High government taxes and the high interest rate regime are discouraging banks from taking on a greater role in the country s economy.
The 35 percent Corporation Tax and 20 percent Financial Value Added Tax (FVAT) are making it difficult for banks to build their balance sheets because post tax profits are further eroded to pay dividends to shareholders.Banks are finding it difficult to grow their balance sheets and maintain capital in accordance with BASEL II. Unless they can retain profits for this purpose they will have to build up Tier II capital which is through debentures etc.
But the current interest rate regime is such that it is too expensive for banks to raise capital that way.
High interest rates are unfavourable to a developing economy such ours as banks tend to be much more cautious when granting loans, resulting in the crowding out of private sector investment.
`Policy rates in Sri Lanka are the highest in the region and therefore bank rates are relatively higher than the rest of the region. The Central Bank tells us that are margins are too high. But it is necessary for banks to maintain these margins otherwise we will not be able to maintain capital requirements while being profitable at the same time,` a top banker said.
Another problem is that by being cautious banks cannot optimise their contribution to the economy because they are mindful that high interest rates translate to a higher number of defaults on loan repayments. Banks need to maintain healthy levels of profits so that shareholders get a satisfactory return on their investments but most importantly, banks will be able to expand their services by investing in new branches, technology and people.
The constant struggle many financial managers go through is to balance the interests of the business as a going concern, which means that profits must be ploughed back to create reserves for future investments, and the interest of shareholders who want a generous cut from the profits by way of dividend payments.
Financial officers of banks not only have to manage to bring about a balance to these two conflicting goals, but have to deal with minimum capital and reserve requirements issued by the regulator to safe guard depositors while balancing its assets (loans) with its liabilities (deposits) to optimise returns. The Central Bank has raised policy rates in a bid to curtail inflation but its policies are not consistent, economists say.
The Banks Association of Sri Lanka said that the matter of high taxes had been taken up with the Treasury on several occasions only to be told that the government is need of revenue.
`We took the matter up again during the last budget and the Treasury said that while taxes will not be increased, it would not be reduced either. We now hear that an amendment to the Inland Revenue Act is being mooted to change the computation of the FVAT and that banks may end up having to pay extra,` Upali De Silva, General Secretary of the Banks Association told the Island Financial Review.
De Silva said that banks presently paid up to 55 percent, while smaller banks paid as much as 65 percent, of their profits by way of corporate tax and FVAT.The FVAT is calculated on staff costs so smaller banks with smaller profits end up paying a higher proportion of their profits because staff costs are likewise proportionally higher than that of bigger banks, De Silva explained.
`The taxes are a killer and banks cannot maintain normal business activities while having to maintain minimal capital and reserve requirements unless the costs are passed down to the customers and this has directly resulted in the increase of interest rates,` De Silva said.