Functions of Central Bank of Sri Lanka (CBSL)

Core Functions

The core functions of the Central Bank of Sri Lanka are:

(a) Conduct of Monetary Policy

Monetary policy is the process by which a central bank manages the supply and the cost of money in an economy mainly with a view to achieve the macroeconomic objective of price stability. Central Bank of Sri Lanka is responsible for conducting monetary policy in Sri Lanka, which mainly involves setting the policy interest rates and managing the liquidity in the economy. The monetary operations of the Central Bank influences interest rates in the economy, affecting the behaviour of borrowers and lenders, economic activity and ultimately the rate of inflation. Therefore, the Central Bank uses monetary policy to control inflation and keep it within a desired path.

(b) Conduct of Exchange Rate Policy

Since January 23, 2001, Sri Lanka has been following an independently floating exchange rate policy, which allows the exchange rate of the country to be determined by the supply and demand for foreign exchange in the economy. The supply of foreign exchange depends on the inflows to the economy such as export proceeds, workers’ remittances, tourist earnings and direct investment inflows, while the demand for the same depends on outflows such as import payments and loan repayments.

The Central Bank, however reserves the right to intervene in the domestic foreign exchange market through the supply and absorption of foreign currency. The aim of Central Bank intervention in the domestic foreign exchange market is twofold. The Central Bank intervenes in the market to limit the undue short-term volatility in the exchange rate and to build up the international reserve position of the country in the medium-term.  

Further, according to the Monetary Law Act, the Monetary Board shall adopt suitable policies and submit a report to the Minster in charge of the subject of Finance, whenever the Board anticipates a serious decline in International Reserves, there is a threat on the international stability of the Sri Lankan rupee or whenever international payments or remittances pose a risk to the stability and national welfare of the country.  

(c) Management of the Official International Reserves

In terms of the Monetary Law Act (MLA), CBSL is responsible for managing the official foreign exchange reserves of the country. The MLA provides the necessary legal framework for international reserves management, covering areas on the maintenance and composition of international reserves, action to preserve the international stability of the rupee, scope of foreign exchange operations of CBSL and the powers and responsibilities of the Monetary Board pertaining to international reserves management.  In managing the foreign reserves, CBSL mainly focuses on enhancing safety, liquidity and return objectives.

The international reserves are denominated in several key currencies and are mainly invested in fixed income securities, money market instruments and gold. At present, the main currency composition of the reserves are held in US Dollars, Sterling pounds, Euros , Yen, Australian Dollars and Chinese Yuan which is mainly decided on the foreign currency debt repayment requirements and income generating capacity of currencies.

(d) Oversight of the Financial System

As part of its mandate of financial system stability, the CBSL undertakes surveillance and oversight of the entire financial system taking into account its interaction with the real economy to monitor and limit systemic risks which could lead to financial and economic crises. Systemic risk is the risk that could cause the collapse or disruption of the whole financial system as opposed to the risk associated with one entity or group within the system that can be contained without harming the entire financial system. Macroprudential regulation addresses systemic risk while microprudential regulation addresses individual entity/group risk. It is recognized that macroprudential regulation fills the gap between macroeconomic policy and microprudential regulation.

The main role of macroprudential policy is to curb excessive risk-taking by the financial system, as systemic risk, that is the risk of widespread disruptions to the provision of financial services could have serious adverse consequences for the economy at large. In this regard, systemic risk has both time and cross sectional dimensions.

(e) Licensing, Regulating and Supervising of Banks and Selected Non-Bank Financial Institutions

The CBSL is responsible for regulating and supervising banks and selected non-bank financial institutions to promote their soundness and to safeguard the interests of depositors and investors. The regulation and supervision of individual financial institutions is referred to as microprudential policy.

