Global Financial Crisis:

Impact on Sri lanka

Gamini WARUSHAMANA
 

Eran Wickramaratne

The financial turmoil which was ignited in the informal financial sector in the country has now spread to the registered financial institutions and commercial banks. The depositors are in a panic while and the banks are in to the extra risk averse position causing a slowdown in the economic activities.

The CEO of the NDB Bank Eran Wickramaratne explained the present financial crisis in the country and the impacts of the global financial crisis and economic recession on Sri Lanka's economy in an interview with the Sunday Observer.

Q: The financial crisis which started in the US has extended to all parts of the globe. How has it affected Sri Lanka?

A: The main impact of the global recession and economic slow down on Sri Lankan economy is the adverse effect on our export industries. Our tea and apparel exports have already been affected as there is an economic slow down in all our major markets, the US, EU, Russia and the Middle East. The global demand is dropping and the global economic growth recorded at 3.5 percent last year will drop to 0.5 percent this year. Meanwhile all advanced economies which grew last year by over 1 percent, will experience a negative growth this year. Therefore it is natural that Sri Lanka too will feel the impacts of the global economic crisis more severely.

On the other hand there is a drop in the domestic demand which now can be seen in the housing, construction, real estate, automobile markets. Crisis in the financial sector of the country is also putting pressure on domestic demand. The money, people invest in the financial companies contributes to increase the economic activities and the crisis in some financial companies and the loss of depositor confidence has affected this sector. So there is a combination of factors of the economic crisis, global and local, hitting us.

Q: How will this end?

A: The recession is still deepening and there is no sign of recovery so far. Very recently the US President Barak Obama called the people to be patient. It is realistic because what governments can do and what these stimulus packages can do all takes time. In an economic cycle, it takes time to recover while confidence is a very important part and eventually it gives returns. 2009 will be a tough year for Sri Lanka but it is not unique to Sri Lanka. This is a global crisis and my view is that Sri Lanka is least affected by the global financial crisis, but we are experiencing negative impacts of the economic recession.

Q: The CB says that the financial sector, especially banks in Sri Lanka are resilient and will not be affected Do you agree?

A: I think this is partly true because there is no direct impact of the global financial crisis on us, other than the indirect impact on our exports and domestic demand I mentioned earlier.

However, one impact of the global financial crisis is the tightening of liquidity globally. Today banks are reluctant to lend to other banks, international rating agencies look at country risks and are cutting down limits to countries. Then in turn cutting foreign currency limits to institutions. Generally there is a tightening of foreign currency. Therefore obviously there is a scarcity of foreign currency and liquidity going around. As a result price of currencies and interest rates have gone up. We are not totally free from the global financial crisis and we have faced indirect impacts in terms of liquidity and cost of finance.

Q: How do you see the present crisis in the financial system in Sri Lanka that started in the informal financial sector and then extended to registered financial companies and the commercial banks?

A: Generally financial markets and financial institutions are interlinked. What happened here is a loss of confidence in the non banking financial sector. Some non registered financial institutions collapsed and immediately the people lost the confidence on other financial institutions too. Unfortunately, some of those financial institutions were mismanaged and the governance issues in them surfaced. Naturally the depositors lost their confidence. What we are now experiencing is the systemic impacts of that. Unfortunately, a vast number of financial companies functioning well but today they are facing systemic impacts and this is the nature of financial markets.

So the big debate today is should the government bail out these financial companies and the banks that are in crisis. This is a global debate.

When financial institutions price their loan products, they consider two components, firstly the risk they taking from the borrowers and secondly the non-performing loans. Both these risk factors are within the control of the financial institution and therefore the institution is responsible for the loans it made and the consequences.

But in a systemic crisis, the institutions suffer from causes made by others. The global systemic crisis arises from the fall of financial institutions, governance failure and failure of effective regulations. Apart from the regulations, the economic slow down itself is a contributory factor. Auditors, rating agencies and other players all have contributed to the crisis and this is certainly not the case in Sri Lanka. There is a rationale, in a systemic crisis governments should intervene to stabilise the system.

Q: The Central Bank says that it informed the public on authorised financial companies and warned them on the risk of illegal financial activities and therefore greedy depositors who invest in unauthorised financial companies are responsible for their losses. Are you satisfied in the way the Central Bank acted at this crisis?

A: Greed is the driving force of the human nature and they go for better returns. No doubt, people should bear the responsibility. However, the authorities too have failed in preventing illegal financial activities and the public has suffered from it. For instance if you drive a vehicle on the road you must have a driving licence and an insurance policy for the vehicle you drive. If you do not posses those the police will fine you. Similarly the public expects illegal financial activities to be curtailed. The financial regulators may not have necessary teeth to deal with the problem. But this has been going on for decades and the public expect the government to deal with it.

Q: The informal financial system in the country is widespread and there are assets worth billions and transactions in the system. Is this a result of the failure of the banking system in meeting the credit needs of various sectors of the economy?

A: For an economy to function smoothly the whole range of financial institutions with different cost structures, different distribution and different business models are needed. You need banks, finance companies, leasing companies, micro finance institutions. All these financial institutions are essential to meet the demand of a growing economy. I think the issue here is the regulation. We should recognise and regulate those financial institutions and then we can protect the depositors. The banks cannot meet all the financial needs of the economy.

Q: After the financial crisis the Investment Banking concept was questioned and some sectors argue that investment banks are a risk to the financial system? How do you explain this in a global scenario and how do the Sri Lankan investment banks differ from this?

