Daily Mirror (Sri Lanka)

Penal rate cut could backfire: Economists

- BY DILINA KULATHUNGA

The cap proposed to be imposed on penal interest rates charged on defaulted bank loans may prove to be an inappropri­ate policy move in stimulatin­g lending, as it could indirectly prompt more defaults, according to leading economists and analysts.

“It will encourage even the good customers to default now because the default penalty has been reduced to a nominal amount. Hence it invites more people to default and we may pretty soon have a situation where even good customers rallying up to be included in the club,” a leading economist in the country said on the grounds of anonymity.

Last Friday, the Central Bank asked the country’s banking sector to bring down the penal interest charged on all loans and advances to a level not exceeding 2 percent from a high of 20 percent charged per annum.

The finance and leasing com- panies were also asked to reduce their penal rate to minimum of 3 percent from an excessive rate of 48 percent charged per annum.

The common stance of most of the economists and analysts Mirror Business talked to was that by reducing the penal rate drasticall­y, the Central Bank was trying to shield a group of customers who were already in the default list.

According to the Finance Ministry, Rs.333 billion worth of outstandin­g debt of state-owned enterprise­s is currently weigh- ing on the balance sheets of state banks. The loss making Ceylon Petroleum Corporatio­n, Ceylon Electricit­y Board and SriLankan Airlines top the list with an accumulate­d outstandin­g debt of Rs.276 billion.

According to them, this was the second instance where the Central Bank used the wrong interest rate to tame the bankers and boost credit growth, in order spur economic growth toeing the government’s rather unsustaina­ble developmen­t agenda.

In June, the Central Bank directed the banks to reduce the interest charged on credit card holders by 4 percent which can result in accumulati­on of large unpaid credit card balances potentiall­y threatenin­g the financial system stability.

Neverthele­ss the Central Bank is of the opinion that the penal interest charged by the Sri Lankan banks and finance companies are excessivel­y high given the current interest rate regime prevailing and thereby has an adverse impact on the financial position of the banks and the financial system stability.

However, the recent annual report of Committee of Public Enterprise­s (COPE) appointed by the Parliament cautioned about a possible systemic risk the country’s banking system may face in light of the unsustaina­ble loans the loss making state-owned enterprise­s had drawn from state-owned banks.

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