Sri Lanka's banking sector is sound amidst a global rout thanks to early regulatory action taken to safe guard the banking system. When all the other countries were expanding credit at very high rate, banking was given massive amounts of loans to fuel the housing as well as the land prices in Sri Lanka.
As a result of that Sri Lanka was able to smoothen and safe guard the banking system before it could form and have disastrous consequences in the economy. Economic analysts have said that Sri Lanka's economy is mostly damaged by government action, usually central bank accommodation of fiscal deficits. Printing money to plug deficits causes interest rates to fall (financial repression), which in turn leads to high inflation and balance of payments problems.
The banking sector in Sri Lanka at present needs a complete overhaul to make it globally competitive. Clearer regulatory guidelines are needed to cover changes in ownership in the banking sector and to handle the implications of mergers and acquisitions
The industry is over-banked and saddled with high costs, especially for distribution, that prevents the optimization of economies of scale. This in turn makes it difficult to attract new investments into the sector.
Banks need capital and investor reluctance to invest is because of the lack of scale of individual banks. The way out of this predicament is mergers and acquisitions need to happen in order to build capital and absorb unforeseen losses and reduce fixed costs.
Though the island’s banking sector was largely unaffected by the global credit crisis as it was not exposed to the risky practices that led to it, it does face structural challenges.
Return on investment is very low in Sri Lanka. The industry return on equity is around 13.6 percent, well below the inflation rate, which acts as a deterrent to attracting foreign investors.
Taxation on banking income is set at the rate of 60 percent, which is both punitive and inequitable compared with other industries. Sri Lanka's overheads are among the highest in the region. The banking sector needs some consolidation to reduce overheads and attract capital.
Last Updated on: 17-05-2010