Standard Chartered’s Optimism Amidst a Credit Crunch

NEW REGULATIONS AND TAXES ARE ERODING BANK PROFITS ALREADY HIT BY LOW CREDIT GROWTH. HOWEVER, STANDARD CHARTERED'S CHIEF EXECUTIVE BINGUMAL THEWARATHANTHRI SEES GROWTH STEMMING FROM OVERSEAS VENTURES OF SRI LANKAN FIRMS AND CHINA’S BELT & ROAD INITIATIVE

Bingumal Thewarathanthri, chief executive of Standard Chartered Sri Lanka, is optimistic about the banking industry’s prospects, despite profits taking a hit due to a sluggish economy, life-sapping taxation policy and burdensome regulations. Thewarathanthri was appointed as the first Sri Lankan chief executive at global bank Standard Chartered’s Sri Lankan unit in January 2019. Standard Chartered Sri Lanka does not publish separate accounts. However, Thewarathanthri said profits of the local unit grew 3% in 2018, with net interest incomes growing nearly 5%. The banking group’s global assets amounted to $709 billion at end-March 2019, up 3% from a year earlier. Its loan book was valued at $325 billion and worldwide deposit base at $410 billion. In the March quarter, the bank made a profit of $818 million, up 2% from a year earlier. Return on equity was 8.5%, up from 7.6% from a year earlier, while net interest margins were 1.56%.

In Sri Lanka, Thewarathanthri’s challenges are unique. “There’s a misconception that banks make a lot of money, so we see new taxes imposed on the industry. Returns on equity are declining at most Sri Lankan banks,” he said. Banks are chasing after cheap capital and funding for better liquidity cover ratios under Basel III regulations, while IFRS 9 has brought in tighter controls on expected credit losses and higher provisioning for bad loans. These regulations are impacting bottomlines, the economic slowdown erodes margins and non-performing loans rise.

“If things continue as they are, banking returns may not be lucrative,” Thewarathanthri says. However, he is optimistic about Sri Lanka’s prospects, provided it’s able to capture Asia’s growth wave, especially capitalizing opportunities from China’s Belt and Road Initiative.

Asia generated 68% of Standard Chartered group’s income of $3.8 billion in the March 2019 quarter. Its banking business across Asia has declined around 3%, while growing 4% in Africa and the Middle East. However, Europe and the Americas saw a 19% decline in the March quarter, contributing just 14% to Standard Chartered’s group topline. According to Thewarathanthri, the banking group’s Sri Lankan unit is seeing growth partly because its Sri Lankan corporate clients are venturing into Asia and Africa.

Excerpts from an interview are as follows:

How did the bank perform last year, and what were the impacts of Basel III and IFRS 9?
The bank delivered strong results in 2018 despite a challenging second half. Usually, the second half of any given year is better – after the many holidays in the first half. The bank was doing really well until the sudden political fiasco in October, which led to a constitutional crisis. On top of that, the overall banking sector’s non-performing loans increased last year. At Standard Chartered Sri Lanka, we recorded year-on-year profit growth of 2%, and income growth of 3% was supported by strong balance sheet growth. Our liabilities, which include deposits, grew 27% and the loan book increased 33%.

Our net interest income only grew by 4.7% due to narrowing margins. Most banks offered high interest rates to attract deposits to manage regulatory liquidity coverage ratios under Basel III. Competition for deposits was intense

Our net interest income only grew by 4.7% due to narrowing margins. Most banks offered high interest rates to attract deposits to manage regulatory liquidity coverage ratios under Basel III. Competition for deposits was intense. We managed to maintain a liquidity coverage ratio of 200%, whereas the statutory requirement was just 100%. But we didn’t want to lose market share, so we raised deposit rates, which resulted in a less profitable net interest income growth compared to the balance sheet. New IFRS 9 rules around non-performing loans required higher provisioning, which impacted the entire banking industry. We provided Rs375 million as a transitional provision. Businesses were also affected by the economic slowdown, which affected loan recovery and non-performing loans. Retail lending also took a hit due to the downturn amid some job losses and higher employee income taxes. From a non-performing loans perspective, 2018 was the worst year since 2009. However, our balance sheet and credit to the private sector grew. During 2018’s first half, credit grew 16%. This growth was unsustainable, as GDP was growing at 3.2%.

Our lending business has three components: global subsidiaries, which includes global corporates of Sri Lankan origin and multinationals; commercial banking; and retail banking. Retail banking also includes small and medium businesses. We have different strategies to grow each of these segments. Our global subsidiaries business was mostly unaffected by macroeconomic conditions. We have seen investments picking up from China and Japan. The Hambantota Port- and Colombo Port City-related investments came through us. Japan has several significant investments planned as well. Investments from European multinationals won’t see much growth as they focus on expansion in other regions.

In commercial banking, we will see a slowdown in credit to construction and tourism. We see growth in FMCG (fast moving consumer goods), apparel and other export businesses. These sectors are growing because our clients are expanding overseas. Energy is also an emerging sector we see developing in Africa. Apparel is an essential segment for us, but the number of clients is limited. Small and medium enterprises will be challenging, particularly those exposed to the tourism sector after the unfortunate Easter Sunday attacks. The Central Bank has instructed banks to offer various concessions, which we are working on. Overall, commercial banking is changing in Sri Lanka. We now see an emerging corporate sector outside the business capital in places like Galle, Kandy and Kurunegala.

