CB contemplating new rules on banks to boost rural sector

 By Chandeepa Wettasinghe
The Central Bank of Sri Lanka is thinking of importing a controversial piece of American legislation to regulate the operations of the banking sector to fund the country’s sluggish rural sector. 

“I can reveal to you that we’re studying a system in the United States, called the Community Reinvestment Act, where the US banks are mandated to reinvest 35 percent of deposits in any region back in that same region,” Central Bank Governor Arjuna Mahendran said last week.

This was revealed just a day after Finance Minister Ravi Karunanayake said that the proposed financial hub in Colombo will be governed by British law.

Governor Mahendran said as a start off, the Central Bank will negotiate with line managers in rural areas to give them targets in order to increase lending.

He noted that the Central Bank had begun surveillance on credit flows within the country to find weak spots.

“We have recently set up 5 new departments to examine in greater detail, bank lending around the country. Not just banks, but finance companies and multi-purpose cooperatives and micro finance institution,” he said.

Mahendran added that each of the 9 provinces will be geographically segmented among the 5 departments, which will have their offices in key cities such as Matara, Anuradhapura, Jaffna and Trincomalee.

“We want to see how much money is being lent to those regions compared to the amount of deposits the regions are giving to the banks. What happened in the past is banks take deposits from all over the country, bring it to Colombo and lend them to the big companies. That has to change,” he added.
Mahendran said that this would be key to reducing poverty in the rural regions, but said that banks and finance companies have been found lending at extremely high rates to such regions.

However, despite the geographical intervention, he was opposed to intervention on interest rates.

“We can’t limit the market rates. They may have to lend at higher rates to mitigate the risk,” he said.
He added that the lack of formal lending businesses in these areas may be prompting the first lender on the scene to impose monopolistic power, and hoped that an increased presence from other institutions may deter such actions. The US Congress enacted the Community Reinvestment Act in 1977. Since then, banks had to continuously relax standards of risk evaluations and borrowings in order to meet the criteria of lending to the region. While some banks lent at exorbitant rates, non-performing loan ratios remained low as many in the regions had opted to liquidate their mortgages in the rising housing market in the previous decades.

Backed by AAA credit ratings, US government owned mortgage giants Freddie Mac and Fannie Mae had provided guarantees and securitized the loans and traded them.Two camps remain divided over the fact that the continuous relaxation of standards directly contributed to the 2008 financial crisis. 
However, there is a general agreement that the lax standards may have spilled over into other lending schemes, indirectly influencing the crisis.

Mahendran said that the Central Bank would not let such a situation arise, as the legislation would continuously evolve with increased lending, rather than allowing standards to fall.

The Central Bank had in the past too engaged in geographical intervention, limiting the opening of ATMs and branches in the Western Province, unless a greater number of ATMs and branches were opened in other regions. The regulation was discontinued last year.