This research investigated the amendments that took place in the banking regulation of Sri Lanka due to the current financial crisis. The consequence of the crisis has been felt differently by many regions. Many developed countries have felt the impact tremendously while developing countries has felt it less significantly. Hence this research will provide an inside view of how the current financial crisis has affected banks around the world ,and specifically how it has affected developing countries like Sri Lanka.There has been many changes in banking regulations around the world in order to minimise the effect and to avoid any further crisis in the future.
The current financial crisis originated as a result of the subprime mortgage crisis, occurred in mid 2007. This was due to the bursting of the US Housing Bubble and high default rates on "Sub Prime Mortgages", which took place in beginning of 2006. According to Shiller (2008), current crisis is the result of a speculative bubble in housing market that began in United States in 2006 and has now caused a burst across many other countries in the form of financial failures and global credit crisis. Most economists' opinion is that the fundamental cause of the credit crisis is macroeconomic imbalance, in the form of large surpluses and Deficits in the current accounts of the balance of payments of many countries (Brunnermeier, 2009).
The major cause for current financial crisis was the reckless providing of loans by financial institutions, particularly to the housing sector, without proper supervision, and the resulting eventual bankruptcy of financial institutions. In other words, this is a crisis that had been caused by the grant of loans to "bad creditors", considering them as "good creditors". The subprime mortgage crisis became more evident during 2007 and 2008, and has now resulted in narrowed liquidity in the global credit markets and banking system. (Cabraal, 2008)
The first signs of an impending credit crisis were observed during the first half of 2007; with an increase in the rate of US subprime mortgage market, reductions in the Prices of mortgage-backed securities, and increases in the cost of insuring these securities against default.
Reduced rates in many securities were announced by several credit ratings agencies in June and July 2007, and Liquidity in the market for short-term asset backed commercial paper started to shrink (OECD, 2008).
The liquidity crises ascended in August 2007, when the LIBOR increased significantly, and the interbank markets effectively became dysfunctional. The European Central Bank and the US Federal Reserve responded immediately By injecting 95 billion euro and $24 billion of credit respectively into the interbank markets.(Goodstadt,2009)
The first UK victim of the crisis was Northern Rock, which published that it had received emergency financial support from the Bank of England, having been unable to refinance itself in the interbank markets. Over the next few days, £1billion was withdrawn from Northern Rock's high street branches, in what was the first bank Run in the UK for over a century. To make the situation calm, on 17 September 2007 the UK Government announced a full guarantee of depositors' savings. Underlying causes of the Northern Rock failure included over-aggressive growth in mortgage lending, and overdependence on short-term wholesale funding (Llewellyn, 2007; Treasury, 2008).
The UK banking system steered the rest of 2007 without enduring any further disastrous events, but in the middle of growing concerns over the extent of write-downs of non-performing loans and securitized assets. UK authorities reinforced the deposit guarantee scheme On 1 October 2007, by eliminating a provision whereby deposits between £2,000 and £35,000were only 90% guaranteed, which had contributed to the loss of depositor confidence in Northern Rock (Treasury, 2008).
In Iceland, banking system almost collapsed where the economy was very dependent on the finance sector. The government had to borrow from the IMF and other neighbours to try and rescue the economy. Eventually, public dissatisfaction at the way the government was handling the crisis meant the Iceland government fell. (Shah, 2010)
Russia's economy also had a dreadful impact from the crisis. One of Russia's key exports, oil, was a reason for a recent boom, but falling prices have had a big impact and investors are withdrawing from the country.(shah,2010)
Sri Lanka has only a minor relationship with the financial institutions that got into difficulties. Because of this reason, there is no significant direct impact on Sri Lankan economy .besides, the change of economic policy of the present government, which has given pride of place to the domestic economy, has also prevented any kind of large scale impact, arising from the international crisis. The Central Bank has been highly concerned about the adverse implications that would arise due to any disruptive lending by banks (CBSL, 2010).
