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Business


Central Bank reduces Statutory Reserve Ratio for banks

The Liquidity ratio for banks which defines the ratio of Reserves that the commercial banks have to hold with the Central Bank under the fractional reserve banking system, was reduced further from last Friday. The Central Bank reduced the statutory reserve requirement (SRR) for commercial banks by a further 75 basis point to 7 percent which is expected to release about Rs. 9 billion to the economy.

The Central Bank has been reducing this ratio since October 2008, because of the drain out of liquidity from the banks as a result of the continuing current account deficit in the balance of payments which has to be funded by running down the foreign Exchange Reserves. This makes the money market short of liquidity, and puts upward pressure on the interest rates in the money market. Dealers said the country’s money market was short of funds by about Rs.19.4 billion. This reduction in the SLR should ease the shortfall in the call money market where the banks lend to each other. The call money rate was about 14 percent, and dealers said once the reduction in the SRR is effected this Friday, call money rates would come down and translate into a reduction in lending rates. The SLR is commonly used to contain inflation and fuel growth, by increasing or decreasing it respectively. This counteracts by decreasing or increasing the money supply in the system respectively. The banks have to hold the reserve ratio with the Central Bank in the form of Cash determined every Thursday. To comply with the ratio the banks hold Treasury securities which are easily convertible to cash by re-discounting with the Central Bank. So when the drain out of foreign exchange and the consequent reduction in liquidity takes place, the commercial banks reduce their holdings of government securities (Government securities).These Treasury securities then end up in the portfolio of the Central Bank which then indirectly becomes the institution that is funding the government’ budget deficit. The Central Banks holdings of Treasury securities have now gone up to Rs 185 billion.

Earlier the Central Bank reduced the interest rates payable by the banks for borrowing from the Central Bank under the Reverse Repo facility. All these measures are to reflect the new monetary policy which has changed its stance from controlling inflation to dealing with the credit crunch through monetary expansion. Is this change in monetary policy justified? Some analysts question it because they say inflation is still too high, and that it raises the Real exchange rate of the Rupee and worsens the competitive position of our exports in the world market. Whether the appreciation of the Real Rate calls for the depreciation of the Rupee is controversial. The Central bank argues that depreciation of the nominal value of the Rupee has never really helped our exporters over the last fifty years that we have followed such practice. They point out that each depreciation has been followed by wage increases in the plantation sector as well as in other export industries soon undermining whatever gains in rupee proceeds obtained through such depreciation. This has been so indeed. But then does it not mean that it is the failure to maintain wage restraint rather than the depreciation itself that is at fault. Another argument against depreciation is that we cannot profit from it because we lack exportable surpluses, and cannot benefit from it to increase exports as China could do. But then there is no controversy that the Real rate of exchange should be maintained for our competitive position in the export crops and export industries.

According to the Central Bank the domestic sector is feeling the impacts of the global financial crisis, and is therefore reducing the amount of cash commercial banks have to hold with the Central Bank, as a percentage of their total deposits, in order to release funds for economic activity. This is undoubtedly the situation. But analysts ask whether we can afford to have growth as previously, when we run a huge current account deficit in the balance of payments. What corrective action does the Central Bank want to take to tackle this crisis? Can it afford to ignore it as in the past year or two, because it could borrow commercially from foreign lenders to fund such deficit? Such funds have now dried up, and whatever short term foreign investments that still remain in the bond and stock markets are still moving out.

There is little or no change of borrowing commercially from the foreign private sector owing to the global financial crisis. Foreign investors continue to realise their investments, even at a loss, and repatriate such funds to their home countries to meet liquidity shortfalls and margin calls in their own countries.

The Central bank launched a campaign to attract Sri Lankans abroad to invest locally in government securities. Perhaps it is too early to expect results but this source is unlikely to produce much. So the Central bank is seeking to obtain funds from regional central banks, through swap facilities where each central bank agrees to provide a part of its Foreign Reserves to assist the other. It is reported that the Malaysian bank Negara has signed up for $200 million dollars. China has offered to provide such swaps for countries in ASEAN. Perhaps India could provide the same facility for she is still flushed with foreign Reserves far in excess of her needs.

