A License Raj

Thursday, 31 May 2018 00:00 -     - {{hitsCtrl.values.hits}}

Sri Lankan Banking and Finance can be categorised as a license raj. This is not because institutions are regulated by the Central Bank, but rather that the capacity to conduct business is contingent on one obtaining a license. The NBFI sector, usually understood as the Finance companies, are heavily constrained by this licensing structure. We live in a context where an insolvent company like ETI Finance is more likely to be involved in lending and deposit taking than a cash-rich company like Overseas Realty PLC.

This is partly due to a long-running conspiracy by the Central Bank and partly due to the love of financial intermediation by the current Governor. The conspiracy is a simple one. They give licenses, and limit the capacity to operate to these licenses. The licenses subsequently become of significant value. Therefore, the chronological distribution of licenses is heavily skewed towards the early 2000s. Insiders knew of the Central Bank’s policy and obtained licenses, which they would sell on to people who honestly wanted to operate as a financial institution in a latter period. Therefore, it is very common for listed NBFI tickers to differ from the existing companies’ names, changing names frequently like con artists. It would be in the public interest to hand out licenses to companies that had the honest capacity to operate as financial institutions, and be more proactive in taking away licenses from ones that did not. The CB Governor, as an economist, has a bias towards the importance of his own profession. The Governor has consistently put forth policy that would require banks to make large computations, and prevent smaller players from operating in the market. Take his current stance that banking corporate debt be limited to institutional players. The debt market sans bank debt is choked of activity, as they will not allow online access to the trading system. Large computations can also be very wrong, and given the banking concentration the Governor wishes to see, would pose significant systemic risk. 

I agree with the CB Governor in a certain sense that there are too many finance companies, which brings about a need for consolidation. I further think that they should not operate as pseudo-banks, but rather as specialist lending institutions. Banks, in my opinion, should be more involved in project financing and have very low risk tolerance. Deposit-taking activity of NBFIs, on the other hand, should have more risk-bearing on the part of the depositor, with return being contingent on the repayment of the borrower. Finance companies currently do handle large sums of cash with little scope for AML, treasury operations, FX hedging, and portfolio diversification. His policy of forced consolidation thinly veiled as capital requirements, however, is misguided.

The new license freeze might be in part due to the existence of insolvent NBFIs. The CB and Treasury might be hoping to sell the license, in lieu of liquidating these companies and settling depositors from their own cash flows. However, the rescue of these companies has been very slow and fraught with suspicious activity, for example the ETI-group owned Swarnavahini, which was too important a media institution to be handed over to any investor. The legal minefield that plagues insolvent NBFIs, compounded by the legal minutiae that is our law, are heavy obstacles to any potential revival. It is unfair and unwise to expect foreign financiers concerned with operating financial institutions to take such risks. Acting swiftly to liquidate these companies will improve the stability of the system.

When I say there are too many finance companies, I don’t mean that there is too much competition. There is a lack of competition. 

Banking tariffs have become more regressive under Indrajit’s tenure. What I mean is that there are too many companies with common ownership, starting with the Government, which owns multiple poorly run finance companies and banks by proxy that should come under common management. LOLC, Vallibel, and the major banks all own too many institutions. Giving an incentive to amalgamate and taking away the value of holding a license will result in a much less superficially dense sector. This would make regulation easier.

If our financial institutions were better regulated and policy was enacted in the public interest, we would have better economic outcomes. Our payment system is incredibly expensive and inefficient. The intent of policy is usually seen through outcomes. It is sad that we currently live in a world wherein the markets are gambling on which firm will consume the other to meet minimum capital requirements. Shareholder wealth is being wasted and firms are being told to operate at scales that are in some instances twice their current operations. How is this more stable, Indrajit?

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