Management Discussion and Analysis

Prudent Growth

The strategic imperative of Prudent Growth represents the Bank’s recognition that value creation for all its stakeholders must be viewed through different time frames – the short, medium, and long term. Prudent Growth provides the orientation for the Bank’s other three strategic imperatives covered in this discussion – Customer Centricity, Leading Through Innovation, and Operational Excellence – and is realised and actualised by them in turn.

As such, Prudent Growth is fundamentally about balance: maximising current profitability without hindering the Bank’s capacity for prolonged success into the future. Put in terms of the contemporary language of Integrated Reporting, Prudent Growth is about balancing trade-offs between capitals. A disproportionate focus on immediate gains in financial capital without sound investments in institutional or human capital will compromise the Bank’s ability to adapt to a changing financial landscape. Investments made without regard to social and environmental justice can have spillover effects, adversely impacting the wider society in which the Bank operates
and manifesting a risk to Bank’s reputation.

Prudent growth thus signifies growth that is: healthy, sustainable, resilient, responsible, and ethical. The elements of such an approach include an emphasis on pure banking; a well-diversified asset and customer base; sound capital, liquidity, and risk management; astute corporate governance; socially and environmentally-responsible lending and operating practices; and conducting business with transparency, honesty and integrity.

Creating Long Term Value

Prudent Growth is the foundation of the Bank’s success, and has allowed it to build a strong deposit and lending franchise with a wide national footprint and a regional presence. This economy of scale provides the Bank with the ability to access resources unavailable to its competitors in order to offer a unique value proposition to its stakeholders. As an acceptor of deposits, the Bank’s moderate risk appetite has created a reputation for stability, earning the trust and confidence of the public. This year, the Bank’s deposits grew to Rs. 1.266 Tn., a growth of 20.19% over 2019. As a result, the Bank’s CASA ratio increased from 37.10% in 2019 to 42.72% in 2020. This surge in deposits was driven by the drop in discretionary spending due to the pandemic, the prolonged low-interest rate environment, and the movement of deposits from the Non-Bank Financial Institution (NBFI) sector to the banking sector. Deposits were the Bank’s largest source of funding, funding 72.92% of the total assets (compared with 75.92% in 2019), indicating the robustness of its financial intermediation role.

As a lender, the Bank is able to cater to the largest corporates (with one of the highest single borrower limits in the banking sector), to SMEs and Micros (with a suite of customised financial solutions and capacity-building programs), and to the ordinary citizen (through a wide range of pure, uncomplicated banking products for every demographic, from infant to senior citizen).

Gross Loans and advances grew by a modest 2.98% given the low demand for credit throughout the year. Consequent channelling of excess liquidity to the Treasury heightened emphasis on investment in Treasury bills and bonds, resulting in net loans and advances as a proportion of total assets decreasing to 51.66% as at December 31, 2020 from 63.77% a year ago. The Bank’s Non-Performing Loans (NPLs) ratio increased to 5.11% at end of the year. Yet, the Bank made the highest ever single-year impairment provision of Rs. 21.484 Bn., including COVID-19 management overlays of Rs. 5.189 Bn. This calculation stemmed from the Bank’s prudent approach, anticipating the potential for credit losses that might remain unrecognised by existing impairment models.

Growth in Deposit base and Lending portfolio

Table - 08

(Rs. Mn.)
(Rs. Mn.)
Deposit base 1,265,966 259,779 17.16%
Gross Loans 947,842 224,021 15.52%

During the year under review, the total assets of the Bank grew by by 25.15%, rising from Rs. 1.387 Tn. at the end of 2019 to Rs. 1.736 Tn. at December 31, 2020. Our market share in total assets, which stood at 11.08% at the end of 2019, improved to 11.84% at the end of 2020. The Bank’s International Operations played an increasingly vital role in our bottom line by contributing 11.79% to the Group’s total assets and 20.46% of profit before tax (refer to the "Financial Review" for further details).

