The Central Bank said the government was working on a policy support package to address illiquidity issues some registered finance companies and specialized leasing companies may face which could threaten the financial system of the country.

"Consequent to the failure of certain unauthorized finance businesses and the effect of certain unfavourable international developments, the Central Bank has recently observed a few stresses within some Registered Finance Companies (RFCs) and Specialised Leasing Companies (SLCs)," the bank said in a statement issued last Tuesday.

The Central Bank said this situation had the potential to put the entire financial system at risk.

"In this regard, the Government, on the recommendation of the Central Bank, is currently developing a suitable policy support package to address the potential risks to the financial system that may arise due to any illiquidity in the regulated financial and leasing sectors," it said.

The bank said a policy support package was under "active consideration and would be announced shortly."

The Central Bank said this package would ensure that the stresses faced by the RFCs and SLCs would be relieved.

The Rs. 25 billion Golden Key Credit Card Company scam that almost resulted in the collapse of Seylan Bank, which was part of the same group of companies, until the Central Bank intervened and restored a level of confidence in the bank, has created a sense of distrust in the financial system.

Senior Banker, Riezie Wijetilleke, Chairman Hatton National Bank, said at a recent seminar that he had always been opposed to over regulation of the private banking sector by the Central Bank but that after recent events, both domestic and external, he now appreciated the role played by the Central Bank.

However, he said recent events had put a dent on public confidence in the financial system and that the work done by many banks over the years to convince people to bring their monies in to banks rather than keeping them in their pillowcases was going through a reversal.

"After a particular bank faced some difficulties recently I received so many phone calls asking me whether their monies were safe in the bank," Wijetilleke said demonstrating professional courtesy by not mentioning the bank in question which was Seylan Bank.

He said that with the several acts of law governing the financial system and with countless directives issued by the Central Bank, the Central Bank could have avoided the Golden Key issue, especially since the credit card company had openly canvassed deposits from the public through advertising campaigns.

"The Central Bank cannot deny its responsibility in the issue," he said adding that it was sad the Central Bank was giving various excuses and evading responsibility for allowing the financial system to experience such issues.

"There is mistrust in the entire financial system and the question would be is how we are going to reestablish trust," Wijetilleke said.

Despite what has happened, Wijetilleke said the banking system was stable.

But he went on to criticize the way state owned banks are run where the Treasury Secretary, a political appointee, has the right to appoint directors of Bank of Ceylon and Peoples’ Bank, which together accounted for 65 to 70 percent of total deposits, from whom other political agents received loans.

The latest report of the Auditor General showed how Rs. 1.54 billion had been written off by the BOC over the last five years and that despite improvements in the bank’s operating results the net interest margin had declined from 50 percent in 2003 to 30 percent in 2007 due to granting loans to state institutions at lower rates of interest while offering high interest rates on customer deposits.

Wijetilleke pointed out that ethics in the financial system could never take hold with the kind of democracy the state owned banks enjoyed.

He said private banks competing for the balance 30 percent of deposits are hampered with over regulation where a bank utilizes 30 percent of its resources to ensure compliance with regulations.

Over the past few months several bankers had publicly said banks would not be able to play an active role, as is desired, to help industries counter the effects of global financial crisis and take development to the cleared areas of the North and East because of high taxation and their inability to consolidate.

Nihal Fonseka, CEO/Managing Director of DFCC Bank, said at a seminar last month that banks may not be able to support industries hit by the global financial crisis as they face the challenge of maintaining liquidity.

"There is an expectation that banks have a role to play to support ailing industries, in good times we would have certainly done so, but not this time," he said.

"Banks are feeling the stress and this is reflected in their performance. A critical factor for us this year is going to be how we maintain liquidity,

"The role we can play in this environment is limited. The government can help. Not by giving us money but by reducing taxes. Banks are the only options left to finance ailing sectors in the economy and with tax concessions we can provide that relief," Fonseka said.

"If banks are to expand and grow, capital built-up is prerequisite. Investors must be attracted in order to do this, however banks are not making enough returns and are facing a dilemma," Manoj Akmeemena, Senior Manager, Strategic Planning, Sampath Bank PLC said at another seminar last year.

He said that the global financial crisis had not impacted local banks as the industry was not as sophisticated as their international counterparts but warned that domestic structural problems could pose problems in the years ahead.

Size does matter for survival and expansion and advocates of consolidation say that by consolidating, banks could reach economies of scale, rationalize infrastructure, ITC and HR costs and strengthen their capital bases enabling them expand and venture into regional markets.

"The question is, do we do this now or wait for things to get worse?" he asked.

Last December, another senior banker told a seminar on the global financial crisis that banks will not be in a position to lend.

"In 2009 and 2010 banks will not be able to lend even if they wanted to as they find it difficult to raise new capital because they continue to make poor returns on equity. They will not be able to lend even if interest rates come down," Nihal S. Welikala, Senior Advisor to NDB Bank, said.