Monitoring and Surveillance
Maintaining Stability in Money and Foreign Exchange Markets
The Central Bank is responsible for maintaining stability in the money and foreign exchange markets
Inter-bank Call Money Market
The inter-bank call money market is an overnight market and mainly serves commercial banks in meeting their immediate liquidity needs and reserve deficiencies. Hence, an important task of the call money market is to facilitate liquidity management in the inter-bank market.
Therefore the orderly and stable functioning of the inter-bank call money market is important to minimise liquidity risk in the banking system as a whole. The stability of the market is supported by the provision of Repurchase (Repo) and Reverse Repurchase facilities by the Central Bank at its policy interest rates.
The policy interest rates of the Central Bank - the Repo Rate and Reverse Repo Rate provides lower and upper bound respectively for the formation of interest rate corridor for the inter-bank call money market. Thus the corridor limits the potential large fluctuations in the short-term market interest rates.
Changes in the Central Bank's policy interest rates have an immediate effect on interest rates in the inter-bank call money market. Changes in the call market rates could lead, within a very short period, to changes in other short-term money market interest rates, such as the yield on Treasury bills, commercial paper and the short-term lending rates of commercial banks. These changes could, with a time lag, affect the medium-term lending and deposit rates of banks, as well as other market yeilds. The inter-bank market and makes frequent adjustment to the liquidity in the banking system.
Frequent fluctuations of interbank call rates even to the boarders of policy rate corridor is not desirable as such changes could inflict larger volatility in other market rates/prices which uses interbank call rate as the benchmark. Central Bank generally prefers market liquidity to be at levels that facilitate minimal fluctuation in the overnight call market rate. Slight shortage in market liquidity makes it easier for the central banks to steer the interest rates as the borrowing banks would have to borrow on the conditions of the Central Bank. Surplus liquidity will not require commercial banks to stick to such conditions. As such the Central Bank conducts its open-market operations by way of Repo or Reverse Repo auction for a determined amount, in order to inject or absorb liquidity to and from the market and to reduce undesirable fluctuations in the interbank call money market rate. The magnitude of the Central Bank intervention depends on the overall liquidity excess or shortfall, prevailing interest rate level well as the macroeconomic environment of the country.
The daily inter-bank call money market transactions averaged Rs.13.1 billion in 2012.
Treasury Bill Market
The Treasury bill market is another segment of the Money Market. Treasury bills are highly liquid money market instruments that provide financial institutions with an alternate source of liquidity and investment. Furthermore, interest rate movements in the Treasury bill market provide a benchmark for the short-term credit market. Hence, changes in the volumes and rates in the Treasury bill market affect the cost, profitability and liquidity of financial institutions. Secondary market transactions in Treasury bills amounted to Rs. 2472 billion for outright transactions and Rs. 13,916 billion for repurchase transactions at the end of December 2012. Treasury bills are also the main securities used as collateral by the Central Bank in the conduct of its open market operations.
Foreign Exchange Market
The domestic foreign exchange market in Sri Lanka is two- fold, namely, the client or retail market and the inter-bank or wholesale market. Retail market includes transactions involving individual or institutional customers while the inter-bank market is mainly organized among authorized dealers in forex market, which comprises all licensed commercial banks. The Inter-bank market helps to manage liquidity within the banking system through currency conversion.
There are two main functions in foreign exchange market, one is to convert currency of one country into a currency of another and second is to help minimize the risks arising from changes in the exchange rate through various derivative products. Above features of the foreign exchange market facilitate funding imports, converting export proceeds and other foreign currency transactions.
The main risk in the foreign exchange market is the volatility in the exchange rate, i.e., undue fluctuations in the rate at which one currency is converted in to another currency. If the volatility is excessive it would create an instability in the foreign exchange market and thereby would affect the value of foreign currency assets and liabilities. There are derivative instruments available in the foreign exchange market such as swaps, options and forwards which help minimize the risk of exchange rate volatility.
Transactions in the foreign exchange market are carried out in the spot market and the forward market. Spot market is the market for immediate delivery of purchases/sales of a foreign currency on the same day (Cash basis), the next business day (Tom basis) or within two business days (Spot basis). The forward market is for the purchase/sale of a foreign currency at a price specified now with the delivery and settlement at some future date exceeding two business days. The domestic inter-bank foreign exchange transaction volumes in 2012 totaled to US dollars 13,420 million while the daily average transaction volume in 2012 was recorded as US dollars 55mn.
Sri Lanka had a floating exchange rate system since 2001 which allowed the independent adjustment of the exchange rate according to the market forces of demand and supply. On 9th February 2012, the exchange rate policy of the country was changed, which resulted in the conduct of interventions in the market for the purpose of curbing excess volatilities using quantities instead of price targets. The Central Bank of Sri Lanka closely monitors the activities in the domestic foreign exchange market to ensure a smooth functioning of the market.
