Rekindling awareness, enhancing expectations and rebuilding credibility

A robust regulator

This article appeared in the Chartered Accountant magazine of the ICASL in March 2009

By Ranel T. Wijesinha FCA, MBA

Flashback!

The sub prime crisis has engaged our minds for well over a year-and-a-half now and throughout this period I often reflected on the East Asian Financial Crisis of 1998 – a crisis which is now 10 years old.

The devastation it caused to a large region of the world, several economies and people, continues to be etched in the minds of many. I yet remember visiting many ASEAN cities in 1998 and 1999 while on work and pausing to devote time to gain firsthand insight into the causes and consequences of this sad event. I was particularly pleased to see the region bounce back before long.

Have we learned any lessons?

There were many similarities between asset quality of the banks in East Asia in 1998 and those in some of the bank crises in the USA last year and it is now established that risk identification, management and mitigation at corporate governance level was weak while the oversight and effectiveness at the national or sectoral, regulatory level was inadequate. This was an enabler of the sub prime crisis.

While much has been written on the East Asian financial crisis and many diagnostic studies and debates undertaken; many conferences held; many technical assistance programmes rolled out by the IMF, the World Bank, the Asian Development Bank, and many other bilateral development partners, the question yet remains whether the banking and financial services sector, the housing sector or the regulators of particularly the Western world – whether in Europe or North America – have actually learned from these lessons adequately?

APB Annual Sessions 2000 and the Korean Chaebols

At a presentation I made to the Association of Professional Bankers in Sri Lanka in 2000 at its Annual Sessions under the theme ‘Towards a Safer Banking System,’ I introduced a special segment on ‘Learning from the Lessons of the East Asian Financial Crisis’. I quoted Arthur Levitt, Chairman of the US Securities and Exchange Commission as follows:

“The significance of transparent, timely and reliable financial statements and its importance to investor protection has never been more apparent. The current financial situation in Asia and Russia (1998) are stark examples of this new reality. These markets are learning a painful lesson taught many times before: investors panic as a result of unexpected or unquantifiable bad news.”

Quoting from my research of an UNCTAD study, which had surveyed a few companies affected by the crisis, I conveyed that:

“The Chaebols dominated the economy of the Republic of Korea. These Conglomerates often engage in related party lending and borrowing. None of the sample companies disclosed the amount of related party lending and borrowing; Less than one-half of the sample companies made reference to the existence of related party lending and borrowing but without disclosure of the amount; None disclosed the amount of foreign debt in the currency of repayment, and not a single corporation or bank followed IAS’s in accounting and reporting for foreign currency translation gains and losses.”

This was only of a sample taken and prior to 1998! But yet recent enough.

I also referred to the President of the World Bank, when he referred to South Korea as follows:

“The culture of the region has not been one of disclosure. If you go back further it was a culture of a smallish number of wealthy people. It was an agrarian society with a lot of people in the country and significant factors of power. It is reflected in the Chaebols. It is reflected in the groups that come together. There were centres of power. There was little disclosure.”

World Bank, Jim Wolfensohn and Arthur Levitt

I wonder what Arthur Levitt and Australian-born Jim Wolfensohn who was Chairman of the International Advisory Board of Citigroup after his 10-year stint at the World Bank had to say for themselves in 2001/2002 after Enron and WorldCom collapsed, and more recently after the US inflicted on itself the 2008 sub prime crisis, which then ‘exported’ itself from the ‘Land of the Brave and the Home of the Free’ to all of us in the rest of the world.

Interestingly, in a message to over 800,000 members, in my capacity as the President of the 23-nation-strong Confederation of Asian and Pacific Accountants, I said in 2002 as follows:

“In the aftermath of the East Asian financial crisis, Western nations in particular and corporate leaders, regulators, scholars and authors of the West, were critical of the East and South East Asian nations, their statutory and regulatory systems, the auditing profession in these countries, accounting and auditing standards and compliance therewith. Their criticism was liberal and in many respects justified. But what is more important I think is whether regulators, professions and corporate Boards of even the developed nations in the West, are yet as vigilant as the global society inherently expects them to be.”