The financial system of Sri Lanka is dominated by the banking sector. The regulation and supervision of banks is governed by the Banking Act and the Monetary Law Act. The CBSL is the licensing authority for banks in Sri Lanka and issues banking licenses under two categories namely, Licensed Commercial Banks and Licensed Specialized Banks (which are savings and development banks). The main distinction between commercial banks and specialized banks is that the former is permitted to accept demand deposits from the public and maintain current accounts and engage in a full range of foreign currency activities, whereas the latter is not.

The regulation and supervision of banks by the CBSL is based on the internationally accepted standards set out by the Basel Committee on Banking Supervision. In keeping with global trends, the CBSL is moving towards the risk-based supervision which focuses on identification of banking risks, management of risks and assessment of the ability in banks to mitigate such risks.

As a part of its regulatory and supervisory functions, the CBSL issues directives on the licensing, operations and closure of banks, the prudential requirements relating to banks, the resolution of weak banks and the enforcement of regulatory actions. The main techniques of supervision include continuous off-site monitoring and surveillance and periodic on-site examinations of banks, meetings with bank management and co-operation with external auditors.

The CBSL monitors the compliance of banks with a number of prudential requirements, including capital adequacy, liquidity, large exposures, asset quality, provisioning for non-performing loans, related party transactions, income recognition, share ownership, investments, fitness and propriety of directors and senior management and preparation and disclosure of financial statements. In addition, internal controls and standards of corporate governance and risk management in banks are also assessed. Further the CBSL has introduced a customer charter providing guidelines on the obligations of banks and customers.

The CBSL also regulates and supervises Non-bank Financial Institutions such as Licensed Finance Companies, Specialised Leasing Companies and Licensed Microfinance Companies under the Finance Business Act, the Finance Leasing Act and Microfinance Act.

In order to safeguard depositor funds, the CBSL operates the mandatory “Sri Lanka Deposit Insurance Scheme” for licensed banks and finance companies.

To increase public awareness, the CBSL periodically publishes press notices on “Financial Institutions Authorized to Accept Deposits from the Public”.

The CBSL regulates and supervises Primary Dealers under the Local Treasury Bills Ordinance and the Registered Stocks and Securities Ordinance. 

To improve the operational efficiency of the domestic money and foreign exchange market, the CBSL authorizes and supervises Money Brokers under the MLA.

The CBSL also has a lender of the last resort (LOLR) facility where funds may be lent to banks experiencing financial difficulties which are unable to obtain funds elsewhere. The main purpose of the LOLR facility is to preserve the stability of the banking and financial system by preventing panic ridden withdrawing of funds by depositors from banks with temporary liquidity problems.The CBSL also has a lender of the last resort (LOLR) facility where funds may be lent to banks experiencing financial difficulties which are unable to obtain funds elsewhere. The main purpose of the LOLR facility is to preserve the stability of the banking and financial system by preventing panic ridden withdrawing of funds by depositors from banks with temporary liquidity problems.

(f) Provision of Settlement Facilities and the Regulation of the Payment System

The maintenance of a well-functioning and secure payment and settlement system is an essential ingredient for a stable financial system. In terms of the Payment and Settlement Act, the Central Bank of Sri Lanka (CBSL) is authorized to regulate and supervise payment, clearing and settlement systems. In addition, the CBSL is responsible for the preparation of a plan for the national payment system and for providing guidance and leadership for the establishment and development of the payment, clearing and settlement systems. Furthermore, the CBSL chairs the National Payments Council (NPC) which consists of the main stakeholders in the payment system. The NPC makes recommendations for the development of financial infrastructure in Sri Lanka.

Accordingly, the CBSL ensures the continuous operation of “LankaSettle System” which is the systematically important payment and settlement system. LankaSettle comprises of two systems: the Real Time Gross Settlement (RTGS) system and “LankaSecure System”. The RTGS system is the fund settlement component of the LankaSettle System which facilitates large value and time critical payments, in real time, eliminating settlement risks. Inter-bank call money market transactions, government securities market transactions, open market operations, net cheque clearing transactions, inter-bank retail payment systems and the common ATM switch transactions are the main types of payments settled through the RTGS system. LankaSecure System consists of the Scripless Security Settlement System (SSSS) and the Scripless Securities Depository System (SSDS) for government securities. The CBSL provides intra-day liquidity facilities on a collateralized basis, free of charge to participants of the LankaSettle system to ensure its smooth functioning.

