The New Vision will require a strengthened financial 127 sector, which is strong enough to steer Sri Lanka

towards the goals set for 2016

In that scenario, the present skewed* banking structure will need some structural changes to ensure that Banks & NBFIs will be equipped to play the required role in the envisaged US$ 100 bn economy
Consolidation in the banking and the NBFI sectors will have to be encouraged, using the attractive tax concessions provided by the Government The regulatory framework will have to be re-designed to monitor the emerging business models of banks and NBFIs The regulatory regime will have to be strengthened, while encouraging diversification of sources of funding and business operations, including through foreign sources The risk profiles of banks and NBFIs will have to be identified and regulated in order to ensure overall stability of the financial sector and enhance public confidence

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Asset size of Present Banks Over Rs. 100 bn

Number of banks 11

Market share 89.4%

Domestic banks with less than Rs. 100 bn

Foreign banks with less than Rs. 50 bn

12
10

7.4%
3.2%

The State Banks will be expected to contribute significantly towards building a strong and dynamic banking sector

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The two large state commercial banks, BOC and PB, will be encouraged to grow and expand towards a stronger regional presence, and to operate with higher levels of capital The NSB will be encouraged to broad base their banking activities to contribute to the economy on a larger scale The Pradeshiya Sanwardhana Bank will be encouraged to serve the niche market of microfinance, targeting inclusive growth in the provinces The other smaller state banks will be encouraged to merge and play a more cohesive role, since at present these banks account for just 1.1% of the market share!

The banks with assets less than Rs. 100 bn will be expected to grow beyond Rs. 100 bn through organic growth or consolidation/merger with other banks/NBFIs, over a reasonable time horizon
The two Development banks, NDB and DFCC, will be encouraged to merge in order to create a strong development bank that could provide a broader impetus to development banking activities Foreign banks will be invited to demonstrate greater participation and contribution to the economy Commencing 2016, new foreign banks will have to be locally incorporated

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In keeping with such vision, banks will be expected to submit broad plans by 30th June 2014 for possible mergers and/or consolidation, and for the greater participation in the economy

In the meantime, banks capital will be strengthened significantly

Key Policy Measure
Increase in minimum capital requirement: Licensed Commercial Banks - minimum Rs. 10 bn Licensed Specialised Banks - minimum Rs. 5 bn

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Target Date
Existing Banks, from 1st January 2016 New Banks, from 1st January 2015 During 1st Quarter 2014 During 3rd Quarter 2014: Issue of guidelines on parallel computation of the Capital Adequacy Ratio 3rd and 4th Quarters 2014: Supervisory observation period In November 2014: Issue Direction to maintain minimum capital ratios effective from 1st January 2015

Migrate to the advanced approach under the Basel II Capital Adequacy Framework requirements by the implementation of Standardised Approach for calculating capital charge for operational risk under Pillar 1
Adopt Basel III Capital Standards Increase in quality and quantity of capital of bank; Introduction of a capital conservation buffer with the intention of creating capital buffers in good times that can be used to absorb shocks in periods of stress; and Introduction of a counter-cyclical buffer to reduce pro-cyclicality to prevent excessive credit growth

while the Risk Management Framework of banks will also be improved further
Key Policy Measure
Issue guidelines on the Stress Testing Framework

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Target Date
During 1st Quarter 2014

Implement the new Liquidity Risk Management Framework by the introduction of the Basel III Liquidity Coverage Ratio (LCR)

In 2014: Supervisory Observation period In November 2014: Issue Direction to maintain minimum LCR effective from 1st January 2015 During 1st Quarter 2014

Introduce a Regulatory Framework for Valuation of Immovable Property of Licensed Banks Introduce prudential requirements to regulate the exposure of the banking system to asset markets and other potential economic shocks and concentrations

During 2014

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Further, several new Regulatory measures will be implemented

Key Policy Measure
Incorporate appropriate changes to existing regulatory framework in line with new accounting standards Introduction of the new off-site surveillance reporting system Amendments to existing Directions and other regulations Establish minimum standards for core banking systems and other IT based platforms used by banks

Target Date

From 2nd Quarter 2014

During 2nd Quarter 2014

Develop a comprehensive supervisory framework for consolidated supervision of banking groups

During 2014

The new regulatory framework will continue to be in line with international best practices
Adopt Standardised Approach for calculating capital charge for operational risk under Pillar 1 in compliance with Basel II Capital Adequacy Requirement Issue guidelines to strengthen
The Stress Testing Framework of the Banking Sector Minimum Requirements in Core Banking System of Banks

134

Develop new Regulations on

Liquidity Risk Management Framework for Valuation of Immovable Property of Licensed Banks

Require banks to further strengthen

The quantity and quality of capital to improve their loss absorbency capabilities The systems and processes to migrate to advanced approaches on the Basel II capital framework The management of banking risks in an integrated manner, and The governance, fitness and propriety of directors and senior management to establish operational accountability

