ADVANTAGES OF UNDERSTANDING BANK CREDIT POLICIES TO AVOID PROBLEMS IN THE FINANCE SECTOR
Posted on October 7th, 2020

BY EDWARD THEOPHILUS

A few months ago, the country-wide highlighted problem that was directed to the president was difficulty in obtaining credit facilities for the small business sector and neglecting small business communities by organized banks in the country. The issue has been widely discussed by bankers as well as policy-makers of the country.  The issue is a pressing question to all communities and it is not a question quickly emerged but it is a question existing in the country since the early 1990s. the budget speech in 1970, Dr.N.M.Perera highlighted the issue and later the government directed several policy actions, despite numerous efforts to solve the problem it is continuing in the country for more than a century. Why this situation and who is responsible to expand the problem?

Historical perspectives of trading bank operations provide evidence that bank credits have been playing a major role in capital formation and investment acceleration in developed and developing countries during the past century.  Investments in the USA, UK, and Australia had been boosted by bank credits after wartime massive backwardness. Bank credits yielding a high level of profits to banks, thereby generating billions of tax revenue to the government. American researchers in the early 1990s on the secret behind the massive Japanese economic achievements have revealed that lower cost of capital manipulated by bank credit policies in Japan gave a big push for investors to broaden their manufacturing base and encouraged investors to make more investment through borrowing from banks.  Japanese corporate management practices engineered the own for large corporations to create credits for debt capital and working capital. The entire finance sector became family trees of banks.

Banks are a vital source of capital for investors all over the world especially, when the share capital is not sufficient to entertain the demand of credits, and especially, in Sri Lanka banks positively responded to the business sector providing credit supports to meet the demand. The mentality of the business community reflects that consumers don’t satisfy with the actions of banks.  The nature in Sri Lanka, despite the concept of market capitalization, small and medium investors contrive the short and medium-term capital requirements from the banking system, and late 1990s in Asian countries, trading banks were severely pressurized by credit demand and the concept of Asian saving should be invested in Asia through Asian bond market came to bruit in the region.  Although the role of banks has reduced in the process of proving finance for business in developed countries the task of capital formation seems to be changed in Sri Lanka, it could be observed that large and small business community are always going to banks seeking credit supports. 

There is little evidence in Sri Lanka that understanding credit policy has assisted in engineering required capital for business. Sometimes ago when I was working in a manager position in a regional Sri Lanka, I considered that credit risks of the bank could be massively reduced by education bank credit policies to customers and coordinated the policy process between the bank and business community using appropriate strategies to educate the business community, the strategy was practically successful. The explicit nature in the current bank management is the details of credit policies are not disclosed to customers and in many instances and customers made hostile responses against banks and in such a difficult situation using unacceptable methods or dishonest strategies to fulfill the requirement.

Credit policy development was a strange management practice bank operations and even bank executives in the past were lacking the knowledge of management strategies regarding credit policy developments and some operational procedure that was set in various operation manuals, in many banks in Sri Lanka operation procedures were compromised on the British management procedures, which had been relied on common law evidence on conventional banking practice. American and Japanese banks departed from the British conventional praxis and manipulated their systems.   Many top bank executives in government banks in Sri Lanka did not know about bank credit policies which were set on a broader spectrum such as accounting, economic, law, and many other conventions.

The policy role until the initiation of policy development in 1989 with the support of Booz, Allen, and Hamilton was a neglected area, but essential to maintain a healthy financial system to stay in a fluctuating environment in a liberal economic system.  Many banks in Sri Lanka considered that the development of management policies for various functional areas such as customers accounting performance, credit administration, asset and liability management, liquidity management, asset quality management, and relationship management would be a partial role of the Central Bank, and trading banks have no participative role in it.  This mentality has been supported by the ownership of major banks in Sri Lanka (the government).  The regulatory role of the central bank ignored the encouragement or making regulation congruous of the market dynamism and diversity brisked in limited functional areas of banks.

Since the 1990s banks in Sri Lanka trading banks especially focused on policy developments, such efforts were outweighed the political influence (since 1978, government politicians influenced the bank management for credit decisions) as the government policies attempted to hold the power of controlling institutions due to several reasons such as borrowing for covering the budget gap, providing employment, entertaining political henchmen, investment in public corporations and many others.

