Opinion

New trends reshaping Sri Lanka’s financial service industry today

By Dr Indrajit Coomaraswamy

Sri Lanka Central Bank Governor Dr Indrajit Coomaraswamy shares an encouraging account on the recent financial services improvements in his country. He identified fintechs along with electronic payments and fund transfer systems as the pillars of modern banking development and revealed noteworthy Central Bank initiatives covering new technology, payment products, consumer protection and system stability.

  • The Central Bank of Sri Lanka welcomes the adoption of new technologies while ensuring the safety and soundness of the banking system
  • Emerging partnerships between banks and fintechs in the country paves the way to an industry revolution
  • A recent initiative by the Central Bank of Sri Lanka is aimed at establishing a less cash society

 

The Central Bank of Sri Lanka has two core objectives: maintaining economic and price stability, and financial system stability. These two objectives are complementary to each other and affect all sectors of the economy. Efficient mechanisms for financial transactions and intermediation are two main pre-requisites for the development of any economy as every economic activity depends on fund movements and other settlements taking place in a timely and secure manner. Financial institutions play a crucial financial intermediation which is the lifeblood of any economy.

With new players and innovative products entering the banking sector, it is already witnessing unprecedented changes. The pace of change is accelerating exponentially with the emergence of new banking models. There are also new non-bank players in the fintech space who are competing to grab an ever increasing share of the banking value chain. Banks need to choose what stance to adopt in responding to these changing dynamics – whether to be a shaper of the future, a fast follower, or to manage defensively. However, staying the same is not an option in this very fast, evolving environment.

Rapid development of financial technology and electronic payments and funds transfer systems have emerged as the twin pillars of modern banking development. Products offered by banks and non-bank institutions have moved beyond conventional banking and we now have access to banking services around the clock. There is an ongoing revolution in our banking industry. Banks have opened another alternative delivery channel through bank-fintech partnerships, which have helped improve efficiencies, lower transaction costs and promote financial inclusion. Partnerships between banks and fintech companies are evolving from mere vendor-customer relationships to those of mentorship and investment by the banks. The fintechs have the technological solutions, while banks have the customer base. Bringing the two together is generating win-win relationships.

Fintech developments using smart phones have taken the centre stage globally. This is leading to another paradigm shift in the payment sphere as the trends move away from payment cards to mobile-based apps like e-money, QR code-based payments, near field communication -based payments and many more. The Central Bank of Sri Lanka is currently grappling with finding the ways and means of embracing these developments and their potential usage in the country, while maintaining stability and security of the system.

Banks need to strive to make the most out of these dynamic changes in the environment not only to stay relevant in the minds of an increasingly savvy and demanding customer base, but also to create differentiation for better customer response through electronic know your client (e-KYC), digital-only banks, biometric enabled ATMs and smart banking through the usage of artificial intelligence.  Capitalising on these for commercial advantage has become critical in a competitive market.

In Sri Lanka, we too are experiencing technological developments that are transforming the financial sector. Digitalization of financial transactions originated in the 1980s, as banks started introducing computerized methods for their day-to-day operations. Since then, a transformation of banking activities from manual processing to digitalisation has taken place. This digitalisation process has been extended to offer better quality service for customers with increased convenience by utilising easy-to-use mechanisms and promoting financial inclusion. As a result, in Sri Lanka, today we are using credit cards, debit cards, internet banking, mobile banking and mobile phone based e-money systems for our transactions.

The economic benefits of effecting payments electronically are well established. The Central Bank is promoting electronic payments to establish a less cash society. This is one of our seven strategic objectives.

The following initiatives in this regard are noteworthy: Establishment of the Common Cards and Payments Switch as the National Payment Switch; launch of the LankaPay Online Payment Platform to facilitate real time payments to Sri Lanka Customs to reduce the cost of revenue collection; implementation of a National Card scheme by Lankaclear in partnership with an international card scheme, to facilitate introduction of low cost products for national initiatives such as social benefit schemes and public transport; appointment of two committees by the National Payment Council to study the potential impact of fintech and blockchain and to make recommendations for implementation of regulations covering application of new technology, new payment products, consumer protection and system stability.

Apart from these, there are two other initiatives that are currently in the pipeline, to be implemented in the forthcoming year. These are the guidelines for institutions providing services for payment related mobile applications and revision of the Credit Card Operational Guidelines, in line with the new developments in the credit card industry

As you know, when introducing new products, emphasis should be placed on security features as well as customer protection. Financial institutions have to conduct sufficient awareness programs for staff as well as for customers regarding Common Electronic Fund Transfer Switch, Sri Lanka Interbank Payment System, real-time gross settlement payments, mobile banking and internet banking, for a better usage of these products.

However, new technologies pose new risks which may be complex and difficult to understand.  Existing risks may also not be eliminated. Asymmetries of information and default externalities do not disappear with the introduction of new ways of supplying financial services. Fintech does not therefore, justify less regulation.

The current banking environment and market players need to be aligned with the requirements of the future of banks.  Banks need to make changes in their go-to market approach, starting with shortening their strategy cycles to months instead of years.  They also need to get better at reading signals of changes in the environment, and become tactically focused on being operationally lean and agile in response to market conditions. This will result in choices being made to adopt or partner with fintech businesses offering digital interactions and to accept that there are alternatives to core legacy IT systems which provide greater speed for revenue generation, effective operations and better customer experience.

