Sri Lanka-Monetary Process

The Central Bank of Sri Lanka, which started operations in 1950, stood at the apex of the country's financial framework in 1988. The bank administered the exchange control system, implemented monetary policy, and regulated the money supply through such means as open market transactions, interest rate changes, and changes in the minimum reserve requirements of the commercial banks.

The private sector relied almost entirely on the banks for credit. In early 1988, the commercial banking system consisted of twenty-six banks: six Sri Lankan banks and twenty-two foreign banks. Two of the Sri Lankan banks--the Bank of Ceylon and the People's Bank--were state banks. These institutions dominated commercial banking, holding nearly 80 percent of total deposits. The profitability of these banks, like that of many other state enterprises, had been hindered by politicians using them to secure employment for their supporters. Recovering loans due from public corporations has also been a problem for these banks.

The four private Sri Lankan banks in 1988 were the Hatton National Bank, the Commercial Bank of Ceylon, the Investment and Credit Bank, and the Agro-Commercial Bank. The last two of these banks began operations in 1987, the first local banks founded after the liberalization of the economy in 1977.

Until 1979 the presence of foreign banks consisted of three British banks (Grindlays Bank, Chartered Bank, and the Bank of Hong Kong and Shanghai), three Indian banks (State Bank of India, Indian Bank, and Indian Overseas Bank), and one Pakistani bank (Habib Bank). In 1979, for the first time in many years, foreign banks were allowed to open branches, and many American and European institutions took advantage of this policy. Newcomers included the Bank of Credit and Commerce International, Banque Indosuez, Citibank, American Express, Overseas Trust Bank, Bank of Oman, Bank of America, European Asian Bank, Algemene Bank Nederland, Chase Manhattan, Amsterdam Rotterdam Bank, Bank of the Middle East, and Bankers' Trust Company. The initial capital requirement, which had been set at Rs10 million in 1979, was increased in 1982 to Rs50 million. The Bank of America ended its activities in Sri Lanka at the end of 1986.

Although the arrival of foreign banks increased the level of competition and led to new facilities, the overall impact on the credit supply remained marginal in early 1988. Credit to the rural sector and small firms was still tight and was channeled mainly by the two state banks.

Interest rate policy in the 1980s encouraged high rates in order to combat inflation and encourage a higher flow of savings to bridge the gap between new investment and total domestic savings. At the end of 1986, treasury bills paid 11 percent and interbank loans cost between 12 percent and 12.75 percent. Loans and bank overdrafts were charged between 12 and 30 percent.

The Central Bank announced a deposit insurance program for small depositors in June 1987, but none of the commercial banks had joined at the end of the year. Only deposits of private individuals up to a value of Rs100,000 could be insured. Government, interbank, and local government deposits were not eligible. Banks that joined would pay four Sri Lankan cents for every Rs100 to the Central Bank. The Central Bank hopes that the confidence created by the program will offset the extra costs to the banks.

In late 1987, the Central Bank offered the commercial banks a number of incentives to join the insurance scheme, including lowering their reserve requirement to a flat rate of 10 percent. In 1987 the ratio was 18 percent on checking account deposits, 14 percent on fixed-term deposits, and 10 percent on other deposits.

The stock market, which was established in December 1985, was a minor source of capital. At the end of 1986, it quoted 173 companies having a total market capitalization of around Rs14 billion. Share transactions averaged Rs2.5 million a week. In 1987 legislation established a securities council to regulate the stock exchange. The proposed council was to be empowered to grant licenses to stockbrokers, set up a fund to compensate investors who suffered losses resulting from the failure of a licensed dealer to meet contractual obligations, and suspend or cancel the trading of securities for the protection of investors. The intent of this legislation was to create confidence in the stock market in the hope that it would attract more investors.

Data as of October 1988