Emerging from recession is continuing to be a painful process for the global community, as largely expected. Whilst growth of the world economy dipped from 3.9% in 2011 to 3.2% in 2012, the overall scenario continues to reflect an intriguing power shift. The 'muscle' that drives the global economy continues to be provided by emerging and developing economies whilst advanced economies are no longer the powerhouses they once were.
The shift in power has been a strong driver of the world economy, reflected in growing domestic demand across many emerging economies as the middle class and its spending power grow. It is also seen in rising new trade corridors, with increased trade between Asia, Africa, the Middle East and Latin America. There is also increased investment, innovation and infrastructure spending across large parts of the world.
Table 01 : World Economic Outlook
Projections (%) | |||
2011 | 2012 | 2013 | |
World Output | 3.9 | 3.2 | 3.5 |
Advanced Economies | 1.6 | 1.3 | 1.4 |
United States | 1.8 | 2.3 | 2.0 |
Euro Area | 1.4 | -0.4 | -0.2 |
Emerging & Developing Economies | 6.3 | 5.1 | 5.5 |
Developing Asia | 8.0 | 6.6 | 7.1 |
China | 9.3 | 7.8 | 8.2 |
India | 7.9 | 4.5 | 5.9 |
Source: IMF World Economic Outlook Update, January, 2013
Looking ahead to the year 2013, as the figures in the chart suggest, despite the challenges from too much austerity in Europe, the world economy should grow at a faster pace than in 2012. Emerging-market outperformance should continue, helped by solid domestic demand.
Source: World Economic Outlook, October 2012
Such has been the magnitude and reach of the financial crisis, that it has triggered an equally profound response from the global banking industry. Whilst history is replete with recessions and reforms of the past, it would be true to say that this time around, the sheer depths of the crisis and the equally far reaching regulatory response set this era apart from all others.
It is not so much a question of consolidation and adjustment, but global banking has been required to undergo radical change - a new order is emerging in terms of performance benchmarks, industry structures, business models, financial structures, taxation, products, pricing, conduct and remuneration. Already there are many indications as to how this 'new order' is changing the global banking landscape.
Internationally active banks are likely to refocus their activities to prepare for new, stricter capital and liquidity requirements. In the EU, very stringent restructuring requirements have been applied to a number of large banks that had received public support in 2008.
With many divestiture plans yet to be concluded, the question arises as to whether such trends will significantly change the structure of global banking towards a more domestic orientation. The evidence seems to indicate a geographic shift but not a pull back. Total cross-border claims of large global banks to emerging market and developing economies have grown since 2006. Cross-border activity entailed both acquisitions and divestitures, suggesting that banks are shifting business strategies to accommodate required changes in risk management practices as well as rebalancing to better reflect their competitive advantages in international markets rather than retreating from them.
The Basel Committee of regulators from nearly 30 countries agreed on January 6, 2013 to ease a new rule, forcing banks to build cash buffers to protect against any month long market squeeze. Accordingly, global regulators gave banks four more years and greater flexibility to buildup cash buffers from the originally planned 2015, so they can use some of their reserves to help struggling economies grow. Basel III has been subject to mounting criticism for its complexity, amid delays to its implementation in the European Union and the US.
The Liquidity Coverage Ratio (LCR) rule is one of the world's main regulatory responses to the financial crisis. It is part of the Basel III bank capital and liquidity accord agreed by world leaders in 2010 and being phased in over six years from January 2013, though there are delays in the United States and European Union.
The adoption of IFRS has plenty of critics around the world. The European Union (EU) has not yet endorsed IFRS 9, meaning IFRS reporters in the
EU cannot early adopt. The EU has indicated that it will only make a decision on endorsement once the entire financial instruments guidance has been finalised.
(Source: Bloomberg, Reuters, PWC, IMF)
Growth in Sri Lanka's GDP dipped to an estimated 6.5% in 2012 compared with the growth of 8.3% recorded in 2011. This was mainly due to the adverse effects of reduction in hydro power generation, agriculture production and deceleration in factory industry output. Further, the credit ceiling imposed by the CBSL also reduced the import driven consumption demand in 2012.
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The reduction in imports expenditure was higher than the reduction in export earnings in 2012 and as a result the trade deficit had recorded a slight decline during the period. However, the current account of the BOP improved with the increase in inflows from worker remittance and tourism etc. Further, the inflows to the financial account have increased mainly due to an increase in Government and commercial bank borrowings and foreign investments in Treasury Bills and Bonds etc. As a result the BOP recorded a surplus of over US $ 100 Mn. in 2012, compared to the deficit of US $ 1,061 Mn. in 2011.
The LKR/USD exchange rate began to depreciate when the Central Bank of Sri Lanka (CBSL) ceased its intervention in February 2012 and this trend continued until September 2012. However since then, the exchange rate has remained at more or less stable levels - between Rs. 128/- and Rs. 132/- to the USD. The BOP and Gross Official Reserve (GOR) position of the economy remained healthy, reducing pressure on the exchange rate.
The budget deficit as a percentage of GDP for the first nine months of 2012 reached 6.4%, exceeding the full year's target of 6.2% mainly due to a shortfall in revenue. The budget proposals presented by the Government for 2013 are more focused on fiscal consolidation in view of reducing the budget deficit to 5.8% and to achieve the growth target of 7.5%. Almost 90% of the Government's recurrent expenditure consists of interest payments on public debt, public service emoluments and subsidies and transfers.
The year-on-year inflation, as measured by the Colombo Consumers' Price Index (CCPI) (2006/07 = 100), remained at single digit level during 2012 closing the year at 9.2%. Improved domestic supply conditions of agricultural commodities coupled with relatively low international prices of imported items, helped maintain inflation at lower levels during 2012. Further, the tight monetary policy and the credit ceiling imposed by the CBSL in view of discouraging consumer related lending reduced inflationary pressures on the economy in 2012.
