Central Bank of Sri Lanka Capital Adequacy Requirements for Licensed Finance Companies

# MONETARY BOARD
## CENTRAL BANK OF SRI LANKA
### FINANCE BUSINESS ACT DIRECTIONS
**06 June 2018** No. 3 of 2018

## CAPITAL ADEQUACY REQUIREMENTS

In terms of powers conferred by Section 12 of the Finance Business Act, No. 42 of 2011, the Monetary Board has determined the minimum capital adequacy ratios for Licensed Finance Companies (LFCs) as given below.

### 1. Minimum Capital Adequacy Requirements

#### 1.1
Commencing from 01 July 2018, every LFC shall, at all times, maintain the minimum capital adequacy ratios in relation to total risk weighted assets as prescribed in Table 1 and 2 below.

**Table 1: LFCs with assets less than Rs.100 billion**

| Components of capital | 01.07.2018 | 01.07.2019 | 01.07.2020 | 01.07.2021 |
|-----------------------|------------|------------|------------|------------|
| Tier 1 Capital        | 6.00       | 6.50       | 7.00       | 8.50       |
| Total Capital         | 10.00      | 10.50      | 11.00      | 12.50      |

**Table 2: LFCs with assets of Rs.100 billion and above**

| Components of capital | 01.07.2018 | 01.07.2019 | 01.07.2020 | 01.07.2021 |
|-----------------------|------------|------------|------------|------------|
| Tier 1 Capital        | 6.00       | 7.00       | 8.00       | 10.00      |
| Total Capital         | 10.00      | 11.00      | 12.00      | 14.00      |

#### 1.2
The capital adequacy ratios referred above shall be computed in accordance with the methodologies and requirements set out in the framework on capital adequacy requirements for LFCs given in Schedule I hereto.

### 2. Regulatory Reporting

#### 2.1
Every LFC shall submit details of computation of capital adequacy requirements through the web-based system in accordance with the formats given in Schedule II as per the following manner.

i. Monthly: report the position as at the last calendar day of each month, and should be submitted within 15 days.

ii. Annual (audited): report the position as at the last calendar day of the financial year, and should be submitted within three months after the closure of each financial year.

### 3. Regulatory Measures in the Event of Non-Compliance

#### 3.1
In the event of non-compliance by an LFC with above Directions, the Director shall act on any one or more of the following.

i. Restrict distribution of dividends or repatriation of profits.

ii. Suspend any business activity that will further deteriorate the regulatory capital position.

#### 3.2
The Director shall lift the above regulatory measures when such non-compliance is rectified.

### 4. Interpretations

#### 4.1
In these Directions,

i. Assets value of an LFC with reference to Table 1 and 2 of Section 1.1 shall be determined based on the latest available audited financial statements.

ii. “Director” means the Director of the Department of Supervision of Non-Bank Financial Institutions of the Central Bank of Sri Lanka.

### 5. Revocation of Previous Direction

#### 5.1
The Finance Companies (Risk Weighted Capital Adequacy Ratio) Direction No. 02 of 2006 and the circular dated 15.03.2007 are hereby revoked.

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**Dr. Indrajit Coomaraswamy**  
Chairman of the Monetary Board and  
Governor of the Central Bank of Sri Lanka

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## Schedule I
### Regulatory Framework on Capital Adequacy Requirements of Licensed Finance Companies

### 1. Introduction

#### 1.1
The new capital adequacy framework is intended to foster a strong emphasis on risk management and to encourage improvements in LFC’s risk assessment capabilities.

#### 1.2
The existing capital adequacy direction was adopted in 2006 for LFCs in line with the Capital Adequacy Accord recommended by the Basel Committee on Banking Supervision (BCBS) issued for banks in 1988. Under this direction risks were confined to credit risk and no capital requirements for other risks such as market and operational risks.

#### 1.3
Therefore, the new capital adequacy framework provides for maintenance of capital adequacy ratios on a more risk sensitive focus covering credit risk and operational risks under basic approach available in Basel II accord.

#### 1.4
The market risk is not considered at this moment as the sector exposure to market risks is considered to be minimal. However, if the necessity arises the Directions would be issued to capture the market risk under the capital adequacy framework.

