By Athapaththu M

By
Athapaththu M.A.S.R.
176004E

FOB/2 Sem Year-2017
Content page

1. Introduction ……………………………………………………………. 1
2. Components of the financial system in Sri Lanka……………………… 2 – 4
2.1. Financial institutions ……………………………………………… 2 – 4
2.2. Financial instruments …………………………………………… 4 – 5
2.3. Financial markets ………………………………………………. 5 – 9
2.4. Financial infrastructures ………………………………………… 9 – 10
2.5. Supervisory and regulatory agencies ……………………………. 10
3. Central Bank role in managing Sri Lankan financial system …………… 11
4. International and domestic development affecting financial stability …12 – 13
4.1. International development affecting financial stability………………. 12
4.2. Domestic development affecting financial stability ……………… 12 – 13
5. Financial issues and challenges …………………………………………14 – 15
6. Financial sector development stability ……………………………….…. 16
7. Conclusion …………………………………………………………… …. 17
8. Reference ………………………………………………………………… 18
Tables
1. Licensed commercial banks ……………………………………………….…. 9
2. Licensed specialized Banks …………………………………………………… 10
3. Loan schemes …………………………………………………………………. 14

Executive summary

A stable financial system is an essential element in an economy. Having a stable system encourages smooth flow of funds between the surplus and deficit parties. Basic components of the financial system include, financial markets, financial instruments, financial infrastructure, Financial Institutions and supervisory and regulatory authorities. All these components of the financial system are inter-related and inter-connected to facilitate this mobilization of funds between parties. Fund mobilization is essential to promote investment and financing activities of the firm.

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1. Introduction
Money was found by people for doing easily their economic dealings. With the expansion of the currency, individuals were able to get the value for their products in cash, to collect money, to succeed their various needs effectively by using money. With time, an institution system pervaded all over the world to collect money and pay money to other persons and institutions as needs of proprietor of money. Therefore, people who live in a country can reserve earned money through the collection of money and payment settlement system. Such a complex and well-structured corporate framework can be found in every country in the world. It is called “Financial System” in that country.
The financial intermediation is the most important task of a financial system. In the current world, the financial intermediation as well as the payment and settlement process are conducted by banks and the various financial institutions. Today, a regular and legal regulatory system with institutional framework can be seen almost everywhere in the world.
In this report, I mention about financial system in Sri Lanka. Under this I report about the components of the financial system, role of the central bank, financial stability and development, and financial system issues and challengers.
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2. Components of the financial system in Sri Lanka

There are five components of the financial system in the Sri Lanka. They are,
1. Financial institutions
2. Financial instruments
3. Financial markets
4. Financial infrastructures
5. Supervisory and regulatory agencies
2.1. Financial institutions
The extra ordinary funds are taken owned institutions and individuals across the financial system by institutions which is financial intermediaries. Then they supply to the investors who expect to allocate for effective investing ways.
The financial system of Sri Lanka consists of four major financial institutions.
I. Banking sector
II. Other financial institutions which take deposit
III. Other specialized financial institutions
IV. Contractual savings institutions

2.1.1. Banking sector
There are three main institutions in banking sector of financial system in Sri Lanka.
I. Central bank of Sri Lanka
Central bank is the institution that carries the pivotal role of the financial system in Sri Lanka. It was established in 1950 as an independent institution by the monetary law act no 58 of 1949.
II. Licensed commercial banks
No Commercial Bank Name
01
02
03
04
05
06
07
08
09
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Amana Bank PLC
Axis Bank Ltd
Bank of Ceylon
Cargill’s Bank
Citibank, N.A.
Commercial Bank of Ceylon PLC
Deutsche Bank AG
DFCC Bank PLC
Habib Bank Ltd
Hatton National Bank PLC
ICICI Bank Ltd
Indian Bank
Indian Overseas Bank
MCB Bank Ltd
National Development Bank PLC
National Trust Bank PLC
Pan Asia Banking Corporation PLC
People’s Bank
Public Bank Berhad
Sampath Bank PLC
Seylan Bank PLC
Standard Chartered Bank
State Bank of India
The Hong Kong & Shanghai Banking
Union Bank of Colombo PLC
Licensed commercial banks is an institution which maintaining the current accounts, savings account and time deposits of other institutions and acting as a foreign exchange trader. There are 25 commercial banks in Sri Lanka under the CBSL.

