Protecting deposit holders

Of Banks and Financial Institutions in Sri Lanka

A country can develop only if it has a stable financial system. In order to have a stable financial system there is a need to have adequate protection to investors. This article analyses the adequacy of the safety nets available to public deposit holder in Sri Lanka and propose improvements to it. The article specifically looks at two key aspects in the safety net, namely, adequacy of Deposit Insurance cover and non-availability of Volcker Rule in Sri Lanka.

DEPOSIT INSURANCE IN SRI LANKA

Deposit Insurance is one of the safety nets that promotes financial stability in a country. Deposit Insurance is a protection cover which should be taken by a Bank or a Financial Institution by paying an insurance premium to the insurance provider. In the hands of a Bank or a Financial Institution, Deposit Insurance is merely an expense which they may not want to spend on. However, when you look at it from the point of view of the Deposit Holder, it is a basic protection cover which safeguards their Deposits. In an unlikely event of a liquidation of the Bank or the Financial Institution, the insurance company pays the Deposit Holder. Regulators of Banks and Financial Institutions in most of the countries make obtaining Deposit Insurance compulsory, so that the innocent Deposit Holders can be protected.

Readers in Sri Lanka may remember that some time back a Financial Institution called Mercantile Credit collapsed and then the Government had to pump in tax payers’ money to bail out Deposit Holders. Likewise, recently, ETI Finance and a few other Financial Institutions went bankrupt and there is lot of pressure for the Government to look after Deposit Holder by paying them out of Government’s tax income. Only solution to this issue is to have an adequate cover of Deposit Insurance and make it compulsory to all Banks and Financial Institutions who take public deposits. Some may say that yes, it is in operation now. Let us see how well it operates.

In Sri Lanka it is compulsory for Banks and Financial Institutions regulated by the CB to take a Deposit Insurance cover of Rs. 600,000. The question is whether this cover is good enough or not. To answer this question, we should understand how the system works.

At present the CB request all Banks and Financial Instituitions regulated by them to pay 0.15% as the Deposit Insurance premium to the CB. In turn the CB gives a Deposit Insurance cover to the Bank or Financial Institution up to Rs. 600,000 per deposit holder.

When a Bank or Financial Institution takes Deposit Insurance cover for Rs.600,000 and then in case if the Bank or the Financial Institution goes bankrupt, all Deposit Holders will be paid by the insurance provider, up to Rs.600,000 per Deposit Holder. If the Deposit Holder has more than Rs. 600,000 then the excess amount will not be paid by the insurance provider. Say for example if one has a deposit of Rs. 1million, then the insurance provider will pay Rs. 600,000 to the deposit provider. The balance Rs. 400,000 can be taken out only if the Bank or the Financial Institution that went bankrupt has excess funds to pay its Deposit Holders. Otherwise, the Deposit Holder has to bear the loss.

Now the question of adequacy of the insurance cover per person can be discussed. To answer the question, we need to know the average deposit size per Deposit Holder. In order to find out what would be the optimum cover, I have tried to reach the CB to get some statistics like the average size of a Deposit. When my assistant approached the CB, they have refused to divulge the information. Hence, I cannot give a definite answer what should be the optimum cover in Sri Lanka. We can only guess that Rs.600,000 is grossly inadequate and it should be much more than Rs.600,000. A few years ago, the Government of Sri Lanka introduced a special deposit scheme for senior citizens. Banks were supposed to pay 15% interest up to Rs 1.5 million per senior citizen. If we take this as the benchmark, we can safely assume that the average deposit size per person should be much more than Rs.1.5 million.