A: The traditional role of the investment banks is to provide advisory services and fund based services. However, later the fund based services of the investment banks increased and they were involved in equity markets, derivatives products, hedge funds and various other areas.

Some of the institutions, which are in fund based activities are called shadow banks. They are leveraging deposits through the banking system but outside the regulations.

The investment banks are not regulated in the same way the commercial banks are regulated. Now the global debate is to widen the regulations to encompass these shadow banks.

If you look at Sri Lanka, we have few investment banks and they are mainly traditional investment banks which are mainly in the advisory services. We don't have hedge funds which can leverage bank credit. Therefore our investment banks have not been affected by the global financial crisis. Our investment banks are approved by the Central Bank and there is a level of monitoring which is different to monitoring of the commercial banks.

Q: Nationalisation of commercial banks has become the last option in the rescuing them at this crisis. How does this international trend and acquisition of the Seylan Bank impact on our banking system.

A: Earlier it was said that the banks are too big to fall and ironically today it says banks are too big to save. Similarly, in life banks are international and in death, the banks are national. That's how the perception of the banks has been changed with this financial crisis.

As I said earlier if the bank failure is driven by systemic risk, there is a moral obligation on the part of the government and the regulator to come in and assist the banks. Banks are different to any other business organisations. In other business or corporations, the largest stakeholder is the shareholder. The management is working to give returns to the shareholder. In banks the largest stakeholder is the depositor. Therefore banks have fiduciary responsibility to safeguard the interest of the depositors. If it is threatened by systemic factors the government should step in. In a crisis authorities can do two things, first provide liquidity to the system. Secondly it can provide equity.

At an equity infusion some times end up owning a large chunk of shares of the bank.

It is not a policy of nationalisation and it is a policy of fulfilling an obligation. Now what is happening in this global financial crisis is this infusion of equity. But as soon as possible, the governments find ways of selling the stake they have from the banks.

Rather than holding them by the governments they quickly sell them directly to the public; this is happening in the US, UK and other countries. The governments stepped in because there was a systemic risk. Once it is removed the market will function.

Q: Today it is said that the banks are in an extra risk averse position and reluctant to extend credit and is the main reason for the economic slow down. Is this true in Sri Lanka?

A: Today in our banking system the amount of Non Performing Loans (NPL) is rising. By the end of last year the NPL was Rs. 75 billion and by the end of February it was Rs. 112 billion. There is a rapid rise in the absolute quantum of NPL. The NPL ratio is also increasing and it is at 6.5 per cent. However, this ratio is little misleading since the bank balance sheets are not growing the ration can grow up. On the other hand recently the central bank has done some redefinition.

The question of risk averse position of the banks is a question of supply and demand. Today two things are happening; first there is a drop in demand. If you look at the trade statistics there is a drastic drop in imports. For example, vehicle import has decreased. But it is not as a result of lack of credit or import restrictions, but because the people don't have money to buy them.

Secondly, if you look at the last two years, the Central Bank had targeted inflation and today it has been achieved. Now we cry of economic growth. In the economy there are trade-offs this is the trade-off of the inflation and growth.

The interest rates were high but today there is a clear indication of a rates cut. In February, there was a deceleration and in the middle of the year the rates will be cut down considerably. The drop in demand in the economy is a result of liquidity and slow economic activities.

On the exchange rate, the main point is our competitors have devaluated their currencies. The argument against depreciation of rupee is debt burden and import cost inflation. If we consider the import cost inflation this is the ideal time for the depreciation of the rupee. On the other hand the growth of our exports is more important for an export economy. In the economy, there are so many leverages and the problem is how you balance them.

Q: Is this a crisis of the capitalist system?

A: This is a down swing of an economic cycle and not a crisis in the capitalist economic system. If we look at post world war II global economic system it is very clear where the economies of the world grow, where the prosperity and wealth was created. Not only the West, the US and the Europe, South East Asia, Singapore, Korea, Malaysia have proven the success of the capitalist system. They have proved that the market system can bring tremendous growth and wealth. Cycles are common in the capitalist system and there are economic crisis once in a way. They eliminate inefficiencies in the economies and allocate resources more rationally than in a central planning system. We have seen the disasters in the central planning system particularly in the Eastern Europe. The central planning system did not align with the political system as well and basically it has been abandoned last two decades.

Now the issue is in the capitalist system that you are going through. In this downturn of the cycle people are vulnerable. They must be shielded from the harshness of the cycle. What you will see is like what we saw in the post world war II . I think once we are out of the crisis, economies that get their economic fundamentals right will come out much stronger.

Q: What is your opinion on the government's decision to get IMF assistance?

A: Our reserve position was declining rapidly and in September it was $ 3.4 billion and it had dropped to 1.7 billion.

Therefore I think the government has act a prudently and opening discussion with the IMF is important and the absolute amount the IMF give is not the matter. It is the fact that gives the confidence to the market participants to reinvest in the economy.

Q: Our sovereign ratings have dropped and how will this affect our borrowing and the banking sector of the country.

A: You will find that ratings of many countries have slipped and this is not a unique issue to Sri Lanka. We should see Sri Lanka's position in the global perspective.

Certainly we have our own problems but here there are global problems too. When the ratings of an economy do slip credit will be scarce and costly.

This is why I said the IMF assistance is important. I think we should think beyond the crisis. My vision is we should create a competitive Sri Lanka.

There are two broad elements to face the situation; Firstly put the ethnic conflict to an end winning the war and win peace. Secondly, my personal view is the greatest resource we have is our people and we should focus on education and expand education opportunities.