With a gradual decline in demand in developed countries for imports from developing countries, Signs of global economic crisis were evident from early 2008. This happened at a time when oil and food prices were increasing. Normally a foreign exchange crisis apparent at a time, however sri lanka did not encounter this in the first half of 2008 due to favourable prices for leading exports like tea and rubber, increase in remittances with oil boom led prosperity in middle east .also commercial borrowing of US$ 500mn.in September by the government, and inflow of foreign funds to purchase treasury bonds and bills by foreigners (Cabraal, 2008)
As per the Central bank of Sri Lanka (2010), it directed all the banks to make a general provision of 1 per cent on performing loans and advances, in November 2006 and increased the Risk Weight applicable for Housing Loans from 0% to 55% in November 2006. Moreover Central bank imposed a limit on commercial banks' borrowing from abroad to 15 per cent of their capital. In addition, it took measures to formalize and strengthen the banking supervision activities and to educate the banks on the management of risks. Internationally, the Central Bank invested its external reserves with highly rated international banks, with foreign Central Banks, and thereby ensured the 100 per cent security and safety of its own reserves.
Banking crises are a periodic phenomenon in the history of international finance. Bank crisis Management comprises an array of official and private responses that extends beyond the insolvency proceedings that are the only tool typically available to deal with corporate bankruptcy in other industries (Lastra 2008). Banking regulation is essentially justified by the necessity of providing a safety net for the protection of depositors from the risk of bank failures. (Darbellay 2008)
The IMF's Global Financial Stability Report of April, 2006 stated that 'the dispersion of credit risk by banks to a broader and more diverse set of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient'.
Many banks around the world have restructured their regulation due to the crisis. Several international organisations have claimed a decisive role in financial regulation. The European Commission has submitted a package of proposals on bank solvency, capital requirements, deposit guarantees, accounting credit-rating agencies, hedge funds and executive pay.(Vaubel 2006)
As per the Central Bank of Ceylon (2007), the financial system of the country is regulated by several legislative enactments. The key Acts relevant to the regulatory role of the Central Bank are the Monetary Law Act No. 58 of 1949, the Local Treasury Bills Ordinance No. 8 of 1923, Registered Stocks and Securities Ordinance No. 7 of 1937, Exchange Control Act No. 24 of 1953, Banking Act No 30 of 1988, Finance Companies Act No. 78 of 1988, Finance Leasing Act No.56 of 2000, Payment and Settlement Systems Act No 28 of 2005and Financial Transactions Reporting Act No. 6 of 2006. The Central Bank was given wide powers to administer and regulate the entire money, banking and credit system of the country. The Central Bank was also given the sole right and authority to issue currency and it also became the custodian of the international reserves of the country. (CBSL, 2010)
One of the core objectives of the Central Bank is to maintain financial system stability. The Central Bank discharges this role by establishing the required legal framework, regulating and supervising key categories of financial institutions, maintaining stability in key financial markets, overseeing the payments and settlements system, acting as lender of last resort and by regular surveillance of the entire financial system, including insurance and stock market activities. Therefore, this research was mainly based on these regulations published by central bank of Sri Lanka. Apart from that, the latest newspaper articles and journals were used to get an in-depth idea about the issue (CBSL, 2010).
The research was done using qualitative research method. As per the QSR international (2007) Qualitative, research is used to gain insight into people's attitudes, behaviours, value systems, concerns, motivations, aspirations, culture or lifestyles. It is used to inform business decisions, policy formation, communication and research. Focus groups, in-depth interviews, content analysis, ethnography, Evaluation and semiotics are among the many formal approaches that are used. The research was mainly done using content analysis of reports and regulations published by central bank of Sri Lanka. According to Shortell(2006) Content Analysis is used by researches to investigate the content of the Mass Media. In other words, it is used to explore the content of various media in order to discover how particular issues are presented.
RATIONAL FOR THE STUDY
This research investigated changes that have occurred in Sri Lankan banking regulations as a safeguard to minimise the effect of current crisis and in order to avoid crisis in the future.
This research was based on all the state banks and prominent commercial banks, which operate in Sri Lanka. Specifically in Peoples bank, Bank of Ceylon, Commercial bank, Sampath bank and Hatton National Bank. All of them are regulated by central bank of Sri Lanka. Therefore, all the banking regulations were formulated by the central bank of Sri Lanka. The Central Bank of Sri Lanka was established in 1950 under the Monetary Law Act No 58 of 1949 and is the apex institution in the financial sector.
Since inception, the Central Bank has been responsible for regulating the financial system of the country. Several key legislative enactments provide powers to the Central Bank to carry out its functions to achieve its primary objectives of economic and price stability and financial system stability. Under these powers, the Central Bank issues directions for the establishment and operations of all categories of financial institutions under its supervisory and regulatory purview. In addition, the Central Bank has been empowered to carry out certain agency functions under other legislative enactments (CBSL, 2010).
This research was conducted using information from central bank and this research will look at following research questions.
