The Global Economy

Overall, the global economy shifted into a lower gear throughout 2013, driven by new forces and threatened by persistent risks. The focal point of the year’s story continued to be China and other Emerging Market Economies (EMEs), which, while not seeing the elevated growth of recent years, continued to lead the way globally. Their performance is projected to remain higher than the advanced economies in the coming year.

The United States, the traditional driver of the world economy, experienced modest growth over the past year, fuelled by solid private demand. While Japan’s economy has seen a vigorous rebound, its growth is expected to slowdown in 2014 by the country’s tightened fiscal policy. In Europe, the member states of the Euro area have begun to climb out of recession, but while the threat of a contraction is declining, the overall economic forecast is tepid.

Since 2010, the growth rates of EMEs and other developing countries were down about 3%, with significant slowdowns in Brazil, China, India and Russia. Southeast Asia experienced economic turbulence, notably in the form of high inflation. India in particular saw its growth forecasts downgraded by the International Monetary Fund and World Bank due to high and persistent inflation, heavy capital outflows and the sharply devalued Rupee.

 

World Economic Outlook

			Projections
	2012	2013	2014
	%	%	%
World Output	3.1	3.0	3.7
Advanced Economies	1.4	1.3	2.2
United States	2.8	1.9	2.8
Euro Area	-0.7	-0.4	1.0
Japan	1.4	1.7	1.7
United Kingdom	0.3	1.7	2.4
Emerging and Developing Economies	4.9	4.7	5.1
Developing Asia	6.4	6.5	6.7
China	7.7	7.7	7.5
India	3.2	4.4	5.4

Source: IMF

 

The Global Banking Industry

The banking industry worldwide is being radically transformed by regulatory change in the wake of the global financial crisis. Most banks are restructuring to reduce complexity and meet new oversight requirements. As part of this simplification process, many institutions are dropping some product lines and even withdrawing from entire markets. To manage costs, many are exploring the possibility
of sharing selected back-office functions.

Further, Banks in emerging markets face unique challenges. Rather than scaling back, they must gear up, reforming structures and key functions to better meet the needs of customers who have recently experienced substantial growth - and to prepare for the next wave of expansion.

Looking Beyond Banks

Rapid change in the banking industry is leaving many business leaders scratching their heads, wondering how their organisations should cope with the paradigm shift. Some are looking beyond banks for banking services. A number of retailing, technology and telecommunications enterprises are drawing on their vast customer bases and transactional expertise to expand banking and payment services.

Source: World Bank (Financial Inclusion)

 

Recovering Financial Health

A recovering economy requires healthy banks. However, five years after the onset of the global financial crisis, the financial positions of key players in various banking systems worldwide are at different stages of recuperation. US banks have recovered the furthest, while some European institutions have a long way to go.

Banks in the periphery of the Euro area are particularly challenged as they cope with significant structural issues, increased funding costs, deteriorating asset quality and weak profitability. Although, other European banks are less pressured, they must continue the process of lowering risk and debt levels to be effective in advancing the economic recovery.

 

Smarter, Simpler, Better Focused

While large institutions continue to play a dominant role in the global banking system, markets and regulators are forcing banks to become smaller, simpler and more focused on servicing their home territories. Many are repairing the liabilities side of their Balance Sheets by reducing the use of wholesale, short-term and cross-border funding.

Outside Europe, banks are experiencing similar pressure to change their business models with the goal of improving profitability. Such change does not come without risks to financial stability. There is a growing need to monitor the challenges posed by cross-border expansion, increased concentration in some markets and the shift of certain financial intermediation activities from the banking to the non-banking sector.

 

The Sri Lankan Economy

The Sri Lankan economy continues on its steady upward path, growing at an average annual rate of 7.5% in each of the past three years. Overall GDP is estimated to have grown by 7.2% in 2013, with expansion in the industry, services and agricultural sectors tracking at an estimated 9.2%, 6.7% and 4.1% respectively.

