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FINANCIAL CHRONICLE™ » CORPORATE CHRONICLE™ » Principal governmental and regulatory policies that govern the banking sector in Sri Lanka

Principal governmental and regulatory policies that govern the banking sector in Sri Lanka

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Senior Equity Analytic
Senior Equity Analytic

Banks in Sri Lanka are established under the Banking Act and require Monetary Board approval. There is no difference between foreign and local banks. Licences are issued to both commercial banks (LCBs) and specialised (or savings or deposit) banks (LSBs).

Banks must either be public companies or a branch office of a foreign bank registered under the Companies Act.

There are several banks owned by the government, partly to address the issue of most privately owned banks being concentrated in the capital and partly for resource allocation into priority sectors – eg, agriculture, small industry and regional development.

Bank supervision, by the Banking Supervision Department of Central Bank of Sri Lanka (CBSL) is based on standards set by the Basel Committee for Banking Supervision. Currently, the Basel III guidelines relating to capital, leverage and liquidity are applicable.

Banks are categorised based on the Internal Supervisory Rating system of banks. This takes into consideration quantitative measures (eg, Capital Adequacy, Asset Quality, Management, Earnings and Liquidity (ie, CAMEL model components)) and qualitative measures (eg, assessment of banks’ compliance with statutory or regulatory requirements, internal controls and the standards of corporate governance).

Recent efforts by the Financial Intelligence Unit of the CBSL to combat money laundering have resulted in Sri Lanka being delisted from the Financial Action Task Force (FATF)’s Grey List and Sri Lanka is no longer monitored by FATF.

Sri Lankan banks have recently introduced digital facilities including online banking, payment gateways and other cashless transacting forms. Presently, Sri Lanka’s digital laws are in the formative stages.

Regulated institutions
What are the defining characteristics of a bank to be caught by the banking laws and regulations? Is non-bank fintech regulated differently?

Banks are regulated under the Banking Act. The key features identified are:

- receiving funds from the public;
- acceptance of money deposits payable upon demand (by cheque, draft, order or otherwise);
- use of such funds for advances, investments or any other operation either authorised by law or by  customary banking practices. There are various laws and regulations covering both the receiving of funds from the public.

All fintech operations are meant to comply with some guidelines that are also applicable to banks on storage of data etc, but non-bank fintechs are not regulated under the Banking Act since they don’t accept deposits. All Banks must comply with the minimum capital requirements.

Do the rules vary depending on the size or complexity of the banking institution?


Primary and secondary legislation
Summarise the primary statutes and regulations that govern the banking industry.

The Banking Act and the Monetary Law Act are the primary statutes. CBSL also issues directions and circulars under these statutes. The directions specify ceilings on shareholdings and specific licensing processes.

The Payment and Settlement Systems Act empowers CBSL’s Payments and Settlements Division to regulate and supervise payments, clearing and settlement systems, and prescribe relevant policies.  

Banks are incorporated or registered under the Companies Act. The law also governs minority shareholders’ interests.

The Foreign Exchange Act and regulations regulate foreign currency related matters.

The Financial Transactions Reporting Act, Prevention of Terrorism (Temporary Provisions) Act, Prevention of Money Laundering Act and Convention on the Suppression of Terrorist Financing Act,  regulate the anti-money laundering and countering terrorist financing regime.

A cybersecurity bill and data privacy bill were proposed in 2019 and are currently in the process of being finalised before it is put to the parliament for enactment.

Regulatory authorities
Which regulatory authorities are primarily responsible for overseeing banks?

The Monetary Board is the primary regulator of all banks since it issues all licences. The CBSL’s various Divisions manage the supervision.

The CBSL’s Bank Supervision Department is the key supervisor of banks. Payment, clearing and settlement is overseen by the Payments and Settlement Division.

Banks listed on the Colombo Stock Exchange (CSE) must comply with the CSE listing rules and are subject to regulation by the Securities and Exchange Commission of Sri Lanka.

Government deposit insurance
Describe the extent to which deposits are insured by the government. Describe the extent to which the government has taken an ownership interest in the banking sector and intends to maintain, increase or decrease that interest.

With effect from 1 October 2010, CBSL requires all LCBs, LSBs and registered finance companies to join the Sri Lanka Deposit Insurance and Liquidity Support Scheme.

Under the Sri Lanka Deposit Insurance Scheme Regulations, depositors will be compensated up to 600,000 rupees per depositor if a licence is suspended or cancelled by the Monetary Board.

Deposits insured under this scheme include demand, time and savings deposit liabilities of member institutions and exclude all borrowing instruments.

The banking sector in Sri Lanka consists of domestic, foreign and state-owned banks. Several of the leading and largest banks in Sri Lanka are government owned or have government participation. It is unlikely that the government will divest itself of the shares in the near future.

Transactions between affiliates
Which legal and regulatory limitations apply to transactions between a bank and its affiliates? What constitutes an ‘affiliate’ for this purpose? Briefly describe the range of permissible and prohibited activities for financial institutions and whether there have been any changes to how those activities are classified.

Affiliate is referred to as ‘related party’ under Sri Lankan law.

Section 3(7) of the Banking Act Direction No.11 of 2007 (for LCB) and Banking Act Direction No.12 of 2007 (for LSB) requires the bank’s board to avoid any conflicts of interest that may arise from any transaction of the bank with ‘related parties’ and to ensure that ‘more favourable treatment’ is not given to them.

Related parties are:

- any of the bank’s subsidiary companies;
- any of the bank’s associate companies;
- any of the directors of the bank;
- any of the bank’s key management personnel;
- a close relation of any of the bank’s directors or key management personnel;
- a shareholder owning a material interest in the bank; and
- a concern in which any of the bank’s directors or a close relation of any of the bank’s directors or any of its material shareholders has a substantial interest.

