The Chairman of the NDB Bank PLC has pointed out the need for consolidation of the banking industry in Sri Lanka saying it is ``an unaffordable extravagance" for the country’s 23 commercial banks to build individual fixed cost bases relating to branches, ATM technology, brand building, risk management and the like in a small economy.

"Industry consolidation needs to happen if these costs are to be reduced," Mr. Manik Nagahawatte, Chairman of the bank has said in its just release annual report pointing out that overheads were high due to lack of scale.

"It is hoped that the Central Bank and the commercial banks will work together in 2009 to facilitate consolidation in the industry."

Nagahawatte is a retired Deputy Governor of the Central Bank.

He also made the point that the high financial services VAT applicable to banks has pushed up the effective tax rate on banking profits to a level which made it difficult to attract equity capital that was needed to absorb unexpected losses, ensure systemic stability and underpin loan growth.

"Therefore it is suggested that the relevant authorities review the imposition of the Financial Services VAT which virtually results in the banks being taxed twice," Nagahawatte said. "These are important structural policy issues which regulators, the government and the banks themselves need to address without delay."

He reported that growth of both lending and deposit mobilization activities of the banking industry had "slowed considerably" in 2008 compared to previous years and with nominal GDP growth.

"Since banks play an important role in fuelling economic activity, a fall in balance sheet growth of a comparatively large magnitude, is a cause for concern," he explained.

The slowing down was partly attributed to the more adverse economic environment which affected customer demand last year and partly due to structural issues facing the banks.

Nagahawatte said that it was well known that what he called the "investor appetite" for providing new equity to the banks was now extremely limited in the context of returns being below the risk-free rate.

The low returns of banks in Sri Lanka also limited the availability of profit retention as a source for needed new capital, he pointed out.

"Returns are low for two broad reasons, namely the high level of overheads, and an effective tax rate of around 60% on banking profits," Nagahawatte said pointing out that the trend of non-performing loans in an economic downturn will put further pressure on profits.

Mr. Eran Wickramaratne, the new CEO of the NDB Bank who assumed duties in April 2008 said he had inherited a bank with a healthy balance sheet which was largely the legacy of Nihal Welikala and S.K. Wickrmesinghe, CEO and Chairman respectively who had guided the NDB Bank during the past few years.

But 2008 saw the beginning of the global economic recession and financial meltdown in a scale not experienced since the 1930s.

"The demand for the country’s major exports had declined, energy costs were at an all-time high and GDP growth slowed down," he said.

"Many companies were experiencing severe cash flow constraints and financial institutions had rapidly increasing non-performing loans (NPLs) and a shortage of liquidity."

Welikala expected the financial crisis to deepen this year as there are no signs of global economic recoveries.

Against this backdrop, he was happy to announce that profit after-tax for the year under review was up to Rs.1.2 billion from Rs.1.1 billion the previous year and the bank had maintained a return on equity of 12.44%.

He further said that their cost income ratio at 47% was one of the lowest in the banking industry and their 2.29% non-performing loan ratio was the lowest in an industry where the average NPL ratio was near 7%.

Customer deposits were up 25% over the previous year and they had obtained additional credit lines from multilateral agencies reducing the dependency on the inter-bank markets.

NDB Bank remains the most well capitalized bank in the country and its strong balance sheet and liquidity enables it "to weather vagaries of a declining economy and finance markets," he said.

The attributable group profit posted this year has only been surpassed in 2006 when the NDB group posted earnings of slightly over Rs.2 billion.

The directors have proposed that a final dividend of Rs.6.75 per share be paid out of the bank’s profits for 2008 against a final dividend of Rs.6 per share paid the previous year.

The dividend payable for the year under review of Rs.249.9 million was up 47% from the Rs.170.1 million paid the previous year.

The bank has a stated capital of Rs.1.03 billion, a statutory reserve of Rs.818.6 million and revenue reserves of Rs.8.1 billion in its books.

The book value per share at Rs.154.69 was up from Rs.142.75 the previous year.

The three top shareholders of the NDB Bank, Bank of Ceylon, Jaya Investments and the Galleon Diversified Fund of Mr. Raj Rajaratnam each owns 10% of the NDB Bank and are its largest shareholders. They are followed by EC Global Limited (9.89%), Dr. S. Yaddehige (4.75%), EPF (4.60%) and the General Fund of the Sri Lanka Insurance Corporation (4.43%).

Nearly 7.9 million shares representing 9.63% of the bank’s equity are either not registered or not allotted, the bank said in the annual report. These shares are largely bonus shares issued in 2006 that remained un-allotted due to a dispute of the share buyer’s entitlement to hold them in terms of ceilings on shareholdings imposed by the Banking Act.