Managing Profitability and growth in an increased compliance and regulated environment

1. Managing Profitability and growth in an increased compliance and regulated environment Dr. Ranee Jayamaha Chairperson Hatton National BANK PLC 17th October 2014

2. Global Financial System -Regulatory Rethinking • Financial crises and adverse impacts on world economy • imprudent banking and laxed supervision • market rigging and scandals • inadequate capital despite Basel I and II • Regulatory responsibilities • safeguard national and global financial systems • encourage to work within the global regulatory framework • safeguard interests of all stakeholders • Tightening regulation is considered to be the solution • Cost to banks, their growth and profitability are disregarded

3. Global Financial System - Regulatory Rethinking • Regulatory tower is rising - new floors are added • “Bailing in” instead of “Bailing out” is considered • Regulators view global and systemically important banks are • too big to fail • too big to save • too big to fix • too big to jail

4. Assessment of Basel Capital Adequacy Framework • Quantitative restrictions are like regulatory commandments • Basel I – “thou shall not”- simple and limited to credit risks • Basel II–“thou shall provide the internal model is correct” –too complicated - discretion with banks – DIY nature- non compliance • banks grew and made profits • supportive elements are missing • Due to simplicity, the Glass Stegall Act was far more effective

5. Basel Capital Adequacy Framework Enhanced quantity and quality of capital under Basel III Source: Basel Committee - BIS

6. Financial Regulatory Framework • National regulatory systems • USA - Basel plus Dodd-Frank regulation • UK - Basel plus Financial Policy Committee Regulations • Europe - Basel plus EU Directives • Stress testing and restrictions on trading book /investment banking • Profitability of banks is from: • reduction of branches / employees • selling /closing non profit earning units • reduced operations of investment arms • restructure overseas operations

7. Sri Lanka’s Financial Regulatory Framework • On Basel II, and moving on to Basel III • Flexible and banks behave well. No criminalization of banking • Regulatory framework is tolerable and allows banks to grow/profit • Mandatory Corporate Governance has saved the banking industry • Need to avoid adhoc regulatory tightening • Inter-regulatory institutional coordination and internal consultation need streamlining

8. Impact of Policy and Regulatory Changes by Advanced Countries • USA: reversal of ultra - loose monetary policy • free loanable funds from the Fed, ECB, BOE • helped banks to grow and maintain profits • Emerging markets benefited due to inflow of funds • Tapering off of QE programmes (June/July 2013) had severe impacts on global financial markets • Uncertainty and loss of business opportunities for banks in emerging countries

9. Cost of Regulatory Reporting and Compliance • Ever increasing regulatory costs (normal + cost of raising extra capital) • Cost of providing data/ information • data requests by multiple regulators /different units of a regulator • not making use of such information for analysis; agony/frustration • maintenance of an army of compliance officers • Cost of compliance with FATF + , UN regulations , FATCA and others • Criminalization of banking business - USA • reprimanding /black listing of banks • unprecedentedly high penalties and non transparent settlements

10. Overall Impact on Growth and Profitability of Banks • Growth has suffered; costs have escalated and profitability lowered • Severe competition and industry wide impact • M0vement of business to shadow and less regulated markets /institutions • asset and property bubbles – potential risks • Restrictions on investment banking and trading book • Shareholder/ investor frustration • Restructure / merge and consolidate

11. Managing Growth and Profitability • Reduce other costs and conduct prudent banking • business restructuring • outsourcing of non-core functions • leaner organizations and use of technology • Share infrastructure and common platforms • Diversify and increase fee incomes where possible • Seek joint operations to minimize risks and leverage on expert knowledge

12. Observations and Remarks • Financial system stability is a prime regulatory objective. Banks are prime constituents of the financial system. Both should survive • Balance between regulations and banking business is imperative • regulatory objectives should be clear • dangers of over-regulation should be understood • Watch dog’s failures should be accepted (2007-2009) • Regulation should not be a wining game • Catching/avoiding a crisis is difficult but complexity aggravates situation