Macroeconomic instability, low growth rates and tightening regulations are making it even more challenging for banks to sustain profits and growth. Competition for banks in the future are no longer from within the industry, but from outsiders, with the likes of telcos, fintechs and IT companies attempting to take slivers of this lucrative business. Facing these challenges head-on are Nandika Buddhipala, Chief Financial Officer of Commercial Bank, and Dilshan Rodrigo, Chief Operating Officer of Hatton National Bank (HNB), both ACCA members at the forefront of driving corporate policy in their workplaces.
Buddhipala worked at a leadingtelco for over a decade and Rodrigo at leading apparel exporting company Brandix before joining their respective banks. Here, they discuss the challenges facing the banking industry and their roles in transforming their banks to become future-ready.
What is the biggest challenge facing Sri Lanka’s banking sector?
Buddhipala: Sri Lankan banks have never been highly leveraged. We have been able to maintain a comparatively sustainable level of capital in relation to assets portfolios, and as a result, banks here are spared the pains of global financial crises.
The prevailing low interest rate regime, resulting in thin net interest margins and lower profitability, will impact capital structures. Adding to this conundrum, since most Sri Lankan companies are not rated, banks are required to make full capital allocations when lending to them. For banks to be more profitable, we need to lend more, and we are constrained here since Sri Lanka has only a handful of listed companies with good ratings. Irrespective of all these constraints, banks still enjoy a strong and solid presence in the country’s corporate sector. Growth can come from lending to small and medium enterprises (SMEs).
At Commercial Bank, we invest in nurturing SMEs, which account for a significant proportion of our lending. Commercial Bank’s present capital structure will serve the bank well in the medium term, but beyond that, the economy must grow to support capital accumulation. Last year, overall lending growth of the banking sector was more than 20%, but can this be sustained with the economy growing in the 5-6% range? We inherit low gross domestic savings as a percentage of GDP, which can lead to liquidity issues in the banking sector if significant lending growth persists. Therefore, liquidity management also plays a significant role in the banking sector.
Rodrigo: Banking is changing. Banks will need to go through a paradigm shift to be relevant in the future. Today, there is no longer the need for anyone to walk into a branch to do banking. Mobile devices and digital platforms keep banks open 24/7 for people to access services at their convenience.
This is the future of banking. Sri Lankan banks are organised in the traditional brick-and-mortar model. In the past, we took pride in extensive branch networks and staff servicing customers on various dimensions. All this is changing. Banks will have to significantly reorganise themselves to stay in business in the digital age.
[pullquote]“For banks to be more profitable, we need to lend more. Banks still enjoy a strong and solid presence in the country’s corporate sector. Growth can come by lending to small and medium enterprises (SMEs).”
Nandika Buddhipala[/pullquote]
At HNB, we are preparing for this change. We took a bold decision three years back to freeze entry level recruitments and branch expansion. We are centralising all our back office operations, revisiting business processes, introducing automation, reengineering processes, and making life easy for customers by making forms simpler and the customer interface easier. Our customer service units will be more marketing oriented; we are basically reorganising the bank around the needs of our customers.
If banks don’t do this, we will find other non-bank digital financial services providers like telcos, online payment companies (like Paypal) and fintechs taking business away from us. We need to transform ourselves for the future; this is the change I am trying to drive.
Going ahead as regulations tighten, it is going to be costly for banks to lend, as for each rupee lent, another rupee has to be set aside as capital. How is Commercial Bank preparing for this challenge?
Buddhipala: Commercial Bank has always been conscious about costs and we have one of the best cost-to-income ratios in the country. The bank’s early investment in technology is now bearing fruit, with our ATM and debit card networks bringing in considerable cost savings. We took steps to rationalise our branch network years ago by introducing a supermarket bank branch model and adopting technology early – bold steps for a bank at the time. We have a target-oriented culture that is driving performance from top to bottom. We continue to invest in digital banking, which will ensure profitability and survival going forward, but the returns may not be immediate. Before joining the bank, I worked for a telco for 14 years, where the challenge was how to maximise returns from heavy investments on technology that changed quite fast.
This is the same concern for the bank, but the investments will translate into significant savings in years to come. In the long run, investments in the digital space will bring down the cost structure, further improving the cost-to-income ratio and ultimately enhancing not only profitability, but customer convenience, which is a priority.
