Non-banking sector consolidation; learning the hard way

One of the most intensely debated issues more behind closed doors than publicly has been the consolidation of the NBFI sector. Sri Lanka’s financial sector regulator since last year has been pushing for the amalgamation of the financial sector in the country with the current 58 NBFIs, which account for only 7 per cent of the financial system’s gross assets and to bring them down to a target of 20.

The Central Bank’s Master Plan follows recent instances of costly and painful failures at several finance companies and one private bank. Therefore, it cannot be ignored that this plan succeeds the failure of several financial institutions in the recent past. Therefore, it is rational to conclude that an overarching objective of the plan was to address the existing weaknesses in the financial sector. However it is also equally important to ask;

a) Why were so many licenses issued in the first place?

b) Why certain mismanaged financial institutions instead of being charged for reckless misconduct are getting safe passage through the consolidation process?

The recent failures of finance companies has clearly revealed that the failed or struggling NBFIs were engaged in risky business models and lacked good governance. Therefore the consolidation drive should not be seen in any way as a safety net for mismanaged NBFIs. Because this should not lead to a ‘moral hazard’; which means the safety net would encourage some of the 20+ NBFIs and their officers to behave irresponsibly by engaging in risky business practices all over again. However similar consolidation drives have already been done in East Asian countries like Malaysia, Taiwan and Singapore successfully to address weaknesses in the financial sector. While consolidation has occurred in most Asian countries, the success has varied across the region. In the more developed countries in the region, financial sector consolidation has benefited both the regulator and the investor. Malaysia, and Singapore serve as good examples of this. However, it would be unwise to think that the proposed financial sector consolidation is without any risk and that we can reap the same benefits as Singapore or Malaysia.

The biggest impact of the consolidation drive in the near term will be felt across the NBFI sector. Consolidation benefits for the NBFIs include enhanced capital buffers, the ability to attract cheaper and longer-term funding, and improved cost efficiencies. If realized fully, these benefits would improve the credit profile of the NBFI sector in light of its lending focus on sub-prime customer segments.

Consolidation is Good 

The reduced number of institutions would also improve regulatory oversight for the Central Bank. It would be a misconception however to think that the reduction in the number of financial institutions resulting from the consolidation would reduce the workload for the CBSL. The regulatory and supervisory function of the CBSL would now have to be conducted at a much higher level with greater technical & financial acumen. The commitment of the authorities to NBFI consolidation is evident from their enunciation of broad mechanisms and specific deadlines that must be met. It is underlined by the provision of tax, advice, regulatory approvals and concessional loans for the timely completion of valuations, accounting assessments, and other due diligence. Much of the NBFI consolidation process is projected by officials to be driven by the acquisition of weaker and smaller institutions by their stronger counterparts, or by the banks, and largely completed by the end of this year, and no later than March 2015. Although the economic and political rationale for the consolidation in the Non Bank Financial Institution (NBFI) is beyond question, however some argue that the process appears too obligatory and the time lines too short for a very meaningful and productive outcome. The problem in Sri Lanka is without deadlines nothing really works. However, today it is incumbent upon directors of financial institutions to be firstly and secondly mindful of their primary fiduciary duty to ensure the safety and soundness of the institution they govern and their decisions to buy or sell could be challenged by shareholders now or in the future.

Progress to date

CJP Siriwardana, Assistant Governor CB speaking at the Central Bank 64 th anniversary oration observed that "from the inception of the financial sector consolidation programme in January 2014, the progress made so far by the banks and NBFIs is commendable. As of mid-September 2014, 8 Banks and 29 NBFIs have confirmed their merger and acquisition transactions under the consolidation programme while a few NFBIs are progressing under the restructuring process. The consolidation unit strongly believes that the Central Bank is in a position to meet the original time plan set for end 2014 for the completion of the consolidation process". While there is no argument against the CB strategy, the proposed merger between banks and NBFIs needs to be managed carefully. Because this implies the creation of a single corporate/legal entity engaging in both banking and finance business. One clear risk is that the governance issues and the credit culture and people practices in the finance business could spill over to the more important banking operations. Therefore, the complex business structure created by the merger between banks and NBFIs needs to be managed well. To prevent this the regulator would have to raise the bar at all levels. If poorly executed, it could further increase the risk of these merged entities and the overall risk to the financial system.

In the final analysis, if there is less devotion to rigid rules by the policy makers the consolidation move can definitely help to tackle the cultural and standard failings in NBFI sector, from running unacceptable risks with public money to mis-selling and above all, push for better regulation and better functioning markets.  Therefore the regulator should not look to push the less appealing NBFIs to larger NBFIs/banks who did not make the deadline. Because given the woes of the balance sheets of some the NBFIs it can surely take the shine right off the project both for the regulator and the acquirer.

In addition, in order to achieve the objectives of the consolidation drive and minimize future risks for the sector, the Central Bank must ensure that the 20+ NBFIs have sound risk management and good governance practices in place and also are regulated well to prevent them from looking for unconventional and risky business to grow their balance sheets, otherwise the spill over to the banks could disrupt the entire financial system in the future.

(The writer was a Bank Director from 2003 to 2014)

Hits: 1
www.island.lk

Thanks Reds for sharing.

Thanks RB