On September 30, 2024, the Central Bank of Sri Lanka (CBSL) introduced a new set of regulations aimed at improving corporate governance within licensed banks in the country. These regulations, officially titled “Banking Act Directions No. 05 of 2024,” were designed to enhance the corporate governance practices of both licensed commercial banks and specialized banks. The primary goal of these new rules is to ensure that banks operate responsibly and with accountability, ultimately promoting the safety and soundness of Sri Lanka’s banking sector and the wider financial system.
The new directions will become effective on January 1, 2025, with certain provisions taking effect at later dates. Once the new rules are fully in place, the existing guidelines issued in 2007 on corporate governance will be revoked.
Why Corporate Governance Matters in Banking
Sri Lanka’s banking sector is a crucial component of the nation’s financial structure, with deposits accounting for approximately 81.5% of banks’ total funding as of the end of 2023. The board of directors (BOD) and senior management—especially chief executive officers and other key management personnel—are responsible for safeguarding depositors’ interests.
In recent years, the banking sector has become more dynamic and complex, with an increasing exposure to risks such as fraud, regulatory failures, and financial mismanagement. Given these challenges, a solid corporate governance framework is more essential than ever. A robust governance system that prioritizes sound corporate values, strong leadership, and effective risk management will help ensure the long-term stability of banks in Sri Lanka.
Strengthening the Legal Framework
The new measures align with the Banking (Amendment) Act, No. 24 of 2024, which came into effect on June 15, 2024. CBSL has focused on improving the legal and regulatory framework for corporate governance in response to both national needs and global trends.
Recent governance failures and market developments worldwide have prompted international regulatory bodies, such as the Basel Committee on Banking Supervision (BCBS), to update their corporate governance standards. Sri Lanka’s new regulations draw from these international best practices, particularly the Basel core principles for effective banking supervision.
Key Areas of the New Corporate Governance Rules
The newly revised corporate governance rules address several key areas to ensure the stability and accountability of licensed banks. Some of the major aspects include:
- Promoting a Strong Corporate Culture
- Banks must establish a culture that promotes professionalism, ethical conduct, and prudent decision-making across all levels of the organization. This culture should reflect the bank’s commitment to its depositors and other stakeholders.
- Diverse and Qualified Board of Directors
- The new rules emphasize the importance of having a diverse and collectively qualified board. Directors should bring a wide range of skills and experiences to the table to ensure the bank is well-managed and able to adapt to emerging challenges.
- Independent Board of Directors
- To ensure unbiased decision-making, at least half of the board of directors must be independent. Additionally, the criteria for determining the independence of directors have been further strengthened.
- Independent Chairperson
- The chairperson of the board must be an independent non-executive director, reinforcing the separation between executive management and the board’s oversight role.
- Board Sub-Committees
- The rules require improvements to the composition and functions of board sub-committees, ensuring they are led by independent directors. Importantly, the chairperson of the bank cannot also chair any sub-committees.
- Related Party Transactions
- To prevent conflicts of interest, banks must establish a Board Related Party Transactions Review Committee. This committee will ensure that all transactions with related parties are conducted fairly and transparently, within approved limits and with proper securities.
- Conflict of Interest Management
- Strengthened requirements are in place to help banks manage conflicts of interest. These measures aim to protect the interests of depositors and other stakeholders, ensuring that decisions are made in the bank’s best interests.
- Oversight of Senior Management
- The board of directors is tasked with overseeing the actions and decisions of senior management. This includes ensuring that key functions such as risk management, compliance, and internal auditing are carried out effectively.
- Foreign Banks Operating in Sri Lanka
- The new rules also impose stricter requirements on branches of foreign banks operating in Sri Lanka. This will help ensure that these branches adhere to the same governance standards as domestic banks.
Expected Impact on the Banking Sector
The CBSL’s new corporate governance rules are expected to significantly strengthen the responsibility and accountability of both the board of directors and senior management within licensed banks. By promoting a healthy mix of independence, ethical values, and strong risk management frameworks, these measures aim to create a more resilient banking sector in Sri Lanka.
These updated rules will help ensure that banks operate in a manner that protects depositors’ interests, mitigates risks, and fosters long-term stability in the financial system. A sound corporate culture and governance structure are crucial for maintaining the trust of the public and ensuring the continued growth of the banking sector.
Conclusion
The Central Bank of Sri Lanka’s introduction of new corporate governance rules marks a significant step toward strengthening the country’s banking sector. With an emphasis on responsibility, independence, and risk management, these measures will help ensure that Sri Lanka’s licensed banks operate efficiently and safely, ultimately benefiting the broader financial system.
For more details on the new rules, you can download the full text of the Banking Act Directions No. 05 of 2024 from the CBSL’s official website. These changes reflect a continued effort to align Sri Lanka’s banking sector with global standards and best practices, ensuring the long-term sustainability of the industry.