Table 1

III. Licensed specialized Banks
No Licensed specialized bank
1
2
3
4
5
6
7 Housing Development Finance
Lankaputhra Development Bank Ltd
National Savings Bank
Regional Development Bank
Sanasa Development Bank PLC
Sri Lanka Savings Bank Ltd
State Mortgage & Investment Bank
These banks are not following-on current accounts. There are 7 banks under the licensed specialized banks.

Table 2

2.1.2. Other financial institutions which take deposit
I. Licensed financial companies
The primary activity of the finance company is to provide/lend money to the deficit parties. Such that they extend credit to individuals for various consumer purchases, as well as to corporates for commercial use. However, they do not maintain current and savings accounts. These companies are only authorized to accept time deposits and lend, invest such money. Example: hire purchase, leasing and real estate business. Finance companies are registered and supervised by the CBSL under the Finance Companies Act.
At present, there are 46 licensed finance companies operating in Sri Lanka.

II. Co-operative rural bank
III. Thrift and credit co-operative societies

2.1.3. Other specialized financial institutions
I. Specialized finance institutions
II. Primary dealers
III. Stock brokers
IV. Venture capital companies
V. Unit trust
VI. Credit rating agencies

2.1.4. Contractual savings institutions
I. Insurance company
II. EPF
III. ETF
IV. Approved private provident fund
V. Non-Government provident fund

2.2. Financial instruments
Financial instruments are any kind of negotiable asset that can be identified by financial factors. This instruments are legitimate. Financial instruments can be categorized as money market instruments and capital market instruments.

I. Treasury bills
The CBSL public debt department issues treasury bills on behalf of the government of Sri Lanka for its short term financial needs.

II. Repurchase (Repo) / Reverse repurchase (Reverse repo)
This is an agreement between the two parties where, one party sell the security/ securities for cash to another party with the agreement of buying the same or similar securities back at a fixed price on a specified future date.

III. Commercial papers
These securities are normally issued by high credit rated and well established corporates with additional bank guarantees of payment.

IV. Fixed deposits
V. Banker Acceptance
VI. Shares
VII. Corporate bond / debentures
VIII. Unit trust
2.3. Financial Markets
Financial markets are places where the buyers and sellers are going to share assets like equities, bonds and currencies. Financial market is the market about credit and capital. Financial markets can be mentioned as follows;
1. Money market vs capital market
2. Primary market vs secondary market
3. Debt market vs equity market
2.3.1. Money market vs capital market
We are categorized as being based on the security period of securities. The government, banks and private companies are the main issuers and the insurance companies, banks and pension and provident funds are the main investors in booth markets.
2.3.1.1. Money market
The money market is the market for short term interest earning assets with less maturity one year. The main task is the facilitating the management of liquidity in the economy. Treasury bills, repurchase (Repo), reverse-repurchase agreement, commercial paper, fixed deposits and banker acceptances are the instruments in money market. The money market segments are directly affected to the CBSL policy rate decisions. It is included the sub markets. They are,
1. Inter-bank call money market
This is a money market for days. Mainly, this will help to manage liquidity requirements of commercial banks by providing purchases and sales among the banks. The fluctuations of the inter-bank call money rates are not favorable in the standing rate corridor (SRC).
Standing deposit facility rate (SDFR) and standing lending facility rate (SLFR) are the main policy rates in the standing rate corridor. The money market will be remained stable by managing the liquidity market by changing this two interest rates by the CBSL.
According to the annual report in 2017, SDFR is increased 7.0% to 7.25% and SLFR is increased 8.50% to 8.75% from 2016 to 2017.
2. Treasury bill market
Variations of interest rate in the treasury bill market give a foundation for short term market interest rates. Therefore, changing the volumes and interest rates in the treasury bill market is affecting on expenditure, profitability and liquidity of financial institutions.
3. Commercial paper market
This market has established for buying and selling the commercial papers. When paying, Commercial papers are issued with high rates by additional bail institutions and with higher ranking.
4. Inter-bank foreign exchange market
This market helps to manage foreign exchange liquidity in the banking system through the exchange of money. There are two main task in this market.
1. Exchanging the currency units in one country to currency units in other countries.
2. Helping to minimize the risk of foreign currency exchange through the use of various derived equipment.
2.3.1.2. Capital market
The capital market that is engaged in providing long term funding. Treasury bonds, corporate bonds, equities, Sri Lankan development bonds, unit trust and fixed deposits are the instruments in capital market.
1. Treasury bond market – The government of Sri Lanka is issuing treasury bonds as a mid and long term when it is necessary to increase local government debt on budgetary needs.
2. Corporate bond market