I understand that the current Government is now considering to increase the Deposit Insurance to Rs. 2 million. I consider this as an excellent move to stabilise the financial sector in Sri Lanka. However, there is an issue connected with the management of the Deposit Insurance scheme in Sri Lanka. In other countries generally such insurance schemes are handled by the Insurance Companies and not by the Regulator. Then to minimise the risk to the Insurance Company, they re-insure it with bigger Insurance Companies. In Sri Lanka, to my understanding, CB acts as the Deposit Insurance provider and it is not an Insurance Company that provides the cover. In addition to it, I understand that the CB has not taken any re-insurance cover in this area. This means that the CB takes the entire risk on Deposit Insurance. When a calamity stuck again, it will be the tax payers’ money that will be used to bail out poorly managed Banks and Financial Institutions. This is not a good system and, in my view, the CB should move out of managing the Deposit Insurance scheme and let the Insurance Industry to take it over. The CB as the regulator can supervise how well the scheme is being implemented. You may ask the question why shouldn’t CB manage this insurance scheme. CB is the regulator. Regulator should not get into managing operational aspects. Also, they do not have adequate knowledge and knowhow on managing these insurance schemes.

It is not clear whether the CB is proposing to take additional insurance premium from Banks and Financial Institutions to increase the Deposit Insurance cover from Rs. 600,000 to Rs. 2 million. As stated earlier, the CB charges 0.15% to provide Deposit Insurance cover. If the CB does not increase the insurance premium then it will be taking 333 percent higher risk than it used to take earlier. There again it is the tax payer’s money that will be used to take this extra risk.

The next question is, whether all Banks and Financial Institutions take even the Rs.

At present the Central Bank request all Banks and Financial Instituitions regulated by them to pay 0.15% as the Deposit Insurance premium to the Central Bank

600,000 Deposit Insurance cover. As stated earlier, it is compulsory only for Banks and Financial Institutions coming under CB to take this cover. There are a number of Banks and Financial Intuitions in Sri Lanka which does not come under the CB supervision. The public does not know about it and they think all those institutions are regulated by the CB. Sometimes they get greedy to get a little extra interest offered by these institutions and make deposits with them. Unfortunately, our regulator CB has no mechanism to stop such instituitions taking public deposits due to various reasons.

VOLCKER RULE

Deposit Insurance looks after the Deposit Holders as the last resort in case of a bankruptcy of a Bank or Financial Institution. Volcker Rule looks after the same Deposit Holder as an ongoing monitoring activity by enforcing restrictions to use of Deposit Holders’ funds. Volcker Rule is a regulation imposed by the Regulator, say the CB of a country, to protect the public Deposit Holders. Volcker Rule prohibits or restricts Banks and Financial Institutions from investing on high risk investments using Deposit Holders’ funds. Sri Lanka does not have any rule similar to Volcker Rule in US.

We Need a Modified Version of Volcker Rule in Sri Lanka to protect Deposit Holders of Banks and Financial Institutions. How does this work? For example, the Regulator can prohibit public deposits being used for paying administrative expenses such as salaries of Banks and Financial Institutions. Likewise, the Regulator, CB, can say that public deposits taken by a Bank or a Financial Institution should not exceed their performing loans and leasing assets. If we introduce such a rule, certainly we can prevent thousands of deposit holders losing their only lifetime savings and a handful of people misusing innocent deposit holders’ money.

Deposit Insurance is one of the safety nets that promotes financial stability in a country. Deposit Insurance is a protection cover which should be taken by a Bank or a Financial Institution by paying an insurance premium to the insurance provider

SUGGESTION

To summarise this short article, the Government’s proposal to increase the Deposit Insurance cover is a good idea and we should welcome it. The Deposit Insurance should be made compulsory to all Banks and Financial institutions and it should not be limited to Banks and Financial Institutions regulated by the CB. The CB should do their regulatory part and let the Deposit Insurance scheme be handled by the Insurance Sector. Finally, to protect our innocent deposit holders, it is high time Sri Lanka introduces a modified version of the Volcker Rule restricting high risk investments and using Deposit Holders’ funds to pay administrative expenses.

The writer is a Fellow Member of the Institute of Chartered Accountants and Chartered Institute of Management Accountants (UK); MBA (Warwick)

Vice Chair of the Audit Committee of the United Nations Industrial Development Organisation, Vienna, Austria.

Senior Director/chair Audit Committee of Assetline Leasing Co Ltd and the Chair of the Audit Committee of David Pieris Group.

Independent Director/ Chair of Audit Committees of two companies at Hayley Group – Talawakelle Tea Estates Plc and Hayleys Consumers Ltd.

Retired from Asian Development Bank as a Financial Management Specialist