Risk-return aspect vital for sound investments

By Lalin Fernandopulle

The crisis in certain financial institutions has snowballed into a larger issue with many banks and lending institutions unable to maintain liquidity levels. The crisis has again triggered panic among depositors. The crisis in some financial institutions surfaced again with the problem at Central Investments and Finance Company PLC (CIFL), which is now under a new management appointed by the Central Bank.

Senior banker and financial analyst, Mangala Boyagoda said that a prudent investment would entail credit risk, the capacity of the borrower to pay back, liquidity, the ability of the company to pay when depositors ask for their money and the risk-return aspect.

Financial sector experts said that the present crisis in certain financial institutions including some State entities is an eye-opener for depositors who look only for high returns and are less concerned about risk factors.

Certain financial institutions attract depositors by pledging high interest rates for Fixed Deposits and various saving accounts expecting to boost short-term gains. Experts said that certain new financial institutions offer 15 to 20 percent interest on FDs to entice depositors who at times are 'pennywise and pound foolish'. Depositors have not learnt a lesson from bogus financial institutions that went bust promising higher interest rates.

Pramuka Bank, Golden Key Company, Ceylinco Group, Sakvithi and now CIFL were some of the institutions that collapsed financially due to mismanagement and corruption.

Chemanex Limited, Managing Director, Preethi Jayawardene said that investors should first consider the financial stability of the organisation in which they invest. They should take into account the risk-return aspect before making a decision. Making prudent decisions are vital for a safe and better return. Many investors go only by the interest rates offered by institutions.

They do not consider whether the institution or bank could pay the interest. Investors should look into the background of the organisation, the credibility of the managers or decision-makers prior to investing.

Jayawardene said that if a company offers high interest rates, depositors should ask themselves as to how the company could pay it. Depositors should first consider the safety of an investment rather than giving priority to returns.Finance companies play a major role in the economy supporting the SME sector and funding large-scale infrastructure projects in the country. Depositors have questioned how could a licensed finance company, regulated and supervised by the Central Bank, be mismanaged and go bust leaving them in the lurch.

The Central Bank will direct institutions to take corrective measures if the organisation is not on the proper track. It is up to the depositor to make prudent decisions based on sound analysis. The regulators are not responsible for short-sighted decisions.The management is responsible for the daily operation of business. The Central Bank provides a framework and benchmarks so that companies do not deviate from them. Financial sector experts said that being regulated is no guarantee that the company will not falter.