Strong performance in the industry and service sectors was given a boost by a number of factors, notably increased domestic demand and normalisation of the Sri Lankan economy, continued infrastructure development, increased private investments, the revival of the tourist industry, the removal of the ceiling on credit expansion and lowered interest rates.

Expenditure on private consumption - which accounts for 70% of GDP - remained as the principal engine of economic expansion, fuelled by rising incomes combined with higher remittances from Sri Lankans working abroad.

 

Exchange Rate

Over the past year, stability was maintained in the foreign exchange market with the substantial increase in inflows including increased flow of capital into the banking sector.

Many trading nations that compete with Sri Lanka experienced currency depreciation in 2013, posing a challenge to our country’s exporters. The Sri Lankan Rupee (LKR) depreciated approximately 2.34% against the US $ (USD) in 2013, compared to a 12.28% depreciation in 2012. The Rupee also depreciated against the Euro by 6.8% and the Sterling Pound by 4.7% during 2013.

 

Foreign Funds

Foreign direct investment increased in Sri Lanka by 42% during the first nine months of 2013, compared to the same period in 2012. Capital inflows to Licensed Commercial Banks (LCBs) and Licensed Specialised Banks (LSBs) amounted to US $ 1,548.3 Mn. in 2013; bond issuances by LSBs accounted for US $ 850 Mn. of this amount.

Sri Lanka’s gross official reserves amounted to US $ 7.2 Bn. by the end of the year - which was equivalent to 4.5 months of imports.

 

Inflation

Inflation as measured by the Colombo Consumers’ Price Index (CCPI) declined during 2013. Softer international commodity prices and improved domestic supply helped to contain the rate of inflation.

Interest Rates

Overall, there was downward movement in Treasury yield rates, as well as lending and deposit rates of major commercial banks. The prime lending rate declined from a peak of 14.4% in early March 2013 to 9.88% by the end of December - a reduction of 452 basis points.

As interest rates have declined, industrial enterprises have increasingly raised funds from the corporate debt market. In 2013, funds raised through debentures amounted to Rs. 68.3 Bn., compared to Rs. 12.5 Bn. in 2012. Both financial and non-financial institutions raised funds through listed debentures during the year.

 

Funds Raised Through Listed Debentures

Delivery channels	2013 Rs. Bn.	2012 Rs. Bn.
Banks
Licensed Commercial Banks	33.4	12.5
Licensed Specialised Banks	2.0	–
Licensed Finance Companies	21.9	–
Non-Financial Institutions	11.0	–
Total	68.3	12.5

Source: CSE

From January to September 2013, the amount of credit extended to Government, corporations and the private sector showed an overall decline. However, the private sector reversed this trend during October and November with a modest increase in assumed credit. An anticipated reduction in interest rates through 2014 should help further to boost private sector credit growth.

 

The Share Market

Mirroring the macro-economic conditions prevailing in the country, the Sri Lankan bourse experienced mixed results in 2013. Even so, net foreign investments in the market amounted to US $ 264 Mn. in 2013. Market capitalisation increased to Rs. 2.5 Tn. by the end of 2013 compared to Rs. 2.2 Tn. in 2012.

The Banking Sector

In 2013, the banking sector expanded both in business volumes and points of contact in the communities it serves.

Delivery channels	2013 (Sep.)	2012 (Dec.)
Branches (No.)	3,426	3,359
Other outlets (No.)	3,031	3,031
ATMs (No.)	2,496	2,415

Source: CBSL

The funding structure of the Sri Lankan banking sector also experienced a positive change, with the recent orientation towards local debt and equity markets and foreign borrowing.

On the strength of its balance sheets, the banking sector raised US $ 1,548.3 Mn. in 2013 through foreign borrowings, compared to US $ 973 Mn. raised in the year before.

 

Funds Raised by the Banking Sector

Original Maturity	US $ Mn.	% of Total
1 year	89.30	5.80
5 years	1,350.00	87.20
7 years	10.00	0.60
10 years	99.00	6.40
Total	1,548.30	100.00

Strong capitalisation and liquidity preserved the stability of the banking sector throughout the year.

