry can survive and thrive on borrowings alone. The state and its institutions should provide a framework for success, beyond tax holidays and low interest rates. Consistency of policy, stability of currency, multi-stakeholder planning of key industries and attracting both FDI and foreign talent to the country are just some of the facets that must all come together before we start looking at enhancing lending portfolios to spur economic growth.
