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