How did current financial crisis affect banking sector in Sri Lanka and in to what extent?
What has taken place as a result of current crisis in Sri Lankan banks?
What measures have been taken by Sri Lankan banks to survive in crisis?
What action has been taken by regulatory bodies for sri Lankan banks
What changes has occurred due to this crisis?
How has they helped to reduce the affect of the crisis?
1.3 OVERALL RESEARCH AIM AND INDIVIDUAL RESEARCH OBJECTIVES
The aim of the research is to identify what changes has taken place in banking regulations in Sri Lanka as a consequence of current financial crisis. The research was conducted in order to find the solutions for the above researchable questions. Therefore the research objectives were;
Identifying how the current financial crisis affect banking sector in Sri Lanka.
Explore what has taken place as a result of current crisis in Sri Lankan banking industry.
Identify the measures that have been taken by Sri Lankan banks to survive in crisis.
Identifying actions that have been taken by regulatory bodies and central bank of Sri Lanka.
Explore the changes in regulations that took place as a result of the crisis.
Assess how effective those regulations have been up to now.
VALUE OF THIS RESEARCH
Very few researches has been done on sri Lankan banking regulations and hardly anybody has researched on changes in banking regulations in sri lanka due to current financial crisis. This research will benefit potential researchers who are interested in the baking regulations in Sri Lanka.
The outcome of this research was to identify the changes that have taken place in Sri Lankan banking regulations as an effect of current financial crisis. It also gives an improved understanding of how the current crisis has affected the banking industry in world. The author investigated how different countries were affected by the crisis. Study shows how the crisis has affected banking industry in Sri Lanka. Furthermore it will provide an in depth awareness about what has been the reasons for how it has affected countries in different ways. It identified how the financial systems of are interlined which will result in failure in one may influence others.
This will explore what safety measures that have been taken by Sri Lankan banks in order to minimise the effects of the current crisis. What situations have taken place as a result of the crisis and in to what extend it has affected the banks in Sri Lanka.
1.5 CHAPTER OUTLINE AND STRUCTURE
Chapter 1 - Introduction:
This chapter provides an overview of the research topic and significance associated with the subject matter under consideration. The author also provides rational and aims and objectives of the research along with a brief outline of overall dissertation structure and its content.
Chapter 2 - Literature Review:
A literature review provides an overview of the relevant and significant literature on a research area. It reviews the critical points of current knowledge on a particular topic .It is usually limited to a particular timeframe, and should include a description, summary and critical evaluation of the materials presented (UCD, 2010)
The purpose of a literature review is to demonstrate the ability to identify the relevant information and outline existing knowledge; identify the "gap" in the research that the work will address; produce a rationale or justification for the study.
The purpose of this chapter is to provide a comprehensive understanding of arguments pertaining to the research area. This chapter would provide an in-depth review of literature, with relevance to underlying research objectives. Theoretical framework, which constitutes basis of the research topic, will also be explored in this chapter.
Chapter 3 - Research Methodology:
Research Methodology may be a description of process, or may be expanded to include a philosophically coherent collection of theories, concepts or ideas as they relate to a particular discipline or field of inquiry. It can also refer to nothing more than a simple set of methods or procedures, or it may refer to the rationale and the philosophical assumptions that underlie a particular study relative to the scientific method. For example, scholarly literature often includes a section on the methodology of the researchers (Answers, 2010).
Detail on research methods and methodology employed to meet the research objectives was provided in this chapter. It will also provide justification for research methods used and critically evaluate their potential in achieving the research objectives. The chapter further discusses limitations and ethical issues pertaining to the research.
Chapter 4 - Findings, Analysis and discussion
This chapter describes the case study based upon the methodology discussed in methodology chapter. This provides an in-depth analysis of results produced from data collected through primary and secondary sources. In this chapter, research findings are interpreted in conjunction with the theoretical framework mentioned in literature review and research methodology.
Chapter 5 - Synthesis, conclusion and implications
This chapter provides the conclusion and implications of the research. Chapter 5 will be concluding chapter, where the comparison of the results of the research with the findings of analogous studies will be conducted.
This chapter has presented the background and the underlying principle of the research. Additionally, aims and objectives of the research were recognized. In addition, the limitations of the whole study will be identified and discussed. The results of the research will be evaluated for the validity, reliability .One more aim of this chapter is to identify possible areas for further research. Finally, overall conclusions of the research will be made.
The next chapter will be the literature review, which provides an overview of the relevant and significant literature on a research area.
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