The Bank’s prudent approach also applies to its dividend policy, which seeks to balance providing substantial shareholder returns while supporting long-term business expansion. Maintaining a consistent track record, the Bank declared a first and final dividend of Rs. 6.50 per share for the year, which will be paid by way of a cash dividend of Rs. 4.50 and scrip dividend of Rs. 2.00 per share, leading to a dividend payout ratio of 46.33%.

Following the lacklustre performance, indices on the Colombo Stock Exchange (CSE) ended the year on a mixed note. ASPI gained 10.52% to close the year at 6,774 points (6,129 in 2019) and S&P SL20 lost 10.18% to 2,638 points (2,937 in 2019). The Bank index followed a similar trend, losing 16.11%. Accordingly, the Bank’s shares were trading at a discount to its book value throughout the year. Yet, the price-to-book value of 0.60 times as of December 31, 2020 (0.73 times as at end 2019), was the highest among the peer banks listed on the CSE.

Remaining Well Capitalised

A strong base of capital is vital for a bank’s sustainability. It helps a bank acquire property and equipment to establish, perpetuate, and expand business, and offers protection against uninsured depositors; and, perhaps most importantly, it acts as a buffer to absorb unanticipated losses and serves as a regulatory restraint on unjustified asset expansion. However, tightening regulatory requirements and more stringent reporting standards, while necessary and justifiable, have created new impediments to the growth of the banking industry.

As a result of more restrictive capital definitions, difficulty in raising fresh capital due to lacklustre market conditions, comparatively higher risk-weighted assets, additional capital buffers and higher capital adequacy ratios (CARs) required under Basel III regulations, higher impairment provisioning under SLFRS 9, and higher taxes, banks are being more conservative in their approach and are therefore bearing the brunt of higher costs and lower returns.

To remain solvent in such a landscape, the Bank considers it a priority to pro-actively manage the capital at its disposal. The Bank assesses its capital requirements through the Internal Capital Adequacy Assessment Process (ICAAP) and the annual strategic planning and budgeting exercise. The tools it deploys include: Risk Adjusted Return on Capital (RAROC), prudent capital allocation, controlled growth in risk-weighted assets, expansion of fee-based services, timely pricing/re-pricing, prudent dividend policy, products and services portfolio and capital instruments. The Bank also recognises that a crucial aspect of its success is the base of confident shareholders whom the Bank can rely on for more capital whenever the need for a capital infusion arises. The Bank consistently maintains capital adequacy ratios well in excess of minimum requirements (see Risk Governance and Management for further details).

Capital management objectives

The objectives of the Bank’s Capital Management efforts are:

  • Remaining compliant with regulatory requirements by maintaining internal capital targets that are more stringent than the requirements
  • Optimum capital usage for maximum profitability
  • Supporting future business expansion
  • Supporting desired credit rating

The Bank received a strong affirmation with the completion of a private placement of shares with the IFC amounting to USD 50 Mn. (Rs. 9.216 Bn.). This investment is the first foreign equity placement of shares by the Bank and collectively makes the IFC, the IFC Financial Institutions Growth Fund, LP (FIG Fund), and the IFC Emerging Asia Fund, LP (EA Fund) a holder of a14.45% stake. Also crucial to note that this is the first post-pandemic equity placement by the IFC, and it is one of the largest foreign investments into Sri Lanka since the start of the pandemic. This is a clear sign of optimism for the Bank’s future.

For further details on our Capital Management, please see Note 68.5 and Disclosure 7 – Summary discussion on adequacy/meeting current and future capital requirements.

Managing Funding and Liquidity

The circumstances that led to the financial crisis in 2007 and the events that followed underscored the fact that funding and liquidity are as important, if not more so, than capital for the financial services industry. Yet, unlike for capital, there had been no internationally agreed-upon standards for funding and liquidity. As a result, Basel III regulations introduced measures to strengthen the funding and liquidity risk management of banks. Its aim was to promote resilience in a bank’s short-term and long-term liquidity risk profile through the introduction of the Liquidity Coverage Ratio (LCR, 2015) and the Net Stable Funding Ratio (NSFR, 2019), respectively. In addition to the conventional Statutory Liquid Assets Ratio, these measures are designed to prevent banks from relying excessively on short-term wholesale funding to support long-term assets.