Overseeing the Payment and Settlement System
Payment and settlement systems (PSS) enable the transfer of money in the accounts of financial institutions to settle financial obligations between individuals and institutions. In a systemically important PSS, a significant proportion of transactions in terms of value consist of transactions conducted in financial markets. Although disruptions to operations of such systemically important PSS are rare, the potential consequences of such a disruption are substantial and widespread and could lead to a systemic disruption and financial shock even beyond the system and its participants, which could adversely affect the stability of the financial sector. Therefore, the safety and efficiency of the PSS, particularly systemically important ones, is critical for the effective functioning and stability of the financial system.
The Payment and Settlement Systems Act No.28 of 2005 (PSSA) provides for the regulation, supervision and monitoring of payments, clearing and settlement systems, the regulation of providers of money services and the electronic presentation of cheques.
The Central Bank performs three key roles in the PSS namely,
|| Overseeing the payment, clearing and settlement system.
|| Operating systemically important payment and settlement systems
|| Formulating a national payments policy and developing the payment systems
LankaSettle - Real Time Gross Settlement(RTGS) System and LankaSecure
The Central Bank operates LankaSettle, the systemically important high value payment and securities settlement system. The LankaSettle system has two components i.e. the RTGS system (which processes large value and time critical payments) and the LankaSecure system (Scripless Securities Settlement System). The integration of the RTGS System and LankaSecure System provides the most secured securities settlement mechanism based on Delivery versus Payment for scripless securities transactions. Participants of the LankaSettle System, as at end Dec 2012, are the Central Bank, 24 Licensed Commercial Banks , 7 Non-Bank Primary Dealers , the Employees' Provident Fund and the Central Depository System of the Colombo Stock Exchange. The RTGS System is operated by the Payments and Settlements Department of the Central Bank.
Real Time Gross Settlement System
The RTGS System is a computer based fund settlement system which processes and settles each payment instruction individually and irrevocably on real time basis using funds in the participants' RTGS Settlement Accounts in the RTGS System. The value of transactions settled in the RTGS System accounts for about 89 per cent of the non-cash payments in Sri Lanka. The RTGS System settles large value and time critical rupee payments. The majority of RTGS transactions are relating to: transactions in the inter-bank call money market, Government securities markets, Open Market Operations, the rupee leg of transactions in the foreign exchange market, urgent payments of customers and net obligations under the systems operated by LankaClear (Pvt) Ltd.
The Central Bank provides an Intra-day Liquidity Facility (ILF) to participating Commercial Banks and Primary Dealers, free of charge against collateral of scripless securities in the LankaSecure System. The average value of ILF granted by the Central Bank per day during 2012 was Rs.15.2 billion.
The RTGS System settled an average of 1,176 transactions a day in 2012, with a daily average turnover value of Rs.179 billion.
LankaSecure - Scripless Securities Settlement System (SSSS) and Scripless Securities Depository System (SSDS)
The LankaSecure System comprises of the Scripless Securities Settlement System (SSSS) and Scripless Securities Depository System (SSDS). LankaSecure facilitates the issue of Government securities and Central Bank securities in electronic or scripless form and settlement of trades of such scripless securities on a Delivery versus Payment (DvP) basis. Accordingly, transactions are settled in the system if the participant who sells securities has sufficient eligible securities in his Securities Account in LankaSecure and the buying participant has sufficient funds in his Settlement Account in the RTGS System to pay for the transaction. All securities transactions settled in the system are irrevocable.
The SSDS is the title registry as well as the custodian for Government securities. The ownership of securities is recorded to the beneficiary level in the SSDS. The holders of scripless securities in the SSDS can obtain up to date details of their investments at any point of time through LankaSecureNet, an internet based facility.
During the first half of 2009, LankaSecure settled about 57 DvP transactions per day. The average number of Delivery Free transactions settled in the system amounted to 48 a day, while transactions relating to repositioning of securities accounted for about 1969 transactions per day.
Cheque Imaging and Truncation (CIT) System - Interbank Cheque Clearing
The Central Bank is responsible for providing facilities for the clearance of retail payments, such as cheques, bank drafts and off-line fund transfers. In 2002, the Central Bank authorised LankaClear (Pvt) Ltd (LCPL), a company jointly owned by the Central Bank and Licensed Commercial Banks to provide cheque clearing facilities. The average number of cheques cleared by LCPL in 2012 was 197,343 per day, while the average value of cheques cleared amounted to Rs. 27 billion per day. The total value of cheques cleared through the CIT system represented 12 per cent of the total value of non-cash payments.
In May 2006, LCPL introduced the CIT system, which facilitates the electronic presentment of cheque images and clearance of cheques. The CIT system introduced a uniform cheque clearing time schedule of T + 1(where T is the day on which LCPL receives the cheque for clearing and 1 is the following business day) throughout the country, enabling Commercial Banks to credit proceeds of cheques to their customers' accounts on the following business day. Under this system, dishonoured / returned cheques have been replaced with a Cheque Return Notification (CRN). The net clearing balances under the CIT system are settled in the RTGS system at 8.30 a.m., while net balances of the Settlement Clearing System of the CIT system (which handles CRNs) are settled in the RTGS system at 2.45 p.m. on each business day.