(Source: Message of President Ranel Wijesinha, February 2002 CAPA Chronicle.)

Sri Lankan Chaebols?

In Sri Lanka, over the last few months, I have been witnessing with considerable sadness the plight of many, after the collapse of finance companies here – particularly Golden Key.

While there may be a number of large depositors, I more recently came to learn that this was also the investment vehicle of several simple, hardworking, wholesome people, some of whom had deposited their only ‘cash assets’ and lived ordinary lives in their homeland in order to educate their children overseas.

My mind went back to the following sentiment I expressed in 2002 to the Confederation of Asian & Pacific Accountants, which may provide any reader with a ‘heart and mind’ driven rationale for strengthening professionalism and governance:

The collapse of the economies of nations – such as what happened four years ago in East and South East Asia, or the collapse of corporates – such as what happened in none other than North America, a few months ago, can be disruptive. It can devastate what otherwise could have been only a continuation of a simple and less-than-extravagant lifestyle for many who are less privileged than those at the higher levels of governance, who are typically better cushioned to absorb the shock and disruptions these events bring. It is this segment of society that I particularly wish to identify and empathise with, since it is only through them that we realise the gravity of the implications of sub-par professionalism or poor governance.”

(Source: Message of President Ranel Wijesinha, February 2002 CAPA Chronicle.)

Post-event regulatory swiftness

While commending the regulatory swiftness with which the Central Bank placed Seylan Bank under the oversight of the Bank Ceylon, thus acting for example very similar to the Central Bank of Sweden almost 15 years ago, and preventing a run on deposits on Seylan and the resultant numerous implications (which would have resulted if it chose to await the outcome of a due diligence, as some thought it should), there is now a far greater challenge ahead.

At the time of writing (March 2009) Seylan’s parent’s conglomerate is beginning to crumble. The collapse of the “pack of cards” that many hoped would not occur for years, has begun. Let us hope that in the larger interest of all concerned the effects of all this can be substantially minimised and my best wishes are with all stakeholders and regulators in this regard.

Surveillance of financial conglomerates

It is in this context that I wish to quote from the Central Bank’s current (March 2009) website in its webpage on financial system stability and under the subsection ‘Surveillance of Financial Conglomerates’. The site refers to an initial report of a Working Group of Regulators for Financial Conglomerates ‘to be completed in early 2007’.  The full extract of the relevant section is as follows:

Surveillance of financial conglomerates

“The existence of large financial conglomerates, especially those that have banks as part of the conglomerate, is another area that has attracted increased supervisory concern in recent times. The regulation and supervision of such financial conglomerates is becoming increasingly more important and complex, due to the potential systemic risk that could arise from the interrelated nature of their activities.

“Large numbers of cross shareholdings, common directors and inter-company transactions are areas that are of key interest in this regard, as it could result in conflicts of interests and abuse of power, which would not augur well for the stability of the financial system. Since there are multiple regulators in the financial system, the supervision of conglomerates often falls under the purview of several regulators, requiring close co-operation and supervision.

“Therefore, a Working Group of Regulators for Financial Conglomerates comprising of the Central Bank, the Insurance Board of Sri Lanka, the Securities and Exchange Commission of Sri Lanka, the Accounting and Auditing Standards Monitoring Board and the Department of Registrar of Companies has been established to monitor the systemic risk of conglomerates.

“The mandate of this working group includes identifying and defining financial conglomerates; identifying the functions of the separate regulators; assessing the systemic risk of such conglomerates by sharing necessary information among regulators, recommending a course of action for regulation and supervision of the respective institutions in a consolidated manner; and proposing necessary legal reforms to address the existing limitations relating to regulation and supervision of financial conglomerates. The initial report of the Working Group will be completed in early 2007.”