Banks are challenged to raise capital to be compliant with Basel III requirements. Is this true for Standard Chartered?
We generate our own capital from retained earnings. I don’t recall a day where Standard Chartered Sri Lanka needed a capital infusion from the parent bank. Our capital ratios are maintained well above regulatory requirements. We’re not a large bank compared to others in the Sri Lankan market, but being a part of a global banking group, we have access to ample liquidity and cheap capital. This is why our work is different from local banks. We add value to Sri Lankan businesses by giving them access to these funds. We’ve been in this market for more than 150 years, and we have the appetite for large transactions beyond our balance sheet in Sri Lanka.

What is your outlook for the banking sector?
There’s a misconception that banks make a lot of money, so we see new taxes imposed on us. Returns on equity are declining in most Sri Lankan banks. Basel III has made things more challenging. Banks are chasing cheap capital and funding for better liquidity cover ratios, so deposit rates have increased. The Central Bank has capped deposit rates so that small and medium businesses, in turn, are not burdened by high interest rates. Also, IFRS 9 has introduced tighter controls on expected credit losses and higher provisioning for bad loans, which impact bottomlines further. If things continue as they are, banking returns may not be lucrative.

There’s a misconception that banks make a lot of money, so we see new taxes imposed on the industry. Returns on equity are declining at most Sri Lankan banks. Banks are chasing cheap capital and funding for better liquidity cover ratios, so deposit rates have increased

Banks have a few options to manage the impact of expected losses due to IFRS 9. They can maintain the loan book at the same level and improve loan repayment collections, or grow the loan book and collections. The right thing to do is to keep the loan book steady and improve recoveries. This can be done by avoiding credit losses by lending more to the economy’s growth sectors. We have brought in some controls to challenged segments like construction and have taken steps to improve loan recovery.

What is the outlook for real estate?
I think we still have room to grow. That is my view. There will be a slowdown in condo sales. There is also a lack of appetite for lending to these kinds of projects. I don’t think prices have fallen. Some of the large projects have a niche clientele both here and overseas, so demand will be healthy.

Standard Chartered has funneled considerable investments into the Colombo Port project. How is that project doing?
The Belt and Road Initiative will cover 65 countries across three continents (Asia, Africa and Europe) with related infrastructure investment estimated at $26 trillion by 2030. Chinese global trade crossed the $1 trillion mark in 2017. Since 2013, China has been involved in over 2,700 infrastructure projects, investing over $70 billion. This presents a vast opportunity for Sri Lanka, especially with the development of the Colombo Port City. Sri Lanka has the potential to be a hub for the region. It can attract global firms’ regional headquarters here and establish centres for procurement, re-invoicing and international arbitration. Sri Lanka can also serve as a maritime hub and International Financial Centre (IFC). These are some opportunities.

Initially, we will see Chinese businesses investing here. We can attract investments from other countries if we have trade treaties and investment promotion and protection agreements, or IPPs because they will want to access China’s multi-country Belt and Road economic zone. Investors won’t arrive just because we have new land. Chinese businesses are sure to invest, but we need to make a compelling case to attract investments from India, Europe, the US or elsewhere. For Port City to succeed, we need to create the necessary framework for an International Financial Centre and attract global companies to set up hub operations here.

Bilateral treaties play a significant role in attracting investment. Vietnam has done this successfully. Around 23% of its exports are Samsung devices. Land-locked Ethiopia attracted $3.75 billion in FDI because of its trade treaties. Sri Lanka has an opportunity. The world’s wealth is shifting from the West to the East. Asia accounts for 60% of global growth—China alone accounts for 30%—and for the first time in history, will be home to half of the world’s middle-income households. Sri Lanka will miss out on this growth opportunity if we continue to rely on traditional exports. We need to raise our game. We need to open up.

To achieve regional hub status, Sri Lanka needs a significant improvement in the ease of doing business. We need policy consistency and an investor-friendly environment. Port, airport and inland transport and logistics infrastructure need improvement. Exchange controls must be relaxed, and tax concessions are required for firms setting up hub operations here. Sri Lanka needs a multi-skilled workforce and bilateral agreements with extensive trading and investment partner countries.

What’s the outlook for the global economy, and the impact on countries like Sri Lanka?
Brexit and China-US trade tensions continue to grab headlines, and they are a cause for concern. The UK and EU parliaments are yet to finalise a deal, so there is considerable uncertainty. Just when everyone thought the trade war was easing, the US hiked taxes on Chinese imports up to 25%. This will impact 40% of Chinese exports. Countries like Malaysia, Vietnam and Mexico will gain from this, as will Sri Lanka, but our exposure is small. That is a positive for us, but the negative sentiment over China-US trade tensions is much larger. The US Fed is now more dovish. This is good news for emerging markets, which are seeing an inflow of funds. Sri Lanka’s recent bond issue is a good example; it was oversubscribed. With all these problems, we are holding on to our reserves position.

To achieve regional hub status, Sri Lanka needs a significant improvement in the ease of doing business. We need policy consistency and an investor-friendly environment. Port, airport and inland transport and logistics infrastructure need improvement

What is your outlook for the exchange rate?
Interestingly, we are holding on; it has depreciated a little bit since Easter to about Rs177/USD levels, but it had fallen to around Rs180/USD in December 2018; so the rupee has appreciated from that perspective. Fortunately for us, oil has hit the Goldilocks-pricing of $70 a barrel right now. If it stays below $70 with continuous controls on imports, exchange rates will be stable. I also believe interest rates will taper down, supporting the growth agenda for industries.