The following is a response from the Central Bank of Sri Lanka to an article carried in the Daily FT on 11 May 2015 by our weekly columnist and former Deputy Governor of the Central Bank of Sri Lanka W.A Wijewardena entitled: ‘The continually loss-making Central Bank puts nation on red alert.’
Mr. W.A.Wijewardena, former Deputy Governor of the Central Bank of Sri Lanka has stated that “the mounting losses [the Central Bank] has made consecutively for two years in 2013 and 2014” pose “a serious threat to its risk management” and have “put the nation on red alert”.
While the Central Bank of Sri Lanka appreciates Mr. Wijewardena’s contribution to the public dialogue on issues of academic interest, the Bank considers it necessary to correct a number of factual errors and possible misperceptions that could arise from the matters discussed in the Article.
1. Generally speaking, a central bank, being the authority for the issuance of currency and monetary management, is not considered a profit oriented institution in any economy. In almost all economies, the prime objectives of central banking include maintaining price stability with a view to support economic growth and employment generation, and maintaining financial system stability. Towards these ends, central banks engage in monetary operations in both foreign and domestic markets as permitted by relevant legislation and internal guidelines. Profit or loss that accrues to central banks is a by-product of such operations, but never an objective in itself. As such, the contents of the said Article in relation to losses of the Central Bank in the past two years must be viewed differently to the treatment of financial statements of a profit oriented institution.
2. With regard to the capital cover, Mr. Wijewardena recalls that in 2002, the Monetary Board decided to gradually raise the capital cover of the Bank to 100% of its domestic currency denominated assets. Maintaining a 100% capital cover is unusual for any financial institution, but this may have been based on judgment of the Monetary Board at that time. Subsequently, the Board had decided to revert to the original provision of the Monetary Law Act (MLA) of at least 15% of capital cover. Furthermore, one may recall that the huge influx of foreign funds following the Tsunami disaster in December 2004 resulted in a sudden appreciation of the Sri Lankan rupee warranting sterilization of these inflows by the Central Bank. This intervention also would have affected the buildup of capital cover, and the knowledge that these inflows were one-off would have influenced the thinking of the Monetary Board at the time that prevented the transfer of profits to the government. This yet again displays the dynamism with which the Monetary Board of the Central Bank of Sri Lanka has operated in the past and will continue to do so in future.
3. Mr. Wijewardena argues that the capital cover has fallen to 19% of domestic assets of the Bank by end 2014 from 103% at end 2007. However, the capital cover at end 2014 as per published financial statements must be corrected as 25% of domestic currency denominated assets.
4. Referring to the Central Bank’s interest payments to commercial banks, the Article argues that the major contributor to the loss on the domestic side of the bank’s operations has been the massive interest out-payments by the bank amounting to Rs. 17.7 billion. Mr. Wijewardena attributes this to the Standing Deposit Facility (SDF) introduced by the Central Bank in January 2014. While it is true that the cost of domestic operations was high and contributed to the loss of the Central Bank, particularly at a time when the slow credit growth caused liquidity to accumulate further in the market, it is factually incorrect to state that this was due to the introduction of SDF. With net credit obtained by the government (NCG) from the Central Bank being low in recent years, the Central Bank’s holdings of Treasury bills have been insufficient to conduct open market operations (OMO) to absorb the entire amount of excess rupee liquidity in the domestic money market. In this context, as a cost minimisation strategy, the Central Bank has been using Government securities borrowed from the Employee’s Provident Fund (EPF) for OMO since 2010. The introduction of the SDF in early 2014 to replace the Central Bank’s Repurchase facility removed the necessity of providing even borrowed Government securities to absorb liquidity under the SDF, thus reducing the absorption cost further.
5. Mr. Wijewardena further states that the “massive interest outpayment” by the Central Bank under the SDF has “enabled the commercial banks to report thumping profits.” It must be noted that had the Central Bank not paid any interest on liquidity absorption, it could have reduced operational costs significantly, but such a move would have jeopardised the conduct of monetary policy and threatened domestic price stability, as extremely low and volatile interest rates could have prompted excessive borrowing and excessive expansion in aggregate demand.
In view of the above, the Central Bank of Sri Lanka wishes to assure the general public that, although public vigilance is always welcome, the nation needs not be on red alert on the financial position of the Central Bank. The Central Bank’s risk management capabilities are being strengthened continuously, in order to ensure its operations are managed properly towards the achievement of its prime objectives of maintaining economic and price stability and financial system stability.
1Prof. Barry Eichengreen and Prof. BearticeWeder di Mauro have recently reiterated this well-accepted point, writing that “the role of the central bank is not to be a profit centre, especially when those profits come at the cost of other, more important policy objectives.” (Central Banks and the Bottom Line, February 2015). See also, Jaime Caruana’s “Foreword” to Central Bank Finances, BIS Paper No 71, April 2013, where he states that “central banks are not commercial banks. They do not seek profits. Nor do they face the same financial constraints as private institutions.”