Apart from replenishing Foreign Reserves through foreign borrowing, we cannot ignore taking corrective measures to put right the unsustainable current account deficit in the balance of payments. The Central Bank has imposed a 100% margin requirement for importers who open Letters of Credit for less essential imports. The government has imposed high tariffs on less essential imports. But we still have to import a large quantity of oil and fertilisers, which still costs significantly despite the fall in their world prices. An economist in the Institute of Policy Studies, has stated that we cannot follow the same policies for domestic economic growth, if we are to contain the deficit in the current account of the balance of payments. This view requires the consideration of the Central Bank and the government.

 

Lessons from financial scams

Many ask the obvious question; how different, really is the Sakvithi tale from the Golden Key Card collapse. I too, would like to ask the same question, but a bit differently; How different is the case of Bernard Madoff from Sakvithi and Golden Key? People invested with Bernard Madoff because of his personality and social background. Mind you, he was the chairman of NASDAQ Stock Exchange. Who would dare to suspect him? Trust and integrity were built in with the position he used to hold. Also, those who invested in Sakvithi Finance, did so, because of the image he had built up within society, and when I read feedbacks from certain clients of Golden Key, the confidence placed in the Company reflects the same similarity.
Sakvithi Finance could not do much damage, as his involvement in the Financial market was limited to only one company run personally by him. But Madoff made many Hedge Funds bankrupt and many other companies go under water, creating waves of suicides in the US

By Haris Salpitikorala FCMA, MCIM, FLMI
Lehman Brothers bankruptcy, the crisis facing one of the largest Insurers in the world, the AIG Group, gives me a sense of DEJA VU.
Closer to home, Satyam Computer Services founder and chairman B. Ramalinga Raju resigned, admitting in a letter to the Industry Regulator and Stock Exchange, that Company accounts and assets had been falsified and profits inflated. The scam is approximately US$1 billion.

When I was trying to come to terms with myself that, in any financial crisis, spiral effects and unexpected problems are common, here comes the revelation that Bernard Madoff - brilliant investor, philanthropist, pillar of the community has created a loss amounting to billions of dollars to investors, and the scale of his alleged scam, approximately, comes to US$ 50 billion or more.

Who is Bernard Madoff? What did he do?

He was a legend in Wall Street Trading and former chairman of the NASDAQ Stock Exchange. He had built up a Trading House that prospered for over four decades. He had been paying very high Returns and the numbers were too good to be true for too long. What he has been doing was to pay the unusual high Return for the early investors, with money from the latter investors. It is a “Ponzi Scheme”, similar to the Pyramid Scheme, using the clients’ capital to pay higher Return. Among those affected were very high profile figures such as US Senator Frank Lautenberg, Hollywood Director Steven Spielberg and many more billionaires. Tremont Group Holding alone lost US$ 3.3 billions. All because of the trust they had on one individual.

Then in our own backyard, problems similar in nature were taking place, with the Sakvithi Finance scam and Golden Key Card drama. This is a new wave of problems created by the greed of individuals, rather than related to the financial crisis.

If a company is mismanaged by the Directors, it, invariably, has to be wound up. But, if it is a Business that victimised innocent bystanders, as the products were mis-sold or clearly inappropriate, given the client’s profile and circumstances, or was sold through unclear ambiguous contractual terms, or sold through improper advertisements and impractical higher interest rates, to woo some of the not so educated in financial matters middle class, that is where public confidence begins to diminish, and the system will gradually collapse.

