The Sri Lankan economy has achieved significant progress over the past eight years and has embarked on a high-growth trajectory, recording an annual average growth rate of about 6.7% during this period, with a post-conflict economic growth of about 7.5% since 2009. Accordingly, the country’s gross domestic product (GDP) has reached $67bn, with a per capita GDP of $3282 in 2013.
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Going forward, an encouraging medium-term macroeconomic framework is in place, envisaging annual real GDP growth of more than 7.5%. In line with the government’s medium-term macro policy framework, per capita income is estimated to surpass $4000 by 2016, putting the economy into the upper middle-income category. The country's overall GDP is expected to reach $100bn. Innovation and dynamism generated through the new development model – which exploits the geographical and comparative advantage that Sri Lanka’s economy enjoys – will bring about steady progress and avoid a possible ‘middle-income trap’ beyond 2016. We will reach an income per capita of $7000 by 2020.
Financial sector growth
Sri Lanka’s drive towards the envisaged growth path will largely depend on the strength and dynamism of its financial sector. To this end, it will need to offer technology-driven financial services to strengthen operational efficiency, strengthen delivery channels, and diversify funding sources by tapping international capital markets and improving cost efficiency. In addition, the financial sector will be expected to expand its business network beyond domestic territories, address external vulnerabilities and spillovers, employ high-quality personnel and a strong corporate governance process, and comply with an enhanced regulatory framework to strengthen resilience.
Financial sector assets amounted to more than $77bn at the end of 2013, with assets of the banking and non-banking sectors accounting for 57% and 7%, respectively. Currently, the banking and the non-banking sectors operate in a highly fragmented and skewed manner, reflecting the dominance of a few large financial institutions, while exposing small institutions to external shocks. As of the end of 2013, the banking sector consisted of 33 banks, of which 21 were local banks and 12 were foreign banks, while the non-banking sector included 58 non-bank financial institutions (NBFIs) with 48 licensed finance companies and 10 specialised leasing companies.
In the past, several small financial institutions operating with low levels of capital and less commitment to strong corporate governance faced financial distress, which brought stress to many depositors and other stakeholders. However, it is expected that strong, dynamic financial institutions will further strengthen the resilience of the country's financial sector.
Pre-emptive strike
Sri Lanka’s financial sector needs to reposition itself to support the next phase of economic growth beyond 2016. The Central Bank of Sri Lanka’s forward-looking policies are designed to enable the financial system to face potential worldwide policies and adjust to sudden volatility, and to pre-empt, as much as possible, any possible financial distress or future failure.Â
Considering the strong macroeconomic variables and stability of the Sri Lankan financial system, and the expected role that the financial system will play in the years ahead, the central bank considered that the time was right to reorganise the financial sector to better serve the economy and support its future needs. Considering this, the masterplan on the consolidation of Sri Lanka's financial sector was unveiled in January 2014, followed by meetings giving the necessary guidance and conveying the expectations of the central bank to the boards of directors and senior officials of banks and NBFIs.
The masterplan spelt out detailed strategies to establish strong and stable banking and NBFI sectors, as follows:
Enhancing the capital base: Building adequate capital buffers during good times. This will help prepare the Sri Lankan financial sector to withstand business cycles without sacrificing investment potential during the forthcoming periods. Similarly, in the run-up to 2019, the capital will be increased under Basel III requirements.
Consolidation of the financial sector: The banking and NBFI sectors need to be consolidated through mergers and acquisitions of businesses to lessen fragmentation and to strengthen the institutional framework. Further consolidation is expected to improve its financial stability, intermediation and access to finance. Consolidation of the largest banks in the sector is expected to benefit from organic growth, while the mid-tier banks are expected to strengthen the sector’s economic viability and grow through consolidation. Consolidation will increase the market share held by financial institutions thus making them less vulnerable to volatilities in the market than smaller financial institutions.
Further strengthening of the regulatory framework of the banking and non-banking sectors: After the consolidation programme, stronger corporate governance practices, capital augmentation and risk management will be undertaken to further strengthen the resilience of the financial sector.
Envisaged outcome
At least five Sri Lankan banks are predicted to have assets of SLRs1000bn ($7.7bn) or more, with a strong regional presence, by 2016, by which time there will be a reduced number of banks as a result of mergers and absorptions. With the establishment of a large development bank, substantial impetus will be provided to develop banking activities in the country. Domestic banks with assets below SLRs100bn will increase their assets to SLRs100bn or more through organic growth and mergers and acquisitions with other banks or NBFIs over a reasonable time period.
Banks will be expected to restructure their group companies and amalgamate their NBFIs into one subsidiary. The number of NBFIs is expected to decrease to about 20, of which three finance companies will specialise in microfinance business. NBFIs are to build up assets to more than SLRs20bn by 2016. NBFIs with low capital and assets will be merged or acquired by banks or larger NBFIs, and local banks will be encouraged to acquire and absorb one to three NBFIs.
The government of Sri Lanka has endorsed this programme and has offered tax incentives to encourage the consolidation process. Further long-term funding through the Sri Lanka Deposit Insurance and Liquidity Support Scheme on concessionary terms was extended to the lowly capitalised NBFIs requiring capital infusion.
Strategic fit
The central bank requested all banks and NBFIs to form internal steering committees to ensure strategic fits with the proposed consolidating entities and to ensure smooth transition to the new arrangement. The entities were requested to submit consolidation plans and to align their immediate future business expansion, new recruitments and other capital expenditure in keeping with the consolidation programme.Â
The central bank ensured that the consolidation process will not adversely affect the staff of the institutions and encouraged institutions to appoint competent human resources consultants to perform independent reviews on senior management. There are also moves to ensure that the valuation of business and conduct of due diligence of financial institutions are true and unbiased, with the highest level of professionalism. To do this, the central bank appointed well-regarded audit firms with international connections to provide advice and guidance to these institutions.
A special unit – the Financial Sector Consolidation Unit – was instituted at the central bank to guide and liaise with all stakeholders, including the Securities and Exchange Commission of Sri Lanka, the Colombo Stock Exchange, the Registrar of Companies and the inland revenue department, to ensure the successful completion of the consolidation process and keep the public informed of the progress on consolidation through monthly press releases and participation at awareness programmes.
So far, satisfactory progress has been made on the consolidation of the financial sector. Three banks with a development banking focus will complete the merger process by the final quarter of 2014. Consolidation of group companies and several mergers and acquisitions of NBFIs and banks have already taken place. The central bank is closely monitoring the progress and is offering the necessary facilitation for the smooth integration of business operations of financial institutions to expeditiously drive the financial sector consolidation programme.
With the successful completion of the financial sector consolidation programme, it is envisaged that the expected outcome of strong and stable financial institutions in Sri Lanka will be an impetus to the growing needs of the economy and will strongly facilitate a $7000 per capita income level by 2020.
Ajith Nivard Cabraal is the governor of the Central Bank of Sri Lanka.