2.3.2. Primary market vs secondary market
It is categorized as being based on market levels.
Primary market is the new releases of shares and debt securities. We can get direct cash from this. Because there is a direct cash flow method.
Example: A company is issuing the shares to public in first time.
Secondary market is the re-traded of shares and debt securities which already issued. We cannot get direct cash from this. Because there is an indirect cash flow method.
Example: issuing the shares of Colombo stock exchange.

2.3.3. Debt market vs equity market
Debt market is the market which purchasing and selling debt securities. There are two main sub markets under this.
1. Government securities market – Treasury bills and bonds
2. Private debt securities market – Commercial papers, private bonds and debentures
Many other markets, as well as the functioning of the equity market is very sensitive to the political and peaceful environment. Market activity depends on the fixed basis and profit of the major institutions. The effect of financial system stability over stock market activity is relatively low due to less exposure the investments and debts of financial institutions to equity market.
2.4. Financial infrastructure
Financial infrastructure plays a major role in the financial system. This is also named as payment and settlement system. We can categorize to following method of financial infrastructure.
I. Systemically important payment systems (SIPS)
i. Real time gross settlement system
ii. Scrip less securities settlement system (SSSS) and Scrip less securities depository system (SSDS)
II. Retail payment system
i. Cheque imaging and truncation system (CITS)
ii. Sri Lanka interbank payment system
iii. US Dollar cheque clearing system
iv. Sri Lanka interbank US dollar on-line payment system
v. Common electronic fund transfers switch (CEFTS)
III. Payment cards and mobile payment systems
IV. Other payment and settlement infrastructures
i. Equities trading system and debt securities trading system
ii. Common ATM switch
iii. Shared ATM switch

2.5. Supervisory and regulatory agencies
There are supervisory and regulatory agencies to supervise and control the all components of the financial system. These agencies maintain the financial stability and smooth flow of fund in economy.
I. Central bank of Sri Lanka (CBSL)
II. Securities and Exchange commission (SEC)
III. Insurance Board of Sri Lanka (IBSL)
IV. Colombo Stock Exchange (CSE)
V. Co-operate department and department of pension funds

3. Central Bank role in managing Sri Lankan financial system

Central bank is the back bone in our economy. It plays a major role in financial system in Sri Lanka. The CBSL manages the Sri Lankan financial system through the following functions.

I. Core functions
i. Maintaining economic and price stability
Monetary policy is managed to maintain the economic and price stability by CBSL. The central bank interest rate, statutory reserve ratio and open market activities are used as an instruments of managing money supply and cash basis.

ii. Maintaining financial system stability
In this, CBSL maintain a strong financial institution in the internal and external shocks. For this, they manage the weaknesses of the banking system, monitor the financial institutions and regulate and manage foreign exchange.

II. Subsequent function for core function
i. Issuing and managing the currency
According to the monetary law act, the currency authority of issuing currency in Sri Lanka is owned by the CBSL. The basis for the issuance of currency is to meet the transaction requirements of each value.

III. Agency function
i. Managing the provident fund
The responsibility of the central bank is to raise funds and surcharge collection, member accounts maintenance, surplus funds investing, charging interest to member accounts and paying funds to beneficiaries.

ii. Managing the foreign exchange
The central bank involves the foreign exchange market in order to prevent the fluctuation of exchange rates and to maintain foreign reserves in a healthy level.

iii. Managing the government debt
iv. Supervising financial intelligence
v. Supervising regional offices
vi. Regional development

4. International and domestic development affecting financial stability

International and domestic developments are directly dominating to the financial stability in Sri Lankan economy.

