ranee jayamaha : glimpse of current financial regulations inaugural speech by dr ranee jayamaha, deputy governor of the central bank of sri lanka, at the client seminar on international trade, organized by hnb ( hatton national bank ), colombo, 13 november 2006. * * * mr theagarajah, officials of hnb, mr richard lightbound from wachovia bank, distinguished participants, ladies and gentlemen. thank you for the invitation extended to me to be present at the client seminar on trends in international trade. let me congratulate hnb for taking the corporate social responsibility seriously and arranging a forum to exchange stakeholder views on an important subject. generally, regulations are not liked by anybody. same goes with the financial community in sri lanka. however, the common factor is that even regulators do not like to rule by regulation. for a better appreciation of the past and present financial regulatory environment, let me first set out the key elements underlying financial regulations. in summary : ( a ) regulations are mainly a reaction to an action by the financial community, although there may be instances in which regulations are brought in on hindsight with a forward - looking approach, but they are a few ; ( b ) there is a clear difference between the objectives of regulators and market participants ; ( c ) regulations are not necessarily a oneway street. they are not there only to tighten markets. many instances can be quoted where regulations have been relaxed depending on the circumstances and environment ; ( d ) regulators should be proactive and work towards the development of markets rather than impeding their growth ; and ( f ) the institutions and markets that are subjected to regulations should not try to find loopholes to circumvent regulations. unless there is a conscious decision by the shareholders, the director boards, the senior management and officials of financial institutions, regulations by themselves do not bring in decided results. let me first deal with the world financial regulatory environment with a brief background of attempts made to stabilise financial systems. over the last 2 decades or so, the financial sector witnessed a radical reform process. the focus of the reforms was on deregulation and liberalization of the financial sector. the volume and value of transactions have increased many times, the speed with which transactions are initiated and completed has accelerated ; new markets have opened up ; there has been a significant expansion in the range of financial instruments ; financial firms have grown bigger and bigger and international businesses have become increasingly concentrated in the hands of a

authorities. since sight money created is payable by banks at any time through legal tender and technically, the banking system does not have funds adequate for meeting all such created money at any particular point of time. banking business thus casts a huge responsibility on the monetary authorities to facilitate, regulate, and protect the banking and payments system. weak corporate governance ( cg ) can contribute to financial instability and that would increase the risk profile of companies in the corporate sector and expose the banks and financial institutions to a greater risk. in a more direct sense, weaknesses in cg arrangements in banks and financial institutions reduce their capacity to identify, monitor and manage their business risk and that can result in poor quality lending and excessive risk - taking by the financial institutions. depending on the resilience of the financial institutions and markets, these risks have the potential to spread across the wider financial system. needless to say that inadequate cg can also lead to a poor credit culture, excessive exposure concentration, poor management of interest risk / exchange risk and inadequacies in the management of connected exposures. some of these risks, singularly or collectively, can lead to potential insolvency and financial instability. in more recent times, the regulators world over have introduced prudential norms on single borrower exposures, group exposures and concentration of credit risks. the underlying principles of such norms indicate some degree of compulsion on the observance of cg principles. to further augment such prudential norms, regulators may even consider introducing mandatory disclosures by banks and financial institutions. where does good governance fit in this scenario? obviously, corporate governance is now identified and acknowledged as a powerful tool to generate trust and confidence in an institution. in that context, good corporate governance is essentially important for banks, because such institutions ( a ) deal with funds raised from the public ; ( b ) are likely to encounter greater risks including frauds and failure ; and ( c ) if such frauds or failures occur in such institutions, it may pose issues relating to public confidence in the financial system stability itself. all these reasons have led to banks tending to depend upon risk management practices based on principles of prudence rather than complying with only minimum requirements. it is also as a result of such realization that many stakeholders and regulators are now consciously looking towards good corporate governance, as one of the prime instruments in its overall effort to maintain financial system stability. in sri lanka, the cbsl has already issued a voluntary code of best