The Sri Lankan authorities have sought technical assistance from the International Monetary Fund (IMF) towards setting up a Special Purpose Vehicle (SPV) by the end of this year, to resuscitate weak finance companies, the Staff Report released by the IMF revealed last week. The report, prepared for the 2016 Article IV Consultation and request for a three-year extended arrangement under the Extended Fund Facility (EFF), notes that although the island’s authorities have viewed the financial system as robust and well capitalized, they have highlighted that existing weaknesses in the financial system are mostly in the non-bank financial sector.

“Some finance companies (comprising 16 per cent of the non-banking sector) need to replenish capital, although the size of capital injection needs would be limited because the total assets of these companies are about 1 per cent of GDP. The authorities reiterated their commitment to finalizing a resolution framework for weak finance companies—through establishment of a special purpose vehicle—by the end of this year, and are seeking support of IMF technical assistance in this area,” the 120 page report, which included the Staff Statement updating information on recent developments noted.
The report said the Central Bank of Sri Lanka is also assessing the possibility of introducing fit and proper assessments for owners of finance companies, and requirements on the Basel III capital standard are expected to be introduced in the first half of 2016 in line with the international timeline.

“Staff concurred with the authorities that continued efforts are needed to strengthen the legal framework for crisis preparedness and resolution. The Fund will work to provide technical assistance in support of ongoing work towards a resolution framework to deal with finance companies which are insolvent or currently operating below the regulatory minimum capital adequacy requirement (which could be done through an establishment of a special purpose vehicle—as suggested in the 2016 Budget),” the statement said.
The IMF has said that while the financial system appears well capitalized and liquid, the authorities should remain vigilant to the risk of a potential rise in Non-Performing Loans (NPL). The IMF said financial soundness indicators for the fourth quarter of 2015 were generally favorable with capital adequacy comfortably above regulatory limits while the asset quality of state banks appears broadly sound, with most of the loans to state enterprises guaranteed by the government amounting to 18 percent of total loans of state banks.

“However, in the absence of a clear and consistent government policy with respect to non-commercial operations of state enterprises (such as subsidies—which frequently end up as SOE debt to state banks), close scrutiny of these banks and stress testing which includes an emphasis on contingent liability risk is recommended,” the IMF said.