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Jegan Durairatnam is CEO of Commercial Bank of Ceylon, Sri Lanka’s largest private sector bank and the country's longstanding recipient of FinanceAsia's Best Bank award in our annual Country Awards for Achievement.
Durairatnam has spent nearly his entire career at Commercial Bank. In a wide-ranging interview, he discusses the country's high hopes for economic development as it emerges from a balance of payments crisis resulting from the high debt levels incurred by the government of Mahinda Rajapaksa, who was unexpectedly voted out of office at the end of 2014.
A new coalition government consolidated power following parliamentary elections in the summer of 2015 and has unveiled ambitious plans to develop a megapolis around Colombo.
Its latest budget focuses heavily on revenue increasing measures as part of an International Monetary Fund plan to get the country's finances back on track.
FA: One of the most controversial aspects of the November 10th budget was the government’s proposed financial transactions tax. There seems to be some confusion about what this will actually encompass. What’s your read?
Durairatnam: My understanding is it will cover all Real Time Gross Settlement (RTGS) transactions. The government says they’re hoping to collect about Rs8 billion ($52.7 million) to Rs10 billion, which is almost one third of the banking sector’s tax take.
On a gross level it’s about Rs40 billion to Rs45 billion. But the government has said it will be tax deductible so the net amount will be about Rs8 billion to Rs10 billion.
And you’re happy to pay it?
Well the government needs the money and we empathise with that position. But unfortunately they’re only looking at the banking sector’s profits and not the large amount of capital we need to employ to do business.
We’re also transitioning to Basel III, which means the sector will need even more capital.
When’s full implementation?
2018, but we have to have to do the calculations from 2017. At the moment, we still don’t know what kind of counter cyclical buffers will be needed. That’s being evaluated right now.
It’s also important to remember that we’re an emerging market country so we need a substantial capital buffer to get reasonable terms in the international markets. For example, for a 5% Tier 1 ratio, foreign banks would only look at domestic banks with 10% plus ratio.
We’ve just done a domestic Tier 2 deal. We’re diversifying our capital so it’s not just Tier 1. Tier 2 has risen from 12.5% to 14%, while Tier 1 stands at 11.5%.
Are you interested in doing a US dollar-denominated Basel-III deal?
No, we’d rather raise the money in rupees. One of our biggest strength is the fact we have the largest foreign currency balance sheet here.
It’s more than 25% so we don’t have a foreign currency requirement as such. Most of our lending is in rupees.
The government rowed back on some of its proposals in last year’s budget. Do you think they’ll do the same with the financial transactions tax?
I hope so. It would have been much cleaner if they’d raised corporate tax levels instead.
Another thing the government is failing to realise is that we’re on the cusp of digitisation and any levies the government puts on that will simply push people back into cash again. That’s the biggest danger with this levy.
What was your overall view of the budget?
We think the government finally got it right in terms of what needs to be done regarding fiscal consolidation, cutting unnecessary expenditure and raising revenue. At long last, we have a government, which is talking about what needs to be done. That’s a good sign, particularly for foreign investors.
But the government only really has two more years doesn’t it? Then there will be pressure for giveaways as the next election cycle looms.
I don’t agree. If the populace sees there’s been a reasonable level of development and an increase in their livelihoods, particularly in terms of job creation, then they’ll vote for them even in times of hardship.
One of the first things the government did when it took office was rationalise the rice subsidy. That was a taboo subject before.
But they took the hard decision and faced off against massive protests. Now the subsidy is under control and everyone is very happy. That’s a tremendous plus for this government.
A lot of people seem to be complaining the government hasn’t built anything yet. Even some of [former president Mahinda] Rajapaksa’s critics say that at least he got things done.
Well the last government was in power for one-and-a-half decades. The new government has only had one year. We need to give them a little time. But the initial chaos from the transition has gone and things are settling down. That’s the key thing.
The projects the government wants to execute are reasonably well defined. Now it’s a question of funding and starting them. I’m very optimistic.
What’s your view on the $1.5 billion Chinese port city development and wider Megapolis, which will cover a large part of the Western region where Colombo is based?
The concept has been evolving and we’ve heard various theories about what will happen there. But the government has appointed the right people to set the policies.
They’ve brought in officials from the Dubai International Financial Centre and The Qatar Financial Centre to advise them. I think it will be very successful.
Do you think we’ll see anything concrete within the next four years when the government’s term is up?
Yes the legislation and policies will be in place by then. Commercial Bank will certainly be taking part.
We’ll fund projects there and it will be a great opportunity for us to grow.
Will that financing differ from what’s come before?
Yes there will be structural differences. For a start, most of the funding will be in foreign currencies. Banks will not be able to rely on deposits alone to make loans.
So where will the money come from?
There’s enough capacity in the capital markets. At the moment we’re looking at our loan to deposit ratio.
We have access to long-term funds so there won’t be a mismatch. The International Finance Corporation (IFC) took a stake a few years ago and also has a seat on our board.
Overall what do you think the government needs to do to make sure Sri Lanka can fulfill its development potential?
We’d like to see a consistent policy framework before projects start. The government has been bringing in the right experts to advice on this. We’d also like a one-stop shop to streamline the process.
One of the best things the government is doing is to re-vamp exchange controls. The prime minister has promised to introduce legislation by early next year.
What difference will this make?
It will make a huge difference because foreign exchange management will be rationalised. We’re currently dealing with guidelines, which are 20 to 25 years old in some cases.
