Daily Mirror (Sri Lanka)

Pro­tect­ing de­posit hold­ers

Of Banks and Fi­nan­cial In­sti­tu­tions in Sri Lanka

- By Lak­sh­man Athuko­rala Business · Finance · Personal Finance · Banking · Sri Lanka · United Kingdom · United Nations · Vienna · Austria · Asian Development Bank · Mercantile Financial Services · Government of Sri Lanka · Chartered Institute of Management Accountants · Institute of Management Accountants

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

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