The CBSL is responsible for providing payment and settlement facilities for commercial banks and primary dealers. As the banker to the banks, the CBSL provides settlement facilities to these institutions which are also participants in the LankaSettle system.

The CBSL is also responsible for providing facilities for the clearance of retail payments, such as cheques, bank drafts and off-line fund transfers. The clearing house function for retail payment instruments has been delegated to LankaClear (Pvt) Ltd, a company jointly owned by the CBSL and commercial banks. With the development of electronic payment systems and instruments such as payments cards, mobile and internet banking, the CBSL is vested with the responsibility of issuing directions, guidelines, circulars and system rules as and when necessary to ensure secure and smooth functioning of all regulated payment and settlement systems in the country.

(g) Issue and Distribution of the National Currency

The CBSL has the exclusive right under the Monetary Law Act to issue currency notes and coins that are the legal tender in Sri Lanka. The issue of currency is primarily based on the transaction demand for each denomination.

The Monetary Board with the approval of the Minister in charge of the subject of Finance shall prescribe the denominations, dimensions, designs and other characteristics of currency notes and coins issued by CBSL. Currently, there are nine denominations of currency notes (Rupees 5000, 2000, 1000, 500, 200, 100, 50, 20, 10) and 10 denominations of coins (Rupees 10, 5, 2, 1, Cents 50, 25, 10, 5, 2, 1) in circulation. The larger denomination currency notes have enhanced security features to deter counterfeiting. A clean note policy is being implemented to upgrade the quality of currency notes in circulation. The CBSL also issues commemorative currency notes and coins.

(h) Compilation, Dissemination and Analysis of Economic Data and Statistics

The key role in compilation, dissemination and analysis of economic data and statistics is to ensure that the CBSL design, collect, compile and analyse information required to formulate macroeconomic policies and disseminate/ publish information on the economy to the general public, government/ private agencies and international organisations. This includes data on real sector, monetary sector, financial sector, fiscal sector, external sector and provincial statistics. In addition, CBSL conducts economic, financial and business surveys. The data and statistics is compiled and/ or disseminated/ published in required standards in a clear, accurate, timely and cost-effective manner and will help to reveal patterns and trends in the economic and financial systems, as well as for research and analysis. The role in this regard is also important in helping the data users and others who re-produce such data and statistics to understand and interpret the information disseminated.

(i) Banker to the Government and its agencies, and provision of current account facilities to LCBs and non-commercial bank Primary Dealers for Government Securities

CBSL, as the Banker to and official depositor of the Government (Section 106 and 107 of MLA) maintains current accounts for the General Treasury, other ministries and Government agencies. Currently, around 60 accounts are maintained by the CBSL on behalf of the above Government  and its agencies. In addition, CBSL maintains accounts for the.  International organizations such as World Bank, and Asian Development Bank. 

Further, in terms of Section 89 of the MLA, CBSL provides provisional advances to the Government, free of charge, with a ceiling of 10 per cent of the estimated total revenue of the Government in a given fiscal year. 

CBSL, as the banker to the banks, provides current account facilities for the LCBs and PDs to ensure efficient interbank payment and settlement. 

 

Agency Functions

In addition, the CBSL also performs the following agency functions on behalf of the Government of Sri Lanka:

(a) Management of the Public Debt

The CBSL is responsible for the issuance, servicing and management of public debt, as the fiscal agent of the Government in terms of the MLA. The main objective is to ensure that the Government’s financing needs and payment obligations are met at the lowest possible cost, consistent with a prudent degree of risk, over the medium to long-term.

The Domestic Debt Management Committee, consisting of CBSL and Treasury officials decides on the Government’s domestic borrowing programme, within the budgetary limits approved by the Parliament.

