The Central Bank of Sri Lanka in its Monetary and Financial Sector Policies for 2023 and beyond noted that there would be pivotal changes to the Banking (Special Provisions) Act that will ‘provide the required legal framework to ensure that the banks are adequately capitalized, and upgrade their resolution framework, safeguard the interests of depositors, and strengthen the regulatory powers of the Central Bank’.
Under the current legal framework, it makes more sense for the banks to roll over existing debts to inflate earnings as the prospect of recovery is a long drawn out and arduous process. Willful default is commonplace and income transfers to controlling interests are widespread in heavily indebted companies.
The Central Bank is also expected to introduce better single-party borrower limits. This will prevent the non-budgetary financing of government programs with the balance sheet of state-owned enterprises.
The regulatory framework is also expected to bring in a bankruptcy code to provide some reprieve to failed businessmen that would otherwise resort to extreme measures.
The Central Bank has also signalled further consolidation of financial institutions both within the scope of the non-banking financial sector and the banking sector.
To ensure that net interest margins somewhat normalize in the real economy in the period ahead the Central Bank is expected to loosen the restrictions on the micro-finance and leasing sectors thereby allowing some degree of competition.
The regulatory framework shall also begin to formally recognize the existence of money lenders and introduce some basic regulations in the sector. The Central Bank acknowledging its failure to have any effective capital controls in the recent economic collapse has decided to gain utility from the International Transactions Reporting System (ITRS) which was introduced slightly before the complete collapse of the currency.
The Central Bank noted that the interest rates are expected to reduce going forward with each coming month as both the government’s financing requirements reduce drastically and the liquidity in the system is increased.
Artificial shortages in key commodities heavily weighted in the inflation index are expected to be solved with direct budgetary assistance from multilaterals.
Monetary policy movements will become more predictable as monetary aggregate growth will be tied to inflation through an inflation-targeting framework.
The Central Bank reiterated earlier stances that the debt restructuring would not harm the financial sector or local economy any further. ‘The excessively high levels of interest rates observed at present are expected to moderate in the period ahead as money market liquidity conditions improve and the risk premia attached to debt restructuring concerns assuage.’
Given the large depreciation of the currency coupled with high rates of inflation and the imposition of additional taxes, there is no rationale based on equal treatment to impose additional haircuts to any LKR-denominated government security. LKR-denominated securities would require additional payments to be put on a fair footing with the International Sovereign Bond holders given the ranges of haircuts noted in the popular press.
The Central Bank also notes that there would be a decline in the fixed deposit rates. Given the need to meet the inflationary target and the current excessive rates at government security auctions, the Central Bank is well placed to finance the government’s borrowing requirement through its balance sheet. (TP)
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Insurance industry calls for clarity on domestic debt restructuring
Insurance industry participants wishing to remain anonymous note that the entire industry has been put into great difficulty by the lack of clarity on the domestic debt restructuring.
They note that they can’t set out guaranteed return rates or entice new customers without a clear expectation of what safe assets like government securities are expected to yield. They further added that a huge counterparty risk would exist if there was a domestic debt restructuring and the current Primary Dealer network was unable to honour contracts held with them.
The participants noted that there needed to be a regulator-driven audit of a certain institution with recent press articles to ensure confidence in the system.
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