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Bank Management Strategies Should Be Radically Diversified To Accept The Post War Business Challenges

Edward Theophilus Wanigasekera

Trading bank system embarked to Sri Lanka with a bunch of selective objectives that were purely based on serving for commercial and plantation sectors through providing short term capital needs. Predetermined dominant objectives of these foreign owned banks were not clearly understood by the domestic businessmen and growing development sectors such as agriculture, industrial, construction and small business of the economy as they assumed that banks were established to support all sectors of the economy despite selective goals.

The banking commission report, which did the foundation work to establish Bank of Ceylon detailed out that the business community of Sri Lanka desires more dynamic role from trading banks with a view to contributing for domestic business growth. The desires of local businessmen did not match with the management strategies and objectives of foreign owned trading banks in Sri Lanka; perhaps it must have based on risk management related issues. The result of banking commission was to generate Sri Lankan own banks in the country. Since the establishment of Bank of Ceylon, a line of Sri Lankan banks appended to banking market in the country. The ownership and management strategies of banking market in the country assorted within the limits of each organization and Central Bank accepted the responsibility of its role, the supervision of banks contemptible to its power given by the law.

The management of economy, though there were certain differences towards the philosophical approach of economic strategies between political parties represented in the parliament, generally displayed an unusual uniformity, which means that no radical economic policy strategies would be in force to stimulate or to accelerate rapid development outcomes. The uniform pattern of economic management did not challenge or warn the bank management as the bank management in terms of traditional lending book was consistent with the economic growth pattern of the country. In other words, the pattern of economic management did not create extra challenge for mitigating risks in banking system.

Although, there were private and government own banks, profit ambitions of entire banking system were moderate to make some profit but not to launch an oligopoly in competition making more profit out of operations. The branch operations in banks entirely based on office instruction circulars issued by the head office and the branch manager was obviously a puppet of head office rather than a risk taker to make profit. In this way, bank management was an easy task with high job security and there were no rewards for efficient and outstanding mangers, who made profits facing to competition and risks.

Since the election of new government in 1977, the management of economic system has radically been changed by the application of market economic system and deregulation of financial markets in which the restrictions became serious barriers to economic development and employment growth in the country. The invitation to worldwide operators in financial markets by the government began stimulating radical growth of dynamic business, change of peoples’ attitudes towards business operation, development of risky financial derivative products, off balance sheet items in banks.

All these changes in the economy and banking system were happen in an instance where bankers in Sri Lanka were never expecting a radical change of bank management strategies in spite of the rules of old lending book. There was a high demand for funds from private sector projects and banks had a strong pressure through competition to respond for business requirements.

The change of business environment impacted on trading banks in all over the world and Bank for International Settlements closely monitored the growing changes and the style of mitigating risks. In 1984, BIS agreed to impose capital adequacy rules with a view to preventing bank failures and protecting customer deposits and made a strong warning to trading banks in the world to accept tolerable risks in credit management. When BIS issues regulations on capital management, government banks in Sri Lanka already trapped in bad debts, which amounted to billions of rupees and risk asset reviews conducted by international audit firms confirmed that both of major government owned trading banks would be needed recapitalization after making loss provisions for credit losses.

Why major trading banks in Sri Lanka relegated so much of obscurities, when there was a smooth lending management process was in operations in terms of traditional lending book? Three possible explanations could consider vital to re-examine diagnosing reasons for failed bank management strategies and such interpretations would be significant strategic advices that current management of banks should be evaluated to prevent future failures with a view to maintaining a healthy bank management structure and to preserve the confidence of domestic and international customers on payment system in Sri Lanka.

The prime reason to failure of credit management strategies could be interpreted as lack of training for lending staff in government banks. The deregulation and expanding business opportunities made an uncertain business environment and introduced new business to sell derivatives, which are regarded as off balance sheet items that are working well in the market as long as there is no hindrance, which would be adversely affecting on risk elements. When a problem emerges from one point, it would be blotted to entire bank system and this type of unsystematic risks could not be detected applying traditional lending book rules.

Recent subprime mortgage crisis in USA began with the unmitigated risk associated with credit insurance products, which were unable to compensate for defaulted subprime mortgages. Credit staff in a bank essentially requires knowledge and skills to quickly identify possible future risks that may be emerged at abrupt times through proper monitoring process of credits and studying the developments of business environment. The risks of credit originate from a weak point of industry environment, competitive strategies of company, management strategies of customers, quality of securities offered to banks, credit structure or covenants imposed at disbursement of credits.

