Sri Lanka - Sri Lanka Central Bank Strengthening Project

Report No. PID9459 Project Name Sri Lanka-Sri Lanka Central Bank... Strengthening Region South Asia Regional Office Sector Financial Sector Development Project LKPE71131 Borrower(s) GOVERNMENT OF SRI LANKA Implementing Agency Address CENTRAL BANK OF SRI LANKA (CBSL) Amarananda S. Jayawardena, Governor Central Bank of Sri Lanka, 30 Janadhipathi Mawatha, Colombo 1, SRI LANKA Contact Person: A.S. Jayawardena Tel: 94 1 477 176 Fax: 94 1 477 712 Email: gov cb@slt.lk Environment Category C (Not Required) Date PID Prepared August 15, 2000 Projected Appraisal Date September 15, 2000 Projected Board Date March 30, 2000 1. Country and Sector Background Background - The Sri Lanka's financial sector comprises diverse institutions, including public and private banks, specialized banks, finance companies, leasing companies, merchant banks, and many provident and unit trust funds. The Central Bank of Sri Lanka (CBSL) operates with a considerable degree of independence in most areas and has a significant role in influencing government policy and managing the financial system. CBSL performs a broad range of traditional central bank activities and carries out financial activities not traditionally associated with central banks -- including managing the GOSL sponsored provident plans and providing financing to selected sectors (agriculture, exports, and troubled finance companies). Sri Lanka's financial system is shallow, with assets concentrated in government securities and liabilities in bank deposits. The banking sector is dominated by the two state commercial banks (SCBs), Bank of Ceylon (BOC) and People's Bank (PB), which account for 55 percent of banking sector assets. There are large inefficiencies in the banking sector as evidenced by high intermediation costs and a high level of non-performing assets. Despite substantial improvement in the bank regulatory and supervisory environment in Sri Lanka since 1988, bank supervision still remains weak. Examiner training is still inadequate and the growth in staff size and experience has lagged behind the growth in the number, size, and complexity of institutions to be supervised. Securities markets have grown rapidly in recent years, but equity markets are still shallow. Primary debt markets are nascent and are dominated by short-term government securities. There is less activity in secondary debt markets due to the captive nature of the main holders of government securities. While CBSL  accepts the use of open market operations as the principal tool for financial market intervention and management, it has yet to fully integrate the use of this tool in its financial market activities. Information Technology (IT) systems in the CBSL is still fragmented with stand alone non-standard and multiple platform systems. There is a need to move to an integrated policy environment, with modern information management practices to ensure accuracy and consistency of information. In general, there are systemic weaknesses in the areas of: (i) Communication Network; (ii) IT Policy and Procedures; and (iii) Major Applications (such as the payment system). 2. Objectives The project will aim at: (a) upgrading the payments system by introducing a real time gross settlement system; (b) improving monetary policy, exchange rate and foreign reserve management; and (c) strengthening the regulatory framework to cover a wider range of financial sector activities such as developing the debt market, particularly by introducing a scripless government securities trading system and an electronic screen-based trading system for primary dealers, and developing E-Business. 3. Rationale for Bank's Involvement The GOSL requested assistance from the World Bank because of its experience in countries around the World and recently in crisis management in the countries of East Asia. The Bank also has extensive experience in private sector development, an important element of which is a sound financial sector 4. Description The proposed project has two main over-arching components: 1. Central Bank Reorganization and Restructuring - which includes three sub-components: 1. a. Monetary Policy management 1. b. Financial Sector Regulation 1. c. Training and Research 2. Making the Payments System More Efficient. 1. Central Bank Restructuring and Reorganization. There is a need to take a fresh look and revisit the role and functions of the central bank to ensure that they are in line with what is required in a modern economic environment. The Monetary Policy Management sub-component will seek to strengthen the Central Bank's monetary management capabilities. It will help to strengthen the systems and procedures relating to more market oriented open market operations. The Financial Sector Regulation sub-component would cover two main areas: (a) the development of a legal framework for the regulation and supervision of money and foreign exchange brokers; and (b) issues related to money laundering. Currently there are no regulations governing foreign exchange brokers and the CBSL is keen to develop this capacity. The proposed project will also support training and the development of research capacities within the Central Bank. 2. Automating the Payments System and E-Business. The main elements of this component, which is likely to comprise the largest part of the potential credit would be the purchase of the hardware and software to assist in the automation of the payments system with a Real Time Gross Settlements (RTGS) capability. The project will also support the CBSL to develop E-Commerce and E-Banking. -2-  5. Financing Total ( US$m) GOVERNMENT 3.0 IBRD IDA 12.0 Total Project Cost 15.0 6. Implementation The Central Bank will take the lead to implement this project. Under the project, IDA will assist the government to set up a task force (overseen by Financial Sector Reform Committee) to develop and further refine the reform areas and to closely monitor the implementation of the project. The Task Force should have strong representation from the IT, public debt, and banking Departments of the Central Bank and the banking sector for effective implementation of Payments System. The Task force should also include a Human Resources/Training specialist as well as an accountant to handle the financial management of the project. Reporting Requirements. A system for monitoring, evaluation, and proper recording should be established by the project administrator and the accountant. This system should include Quarterly Reports on implementation progress of the project for the Chairman of the Steering Committee and for IDA. 7. Sustainability There could be risk from supporting a highly sophisticated payments system which proves to either be "overkill" for the requirements of the country -- or alternatively not utilized to its full potential due to the lack of sophistication of the sector. This should, however, be dealt with in the design stage of the project to ensure proper balance. It is also a risk that, while developing and modernizing the central bank, the Government remains unprepared to deal with the more fundamental problems in the commercial banking sector. It is anticipated that the current project will provide a useful vehicle for dialogue with the central banking authorities in Sri Lanka and it is hoped that this will ultimately lead to some agreement on tackling the more fundamental commercial banking reforms, ensuring sustainability of the benefits. 8. Lessons learned from past operations in the country/sector Lessons from other IDA-financed TA projects in Sri Lanka indicate that these TA projects are usually slow to implement and disburse, and are difficult to administer, in particular in large projects. The following are some of the lessons learned in managing above mentioned IDA financed operations. (i) Setting up an efficient administrative unit made a very significant contribution to the success of the project, in particular if it is headed by a senior official, with coordination among various stakeholders; (ii) Lead taken by the CBSL and MOFP in the Policy Dialogue to keep the reform program on track; (iii) IDA's close and continuous coordination with the senior staff of the CBSL and MOFP provide an opportunity for IDA to bring to the notice of the senior policy makers the issues relating to the slow progress in the financial sector; and (iv) Proper monitoring and reporting with regular reviews of the issues. IDA will attempt to keep this project small and focused and will take notes of above mentioned lessons learned in order to effectively achieve the - 3 -  project objectives. In addition the government prepared a well thought out program with specific and focused objectives and expected outputs. IDA will coordinate with other donors and activities in CBSL to avoid duplication of work and maximize the efficiency and transparency of the project. A participatory approach in project development and implementation is important in building ownership and successful outcomes. For this project, the CBSL's commitment is evident as discussed below. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) Issues Not applicable. 11. Contact Point: Task Manager Simon C. Bell, Financial Economist, SASFP The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: 202-473-4931 Fax: 202-522-1145 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. - 4 -