Both Sakvithi and Golden Key probably fall into one of those categories. They used to offer attractive monthly interest rates and benefits, which other financial institutions were not able or not willing to offer, sensing liquidity problems.
This is where compliance in Finance industry becomes a vital tool, to ensure that individuals do not become greedy to the extent of taking others’ hard earned money for granted. Therefore, authorities have to now call for greater transparency. With disclosure of risk and proper explanation of how low or high Returns they are going to get from their investments. Authorities also have to ensure that compliance is not limited only to a piece of paper or to a Business owned by few ordinary people, but apply to every Business owner, irrespective of their social standing.

Different

Many ask the obvious question; how different, really is the Sakvithi tale from the Golden Key Card collapse. I too, would like to ask the same question, but a bit differently; How different is the case of Bernard Madoff from Sakvithi and Golden Key? People invested with Bernard Madoff because of his personality and social background. Mind you, he was the chairman of NASDAQ Stock Exchange. Who would dare to suspect him? Trust and integrity were built in with the position he used to hold. Also, those who invested in Sakvithi Finance, did so, because of the image he had built up within society, and when I read feedbacks from certain clients of Golden Key, the confidence placed in the Company reflects the same similarity.
Sakvithi Finance could not do much damage, as his involvement in the Financial market was limited to only one company run personally by him. But Madoff made many Hedge Funds bankrupt and many other companies go under water, creating waves of suicides in the US.

What authorities can do now

When such problems arise in the Financial sector, the Central Bank of Sri Lanka asks the industries to do the right thing. If you look at the words “Do the right thing” I am tempted to ask “By whom? The Sakvithi scam and the Golden Key collapse are very recent incidents, but we too, had numerous experiences of similar nature in the past in Banks, Finance companies (legal and illicit too). If sufficient fuss is made, the issue gets debated at the national level. The government gets involved, and clients get compensated. But soon it is forgotten and a new wave of problems begins to appear. The government’s foremost priorities of getting involved in such situations are monetary stability, financial soundness and market conduct. So, the bounden duty of the government is to secure a strong foundation, which is public confidence of the system, in order to create overall stability. No system will prevail long, if the public lose confidence.

There is a need for more transparency: Until now, only theories emerged to solve the pressing problems we face within the Financial market. Yet, at this point, it looks as if much of the Industry has been destroying values, not enhancing them. It is not just a matter of money lost by those who invested, in order to make more money. What about those who planned for their retirement, from the Interest income? Who takes care of their daily needs now? Those who promised to manage other people’s Savings, and also, those who allowed others to do so, need to answer this question. We have to go on tinkering with the current procedures, to introduce more sophisticated Regulatory system. When selfish individuals are involved in their own agenda, they, eventually, try to maximise their own wellbeing in the free market and ignore the larger social, cultural and natural environment that surround them; the aspect of moral obligation towards their clients. In simple terms, they even forget the fact that, the huge pile of money they are sitting on, doesn’t even belong to them.

With such things happening so fast, one after the other, leaving investors bruised and confused, what lessons are left for us to learn?
Following are a few suggestions.

1. Trust no individual

If there is one lesson we can learn from this crisis, it is trust no one for that matter, not even a company. It is frightening to learn that, the institution we entrust our money to, the ones we thought are run by intelligent, honourable and trustworthy individuals, put together deals that led to a massive Liquidity problem or hand over money to people who are not capable of protecting the client’s interests, but only go for risky deals for high yields.

These are very clear examples to show that, every CEO has his own agenda. The owner of the company wants to make his own profit; CEO wants to achieve the target, to enhance his own bonus. The Relationship managers want to make their own Sales quota for promotions. But all these are done at the expense of the customer’s hard earned savings. The authorities or the Directors cannot run away from their responsibilities, disregarding public interest.

Understand

In the absence of all this protection and compliance, the only way to protect your interest is to understand well what you are investing in, and to investigate the stability of the company, not the reputation or social standing of a person. Remember that, there is no free lunch, and anything that looks too good, is often too good to be true.