The Bank accords as much importance to funding and liquidity as it does to capital, ensuring that it has sustainable sources of funding and that it maintains adequate levels of liquidity at all times. The Bank will not compromise on liquidity in its drive to generate returns for investors, and this tenet has contributed greatly towards public confidence in the Bank.

To actively monitor the funding, liquidity requirements and pricing of assets and liabilities, the Assets and Liabilities Committee (ALCO) of the Bank meets fortnightly. It extensively deliberates on developments such as market liquidity, current and perceived interest rates and exchange rates, changes in policy rates, credit growth and facilities in the pipeline, capital market developments, projected capital expenditure and alternative funding options etc. that affect funding and liquidity.

Over the past several years, the Bank has further strengthened its funding and liquidity by encouraging the use of electronic cash and cards to reduce cash holdings and establishing credit lines with strong overseas counterparties (enabling it to access foreign currency funds at attractive prices). Funding sources of the Bank for onward lending, in order of their assessed stability, include:

  • Retail deposits mobilised through the branch network
  • Low-cost foreign currency borrowing (provided the interest and swap cost attached to such borrowing is cheaper as compared to the cost of wholesale deposits)
  • Selected long-term wholesale deposits
  • Re-purchase agreements

Funding and Liquidity Management Objectives

The objectives of the Bank’s funding and liquidity management efforts are:

  • Honouring customer deposit maturities/withdrawals and other cash commitments efficiently under both normal as well as challenging operating conditions
  • Remaining compliant with regulatory requirements by maintaining internal funding and liquidity targets which are more stringent than the requirements
  • Optimum usage of liquid assets to maximise profitability
  • Funding future business expansion at optimum cost
  • Supporting desired credit rating
  • Ensuring compliance with to Basel III funding and liquidity requirements

The Bank manages its funding and liquidity ratios on a daily basis and monitors the Liquid Assets Ratio to ensure adequate funding to maintain liquidity at the desired levels.

Being a Truly Diversified Entity

Another important dimension of the Bank’s prudent growth is its commitment to diversification. Apart from being a risk management tool to avoid excessive concentrations, diversification has helped the Bank remain more agile in weathering and responding to changing market conditions, thereby reducing performance volatility and ensuring stable, sustainable value creation. The Bank has successfully accomplished a high level of diversification in its operations across many parameters, including:

  • Geographically (Sri Lanka, Bangladesh, The Maldives, Myanmar, Italy and BPOs in several other countries)
  • Customer profile (See customer segmentation – Table 10)
  • Banking channels (See channel mix – Table 11)
  • Currency wise product mix (See Note 34.1 (b) and Note 46.1 (b))
  • Products and services portfolio (A complete suite catering to the requirements of all segments of customers from infants to senior citizens).
  • Funding profile (Please refer the figure 09 for details)
  • Maturity profile (No serious mismatches in maturity profile, particularly given the growing core component of CASA balances – See Note 61 to the Financial Statements).
  • Economic sector (A well-spread sector diversification of assets by economic sector with no excessive concentration to any particular sector – See Note 34.1 (c) to the Financial Statements).
  • Sources of revenue (An acceptable mix of fund-based and fee-based revenue with significant market share in country’s imports and exports as well as a market maker in Treasury operations – See Note 13.1 and 14.1 to the Financial Statements).