4.1. International development affecting financial stability
According to the world economic outlook which published by the international monetary fund. The growth of world output and outlook for growth was further divergent. The world output has increased from 3.2% to 3.8% in 2016 to 2017. In 2017 the global economy recorded a high growth rate of 2/3 comparatively 2016. Although the global economic development overall as a whole was solid in 2017, the developed countries had to use a looser monetary policy continuously because inflation was low.
Sri Lanka’s economic growth was slower than the normal growth rates of emerging markets in 2017 and it dropped below the estimated global economic growth.

4.2. Domestic development affecting financial stability
By means of favorable macroeconomic policies, the contribution of the private sector is predicted to increase gradually over the medium term, with an increase in economic growth. In 2017, Sri Lanka’s economy continued to grow at a low level. The annual real GDP growth is expected to increase gradually to 6% by 2022. Sri Lanka’s economic growth strategy is to develop Sri Lanka as a regional hub as a social market economy. A number of important projects such as Port City Development Project, Municipal Project and Economic Zones projects are being implemented. In the Regional Development Department provide a number of additional services to provide various refinancing, interest subsidy and debt guarantee schemes.

Source of funding Name of the loan scheme
Funds of Sri Lankan government – Micro finance loan project for poverty reduction
– Micro finance loan project for poverty reduction part II
– “Swashakthi” loan project
– “Athwela” loan project (scheme for rehabilitation of damaged economic activities)
– Self-employment promotion loan scheme part II
– Tea development project (TDP)
– New comprehensive rural loan scheme
– Working capital loan scheme for tea industry (WCLSTF)
Funds of CBSL – ‘Subhagya’ loan scheme
– Large scale milk product development loan scheme (CSDDLS)
Transferred funds – National agro business development project (micro finance loan scheme)
– Youth diriya loan scheme (National agro business development project)
– Loan scheme for out growers (National agro business development project)
– Project to re-energize economic activities after disasters
Table 3

Source: CBSL annual report 2017

5. Financial issues and challenges

Here you can see the following issues and challengers that emerged in accessing Sri Lanka to a high growth path.

I. Agriculture policy has a lack of attention to empower farmers for commercially variable activities.
They are not paying much attention to agriculture sector. Therefore, farmers should be encouraged to increase the scale economies. Improving the financial availability in the agriculture sector and improving the agricultural supply network for local and international market access.

II. Shortcomings of the structural organization of the plantation industry and the practices of weak agro management of enterprise level.
Re-cultivation, high labor cost, reduced product quality, pesticide threats, low quality imported seeds, fertilizer use and uninterrupted support of an institution are some issues of this. When we consider the tea industry, reduction of focus on innovation and lack of necessary changes as a result of weakness in productivity I the international market.

II. Failure to develop in industry sectors by means of high investment for infrastructure development.
Industries cannot attract the infrastructure underprivileged and infrastructure is in the interest of attracting the private sector investment.

III. Policy issues regarding the contribution of the labor market to the growth process with the effort of a middle income economy, although low in unemployment.

6. Financial sector development stability

The stability of the financial system is the ability to stand out for internal and external shock in an economic, financial, political and any other field. Here are some of the significance of the financial stability.
I. Providing a favorable environment for depositors and investors.
II. Conductive to effective financial intervention and effective market impact.
III. To promote investments and contribute to economic growth.

7. Conclusion

We can get a good understanding financial system in Sri Lanka thorough this report. We could know about what is the financial system? What are the components of financial system in Sri Lanka? What is the role of managing Sri Lankan financial system by Central Bank? How is affecting the international and domestic developments to financial stability? What are the issues and challengers in financial system? And what is the financial sector development stability?
According to the facts of this report, a strong and stable financial system is needed for the economy. Financial components are main roles of financial system. After that I have mentioned the aspects of managing financial system by CBSL. The central bank is the main controller in our country. Then I have reported about global and domestic developments. In this part, I have described world economy outlook and situations of Sri Lankan economy. After that I have analyzed issues and challengers in financial system. In that, I have pointed not only issues but also solutions are here. Final is about financial stability.