2. Read the fine Print

It is worth quoting one real case study, to show how companies can misrepresent facts in an advertisement, and get away with the responsibilities, by having fine prints in the legal contract. This is the example of fine prints. There was an advertisement proclaiming full payment for an amount of unpaid bills of a default of an Export Credit Insurance Policy, by a leading Insurance Company. These attractive terms were printed in their brochures as well as widely advertised over TV. The agent who sold the Policy also promised full payment for all unpaid bills, in case of a default. To add to these gimmicks, it was printed in the front page of the Policy, that 85% of all unpaid bills would be met by the Company. In reality, this was not the case, When the Policy was brought, to claim for default in the payment. It was shocking how the Company came out with a legal jargon, which was printed in the Policy, that was delivered to the client long after buying it, that the Claim would be restricted to 30 times the Premium paid. This is how companies could do wrong things in the right manner.

Fine prints in the legal contract

What happened here was that, the clause in the Policy, what was given in the brochures and what was advertised, did not complement one another. They differed and were contradictory. The clause in the Policy was unfair, and was never highlighted to the client before the Policy was bought. This client suffered a severe loss in an export Business, which he would not have incurred, had it not been for the misleading advertisement. I am sure he would never have undertaken to buy such a Policy, as expressed in the clause, if he was informed of the correct facts... It is now well known that, such an erroneous advertisement was a clear attempt of the Insurance Company to woo the public into buying. This is a clear misrepresentation, but not contractual.

It is only at the stage of claim that the client realised it, and even the Sales manager who brokered the Deal also has missed the fine print, which resulted in him leaving the job, having lost confidence to work with that company. The manager in charge of that department too, was unaware of the fact that, Claim is restricted from a finer print. The company stopped selling such Policies from there on, which meant that, after the incident, they too realised the consequences of such contractual terms laid down by their Re-Insurer.

The victim paid the price .The lesson to be learnt was that, some companies do things to make money, and some managers work because they need jobs, but in actual fact, no one really studies the consequences and prepares for contingencies.

Trust

So, the lesson we can learn from this episode is, to trust no one and to read every clause, before you hand over your money to third parties for investments. Clients should inquire how or where their money was invested, to give such high Interest rates? Who is liable for Withholding Tax, if/when authorities query? Who are the key people involved within the company? If something happened to them, who will take over the responsibility? Have they any Security Deposit with the Central Bank, or any Solvency Margin set aside with the Central Bank, to face any eventuality?

3. Never put all your eggs into one basket

The good old theory needs reminders. I know, there are people who have invested everything, either with Sakvithi Finance or with Golden Key. Their intention was not to touch the Capital, but to live on Interest earned. They had no other income, so, their Capital was of utmost importance to them, and also, the Interest to meet their daily living. They are now confronted with a serious problem as to how to find the means to make ends meet. While they are engrossed with this uncertainty, they also spend their day in doubt, unsure of when they could get back their Capital, leave alone accumulated Interest. Despite suffering heavy losses from soured investments and this volatility, they can expect this year to be worse, as the damage extends throughout the economy, via more job losses, may be within the family circle, bad debts and bankruptcies.

4. Never be greedy

Last, but not least, please remember, we need money to survive those rainy days and to retire on. But, we will lose the meaning of it all, if we go to extremes, and allow money to dominate or overpower us with greed.

Solutions

Although Central Bank economists have long talked about “Externalities” or spillover effects of private economic activities, the above mentioned remained outside the basic economic dictum. As a result, economists tend to recommend solutions to Market failures on an ad hoc basis, and not surprisingly, solutions are not well implemented. But the present Financial crisis, and the ongoing environmental degradation should lead economists to re-examine the theoretical tool kit they use to justify the Financial market.

It is time, that different statutory requirements be enforced in the Finance Industry, to cover new areas of abuse by greedy individuals.

Finance Institutions pay lip service to guidelines, as long as their cash register rings. Guidelines are denigrated to extracurricular activities, and are lame in the face of the money game. The rule of law must never relegate its moral authority and responsibility to the laissez-faire approach, which causes the Industry to lose Public confidence.

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