Figure - 09

Socially and Environmentally Responsible Lending

Banking, in comparison to many other industries, has a minute environmental footprint of its own. It consumes few natural resources and creates minimal emissions and waste, evidenced by the fact that there are no mandatory requirements for environmental certifications that banks have to obtain. But the Bank, in its capacity as a Domestic Systemically Important Bank, is a financial intermediary with a wide national reach and influence. As such, it recognises that it has a vital role to play as an advocate and driver of sustainability in Sri Lanka. The Bank was involved in the formulation of a Sustainable Banking Initiative (SBI) in the country in partnership with 18 members of the Sri Lanka Banks’ Association, and social and environmental concerns are integrated into the Bank’s core business activities. The Bank has been a member of the UN Global Compact since 2002.

As part of its strategic pillar of prudent growth, the Bank is mindful that its funding activities can have a major influence on issues of sustainability both inside and outside the Bank. The Bank has played a pioneering role in Green Financing in Sri Lanka over the past decade, financing the first commercially viable wind power project and the first commercial scale solar power project in Sri Lanka. The Green Financing portfolio support projects that focus on renewable energy, energy and water efficiency, waste management, emission reductions, drip irrigation, and rain water harvesting. In 2018, the Bank partnered with the IFC to strengthen its Green Financing strategy.

During the year under review, the Bank issued a Position Statement on Climate Change, affirming its commitment to combating climate change at the highest level of the Bank. It is against the backdrop of strong consensus amongst the scientific community that human influence, particularly the burning of fossil fuels and deforestation, has been the dominant cause of observed warming in the global climate system since the mid-20th century. This Position Statement of the Bank is, in fact, an articulation and an unification of a multitude of actions the Bank has been implementing and committing to over the past decade, and underscores its added resolve to fight this challenge in the future.

Furthermore, the Bank utilises a Social and Environmental Management System (SEMS) to assess and manage social and environmental risks in a strategic and systematic manner. Procedures and work flows within the framework of SEMS ensure that the Bank’s lending is to environmentally sustainable, socially acceptable and economically viable projects. The Bank’s SEMS is supplemented by the adoption of an IFC developed tool, the Climate Assessment for Financial Institutions (CAFI) tool, that assists in monitoring and reporting climate impact data. In its implementation of SEMS, the Bank adopts an approach of partnership with its stakeholders with the objective of encouraging positive changes instead of merely rejecting proposals that do not meet the Bank’s social and environmental standards. The goal of the Bank is to be a leader that seeks to build partnerships across ecosystems, and every attempt is made to assist customers and suppliers to become compliant with relevant requirements and regulations.

The Bank’s Green Financing, some of which is supported by international lines of credit, contributes towards the fight against climate change in alignment with the UN Sustainable Development Goals 7 (Affordable and Clean Energy) and 12 (Responsible Consumption and Production). The Bank’s Green Financing Vision prioritises 2 goals:

  1. To become the No. 1 Green Financing institution in Sri Lanka
  2. To grow the Green Financing portfolio to be 3% of the loan book by 2025

Initiatives taken during the recent past towards achieving these goals include:

  • Engaging in multiple capacity building programs.
  • Over 500 staff members have participated in internal training programmes.
  • Over 60 staff members have participated in training programs conducted by external industry experts.
  • Guidelines & Circulars have been issued on Green Financing.
  • The climate impact of these Green facilities has been calculated via the IFC developed CAFI tool. The Bank’s Green Financing portfolio has resulted in reducing 180,933 tonnes of CO2 equivalent emissions to the atmosphere.
  • A Green Financing Performance Award for Personal Banking and Corporate Banking has been introduced.
  • Special rates have been offered by the Bank on Green Leases and Loans to incentivise growth in the Green Financing sphere.

During the year, the Bank made particular strides in terms of the composition of its Green Loans portfolio by including a wider array of projects.

Table - 09

Green Purpose (end of 2020)
Renewable Energy Projects (Solar, Hydro, Wind, Biomass) 38
Resource efficiency and recycling projects - Energy, Water and Material 19
Climate smart agriculture 17
Environmentally friendly transportation and related services 10
Water saving consultancy and related service providers 7
Others 8

Concessionary Green Loans for Renewable Energy

The Bank, in its capacity as a Domestic Systemically Important Bank, is a financial intermediary with a wide national reach and influence. As such, it recognises that it has a vital role to play as an advocate and driver of sustainability in Sri Lanka.

