Financial Regulator’s Dilemma Amidst Persistent Fragilities

Addressing the Seventh Asian Monetary Policy Forum, Chief Economist of the International Monetary Fund (IMF) Gita Gopinath stated that the world economic growth trajectory was on a shrinking trend. It will very likely be worse than what we had projected, she said. While most of the economies are focusing on re-opening, there have been reports regarding a possible second wave of the COVID-19 pandemic as well. The adverse impacts this can have on economic resilience does not require elaboration. The novel corona epidemic generated exceptional challenges which required exceptional solutions. Financial regulators have come up with very flexible macroprudential support to address acute market stress during the pandemic. In keeping with such international policy measures, the Central Bank of Sri Lanka (CBSL) also introduced extraordinary regulatory measures to provide relief to pandemic-affected individuals and businesses. Accordingly, Domestic Systemically Important Banks (D-SIBs) and non-D-SIBs were allowed to draw-down their Capital Conservation Buffers by 100 bps and 50 bps, respectively, to facilitate uninterrupted credit flows to the economy.The CBSL also withdrew the requirement to classify all credit facilities extended to a single borrower as non-performing when the aggregate amount of all outstanding non-performing loans granted to such borrower exceed 30% of total credit facilities.Sri Lanka’s business sector has been facing extreme challenges as the pre-Covid-19 economy also carried dark spots which have now been compounded. The tourism and travel industries were severely affected by the Easter Sunday bombing which occurred, in April 2019, and all businesses, in general, were affected by the pre-election political uncertainty which emerged towards the latter part of 2019. The banking sector was required to assist such businesses by providing debt moratoria and other relief packages introduced by the authorities during 2019 and in the beginning of 2020. The COVID-19 pandemic added new challenges for the country’s business sectors which were already vulnerable. In response, new debt repayment deferral policies were introduced to alleviate cash flow pressures on businesses and households. All such persistent fragilities in the economy and uncertainty about an end date of the health crisis have put severe strains on the financial system. The CBSL, as the prime regulator of the financial system, has a crucial task to ensure banks keep credit flowing to the real economy while preserving the safety and soundness of individual institutions and the entire system. However, the regulator alone cannot prepare the financial system and the economy to withstand the unfolding of a crisis of unprecedented scale. The purpose of this article is to invite the attention of all the stakeholder authorities to focus on the need for policy measures to be formulated to strike a delicate balance between the positive countercyclical role of financial intermediation during a time of an unprecedented crisis and the need to preserve the resilience of the financial system.