THE PROPOSED BANKING ACT AND VITAL AREAS TO BE CONSIDERED IN THE ROLE OF THE CENTRAL BANK (PART 1)
Posted on January 14th, 2020

BY EDWARD THEOPHILUS

It is a pleasure to hear that Prof.W.D.Lakshman, the governor of Central Bank publicly announced that a new banking act will be enacted in 2021.  According to news reports, the following areas would be the major consideration in the proposed legislation. However, the governor’s statement did not give clear information on whether the proposed act would be an admixture of all enactments since the establishment of Central Bank on the advice of John Exter and the law relating to negotiable instruments will be included to the proposed legislation.  Central Bank has accounts of government departments with cheque books and if the funds transferring of the treasury continue, it would be useful enacting of law relating to the negotiable instrument in Sri Lanka. 

I have recently published several articles regarding banking operations in the Lanka web and pointed out significant issues in banking operations in the country.

  • Approval for establishment of branches and banking outlets – This is a vital activity in the trading banks with the approval of the central bank and it is subject to the regulation of Central Bank.  It is observed that the Central bank of Sri Lanka permitted many banking outlets for domestic and foreign-owned without considering capital requirements consistent with the dynamic economic environment and in this process, the regulatory authority has less emphasized the possibility of insolvent threats. The proposed banking act should focus to incorporate regulations rationally thinking about this area.  What would be the future regulation regard to capital requirements? It is essential to cover the proposed legislation and it shouldn’t be too flexible and rigid as the change in the economic environment needs direct involvement of the central bank and changing regulation from time to time. 

In the Western countries, population density also considers in opening branches of banks as people in the rural area needs banking services.  Foreign banks may not involve in the area and domestic banks should concern and be regulated by the banking act and should not allow opening branches like emerging mushrooms.

Did foreign banks bring enough capital to operate in Sri Lanka as a registered bank in the country or they operated as a branch in Sri Lanka covering or showing the capital structure of the head office overseas? BIS regulations regard capital adequacy concerns on this matter.  Foreign banks or branches need to maintain risk-weighted capital regulation of Bank for International Settlements.  In this connection think about the experience of Bank of America branch in Sri Lanka and later the business operations of BA took over by Mercantile credits which also bankrupted.  The capital adequacy of domestic banks, which were emerged like mushrooms after 1978 seems a question and practical experience shows that they have not maintained adequate capital and this area must be strictly covered by the proposed act. Credit demand and quantity rapidly increase due to four main reasons, inflation, increase in business cost and government promotion for business investment and expansion of the existing business.

When a person visits a rural town, it is seen that so many bank branches from various banks and they compete without enough business to distribute among branches. Resulting allowing many bank branches, non-bank finance institutions it seems that an intense competition between each other and competition is good environment which generates benefits to customers, but in Sri Lanka, it is not happening because branch managers have no authority to give benefits to customers regarding the price of loans and charges relating to non-credit business and other transactions  Bank managers in Western countries have limited power and electronic technology supported to reduce staff in rural branches and reduce the delegated authority of rural managers to perform such functions by regional managers and officers in head office.

Head Office authorities scare to delegate more power to branch managers, one reason is it may encourage credit frauds and other malpractices. The cost of branch management has skyrocketed and this situation has created to implement weak regulation or neglecting regulation of the Central Bank especially in exchange, credit and other restrictions. The power to make strict regulations is needed for the central bank to control unnecessary competition and rigid regulation also needed for the approval of the establishment of branches and banking outlets.

The Central bank also needs to regulate the operation procedures of trading bank branches although it is the role of trading bank head office. When opening branches by trading banks should not allow opening branches of several trading banks in small townships, like in the Western countries trading banks can agree with banks open one branch in small rural towns to provide the services to the community in the area. This practice doesn’t appear working in Sri Lanka despite it is a good policy to be adopted.

Central bank regulation should direct trading bank branches to maintain branch liquidity requirements as a strategy for the effective management of banks. Bank liquidity management is the responsibility of individual trading banks and many bank executives have no clear understanding of this strategy and branch managers have not been trained by the training department how to manage the money base of a branch. Liquidity management is a broader concept in foreign countries, but simply, it could consider that the money base of a trading bank shows management stewardship of branch managers and the reconciliation of money base with financial assets minus liabilities of the branch would be easily supported to successful liquidity management of the entire bank. The weak bank liquidity management has forced many trading to borrow from overseas pushing the indebtedness of the country.  Therefore, Central Bank should concern about this matter as regulatory authority and prudence controls will be a useful measure to play a good regulatory role.

  • Strengthening Consumer Protection – Foreign countries have banking ombudsmen for this purpose and customers can make direct complaints to the office of banking ombudsmen if individual banks disregard customers’ complaints. Customer complaints might be a pain to the head office and the credibility of a bank.  The culture of Sri Lanka is the bank executives show the public that they are superior in knowledge and practice. It is not a truth.  Sri Lanka has no such an institution for consumer protection purposes. If anyone investigates the history of consumer protection it could be found that many banks disregarded in practice and acted like a bull in a clay utensil shop.  In addition to this office, the Western countries appoint commissions for banking inquiry and in Australia investigations made on several occasions by banking commissions.  The proposed banking act needs to considered for establishing a Banking Ombudsman Office and giving authority to Central Bank to appoint a banking Inquiry Commission to investigate issues from time to time.
  • Deposit Insurance – This is a good idea but the problem that needs to consider is who will pay the insurance premium.  It shouldn’t be like a credit insurance system, which creates counterfeit obligations to compensate deposit owners and liability to make profits to insurance companies out of hard earn money from poor people. Go back to the case of the Leeman Brothers. Sometimes banks can take the balance of deposit holder until the account gets nil balance and in the case of current accounts or cheque accounts banks may get insurance premium overdrawing accounts. If the bank pays insurance premium it would cost to the bank and impact on the profitability of banks. If it shifts the cost to customers it would be an additional cost to customers like debit tax and the cost of collecting premium may be an additional cost to the bank. 

The deposit insurance program has a positive aspect and if banks work like custodians of customers to protect customer deposits, especially banks make good decisions in the process of lending business considering they lend their own money, it will protect customer deposits. The experience of Sri Lank has proved that bank executives have not worked as custodian of customer deposits and made bad lending decisions without protecting customer deposits.

   Will deposit insurance promote bank employees to cheat customer deposits with an expectation that insurer will pay for damages when they cheat customer deposits. What would be the answer? (Continue in Part 2)

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