The banking industry experienced a general deterioration in asset quality throughout 2013, reflecting banks’ operational challenges and the delayed effects of rapid lending from years before. The surge in non-performing loans (NPLs) from gold-backed borrowing (pawning) caused the sharp overall
rise in NPLs in 2013.

Alongside, rising NPLs and higher provisioning requirements have adversely affected capital positions of banks. Relying mostly on retained earnings, the equity of banks is unlikely to increase unless domestic equity markets rebound to support capital-raising initiatives.

The funding of Sri Lankan banks will continue to depend largely on their deposits. Lower demand for loans provided some respite for the sector’s loans-to-deposits ratio, which nevertheless remains relatively high at 82%.

Key Performance Trends of the Banking Industry

Sri Lankan banks’ payment and settlement systems were expanded and strengthened over the past year. Customers saw lower transaction costs with efficiencies resulting from the transition to a common ATM platform in July 2013. They gained added payment-card security with the introduction of line-encryption technology for Point-of-Service (POS) terminals.

New Banking-Related Legislation/Policies Adopted in 2013
Strengthened banks’ Internal Capital Adequacy Assessment Processes and Risk Management Frameworks.	Issued Directions on implementing the Supervisory Review Process for banks in accordance with Pillar 2 of the Basel II Capital Accord.
Streamlined regulations governing the banking sector’s exposure on the stock market.	Issued Directions to better protect customers and shareholders from risk associated on exposure to stock market.
Brought greater transparency to disclosure requirements.	Prescribed formats for the preparation and publication of Interim and Annual Financial Statements.
Reduced interest rates on loans and advances in line with the low rates prevailing in Sri Lanka and other peer and emerging economies.	The maximum interest rate was prescribed at 24% p.a., and the maximum penal interest rate at 2% p.a. above the applicable rate.
Liberalised the foreign borrowings of licensed banks.	Exemptions were granted for foreign borrowings by LCBs of up to US $ 50 Mn. per transaction through 2013 to 2015.

 

The Bangladesh Economy

Commercial Bank operates a fully fledged branch network in Bangladesh. A reasonable share of our income is generated from that operation. Therefore, to bring the entire operations of the Bank into correct perspective, it is pertinent to review the macroeconomic environment of Bangladesh in order to gauge the success of that operation.

Bangladesh’s rapidly developing market-based economy has grown at an average annual rate of 6.7% over the past several years. In the 2011-2012 fiscal year, the country’s per capita income climbed to US $ 1,044. The past year saw a great deal of political and social turmoil, including a war-crime tribunal and a general election boycotted by the opposition. The political environment was unstable later in the year
by a series of protests, strikes and blockades.

 

Striving for Stability

Despite its political troubles, Bangladesh managed to maintain a Ba3- stable rating from Moody’s and a BB- sovereign rating from Standard & Poor’s for the fourth consecutive year, indicating some confidence in the country’s continued economic stability.

Political unrest, combined with other internal and external factors, undermined the target of 7% annual GDP growth set by the Government at the beginning of the year. The IMF forecasted that the growth rate would in fact be less than 6% for the first time in the past five years. The service, industry and agriculture sectors contributed 50%, 30% and 20% respectively to overall GDP.

Bangladesh realised significant growth in its international reserves during the fiscal year, exceeding
US $ 18 Bn. in December 2013 for the first time its history. This growth was well-supported by expanding exports and declining imports, along with the healthy flow of remittances from abroad. Against the US $, the national currency appreciated 2.6% from the beginning of the year, mainly due to a positive current account balance and all-time high international reserves.

 

Inflation

The inflation rate in Bangladesh has been declining since February 2012. The last reading, released in September 2013, was a moderate 7.13%.

The inter-bank call money rate declined from 20% recorded in January 2012 to 7.25% in December 2013.

 

The Path Ahead

The Bangladesh Government has identified a number of macro-economic targets for the year ahead. These include GDP growth of 7.2%, an inflation rate below 7%, exports growth of 15%, imports growth at a steady 10% and remittance growth of 15%.