The credit staff must be able to identify future possible dangers through early warning signals that may be coruscated from the customer behaviour and to mitigate such risks through strategic restructuring process of credits. Many developed countries offer rescue packages out of taxpayers’ money to prevent the failure of business and abate the repercussions to banks, employees and other interested parties. However, Sri Lanka’s government finance management strategies and the regulatory process of Central bank have not developed enough to work on micro level failure of bank customers and the fiscal environment in Sri Lanka does not reflect the ability of government intervene for preventing business failures at micro level.

Most of credit staff members in government banks have not been trained to identify such dynamic risks and basic education of credit staff is insufficient to understand complicated developments in business environment, complex finance methods to predict risks and to apply credit analysis methods that focus on multiple elements of credit risks using customer data. Strategic credit structuring knowledge requires mitigating risks with a view to safeguarding the bank capital base. Credit staff needs broader knowledge of economics, accounting, finance, market regulations, international and domestic business environment. As there is no good statistics and information storing system on industry and individual companies, banks are needed to develop effective data bases for their own use and conduct research and surveys to inject information and data to the central credit information system. According to the rules of traditional lending books, these are not a part of credit staff job and liquidating collateral of customers is the ultimate task to recover loans. Modern credit management does not expect to recover loans liquidating business but, remedial management attempts secure the business as well as banks.

The second explanation for the question raised above could be pinpointed as dishonest elements of credit staff in the banking system. Huge quantum of failed credits in banks has a visible relationship with decision making involved in pedestal dishonest elements. Bank management strategies in Sri Lanka under the conventional rules of lending book have centred the credit authority to individuals such as branch managers, area managers, assistant general managers, deputy general managers and general managers, whose decision are not scrutinized by independent audit process. The credit approval authority is powerful within bank staff as well as within the business community as they were given individual authority to deal with bank liquidity, customer deposits and bank capital. In this background, credit approval authority has opportunities to do silent frauds; manipulate the weak system to make credits for dishonest purposes, use customers to defraud banks and variety of chances to get advantages from the authority.

Few decades ago, many banks in global arena used this type of management strategy that nucleases credit authority to individuals. The strategy was changed by replacing centralized credit authority to head office using computer technology in order to prevent the working of dishonest elements of credit staff in decentralized system and provide efficient service to customers at lower cost. Under the centralized credit authority, no relationship exist between the credit approval authority and the customers and the credit staff role is circumscribed to collect credit data of customers and submit them to central approval authority. There is no evidence that credit approval system of banks in Sri Lanka have changed to prevent or control dishonest elements of staff.

However, credit approval authority in banking system is still with individuals, who have close relationship with customers and the system has become too corrupt and individuals have many opportunities for manipulation to defraud banks assets. Many American banks used a system that nucleases the credit approval authority to individuals expecting that it will reflect the accountability of individual decisions, but the concept has been changed because the technology could be invented sustaining more accountable and less fraudulent credit approval system centralizing credit approval authority in the head office for entire bank. Although the banks in Sri Lanka have spent monumental amount of fund to access the technology, they have failed to use the technology for cost saving and to control credit losses incurred by the dishonest elements of credit decision making process.

Third cause that could be interpreted as reason to failure credit decision making is the political influences to credit approval authority. Compared to many other countries, it is believed that political influences to credit authority are higher in Sri Lanka than other countries and this situation is contributed by the form of ownership of the banks. The major banks are fully owned by the government wherein the board of directors are appointed on the basis of political affluence rather than knowledge and skills of selected persons. Powerful politicians in the government no matter whichever the party is in power do influence to the board directors in banks to gain variety of advantages and credit facilities. The influence dilates not only to politicians but also assist to their friends and cronies.

When credit authority is acting on the influence of politicians, credit proposal could not be analysed considering risk factors and structure the credit with appropriate covenants to secure the safe return of funds and the capital base of the bank. In such a credit proposal, the major risk factor is political influence, however, such risk could not be considered when approving the loan. Very rare evidence exist in government banks that credit authority was forcefully pushed by politicians, but actually what is happening is politicians friendly influence to directors, who were appointed by them as an appreciation for the extended support during the election period.

The major reason to happen this influence is the ownership of the banks remaining in government hand. As long as banks ownership remains in government hand, the government should bear the cost of credit losses incurred to banks by political influences and should take responsibility to maintain capital requirements in terms of BIS rules and recapitalize banks against credit losses. The direct impact of this action is to be widen the budget deficit and creating unnecessary economic problems to the country diverting government’s funds necessary for development purposes to manage banks. Many politicians and government policy makers have no precise understanding about the unprofessional behaviour of bank officers as well as politicians. Although the truth is bitter, it should be educated to government authority by the banks or if there is partial ownership of banks transferred private or other government institutions, which could contribute or invest their money in bank shares, members of director board elected from non government ownership of banks will be attempted to scrutinize the operation management of credit system and it would give big relief to the government not only general administration of banks but also funding for capital requirements.