(Extract of current Central Bank Website March 2009)

It is now a national imperative that the outcomes of this Working Group (if it had been completed) are critically reviewed to determine where it is incomplete in relation to the Central Bank’s regulatory oversight and effectiveness.  Perhaps we could have saved the monies of depositors and, the public moneys that would now go towards bailouts and stimulus packages if greater attention was paid to surveillance of financial conglomerates.

Now is the time!

Now is the time to get back to the drawing board regarding this matter. I raised this issue at a Transparency International Round Table Discussion in February/March 2009. My recommendation was that the “regulatory oversight (scope) and effectiveness” of all regulators, in the financial sector in particular, must be subjected to a rigorous review.

Not only the Central Bank but also institutions such as the Securities and Exchange Commission of Sri Lanka, the Accounting and Auditing Standards Monitoring Board and the Insurance Board of Sri Lanka should subject themselves to this review. I am pleased that this recommendation was accepted and is embodied in a letter the Executive Director of TISL J.C. Weliamuna has written to the President of the country.

Statutory/regulatory/institutional review

Enabling statues will also have to be studied to determine whether the desirable scope and regulatory coverage or oversight of these institutions is not constrained by inadequate statutory provisions. Risk mitigating or minimising measures such as deposit insurance, which has been tossed around for over a decade and half or more in this country, must now be identified and implemented.

Once the above is done, a key consideration will be to then determine ‘institutional capacity inadequacies’ (human/technical) and to design and implement capacity building initiatives. The jurisdiction or remedy the Consumer Protection provisions of the Consumer Affairs Authority Act have over banking, leasing, finance and related firms, their products and services should also be reviewed. The role of the Financial Ombudsman in this regard may also require to be studied.

The market economy has not failed!

Then, the less than aware ‘mantra’ that the market economy has failed will also subside. A market economy is not one where there is freedom of the wild entrepreneur or philanthropy without conscience or responsibility to the source of money that enables it, but one driven by an economic strategy, with desirable and effective regulation.  

While recognising that I may be swimming against a global tide, whether catalysed by Sarkosy in France, Chavez in Venezuela or even by pockets in America, let alone in Sri Lanka, may I make bold to submit that the concept of a market economy with regulation has been tried and tested, is sustainable and is indeed here to stay.

Sustainability of political parties, on the other hand, can well be made the outcome of all this since aware, fair, objective and timely regulation will endear people – the depositor, the investor, the consumer, the voter – to the political party that facilitates it rather than one which stifles it, thus enabling the voter to enjoy a more affordable and comfortable lifestyle.

This is about a lifestyle where the Government focuses its scarce resources on necessities like health, education, water and electricity, roads and communication etc and ensures the robust regulation of all of it rather than a contrary strategy – one where Government focuses on intervention and ownership of banks and businesses, which in an yet emerging economy such as ours, can well be, at the expense of a better lifestyle for the less than privileged.

(The writer, an International Management Consultant, is a Fellow of the Institute of Chartered Accountants of Sri Lanka with extensive work experience, both locally and overseas, in industry and public practice. His more recent assignments for multilateral development banks have been in Afghanistan, India, Armenia and Azerbaijan. He possesses a Masters Degree in Business Administration from the Graduate School of Business of the University of Pittsburgh, in Pennsylvania, USA. A Past President of the Institute of Chartered Accountants of Sri Lanka and Past President of the Confederation of Asian and Pacific Accountants (CAPA) he has served the Public Sector as a Member, Securities and Exchange Commission of Sri-Lanka; a Member of the first Consumer Affairs Council under the Consumer Affairs Authority Act; a Member of the Accounting and Auditing Standards Monitoring Board; Chairman of the Monitoring and Advisory Committee of the Ministry of Power and Energy; Member, Governing Council, National Institute of Business Management and Member, Board of Management, Post Graduate Institute of Management.)