Interest rates recorded an increasing trend in line with the increase in policy rates and tight monetary conditions until policy rates were cut down by the CBSL in December, 2012. The credit to the private sector decelerated with the increase in interest rates and the credit ceiling imposed by CBSL on bank lending.
The CBSL decided to reduce Repo and Reverse Repo rates by 25 basis points in December, 2012 and also to lift the credit ceiling from 2013, considering the reduction in private sector credit growth, inflation etc.
The operations of the share market were subdued due to the adverse market conditions that prevailed throughout the year. Nevertheless, the net foreign inflows to the share market were recorded at Rs. 39 Bn. in 2012.
Source: CBSL * CBSL estimates |
Sri Lankan banking sector looked reasonably healthy in terms of capital adequacy, asset quality, profitability, number of banks and bank branches. However, from a macro viewpoint, the sector remains relatively small in relation to the size of the economy.
Access to finance increased whilst the service delivery channels of banks continued to expand. The banking sector recorded satisfactory growth in profits despite shrinking margins, moderate growth in lending and relatively slow income growth during the year. Depreciation of the rupee, with the greater flexibility of the exchange rate resulted in an increase in the net gain from revaluation of foreign currency assets and liabilities.
Capital Adequacy ratio of banks improved in 2012 and were maintained well above the stipulated minimum level of 10%. Similarly liquidity ratios were maintained well above the minimum regulatory level of 20%.
Deposits continued to be the main source of funding. The share of borrowings in total funding recorded an increasing trend, especially banks raising funds from overseas sources to improve the Tier II capital.
The banking sector became strong and competitive in recent years and recorded reasonable growth in volumes.
The Current Accounts:Savings Accounts (CASA) ratio of the banking sector has been steadily deteriorating in recent years as evident in the shift from low cost deposits to high cost deposits for higher gains. This trend is likely to increase the cost of funds in the banking sector.
The loan to deposit ratio of the banking sector increased significantly since 2009 as growth in loans outpaced the growth in deposits.
The loan growth of the banking sector has moved in line with the economic growth resulting in fresh demand for credit, which in turn would increase the economic activities in the country. This demonstrates the pivotal role the banking sector plays in the economic growth.
According to Fitch ratings, the non-performing loan (NPL) ratio of the Sri Lankan banking sector could see a slight deterioration in 2013 from the current 4%, but will remain below 5%.
The Fitch outlook on the National Long-Term Ratings of most Sri Lankan banks is 'Stable'. Fitch believes that domestic prospects should still be sufficient to support a reasonable performance and profile as the level of penetration still remains low.
Fitch expects profitability to moderate due to dampened Net Interest Margins (NIMs) amidst intense competition for deposits and a potential rise in credit costs, as loan-loss reserves remain modest. Earnings reported in 2012 have been bolstered through foreign currency income from translation gains.
According to Fitch, enhanced core capital buffers, alongside structural changes that can support the ratings of Sri Lankan banks through economic cycles, could be positive for the outlooks and/or ratings. Preliminary impact assessments of revised local accounting standards pertaining to the presentation, recognition, measurement and disclosure of financial instruments effective in financial periods beginning in 2012, have not revealed a significant impact on banks that have disclosed it.
Effective from January 1, 2012, all Sri Lanka Accounting Standards converged with the International Financial Reporting Standards (IFRS). This convergence has brought substantial changes on measurement, recognition and disclosure requirements of entities. Among these changes, arrival of the Sri Lanka Accounting Standards LKAS 32 on Financial Instruments: Presentation, LKAS 39 on Financial Instruments: Recognition and Measurement and SLFRS 7 on Financial Instruments: Disclosure brings a revolutionary change to the banking industry.
The established business models need radical changes to comply with new requirements. Reporting frameworks are substantially different compared to previous methods. The provisioning policy was changed to an incurred loss model based on the actual evidence of impairment from regulatory time based provisioning. A majority of items which appeared under Off-Balance Sheet were brought into the On-Balance Sheet.
The additional disclosures required under SLFRS/LKAS may provide further insight for investors and it has significantly improved disclosures in the Annual Report. The move towards SLFRS/LKAS holds significant implications for financial sector in the country as it demands heightened levels of transparency pertaining to the utilisation of public funds in the course of business.
Amidst many challenges, the Bank successfully migrated to new standards from January 1, 2012 and published the impact of SLFRS/LKAS in interim accounts for first three quarters of 2012. The detailed financial statements were prepared as of December 31, 2012, the first full year after moving into new accounting standards.
A consultative paper on Internal Capital Adequacy Assessment Process (ICAAP) was issued, which requires banks to assign capital for additional risk not covered under Pillar 1 of Basel II. Such a process will foster a strong emphasis on risk management and encourage improvements in banks' risk assessment capabilities.
In order to promote a high standard of business conduct and market practice for the orderly conduct of the foreign exchange trading activities, a directive was issued by the CBSL covering market practices, ethics, standard of conduct and practices.
As legislated by the CBSL, the credit growth of licensed banks has been contained to 18% of the total rupee outstanding as at end of year 2011 or Rs. 800 Mn. whichever is higher. However, the banks could have granted credit in the year 2012 in excess of 18% or Rs. 800 Mn. up to 23% of the total outstanding as at end of year 2011 or Rs. 1,000 Mn. whichever is higher, provided that corresponding funds are raised from overseas sources.
Across the banking industry, different age thresholds have been employed by various constituents to define senior citizens in the course of their operations. In order to maintain a sense of parity and conformity within the industry, the CBSL requested licensed banks to use a common threshold of 55 years of age in identifying senior citizens.