They have no basis in today’s reality. Fortunately, the government realizes this.
It will also make sure it puts the necessary safeguards in place for a third world country to prevent capital flight. It’s absolutely necessary as a next step to drive investment into this country. At the moment domestic companies need approval to take money out for capital purposes.
Can you give some examples of how the current legislation is hindering FDI?
A foreign investor cannot invest in a Board of Investment (BOI) company via an SIA account for instance. It’s an anomaly foreign investors aren’t used to.
There’s also a lot of ambiguity surrounding the regulations, which isn’t good. As a foreign investor one of the first things you want to clarify is how straightforward and transparent the process is. You need a set of regulations you can read and clearly understand. That doesn’t exist at the moment.
Overhauling the exchange control regulations and passing a new foreign exchange management act will completely change the FDI dynamics in this country.
Can Sri Lanka achieve the GDP rates it did immediately after the end of the Civil War?
In the current climate, 4% to 5% growth is a given. But 6% would be good, as it would take us out of the middle-income trap in about two years.
It’s realistic target if the government can keep expenditure down and manage the fiscal side.
What sectors will drive that higher growth?
Education is a very important one. At the moment too many people spend a lot of money sending their children overseas for their education.
We need to set up good universities here. They will contribute to our growth.
Hospitals will be important too. They’re just starting to grow outside of Colombo.
And finally, Business Processing Centres are growing exponentially. I don’t mean call centres, as Sri Lanka has peaked demographically, but higher end services such as accountancy, legal services, filing services etc.
One change we need to see is for job seekers to stop looking for employment in banks or government the whole time. Unfortunately, the government pays too much so the private sector finds it hard to compete. That needs to change.
So what do you think Sri Lanka will look like in 10 years time?
It will have just come out of the middle-income trap and be poised to take on its big neighbours. We will be India’s Hong Kong.
What about China? Won’t the country be creating a lot of jobs here?
Yes but India is much closer and a better alternative for us. I’m not sure how much sense it makes for us to manufacture goods for China from here, or whether the Chinese will still be here in 25 years.
But there are a lot of things Sri Lanka can do to service India. The latter imports various components that could actually be assembled here if companies feel there’s less bureaucracy than their homeland.
What short-term challenges does the banking sector face here?
There’s a problem with liquidity. Smaller banks are offering deposit rates far in excess of lending rates and that’s why net interest margins are stressed. This won’t change in the short-term, but it will over the medium term.
The government is also trying to curb private sector credit growth. It is slowly dropping because of a fall in private sector consumption. We reigned in our level from 26% last year to 18% this year. That’s a sustainable level.
Earlier you mentioned digitisation. How automated are you?
Branch automation is really taking off and it’s about 30% to 35% right now. We saw a big shift about a year ago, when we introduced the first cash deposit machines. We’ve always been big in ATM’s, but we still had substantial crowds coming into branches.
We knew people would take cash out of a machine, but we didn’t think they would put money in one. But when they saw their accounts were being credited instantaneously, their attitude changed.
Having said that, I don’t think Sri Lanka will go cashless anytime soon. What we’ve seen is a slow acceptance about using a machine rather than going to a counter.
As Sri Lanka starts to present more of an international face, do you want to expand overseas more as well?
We still think there’s plenty of room to grow here, but we want to keep the balance between our domestic and international assets. Our international assets are about 12% of the total and we’d like to take that level to 15%.
International growth doesn’t come easy so when you see an opportunity you need to take it. We’re always on the look out, but that doesn’t mean we’ll just go into a country and start operations there.
We also have a subsidiary in the Maldives and a rep office in Myanmar.
We have also just opened a remittance office in Italy and would like to open some more across Europe such as France.
It took us four years to convince the Bank of Italy that our anti-money-laundering regulations and such were in order. There are 160,000 Sri Lankans working in Italy and all their money was being remitted via unreliable sources.
The Sri Lankan government asked us if we could do something about it. It was very difficult to check the source of funds, so we thought we should sort the problem out at source and open up ourselves.
Your biggest overseas operations are in Bangladesh. Do you want to expand further there?
Ye we have 18 branches. We got a good buy. Credit Agricole was selling out and it was a neat small business.
A lot of Sri Lankans are employed in the Bangladeshi garment industry. Many factories employ them as managers so our expansion there makes sense from a cultural perspective.
Most of the other banks handle MNCs and top corporates. We see a substantial level of high end SME’s, which are evolving. We think there’s enormous scope there and we’re just starting to explore that as well.
You also mentioned Myanmar.
That’s still in a research phase really. We’re not very sure of the legislation there yet, but we do see a niche in the low-end SME segment.
All the other foreign banks seem to be targeting micro loans or high-end corporates. But I’d say 90% of the business here is low-end SME. That’s why we’ve gone there.
Are you still taking market share from the state-owned banks?
Yes all the time. But the public banks have got their act together. They’re reasonably strong and very competitive.
Our market share is currently 13% and will continue increasing. We’re winning new business and continuing to take market share in the SME segment.
The big banks have tended to neglect the SME’s, whereas it’s an area where we’ve always been strong. This is a sector, which doesn’t just grow overnight. It doesn’t easily move on rate hikes, but is based on loyalty and trust.
There’s a learning curve servicing SME’s and we’ve done already. We pivoted towards them about 10 years ago and we’re now bigger than the state-owned banks in this area. It’s very satisfying.