The successful bank management should be able to maintain bad debts less than 2% of total value of credit portfolio. Bad loans of government banks, sometimes equal or more than 20% of total credit portfolio, which could be allocated to above three explanations as 50% incurred due to lack of knowledge and skills of credit staff, 25% links with dishonest elements of credit approval authority and 25% rest concerns with political influences. The credit management in government banks has a serious weakness originating tremendous fiscal problems to the country and crippling the confidence on the financial system in Sri Lanka. In this situation, responsible authorities requires to take quick actions to shake up bank management strategies emphasizing three major issues in relation to credit management.

The management of government banks responses to current issues pointing finger for the quantum of profits made through annual operations. If we critically analyse bank balance sheets and financial statements of past ten years, it would be easy to find that a large percentage of profits were contributed by exchange gains in declining of foreign value Sri Lanka rupee and unrealised interest revenue provided against bad loans and government transactions. According to accounting standards, such earnings are regarded as noncash items and the transfer of profits, which is generated from non cash revenue sources to the government treasury and spending them by the government would be impacted on the rising inflation of the country. Therefore, the government policy makers should seriously and critically analyse the concept of profitability in government banks. Partial privatization of government banks does not means that government is selling its assets private and the government should keep controlling interest and should attract the help from private sector to successfully manage its organizations reframing management strategies.

The government banks need an effective asset and liability management strategies with a constant monitoring process. Lending business of government banks are running at a loss and such losses should be covered by the diversification of revenue sources. For example, there is no harm to profitability of government banks keeping agriculture and small business portfolios at a loss situation, if other lending business such corporate, international and retail markets would remain as profitable sources. Agriculture and small business portfolio also could be maintained at break even or lower profit level, if the credit management of banks are efficient enough to mitigate risks. The business environment in agriculture and small business in Sri Lanka has dramatically changed compared to the environment two three decades ago. The capacity, services, knowledge, skills and opportunities of small business operators and agriculturalists have greatly improved during the past two decades to they have opportunities to control their failures and risks using a variety of business services provided by the government and hedging the risks through insurance programs.

Due to the competition for mobilizing deposits, the gap between deposit rate and lending rate is too narrow in Sri Lanka, when compared to trading banks in developed and developing countries. The traditional book of bank management stagnated at a point that bank liquidity is determined by customer deposits. However, modern concepts and strategies of bank management evince that banks have tremendous opportunities for liquidity management through new strategies such as securitization, issue of bonds and equity capitals, and short term borrowing at call market. The mobilization of equity capital from non government sources is an urgent need with a hope of share buyback for government banks. If each government attempts to mobilize Rs 500 billion equity capital through issue of ordinary shares to domestic and foreign investors, it would support to build a strong capital base for bank to expand their business.

The bank management essentially requires understanding the current development in business environment in Sri Lanka. During past 30 years, Sri Lanka’s economy was backward and some areas were stagnated as a consequence of ethnic war and the exchange value of Sri Lanka’s rupee dramatically declined rising the inflation to a hyper inflation. In 2009 this situation will reverse back, obviously ethnic war is ending and Sri Lanka’s economy will demand monumental amount of capital for new projects and infrastructure development. Exchange value of Sri Lanka rupee will be tremendously improved, sometimes, it may be US $ 1.00 equal to Rs 60 giving a strong support to import capital goods for development and reduce inflationary pressure in the country. The environment of the country would radically change allowing free movement, which will be ideal ground for business development. The risk of investment created by war and terrorism possibly reduces foreign and local investors to opening the way. Trading banks in Sri Lanka should be prepared to face for new environment increasing their capital base to support for developing business.

How could expand the capital base of banks is a serious question that bank management should wisely consider to expand the business base and respond to the credit demand. Banks will have opportunities to open many branches in north and east. The future business environment in the country will be a great challenge to bankers, who are desperately looking for this opportunity.

Banks may have to issue bonds for debt capital raising and we can estimate that each government bank needs minimum Rs 200 billion additional capital to accept the challenge for future investment and business boom. It is seen that many banks in developed countries are raising equity capital by billion of dollars at this moment as they need to successfully face to global credit crunch and to get ready for post recession business boom that will demand more capital to provide finance requirements of business and Sri Lanka’s banks need to make note that post war Sri Lanka’s economy will join had with post recession global business boom.

If trading banks are unable to successfully respond to new business boom, there would be no alternative, government should invite foreign financiers or otherwise at political ground government will fail as expectations of general public turn to economic development. It is impossible to assume that the government, which made monumental achievement defeating war of terrorism, will neglect the cry of people for economic betterment.

Edward Theophilus Wanigasekera, Sri Lankan born Australian citizen. He works as the Head of Technical Vocational Education, at the University of Goroka, in Papua New Guinea.

- Asian Tribune -

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