Sri Lanka’s prime minister, Ranil Wickremesinghe, and his junior coalition partner, president Maithripala Siresena, took a drubbing in local elections against a party backed by former president Mahinda Rajapaksa in February.
The results suggest a handover of power could be on the cards when presidential elections are held in the summer of 2020 and has led to intense infighting amid the upper ranks of the embattled coalition.
The country's increasingly messy politics have also led country specialists to question whether the coalition has a strong enough mandate, or the will to drive through the tough reforms needed to deliver higher economic growth and ensure their continued political survival.
In 2017, for example, the economy grew by 3.1%, a 16-year low and about half the level it should for a country aspiring to gain emerging market status.
This has led to growing chatter, even among the liberal elite, that perhaps Sri Lanka should sacrifice some personal freedoms if a strongman like Rajapaksa can deliver higher growth and build the infrastructure the country so desperately needs.
This April, Wikremesinghe narrowly survived a parliamentary no-confidence vote and the coalition continues for now. But Jim McCabe, Standard Chartered’s chief executive in Sri Lanka, summed up the prevailing mood when he told FinanceAsia: “The government is well aware that it’s running out of time to demonstrate results.”
What Sri Lanka needs to stimulate growth is banking reform and and tangible infrastructure projects.
Where the former is concerned, two wholly government-owned monoliths: Bank of Ceylon (BoC) and People’s Bank, oversee an overbanked and inefficient financial sector.
Both state-owned banks know they have a number of structural issues to address before they can shoulder their share of stimulating economic growth including: non-performing loans to state-owned enterprises, Basel-III compliance, and declining net interest margins.
IPO SOLUTION
In financial circles, there is a general consensus that a stock market listing would solve a number of problems. Sri Lanka, Bangladesh, and Mongolia remain the only Asian countries that have yet to float their largest state-owned banks.
“Any flotation that raises new equity would help meet Basel III requirements and aid Sri Lanka’s bid to gain MSCI [Emerging Market] status,” said Sharhan Muhseen, a Sri Lanka coverage banker for Credit Suisse.
Senarath Bandara, CEO of Bank of Ceylon and People’s Bank CEO, N. Vasantha Kumar, both say the final decision rests with the government.
“In the last budget, the government stated that state banks could broaden their ownership to employees and depositors,” Bandara said. “A flotation would definitely boost the stock market and the government will soon lay out a mechanism to execute this.”
One big hurdle stands in the way. The banks are heavily unionised and past experience in the insurance sector suggests the plan could meet heavy opposition, even if union members are promised stock.
More importantly, the political opposition would almost certainly harness resistance to garner votes; something the government is unlikely to countenance right now given its precarious electoral position.
Kumar also highlights that People’s Bank has a wider role within society beyond making prospective shareholders money. “We were set up in 1961 to serve the rural community and have a strong family-like ethos,” he said.
Something investors in a potential IPO might not appreciate given financial analysts' tendency to focus on cost cuts as a means to boost net income.
DIGITAL MAKEOVER
However, a gradual reduction in People’s Bank and BoC’s workforce may yet happen as they execute a digital transformation.
At its most visible, this has led People’s Bank to ditch its muddy brown logo and decades-old font for a vibrant yellow and red colour scheme, which is starting to adorn its 590 branches and 150 new ATM/CDM/bill payment kiosks (rising to 250 by year-end).
So too, BoC has over 900 integrated CDM/ATM kiosks across the country and hopes to open 10 fully automated and 24-hour BoC DIGI centres by year-end.
“We’re taking these initiatives to empower all Sri Lankans through technology,” Bandara said.
Priyantha Edirisinghe is the man in charge of People’s Bank’s digital revolution. Like most of his peers he used to work for an overseas bank (Citi Australia) but unlike many of them his office now would not look out of place in a New York advertising agency.
Edirisinghe’s makeover of a crumbling heritage building in Colombo into an IT hub symbolises just how fast the bank as a whole is changing.
“By the end of the year, we hope to have trained 500 digital agents who can visit customers’ homes and set up accounts, or conditionally approve loans on their tablets within a matter of minutes,” he said.