This will help us allocate capital much more efficiently and maintain adequate capital buffers to finance lending in the future.
HNB’s entry into digital banking is fairly recent. How has the journey been so far?
Rodrigo: We have an exciting digital banking product pipeline over the next few years. You cannot go halfway with digital. There must not be any hesitation, because then you lose momentum. So we put a lot of effort to make sure the staff embrace digital before our customers, reorganise processes and invest in digital infrastructure. HNB is going through a culture change, and managing this is tough but it must be done.
Impetus came for me because of my experience outside banking. I worked for leading apparel export company Brandix before joining HNB. Brandix faced a similar dilemma when it realised it needed to transition from a basic cut-and-sew manufacturer to a value-added manufacturer taking ownership for most aspects of the value chain. This called for radical changes, but it had to be done if the company wanted to survive. Earlier, we had a turnaround time of eight months from design to delivery. Our buyers wanted it brought down to three months – a daunting task for Brandix, but we embraced the challenge. With the assistance of global consultants, we mapped the entire production process, identified redundant processes and introduced new ones, while investing heavily on technology. We did some big changes and reaped massive benefits. A sampling function that earlier took three months out of the eight-month turnaround now takes two weeks, and this helped Brandix retain and secure new global brands when the industry began consolidating around a few global suppliers.
I was very much involved in this process, and this experience served me well at HNB, which is now going through a similar game-changing transition. Managing change is not easy; there are issues with staff, unions and even customers, but change is imperative for survival.
[pullquote]“We have an exciting digital banking product pipeline over the next few years. You cannot go halfway with digital. There must not be any hesitation, because then you lose momentum. So we put a lot of effort to make sure the staff embrace digital before our customers, reorganise processes and invest in digital infrastructure.”
Dilshan Rodrigo[/pullquote]
What is the outlook for inflation, interest rates and exchange rates, and how will these affect the banking sector?
Buddhipala: The volatile nature of interest and exchange rates at the broad outset is affected by macroeconomic fundamentals such as the current account, balance of payments, sovereign reserves, the fiscal deficit and policy measures taken to arrest these parameters. External factors too impact interest and exchange rates, and the inflation outlook as well. Management of such risks is part and parcel of the banking business. The impact of volatile macroeconomic variables may differ from bank to bank depending on balance sheet structures. The regulatory framework, which allows limited open positions (the difference between assets and liabilities in foreign currency), allows banks to manage exchange risks. Most banks tend to adopt floating rates for lending to manage interest rate risks. These are examples of a few straightforward strategies to managing risks. Rodrigo: Twin problems on the fiscal and balance of payments fronts indicate that interest rates will remain at double-digit levels until structural issues in the economy are overcome. Timely assistance from the IMF will put the economy back on track and, more importantly, the process will ensure fiscal and monetary policy discipline. Meeting large and significant debt service commitments will continue to put pressure on exchange rates and inflation over the short term.
Improved foreign direct investments and long-term capital flows to equity and debt markets will result in a turnaround in macroeconomic indicators over the medium term. I have no doubt we are now moving in the right direction, with the foreign policy and partnerships in place to realise the true potential of our country. For the banking sector, all these trends point to strengthening deposit mobilisation to ease liquidity issues, selective lending, sharpening the focus on asset quality and driving digital banking, while focusing on cost optimisation efforts in the short term.
What are the challenges in recruiting and retaining key talent?
Buddhipala: Banks will always have to work hard to attract and retain key talent. Despite the bleak outlook for most developed economies, Sri Lanka continues to lose its talent to them. The brain drain of young talent who possess internationally recognised qualifications such as ACCA still continues.
Do Sri Lankan banks need to consolidate?
Rodrigo: I think there is significant opportunity for consolidation in Sri Lanka’s banking sector. Eighty five percent of the market is held by seven banks, while the balance 15% is held by 15 local and foreign banks. We also have over 50 NBFIs – many of them with similar product propositions to banks. All this leads to a banking density between 3,000 and 5,000 (population per branch) across regions, which is very low even by regional standards. There are significant technology investments in core banking systems, ATMs and digital banking platforms, and if shared, will bring results in massive economies of scale, and improved ROI and ROAs for the sector.