CIFL crisis:

Depositors left in the lurch

By Gamini Warushamana

Depositors again panicked over the instability of some financial institutions in the country following the crisis at Central Investments and Finance Limited (CIFL), a registered finance company.

The CIFL financial crisis was described as a 'liquidity and management issue' due to allegedly an inside racket and depositors have not got their money back. It is reported that directors and top officials of the company were involved in the scam, violating Central Bank (CB) regulations.

According to reliable sources, CIFL had granted higher interest rates between 15-18 percent for some depositors who were major investors in the company, violating CB authorised interest rates for fixed deposits at 14.45%. However, in their fixed deposit certificates they had shown the authorised rate of 14.45% and the rest has been given in cash up-front.

Global financial crisis

This is the first incident reported after a series of problems at several banks and financial companies between 2008-2011. These occurred during the global financial crisis.

The Finance Company and five entities belonging to Ceylinco group - Ceylinco Golden Key Credit Card Company Ltd, Ceylinco Finance and Guarantee (F and G), Ceylinco Investment and Realty (CIR), Ceylinco Profit Sharing Ltd, and Ceylinco Shriram, faced liquidity issues.

In addition, financial scams by Sakvithi Constructions and Piyadasa Ratnayake or Danduwam Mudalali shocked the financial sector and thousands of depositors lost their money.

These unregistered finance companies had collected billions of rupees in deposits from the public and until the institutions collapsed the authorities had not recognised the threat they could cause to the financial system or the risk depositors faced. There was no warning regarding such unregistered financial companies or any action taken against them prior to the crisis.

Trust

However, after the crisis, authorities took stringent action against such unregistered companies and introduced new legislation to govern the financial system. According to analysts, the CB handled the crisis carefully.

Over the past two years public confidence in the financial system had been restored and most of the financial institutions and banks that faced liquidity issues recovered and are functioning smoothly.

However, some institutions collapsed and a large number of depositors suffered and have not received their money as yet.

In the financial service business the sine qua non is the trust of customers - the depositors and borrowers. Anything that damages this confidence may lead the institution to a crisis and it will also lead to a widespread financial crisis.

Whenever customers lose trust in the safety of their deposits they rush to withdraw their deposits and the institution would be unable to pay them back. Then the institution will inevitably collapse.

CB supervision

After the financial crisis in 2008-2011, the steps taken by the CB focused on restoring the confidence of depositors. Strategic investors were found and in most cases state banks or financial institutions were appointed as Managing Agents and new directors were appointed.

Without injecting public funds to rescue them, deposits and other debts were converted into equities. The balance sheets of the crisis-hit companies were restructured to attract new investors, deposits and interest rates were also rescheduled. Dues recovered and real estate disposed of.

In this case too, the CB has intervened and appointed People's Leasing and Finance PLC as the Managing Agents of CIFL.

In addition, the CB recently launched a Liquidity Support Scheme (LSS) for licensed finance companies to ensure financial stability and enhance public confidence in the financial system. Accordingly, licensed finance companies that face liquidity constraints are encouraged to revive and restructure their operations.

After the 2008-2011 crisis, the CB carried out a campaign against unregistered finance companies and warned depositors of the risk of investing in them.

These unregistered finance companies offered high interest rates and not only ordinary people, but reputed businessmen, politicians and wealthy celebrities who had invested their money in them suffered with the collapse of the institutions.

Interest rates

The existence of institutions of this type also reflects a weakness in the financial sector of the country. They exist because there is a demand for their financial services.

As we know the formal financial system is not friendly towards SMEs and micro enterprises and they face difficulties in finding finance and, therefore, tend to borrow from money lenders at higher interest rates. These money lenders can offer higher interest rates to depositors compared to what formal financial institutions offer.

While warning about unregistered financial institutions, the CB has been promoting registered financial companies as a safe haven for depositors and the CB frequently publishes a list of registered finance companies.

Therefore, the public trusting the CB's recommendations invested their money in these institutions. CIFL is one such institution that the CB had recommended. These registered institutions are regularly supervised by the CB.

So what is the message given by the crisis at CIFL?

Either weaknesses in CB supervision or that CB supervision is not a guarantee of the safety of financial institutions.

Risk-return spectrum

With the CIFL issue, people are now in a dilemma as to where they could invest their money safely. Usually all investments carry a risk. The return in terms of interest or profit is considered as the reward for bearing such risks and if you invest in high risk ventures you can get higher returns. Safe investments carry lower returns. Generally government securities are considered the most safe investment and in Sri Lanka depositors prefer state banks and think that government backing is the guarantee of the safety of their money.

However, this is not always true and even governments can default. For instance the Argentina government went into bankruptcy during the economic crisis from 1999-2002.

The general preference of risk averse investors are fixed deposits. They also have limited investment options. Most of the ordinary investors such as pensioners and expatriate workers do not know how to invest in the stock market, government securities or debentures of blue chip companies.

Now they again have a question as to how safe their deposits are. According to analysts if the economy of a country grows fast, macroeconomic fundamentals are sound and the country has a strong foreign reserve position, the financial system of the country too will be strong while risk will be low.

The regulator, the Central Bank, also has a role in ensuring the stability of the financial system and it depends on the legal framework, monitoring and supervision process.

In a competitive financial market, individual banks and financial institutions too manage transparency in its business and disclose a true picture of its profits, assets and liabilities.

The ratings of independent rating agencies also help investors to get an idea of the financial position of the institution they deposit their money in. Listed companies are governed by another set of regulations under the Securities and Exchange Commission and the Colombo Stock Exchange and registered companies have strict disclosure requirements.

Depositors should be vigilant about their bank or financial institution. Annual reports, quarterly financial statements give the financial position of these companies. Investors can also diversify their investment portfolio and reduce risk. Despite all these factors, nobody can give an assurance that an investment in any financial institution is totally risk-free.

For instance, the oldest merchant bank in London, The Barings Bank, collapsed in 1995 due to unauthorised trading by its head of derivatives trading in Singapore. A similar scam has allegedly taken place at CIFL.

Therefore, Central Bank supervision of registered financial institutions and banks should not be the only guarantee that investors should depend on and there are other indicators that they can check before investing their money. Investors should always remember the risk-return spectrum, that high interest or return carries high risk.