However the benefits of digital banking might not be immediately apparent for customers or potential investors given many rural families still live in un-plastered houses, sitting on plastic chairs under a single exposed light bulb.
CAPITAL GAINS
To have a greater chance of boosting economic growth and making money, the two state-owned banks also hope the government will cut the dividend payments they make to the Sri Lankan treasury so they can boost their Tier 1 capital ratios to meet the new Basel III ratios and maintain loan growth.
Kanishka Perera, head of research at Asia Securities, says this is the main issue they face, since they can easily boost their Tier 2 capital by issuing bonds.
He calculates that BoC has a Tier 1 shortfall of about Rs50 to Rs60 billion ($320 million to $380 million) over three years based on 15% loan growth, while he says Peoples Bank’s has a more manageable Rs24 billion to Rs33 billion gap.
Sri Lanka has no framework for the issuance of perpetual securities so the best option banks have to lift their Tier 1 capital is to bolster retained earnings by cutting their dividend payments. Bandara and Kumar say they would like to pay 25% of profits this year, down from 29% last year and 53% the year before.
However, other bankers believe the Ministry of Finance prefers the current circular route whereby banks pay it a dividend and it then injects the capital straight back. In 2017, it pumped Rs5 billion into each bank and has already agreed to pump a further Rs5 billion into BoC this year.
The central bank is also being flexible about the capital buffers banks maintain above the regulatory minimum. The government has given Sri Lankan banks until January 2019 to boost their Tier 1 ratios from 7.75% to 10% and their overall capital adequacy ratio (CAR) from 12.875% to 14%.
At the end of 2017, BoC reported a Tier 1 ratio of 10.87% and overall CAR of 14.49% so it is just there. People’s Bank is not far behind on 11.49% and 13.71% respectively.
“The Basel III requirements will be broadly met,” central bank governor, Indrajit Coomaraswamy told FinanceAsia. “I don’t see any big issues there.”
The banks have also been preparing to meet the new IFRS9 accounting standards, which require banks to provision against future as well as stated losses. However, they have been given extra leeway and now have until the fourth quarter to comply.
Asia Securities’ Perera forecasts that it will cost banks about 1% to 2% of their capital, but notes they are hoping the government will allow the necessary write-offs to be 100% tax-deductible.
The state banks are also trying to reduce their SOE exposure. Unlike foreign banks, they are able to zero weight it. But it still exacts a heavy price since it cannot be written off (the government guarantees about 80%) and it ties up capital, which could be more productively used elsewhere.
From his office at the top of BoC Tower, Bandara has a 360-degree view of the construction activity across Colombo, including extensive land reclamation. But ironically most of it is being funded by China.
The state-owned banks need to address their SOE exposure before they become true growth engines. They estimate their overall exposure amounts to about one third of their loan books. Lowering it will depend on how willingly the weak government is to tackle SOE restructuring.
There are signs of progress since the government is moving ahead with the prospective sale of a strategic stake in the national flag carrier.
Country specialists say there are other measures the government could take to boost the banking sector. Some argue that it should sell its 15% to 20% stakes in many of the private sector banks, then inject the money back into the state-owned ones to “pump prime” their performance and “lift all boats”.
Others disagree on the grounds that the money might go to waste. They also point out that the stakes offer portfolio diversification for their ultimate owner, the Employees Provident Fund, the largest social security scheme in Sri Lanka with assets of Rs1,665 billion.
Less controversial are calls to rationalise the financial sector, which encompasses 44 finance companies, 26 commercial banks, and seven specialised banks.
The central bank’s Coomaraswamy agrees. “There are too many institutions,” he said. “We’re moving ahead with resolution for distressed companies. We need to ensure there’s no regulatory forbearance and we’re steadily increasing their capital requirements to encourage consolidation.”
Nudging the larger banks to consolidate will be much harder without the strong arm of government, which is currently lacking.
“Sri Lanka’s coalition government had a golden opportunity to institute reforms when it first took office,” one country specialist concluded. “It’s not going to address that now all of its energies are about fighting for survival.”
