Towards a stable, competitive non-bank finance sector

by Dinesh Weerakkody

According to a recent news report the Minister of Finance has proposed to set an upper limit of Rs.10 million on banks to do leasing business, to which the heads of the commercial banks had protested during their meeting. Perhaps a percentage ceiling on the total exposure to leasing may be a better option than imposing an upper limit.

The top 10 NBFIs account for 70% of the estimated over Rs. 700 billion leasing market whilst the banks handle the balance or Rs. 220 billion. This decision may be totally contrary to the Government policy on developing the economy with a vision of a highly-competitive social market economy that aims to improve consumer choice and a provide a platform for innovation.

Banks such as the HNB and NTB expanding aggressively into the leasing business can offer better options and better rates and most companies still prefer one provider for all their banking services.

Amalgamation

The Minister of Finance on the other hand knows the challenges facing the NBFI sector and knows the importance of a vibrant and stable NBFI sector and the role they play in financial inclusion.

In fact, one of the most intensely-debated issues more behind closed doors rather than publicly has been the stability of the NBFI sector.

In 2014, Sri Lanka's financial sector regulator pushed for the amalgamation of the financial sector in the country. The current 50+ NBFIs, only account for only 7% of the financial system's gross assets, but millions are served by this sector.

The Central Bank's Master Plan in 2013 was an attempt to prevent further costly and painful failures of finance companies. Therefore, it is rational to conclude that an overarching objective of the plan was to address one of the key weaknesses and risk in the overall financial sector, which we have still not fully addressed. However, it is also equally important to ask: Why so many licenses were issued in the first place and why certain mismanaged financial institutions instead of being charged for reckless misconduct were given safe passage through the consolidation process?

The past failures of some finance companies have clearly shown that the failed or struggling NBFIs were engaged in risky business models and lacked governance. What the regulator has done so far to address these issues, needs constant monitoring by those responsible for the sector, especially the Ministry of National Policy and Economic Affairs needs to keep an eye on this sector.

Need for Stronger NBFIs

Given the challenges faced by the NBFI sector the recommendations made in 2015 to enhance capital buffers on a properly enforced time plan must be accelerated and those NBFIs who fail to meet those thresholds must be restricted from accepting deposits.

This will pave the way for stronger NBFIs and their ability to attract cheaper and longer-term funding and improved cost efficiencies. This would help to improve the credit profile of the NBFI sector in light of its lending focus on sub-prime customer segments.

The reduced number of institutions would also improve regulatory oversight for the Central Bank. It would be a misconception however to think that the reduction in the number of financial institutions resulting from the consolidation would reduce the workload for the CBSL.

The regulatory and supervisory function of the CBSL would now have to be conducted at a much higher level with greater technical and financial acumen. Although the economic and political rationale for the consolidation in the Non Bank Financial Institution (NBFI) is beyond question.

However, it is incumbent upon directors of financial institutions to be firstly and secondly mindful of their primary fiduciary duty to ensure the safety and soundness of the institutions they govern.

There is definitely a cultural and standard failings in the NBFI sector from running unacceptable risks with public money to mis-selling. Given the woes of the balance sheets of some of the NBFIs, the Central Bank must ensure that the NBFIs stick to proper guidelines and follow risk management and governance practices.

The sector needs to be regulated well to prevent them from looking for unconventional and risky business to grow their balance sheets, otherwise the fallout from this sector could disrupt the entire financial system in the future.

There is a lot of experience to get and follow from countries like India and Malaysia to help this sector to get their act together fast and contribute further.

(The writer was a Bank Chairman and Director from 2003 to 2014).