On the part of the regulators, we also need to reinvent our supervisory models to take account of the spread of fintech, blockchain and artificial intelligence. In this scenario, the tasks of ensuring financial stability, protecting customers and maintaining competition would change in a very material way.

The Central Bank of Sri Lanka, being the regulator, is committed to achieving a balance between regulation and innovative digitalisation. We are seeking to promote technological advance while minimising the risks associated with the rapid change.

At present, an increase in the non-performing loans is being observed due to the impediments in the operating environment. The challenge in the period ahead is to increase the flow of credit while maintaining quality in regards to the expectation that credit growth would pick up in the medium-term in line with the prevailing monetary policy stance and the Banking Act Directions issued to enhance credit flows to the economy.

With the enhanced minimum capital levels to of banks be effective from 31 December 2020 and the implementation of Basel III Capital Requirements, banks are expected to meet the enhanced requirement for high quality capital. Those which are unable to comply, will be encouraged to consolidate on a voluntary basis. Further, the adoption of the Basel III Leverage Ratio and (the new Accounting Standard)-SLFRS 9, will also result in banks augmenting their capital level to meet these regulatory requirements. This will improve the ability of the banking sector to absorb shocks arising from financial and economic stresses and reducing the risk of spillover of distress from the financial sector to the real economy in the coming years.

The liquidity positions of banks are expected to be maintained at healthy levels with the adoption of the Liquidity Coverage Ratio and the Net Stable Funding Ratio under Basel III Liquidity Standards. As a result of this, the liquidity profiles of banks in the short- and long-term will be strengthened. The objective is to promote structurally resilient banks with stable funding sources.

Trends and changes in macro-economic variables will be monitored to identify any adverse trends in order to address any spill-over risks arising from the real economy to the banking sector. Appropriate macroprudential measures will be introduced, if necessary, to pre-empt any future risks to the stability of the banking system. The regulatory and supervisory framework pertaining to licensed banks will be further strengthened in line with the Basel Core Principles on Effective Banking Supervision and other international and regional best practices. 

The legal and regulatory framework of licensed banks will be further strengthened through the drafting of the new Banking Act.The key areas to be factored into the proposed new Banking Act include an overall mandate for supervision and regulation, a differentiated regulatory framework to facilitate proportionality, strengthening corporate governance, consolidated supervision, a resolution framework, the capacity to impose monetary penalties/fines, ring-fencing of banks to mitigate contagion risk, strengthening provisions for mergers, acquisitions and consolidation, subsidiarisation of large foreign banks and holding company structure for banks.

Bank Examination methodology will continue to be enhanced focusing on the efficiency, effectiveness and sustainability of individual banks and the banking sector. A new supervisory rating model (The Bank Sustainability Rating Indicator-BSRI) is being developed by the Central Bank of Sri Lanka with a view to facilitating a risk based supervision framework to enable early intervention and prompt corrective action.

Consolidated supervision of banking groups will also be carried out to protect banks from contagion risk, and to ensure the stability and the soundness of the banking sector and the financial system. Accordingly, a regulatory framework on consolidated supervision will be formulated and provisions in this regard will also be brought into the Banking Act. Further, in order to strengthen inter-regulatory cooperation and collaboration in this regard, the Central Bank, Securities and Exchange Commission of Sri Lanka and the Insurance Regulatory Commission of Sri Lanka have entered into a tri-partite memorandum of understanding on risk-based consolidated supervision where the Central Bank will be the lead regulator.

With the increased risk in cyber security, changes will be introduced to the regulatory and supervisory framework in line with international standards and best practices. The proposed regulations will prompt banks to upgrade and strengthen their information systems and related technological platforms. The Central Bank has also issued a road map to banks to improve technology risk resilience with a timeline for implementation in 2019 and 2020. Further, a consultation paper on technology risk resilience has also been issued to banks for comments and observations.

The banking sector is expected to increase access financing with a view to enhancing inclusion and supporting economic activities throughout the country. The CBSL, is seeking to promote this through digital initiatives such as mobile/phone banking and internet banking with the increased usage of Information Technology as a service delivery channel. This will need to be complemented by preventive measures to strengthen information security management of all systems related aspects.  

Large commercial banks will be encouraged to look into avenues of regional expansion, which will lead to an increase in the geographical reach of the local banking sector. Hence, close interactions will be maintained with other regional regulators with a view to enhancing information sharing among regulators and cross-border supervision.

The combination of regulatory efforts to strengthen the capital and liquidity levels of banks, the expected improvements in risk management and corporate governance and more stable macroeconomic fundamentals, are expected to enhance the resilience of the banking sector in the medium term.

In conclusion, we should continuously work together for the sustainable development of the sector and the region. It is in this context, we hope that this forum would help the industry participants to understand the future evolution of the banking and non-banking sector and the evolving strategies for reaping maximum benefits from the changing landscape in banking and financial services.

Dr Indrajit Coomaraswamy, Governor of the Central Bank in Sri Lanka, delivered this keynote speech at The Asian Banker Finance Sri Lanka Conference on 5 September 2019.

 

 



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