Ethics and Conduct

While the Bank’s fundamental business of financial intermediation requires adherence to government regulations, operating in a community of stakeholders means that it also needs a ‘Social Licence’ – in other words, tangible evidence of ethical and conscientious behaviour. The Bank has long been renowned for its compliance to both the letter and spirit of the law. The Bank places a premium on the trust and confidence of its customers and stakeholders – a strength it has carefully cultivated for over a century – and recognises that it has a responsibility to maintain the highest ethical standards and integrity in its business activities. The Bank takes a zero-tolerance approach for corruption, bribery and fraud. The Bank, its Board of Directors and all of the employees are dedicated to act professionally, ethically and with integrity in all business dealings and relationships with all stakeholders.

Through on-site audits and online surveillance, the Inspection Department of the Bank reinforces the provisions of the Code of Ethics. The scope and frequency of audits are determined using a risk-based model and this approach ensures that customers continue to benefit from the highest levels of integrity. In addition to the above, a Whistleblower Charter is in place to allow employees to report unethical or any known or suspected frauds or misappropriations by staff members to the Compliance Officer of the Bank to safeguard the interest of the Bank and all its stakeholders. Training is provided to all employees and the members of the Board of Directors on Anti Money Laundering (AML)/Combating the Financing of Terrorism (CFT), Compliance and Anti Bribery and Corruption from time to time.

The Bank continued to further strengthen the related systems, processes and controls during the year.

Anti-Money Laundering

The Bank conducts its Money Laundering and Terrorist Financing (ML/ TF) Risk assessment as per the established ML/TF Risk Assessment Policy. Risk reviews are conducted and reported to the Board on a quarterly basis considering the risk exposures arising from its customers, delivery channels, products and services and geographical locations in which it conducts business.

Anti-Bribery and Corruption

Bribery and corruption is illegal, dishonest and damages the reputation of the Bank. Therefore, the Bank is committed to countering bribery and corruption in all forms, and promotes a culture of compliance and genuine engagement with anti-bribery and corruption standards. The Bank also recognises that different jurisdictions, sectors, transactions, business opportunities and business partnerships pose greater bribery and corruption risks and seeks to identify and manage these risks. Accordingly, the Bank seeks to establish rigorous policies, procedures and controls to assist it to operate within its risk appetite at all times and expects all its employees to refrain from giving or accepting bribes, kickbacks or commissions or taking part in any form of corruption. The Bank has developed a comprehensive Anti-Bribery and Corruption Policy which will be submitted for approval of the Board during the first quarter of 2021. Once approved, it will be made available at the Bank’s web site.

In addition, the Bank has a Whistleblowers Charter and guidelines on accepting and offering gifts or other illegal gratification, collection and borrowing of funds/obtaining undue favours from customers and suppliers, and holding a Directorship/being a Partner/Shareholder in private companies enumerated in the Code of Ethics and administrative circulars. In implementing the Code of Ethics and affirming its commitment to the 10th Principle of the UN Global Compact, the Bank expects all employees not only to fight corruption, but also to demonstrate that they do not abuse the power of their position as employees for personal financial or non-financial gain, solicit or accept gifts, compromise employees or the Bank. No employee of the Bank should offer any bribe or other illegal gratification in order to obtain business for the Bank.

The Bank also aims to encourage and influence all of its non-controlled interests (such as non-controlled joint ventures, partners, contractors, sub-contractors, vendors, suppliers, service providers, consultants, representatives and others performing work or services for or on behalf of the Bank or any other person associated with the subsidiaries and associate of the Bank) to have and implement anti-bribery and corruption policies and procedures to an equivalent standard of the proposed Policy of the Bank.

Figure - 10