Types of transactions covered include:

the grant of any type of accommodation, as defined in the Directions on maximum amount of accommodation;
the creation of any liabilities of the bank in the form of deposits, borrowings and investments,
the provision of any services of a financial or non-financial nature provided to the bank or received from the bank; and
the creation or maintenance of reporting lines and information flows between the bank and any related parties which may lead to the sharing of potentially proprietary, confidential or otherwise sensitive information that may give benefits to such related parties.

‘More favourable treatment’ includes granting of ‘total net accommodation’, exceeding a prudent percentage of the bank’s regulatory capital, as determined by the board, charging lower interest or paying more than the bank’s deposit rate for a comparable transaction with an unrelated comparable counterparty; providing preferential treatment or providing or receiving services without an evaluation procedure.

Most banks are listed with CSE and are also expected to comply with the CSE’s related-party transaction regulations.

Regulatory challenges
What are the principal regulatory challenges facing the banking industry?

The key regulatory concerns are the following.

Statutory Reserve Requirements (SRR) – LCBs must maintain reserves against deposit liabilities denominated in Sri Lanka rupees (ie, the proportion of the deposit liabilities that commercial banks are required to keep as a cash deposit with the CBSL). In 1981, the CBSL started to use open market operations and SRR to control the money supply. Over the years, the SRR has fluctuated and recently, due to covid-19, CBSL has cut its SRR to 2 per cent with effect from 16 June 2020, releasing approximately 115 billion rupees into the banking system. The low reserve requirement policy is utilised to make an impact on the liquidity of the banking system during the crisis. A lower effective rate of reserve requirement means lower costs for the banks. This means that banks can reduce lending interest rates.

Interest rate fluctuations and controls – CBSL resorts to interest rate fluctuations to conduct monetary policy. This has sometimes impacted banks as spending, is encouraged.
Currency inflation controls – an adverse shift in monetary policy leads to inflation. In the recent past, this has posed a crucial concern.

Caps on lending rates – Non-performing loans are an issue for most banks, especially during the pandemic. In response to concern over deceleration in credit demand and continued increases in non-performing loans, CBSL took measures to induce a reduction in market lending rates such as a reduction of the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR), the reduction of the SRR applicable on rupee deposit liabilities of LCBs and the imposition of caps on rupee deposit interest rates offered by the licensed financial institutions.

Inability to regulate and supervise sophisticated commercial banking systems – data privacy and cybersecurity issues especially with the high use of FinTech due to the Pandemic. Currently, Sri Lankan law doesn’t provide for data privacy and cybersecurity.

The Sri Lankan FinTech SandBox was introduced to encourage as well as enable FinTech initiatives to promote efficiency and increase access to financial products and services.

Consumer protection
Are banks subject to consumer protection rules?

Yes. For example, specific requirements were introduced:

The Financial Ombudsman scheme of Sri Lanka – an alternative dispute resolution mechanism for customers of the licensed banks and finance companies. However, prior to any complaint being submitted to the financial ombudsman, the complaint should first be referred to the Complaints Settlement Officer or Complaints Resolution Officer of the relevant financial institution.

Customer Charters of licensed banks and finance companies – The CBSL has, under the Banking Act and the Finance Business Act, issued Customer Protection Frameworks to safeguard the rights and interests of financial customers. The salient obligations of the licensed banks and finance companies include providing factual information to customers, providing information in languages preferred by customers, facilitating customers to understand the terms and conditions, displaying key information and protecting customers from abusive debt collection practices.

Further, licensed banks and finance companies must publish audited financial accounts.

A proposed new Banking Act will provide a stronger financial consumer protection framework.

The recently established Financial Consumer Relations Department (FCRD) by CBSL will handle all external complaints and grievances directed to CBSL on entities regulated by CBSL under section 33 of the Monetary Law Act. Initially, the FCRD will only focus on financial consumer complaints and grievances on FSPs which are regulated by CBSL, with the objective of establishing an independent watchdog.

Future changes
In what ways do you anticipate the legal and regulatory policy changing over the next few years?

Proposals for a new Banking Act are under way. Present proposals are changes to the types of banking licences currently issued, streamlining of approval to establish branches and other banking outlets, strengthening consumer protection, deposit insurance, governance, amalgamating both offshore banking unit and domestic banking unit operations into a single banking business, and improving resolution, enforcement and supervisory actions. It is also noted that the proposed act will govern the banking licences and regulation of banks in the upcoming Colombo International Financial Centre in the Colombo Port City.

Due to covid-19, banks may overhaul some of their protocols and policies around access management, finding ways to increase flexibility without compromising security.

The banking sector will move parts of its IT operations to public cloud environments. Most banks currently use their own private clouds. But in a lockdown and other similar emergency situations, these can be challenging to maintain. Cybersecurity will remain a top priority for banks in the future. Regulations on IT and security of banks may change quite significantly in the future.

Several regulatory measures aimed at enhancing efficiency of transmission of recent monetary policy measures to influence market lending rates are expected. CBSL expects a boost in the growth of credit and money supply expecting further reduction in lending rates and the anticipated improvement in investments. Capital ratios are expected to improve with the infusion of capital to meet the enhanced minimum capital requirements for banks by late this year. To strengthen crisis preparedness and resilience, banks must implement recovery plans to minimise the adverse impact on troubled banks and their potential spillover effects to the financial system.

Law stated date

Correct on
Give the date on which the information above is accurate.

12 February 2021.

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