Commercial Bank consolidated its position as the premier Bank in the country and continues to be the most profitable, financially strong and sound Bank measured in terms of profits, profitability and financial ratios and the local and international recognition it has received.

Economy & Banking Sector

Economy
The Sri Lankan economy showed mixed fortunes in 2007. The GDP growth rate for 2007 is expected to be around 6%. The rate of unemployment was 5.6% in the third quarter of 2007, recording an improvement from 6.4% in the corresponding period of 2006. However, a cause for concern was the high rate of inflation. Interest rates also recorded high levels with T-bill rates topping 20% by the end of the year. Besides, the LKR/US$ exchange rate displayed considerable volatility due to a host of factors including high oil and commodity prices in international markets and internal risks associated with war, political instability and macroeconomic policy. The rupee noticeably strengthened against the US dollar towards the end of the year mainly due to the Government’s successful mobilisation of foreign exchange inflows through its sale of treasury bonds to foreigners and its debut international bond issue towards the latter part of 2007.

The main issues confronting the Sri Lankan economy in recent years could be identified as high inflation, negative real interest rates, current account deficits and wide trade gaps, modest Balance of Payments (BoP) surpluses, an ever depreciating rupee and consistently wide revenue and fiscal deficits. Similarly high oil prices, slow fiscal consolidation, and security concerns are key risks to the near term growth-inflation outlook.

Some of the macroeconomic indicators of the Sri Lankan economy for the year 2007 is given below:

Snapshot of the Sri Lankan Economy

Interest Rates (%)

Banking Sector
The banking sector in Sri Lanka is the largest sub-segment within the Sri Lankan financial sector, accounting for 57.5% of financial sector assets as at end December 2006. Although there were 23 licensed commercial banks in operation as at June 30, 2007, the six largest commercial banks accounted for 65% of total banking system assets. The state-owned National Savings Bank, which is the largest licensed specialised bank, accounted for another 10.5%. Overseas operations of Sri Lankan banks have been very limited. Commercial Bank acquired Bangladesh operations of Credit Agricole Indosuez in 2003 and operates 9 branches across the country. The state-owned Bank of Ceylon has branches in London, Chennai and Male.

Despite, the volatile and rising interest rate environment, the Sri Lankan banking industry managed to sustain profitability. Although the volume of gross Non-Performing Loans (NPL) of the banking sector increased in 2007, the NPL ratio has declined steadily over the past few years mainly due to rapid loan growth and the improvement in Risk Management practices of banks, albeit there are significant disparities among individual banks.

Bank credit has expanded by over 20% annually over the last three years. The sectoral distribution of credit is fairly broad-based. Lending to the consumption sector amounted to around 20% of total credit, while loans to the housing, construction and property development sector accounted for around16%. Deposits in the banking sector had grown by a compound annual growth rate of 17.1% during 2002-2006. The high cost of living as well as comparatively higher rates offered for Government securities will continue to pose a challenge in mobilising deposits.

The physical infrastructure of Sri Lanka’s financial system has considerably improved over the last several years, in terms of technology as well as availability. The Real Time Gross Settlements System (RTGS) and the Scripless Securities Settlement System (SSSS) introduced in 2003 and 2004, respectively, allow easy settlement of time-critical payments and the paperless transaction of Government securities. In 2006, a cheque imaging and truncation system was introduced to expedite the clearing of cheque-based payments countrywide.

New Directions issued by the Central Bank in 2007 on shareholder limits to facilitate broad-basing of ownership of banks. Similarly, directions have also been issued in relation to single borrower limits. As the basic form of Basel II Capital Adequacy Framework is operational from January 2008, banks have gradually begun to create separate risk management structures.

The Central Bank will also introduce a mandatory Code of Corporate Governance in place of the voluntary code that now exists, making Boards of Directors of banks responsible and accountable for the banks’ performance and risk management, while attaching high priority to depositors’ interests. In addition, the Colombo Stock Exchange has issued guide lines on rules on Corporate Governance principles with effect from financial years commencing on or after April 1, 2007. Additionally, a revised format for publication of banks’ Financial Statements in their Annual Reports is to be introduced to improve disclosure requirements. The Central Bank of Sri Lanka is also expected to facilitate the adoption by banks of internationally accepted accounting and reporting standards such as IAS 32, IAS 39 and IFRS 7.