Amend the Banking Act to take into account the new developments in domestic and international financial markets
Supervision of bank dominated financial groups to be strengthened Provisions to facilitate mergers and acquisition of banks to be introduced Bank resolution measures to be strengthened

The resulting outcomes will lead to a new equilibrium in the banking sector in Sri Lanka
Larger aggregate capital base Increased potential to finance large scale transactions Increased investments by foreign investors
Improved level of efficiency and corresponding profitability Availability of a full range of financial services at affordable costs More effective supervision

135

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At the same time, in order to ensure Financial System Stability while moving towards a US$ 100 bn economy, the consolidation of the NBFI sector will be vital
The objective of merger/consolidation plan would be to fashion an NBFI sector that comprises of smaller number of large NBFIs, which are fully compliant with the Central Banks regulatory framework, and which will serve to
Increase the quality and quantity of capital to improve the NBFIs loss absorbency capabilities and enhance resilience to internal and external shocks Attract low cost, long term funds in the form of deposits/debt instruments

Improve cost efficiencies in order to be competitive

Diversify the business models and be ready to deal with market volatilities

Manage risks in an integrated manner

Improve the governance, fitness and propriety of directors and senior management to establish operational accountability

Accordingly, a NBFI sector consolidation plan will be implemented with incentives proposed from the 2014 budget
A corporate group will be allowed to operate only one NBFI after end June 2014
Accordingly, they will be required to acquire/merge if they operate more than one NBFI. A group is to be defined as a holding company, which owns more than one NBFI, or where common shareholders or directors own controlling stakes in more than one NBFI

137

Licensed Banks will be actively encouraged to acquire NBFIs Large NBFIs will be encouraged to acquire or merge with smaller NBFIs Smaller NBFIs will be encouraged to merge with one another to create large NBFIs New investors or banks or large NBFIs will be encouraged to acquire negative net worth NBFIs, or lowly capitalised NBFIs with the new equity investments being made directly into the negative net worth NBFIs or selected lowly capitalised NBFIs in order to supplement the capital of such NBFIs
When a new investor makes an equity investment of that nature, a matching long term advance will be made through the Sri Lanka Deposit Insurance and Liquidity Support Scheme, on concessionary terms

Consultancy fees for merger and consolidation processes will be paid by the Central Bank to facilitate the process The Central Bank will also establish a separate unit headed by an Assistant Governor to assist in the merger/consolidation process

The NBFI Consolidation/Merger Plan will be implemented according to a time-bound plan

Consolidation/Merger Strategy A group could operate only one NBFI Directors who own controlling shares in more than one NBFI to arrange for the merger between the NBFIs Target Date for Completion June 2014 June 2014

138

Investors or Banks or Large NBFIs to acquire negative net worth NBFIs or selected lowly capitalised NBFIs

NBFIs, which are currently having negative net worth are expected to be absorbed by December 2014: Others to be completed by 2015 1st January 2016
1st January 2018

Increase of minimum core capital of a LFC to Rs. 1 bn

Increase of minimum core capital of a LFC to Rs. 1.5 bn

When the consolidation process is completed, the NBFI sector is expected to comprise about 20 NBFIs, each with an asset base of around Rs. 20 bn

Simultaneously, the Central Bank will significantly enhance the level of regulatory action in the NBFI sector, and will

139

Introduce a system of lower leverage ratios to NBFIs which are only partially-compliant with the Directions of the Central Bank Publish the maximum deposit levels for each NBFI on a quarterly basis, beginning 2Q, 2014 Introduce a liquidity support fund for NBFIs which require short term liquidity support, by 2H, 2014 Closely monitor the implementation of the proposed consolidation/merger plan Strengthen the risk focused regulatory and supervisory system Use an online early warning system to identify emerging risks in an NBFI Impose penalties on, and/or disqualify from holding office, key management personnel when there are continued non-compliances of Central Bank Directions Review and follow up the rehabilitation process of weak companies in the NBFI sector, and revive such companies in keeping with the proposed medium term consolidation plan Expedite the investigation processes on unauthorised finance businesses

In this newly emerging scenario, certain marketing practices currently pursued by Banks & NBFIs will have to be discontinued

140

Lottery schemes will be prohibited New guidelines will be issued on non-interest incentive schemes offered by banks to mobilise deposits Accuracy of disclosures on interest rates, fees and charges, etc. will be closely monitored The implementation of the current Directions on Customer Charter of banks will be enforced More focused attention will be given to customers complaints and consumer protection, so as to address grievances in an efficient and timely manner

The emerging macro-economic fundamentals will be ideal for the introduction of effective superannuation products by Banks and NBFIs
The current and impending low interest regime is likely to be challenging to savers who are dependent on interest income
Therefore, Banks, NBFIs and Insurance companies will be encouraged to develop and introduce effective and innovative long term superannuation products to provide more opportunities to long term savers:
Annuities

141

Pension products, including Employer sponsored pension products

Insurance schemes with pension plans Long term Super-savings accounts

Such products will also fulfill the emerging need for long term savings instruments that are needed to fund long term projects