The CBSL raises funds from the public by issuing Government securities, such as short-term Treasury Bills and medium and long term Treasury Bonds of varying maturities. Treasury Bills are issued in terms of the Local Treasury Bills Ordinance while Treasury Bonds are issued under the Registered Stock and Securities Ordinance. The CBSL conducts regular auctions to issue Treasury Bills and Treasury Bonds, through Primary Dealers in Government securities. Treasury Bills and Bonds are issued in scripless form and are accounted for in “LankaSecure” which is the central depository and title registry for Government securities.

The CBSL also issues dollar denominated Sri Lanka Development Bonds and funds are also being raised from the international capital market by issuing medium/long term fixed rate Sovereign Bonds.

(b) Foreign Exchange Management

The CBSL carries out its duties and functions as an agent of the Government in managing foreign exchange transactions under the Exchange Control Act. The key functions include   formulation of policies on foreign exchange transactions, granting permission and licences on specific foreign exchange transactions, monitoring of foreign exchange inflows and outflows on current account transactions and liberalized capital account transactions and advising Authorised Dealers on good practices.

At present, foreign exchange transactions relating to goods and services in trade (i.e. current account transactions) are freely permitted without restrictions through Authorised Dealers in foreign exchange (mainly banks)  subject to their exercising due diligence to identify the bona fides of the transaction. In general, transactions relating to the acquisition of real or financial assets (i.e. capital account transactions) are partially liberalized and some may require CBSL approval unless allowed in terms of a general permission.

The current focus is for the further relaxation of foreign exchange transactions, particularly capital account transactions, in line with the macroeconomic policy stance to promote Sri Lanka in global business activities, with a view to enhancing investor confidence, strengthening foreign reserves and stabilizing the foreign exchange market.

(c) Fund Management and Custodian of the Employees’ Provident Fund

The Employees’ Provident Fund is the largest superannuation fund in Sri Lanka and was established under the Employees’ Provident Fund (EPF) Act. In terms of the provisions of the EPF Act, the CBSL is the custodian of the fund and responsible for fund management. The main activities carried out by the CBSL in this regard are the collection of member contributions and surcharges, maintenance of member accounts, investment of surplus funds, crediting of interest to member accounts and the payment of benefits to beneficiaries.

(d) Facilitating Financial Inclusion

To promote financial inclusion and to achieve balanced growth in the country, the CBSL on behalf of the Government is engaged in regional development activities through increasing access to finance, and conducting awareness building and skill development programmes. This is done by providing affordable finance to needy sectors through Participating Financial Institutions (PFIs).  The CBSL implements various refinance schemes, interest subsidy programmes and credit guarantee schemes and deliver credit supplementary services mainly focusing on three broad sectors - agriculture and animal husbandry, small and medium scale enterprises and microfinance. Public awareness programmes are carried out especially focusing on the financial literacy, entrepreneurship development, skills development and post-harvest technology etc. The credit schemes and credit supplementary services are funded by the Government of Sri Lanka (GOSL), the CBSL, donor agencies and PFIs.

(e) Financial Intelligence services to prevent, detect, investigate and prosecute Money Laundering and Terrorist Financing

The FIU-Sri Lanka was established in March 2006, in terms of the provisions of the Financial Transactions Reporting Act No. 06 of 2006 (FTRA). The FIU functions as a unit in the Central Bank of Sri Lanka, in terms of the order made by H.E The President under the Act to be the institution designated to operate as the FIU. The key functions of the FIU include the collection and receipt of information on financial transactions for the purpose of detecting possible links to money laundering, terrorist financing and other unlawful activities defined in the FTRA, investigations into suspicious financial transactions, the dissemination of information to relevant law enforcement agencies and regulatory authorities and the conduct examinations of reporting institutions. Institutions engaged in Finance Business and Designated Non Finance Businesses and Professions (DNFBPs) are the main institutions covered under the FTRA.