Since early 1990, Sri Lanka has been recording the highest number of failures in non-banks financial institutions, and the Central Bank directed policy development for trading banks. The liberal economic system encouraged more imports without discipline and customers jumped to non-bank financial institutions for borrowing to purchase imported vehicles and many other items. The burden of credits in the country did not distribute among the banks and non-bank financial institutions.  Bank customers did not understand bank credit policies, and non-bank financial institutions became more liberal credit providers considering making profits from the liberal credit market.  The worse result of the shifting customers from banks to finance companies was the lack of protection for deposit holders in non-bank financial institutions.  

The volume of non-performing credits in the financial system in the current market is more than 10% of the total credit portfolio and this reflects the unprofitability of trading banks and rising costs for litigation of customers and recovery efforts. The major bank in Sri Lanka, Bank of Ceylon has recorded a volume of loss in the current year and the magnitude of credit loss has been not disclosed by the bank to people, various factors may have been contributed to this negative result, it needs to understand that ignorance of credit policies by customers, government authorities, politicians and managers of the financial system.  How to correct this situation should be the major strategy of the financial system during the next decade.

Deregulation began in the late 1980s forced many banks in the world to disclose credit policies to customers to control risk factors and to secure market share in the intense competition, many analysts view that deregulation gave excessive power to banks despite the point that the market competition will generate pricing benefits to customers, however, some views that the deregulation gave the power to exploit customers, and finally, when liberal decision making of banks appeared banks were exploiting customers and the regulatory authority established a banking ombudsman office and many times the ombudsman office investigates the consistency of bank credit policies and credit decisions.

The prime objective of bank credit policies is to protect banks’ capital base and customer deposits.  These two factors are associated with securing international confidence in the payment system.  In Sri Lanka, 99% of credit customers have no understanding of the prime objective of bank credit policies.  Neither private nor government banks attempted to educate the prime objectives of bank credit policies which impact the entire financial system of the country. Many banks use vision, mission, and objectives for advertising intending to attract customers and no leaflet has been issued to describe credit policy. Bank customers must understand that capital and customers’ deposits are the foundation of a bank and credit policies constructed to strengthen the foundation and bank staff have a fiduciary obligation to protecting the foundation. 

The second aim of credit policy is to maintain a quality credit portfolio in a bank, which reflects the profitability of a bank and the entire banking system in a country. Credit portfolio management associated with various concepts and trading bank experts always advised that the management of a diverse credit portfolio helps to risk minimization like in investment management.  For example, a bank could maintain Rs. 100 billion credit portfolio that should be allocated to different industrial areas in terms of risk and return.  This is a highly practical aspect that invites more research in a bank and to set the portfolio structure base on practical finding, the profitability of the industry, accounting standards, and prognosis. The method of setting a portfolio structure is banking secrets, which might differ from one bank to another.

Banks don’t need to disclose internal secrets to customers or one bank to another as they are management strategies, however, customers must know the bank credit policy regarding the accounting standard, management quality, and collateral quality expected by banks. If customers have not a clear understanding of policy matters on industry discerning, competitive standards of companies, management attributes of customers they would have gone to the president asking credit supports from the banking system as it happened in the recent past.       

To understand bank credit policies and to gain mutual befits from this process customers need to realize several points.  The first requirement is that banks provide credit supports to customers based on capital and customer deposits, which are direct liabilities of the bank balance sheet. Bank credits are risk assets, which generate from the liabilities to support the community. Banks whether they are owned by the government or shareholders banks have an extreme right to protect the organization.  Therefore, banks cannot extend credits customers disregarding the protection of the organization.

Protecting for banking organizations, they need to place various covenants and banks can accept risk a tolerable level and many politicians in Sri Lanka have no idea about this.  The ignorance of politicians presses banks to go beyond the tolerable level. The president and the prime minister need to educate politicians on this matter and banks should educate customers on the policy matters.

The regulatory authority of the Central Bank has a responsibility towards the trading banks that customers should be given lending policies to reconcile the knowledge gap between the bank and customers.

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