Development banker

The outgoing Chairman of Sri Lanka’s stock exchange and CEO of the country’s leading development bank featured in Securities & Investment Review, January 2012 of Chartered Institute for Securities and Investment (CISI)

It turns out that, with the right attitude, steering a nation’s stock exchange through the country’s civil war is less complicated than you might expect. “We decided not to worry about what we couldn’t change, but rather to make plans for better times,” says Nihal Fonseka, who until June 2011 was Chairman of the Colombo Stock Exchange.

The Tamil Tigers’ 26-year-long insurgency made for low turnover at the exchange, and a paucity of new listings. When he was appointed in 2006, rather than trying to create a more favourable business environment – a task beyond his control – Fonseka focused on reforming listing rules and corporate governance procedures. He also actively engaged potential issuers who would be in a position to list when Sri Lanka’s circumstances improved.

“Things began to get better in 2008, but improvement really started after the end in May 2009 of the ongoing violence,” he explains. “Since then, the growth has been huge.”

On the back of a GDP increase of 8%, Sri Lanka had, by the end of 2010, spent two years as the world’s second-best performing stock market, with the all-share index tripling in value in that time.

Since 2000, Fonseka’s other involvement in the prosperity that has followed the end of the civil war has been his support of entrepreneurs.

He is also Chairman of the Association of Development Financing Institutions in Asia and the Pacific and, in January 2000, became Chief Executive Officer of DFCC Bank, the pioneering Sri Lankan development bank (see box). It gave his work a welcome social application.

“All my life I’d been at a commercial bank. I’m not saying they don’t contribute, but they get in on businesses after they are up and running,” he says. “Here, most of our work is supporting entrepreneurs for project funding. These are typically start-ups, so we are helping to create something.”

For the Colombo Stock Exchange, meanwhile, the bull run – fuelled in part by sharp increases in retail participation – came to an end in 2011, with the market now more than 20% below its February high. Regulatory intervention this year has focused on dampening demand using measures such as limiting the credit lines that brokers can extend to retail customers and the amount of credit that banks can extend for stock trading and initial public offerings, as well as forced selloffs of unsettled trades. “The volumes of retail trading increased rapidly, and we saw a number of fundamentally weak stocks being pushed up to unrealistic levels before regulators moved in,” Fonseka says.

Over the long term, Fonseka notes that, as global equities volumes record a 30% fall-off since the end of 2008, the challenge for the Colombo Stock Exchange is similar to that facing any exchange around the world: widening investor participation, increasing the number of issuers and expanding the product range.

This will not happen until liquidity increases, reducing the high market-impact costs associated with trading – especially for institutional investors with larger order needs. It means reducing high transaction costs and attacking operational risk by migrating to delivery versus payment and a central counterparty, and diversifying tradeable instruments beyond the cash market.

There are encouraging signs on the supply side so far. Despite a boom in private credit offered by commercial banks – up 28% last year – firms are increasingly looking to capital markets for equity sales and debt issuance, says Fonseka. The Sri Lankan Government is playing a central role in this, and the initial public offering in November 2011 of the state-owned People’s Leasing Company raised $75m. “At a deeper level, the complexities of buying land in Sri Lanka are a serious impediment to growth,” he says.

The Government is the biggest land owner, and land investments involve negotiating complex land laws and a lengthy process of bureaucracy. “There is a pressing need to streamline the process whereby land is put into productive use.”

Education, education, education

As Chairman of the CISI’s Advisory Council for Sri Lanka, which was established in 2011, Fonseka has pioneered efforts by the industry to improve skills among those working in the financial sector. The banks, he says, have made significant progress in raising their educational standards.

“Financial education has been clearly established, and incentives are now linked to the level of qualification,” he says. “But areas including corporate finance, securities trading and investment advice, as well as compliance operations and operational risk management, could all benefit from a greater focus on education.”

 Fonseka is rare among Sri Lanka’s leading bankers in having completed his education in his native country. After studying physics and mathematics at the University of Ceylon in Colombo, he considered a research job in physics before realising that this would mean leaving Sri Lanka.

Despite the fact that “banking, back then, was not as appealing as it is now,” he took a job with HSBC, where he worked for 23 years – most of which was in Sri Lanka. The subsequent move to DFCC freed him from the mainstream commercial banking world that, he feels, has become unnecessarily siloed.

“I find it amazing that very few people understand how the wider finance industry works,” he says. “Indeed, the structure of businesses generally works against this.”

The appeal of DFCC’s social goals conflicted with how effectively these were being implemented. “The firm had to change in the 1990s,” Fonseka notes. “Commercial banks started getting in on development funding and we were struggling to compete with them. We realised that being a one-product bank wasn’t going to work – we needed to diversify our own product base.” Part of this involved encouraging people to think in a commercial banking way, so Fonseka’s first initiative was to implement a comprehensive IT infrastructure.

“Everything was paper based, but we needed better technology – for example, to process loan applications faster,” he says.

According to Fonseka, having a broad view of the entire industry is especially important if you are to succeed in the financial industry of an emerging market. He concludes:

“This is why having a good grasp of the basics is so important: if you take the trouble, I think that that makes your decision-making more informed. Especially if you come to Sri Lanka, where you will be serving customers with a diverse set of needs, you need a good understanding of how the wider industry is composed.”