In March 2011, Lanka clear migrated to the direct connectivity mode of settlement clearing enabling the advancement of window cut-off time to 7.30 p.m the next day. This enable commercial banks to release cheque proceeds to customers acoounts before 3.00 p.m the next day.
Sri Lanka Interbank Payment System
Sri Lanka Interbank Payment System (SLIPS) was introduced in 1993 by the Central Bank, as an off-line retail fund transfer system. With the establishment of LCPL, operations of SLIPS were handed over to LCPL in 2002. SLIPS handles pre-authorised small value bulk payments (direct credit and debit transfers). In 2010, SLIPS was upgraded to an on-line interbank payment system to facilitate settlement of transactions on T+0 basis. Transactions are cleared electronically on a multilateral net settlement basis and interbank net balances arising from SLIPS transactions are settled in the RTGS at 8.30 a.m. and 3.00 p.m on each business day. During the year 2012, the daily average value of transactions cleared through SLIPS was 2.3 billion. CBSL issued the General direction, Sri Lanka Interbank Payment System No.01 of 2011 to the participants of the system and Lanka clear,with the objective of facilitating the smooth operation of SLIPS.
Rupee Draft Clearing System and US Dollar Cheque Clearing System
LCPL also operates a Rupee Draft Clearing System and US Dollar Cheque Clearing System. In the Rupee Draft Clearing System, cheques and drafts of foreign banks drawn on their 'nostro' accounts with Commercial Banks in Sri Lanka and in favour of customers of Commercial Banks in Sri Lanka are cleared manually by LCPL. The net clearing balances of this system are settled at the RTGS at 2.15 p.m. on each business day. The daily average value of cheques cleared by this system was Rs. 1.5 million in 2012.
The US Dollar Cheque Clearing System was launched in 2002 and is a semi-computerised clearing system for cheques and drafts in US Dollars issued by Commercial Banks in Sri Lanka and payable to Sri Lankan individuals and institutions, and issued by banks and exchange houses abroad and drawn on Commercial Banks in Sri Lanka. This system reduced the time lag for clearing and settlement of US Dollar cheques and drafts from 3 weeks to about 4 days. The system also reduced the clearing charges by banks significantly, as previously cheques and drafts had to be dispatched to correspondent banks abroad for realisation, whereas now they are exchanged over the counter locally. The settlement of interbank clearing balances of the US Dollar Cheque Clearing System takes place through the accounts of participants maintained in a private Commercial Bank. A daily average of 221 cheques worth of US $ 850,152 was cleared in the system during 2012.
Equities Trading System and Debt Securities Trading System
The Colombo Stock Exchange operates two on-line systems: i.e. the Automated Trading System (ATS) for real time trading of equity (shares) and the Debt Securities Trading System (DEX) for trading of beneficial interest of Government securities and corporate debt securities. Stockbrokers licensed by the Securities and Exchange Commission of Sri Lanka (SEC) perform as direct participants in the ATS and DEX. At the end of Dec 2012 there were 28 direct participants, 15 member firms and 13 trading members permitted to trade in the DEX System.
Surveillance of Financial Conglomerates
The existence of large financial conglomerates, especially those that have banks as part of the conglomerate, is another area that has attracted increased supervisory concern in recent times. The regulation and supervision of such financial conglomerates is becoming increasingly more important and complex, due to the potential systemic risk that could arise from the interrelated nature of their activities. Large numbers of cross shareholdings, common directors and inter company transactions are areas that are of key interest in this regard, as it could result in conflicts of interests and abuse of power, which would not augur well for the stability of the financial system.
Since there are multiple regulators in the financial system, the supervision of conglomerates often falls under the purview of several regulators, requiring close co-operation and supervision.
Therefore, a Working Group of Regulators for Financial Conglomerates comprising of the Central Bank, the Insurance Board of Sri Lanka, the Securities and Exchange Commission of Sri Lanka, the Accounting and Auditing Standards Monitoring Board and the Department of Registrar of Companies has been established to monitor the systemic risk of conglomerates. The mandate of this working group includes identifying and defining financial conglomerates; identifying the functions of the separate regulators; assessing the systemic risk of such conglomerates by sharing necessary information among regulators, recommending a course of action for regulation and supervision of the respective institutions in a consolidated manner; and proposing necessary legal reforms to address the existing limitations relating to regulation and supervision of financial conglomerates.
Lender of Last Resort
In situations of emergency or imminent systemic banking or financial crisis, the Central Bank may provide loans against accepted collateral, to illiquid but solvent banking institutions. This facility is commonly known as the "lender of last resort facility".