#### 1.5
Further, a capital surcharge has been introduced for Domestic Systemically Important LFCs in view of creating higher capacity for greater loss absorbency in large institutions as announced in Basel III framework.

### 2. Capital adequacy requirements

#### 2.1 Total Regulatory Capital
Total regulatory capital of LFCs will consist the following:

i. Tier 1 Capital  
This represents core capital of the company representing shareholders’ equity and reserves.

ii. Tier 2 Capital  
This represents supplementary capital such as instruments containing characteristics of equity and debt, revaluation gains and general provisioning/impairment allowances.

#### 2.2 Risk Weighted Assets
Capital adequacy requirements shall be maintained as a percentage of Risk Weighted Assets (RWA) calculated based on the following approaches adopted by Basel Committee on Banking Supervision for banks:

i. The Standardized Approach for credit risk  
ii. The Basic Indicator Approach for operational risk

#### 2.3 Capital Buffer for larger LFCs
i. Capital surcharge for Domestic Systemically Important LFCs (D-SILFC) with total assets equal or more than Rs.100 billion shall be implemented on a staggered basis.

ii. D-SILFC must have a higher capacity for loss absorbance to cover the greater risks that they pose to the financial system.

iii. The capital surcharge requirement for D-SILFC are to be met with Tier 1 capital.

iv. The phase-in arrangement for capital surcharge on D-SILFC is indicated in Table 1.

**Table 1: Capital surcharge on D-SILFC**

| | 01.07.2018 | 01.07.2019 | 01.07.2020 | 01.07.2021 |
|---|---|---|---|---|
| Capital surcharge on D-SILFC (%) | - | 0.50 | 1.00 | 1.50 |

#### 2.4 Capital adequacy ratios
Timeline for implementation of capital adequacy requirements is given at Table 2 and 3 below:

**Table 2: LFCs with assets less than Rs.100 billion**

| Components of capital | 01.07.2018 | 01.07.2019 | 01.07.2020 | 01.07.2021 |
|-----------------------|------------|------------|------------|------------|
| Tier 1 Capital (%)    | 6.00       | 6.50       | 7.00       | 8.50       |
| Total Capital (%)     | 10.00      | 10.50      | 11.00      | 12.50      |

**Table 3: LFCs with assets of Rs.100 billion and above (including capital surcharge on D-SILFC)**

| Components of capital | 01.07.2018 | 01.07.2019 | 01.07.2020 | 01.07.2021 |
|-----------------------|------------|------------|------------|------------|
| Tier 1 Capital (%)    | 6.00       | 7.00       | 8.00       | 10.00      |
| Total capital (%)     | 10.00      | 11.00      | 12.00      | 14.00      |

### 3. Other Comprehensive Income (OCI) as per accounting standards
Accumulated OCI gains reflected in the statement of changes in equity shall not be included in the regulatory capital. However, OCI losses not adjusted in the retained earnings must be immediately deducted.

### 4. Reporting format
The reporting formats given at Schedule II collect information relating to capital adequacy computation of LFCs.

Part 1 -  
(A) Computation of Capital Ratios  
(B) Computation of Total Capital  

Part 2 -  
(A) Computation of Risk Weighted Assets amount for Credit Risk  
(B) Credit Equivalent of Off-Balance Sheet Items  
(C) Exposures Recognized under Credit Risk Mitigation (CRM)  
(D) Computation of Risk Weighted Assets amount for Operational Risk

### 5. Instructions for completing the reporting formats
The instructions and details/definitions for completion of the capital adequacy formats given in Schedule II are described with the web-based return codes as follows.

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## Part 1: Computation of capital adequacy requirements of LFCs

### Part 1 (A): Computation of Capital Ratios

| Code       | Item                                                                                                                              | Amount/% |
|------------|-----------------------------------------------------------------------------------------------------------------------------------|----------|
| 20.1.1.0.0.0 | **Tier 1 Capital**<br>The Tier 1 capital should be after regulatory adjustments. The amount must agree with item 20.2.3.0.0.0 of Part 1 (B) |          |
| 20.1.2.0.0.0 | **Total capital**<br>The amount must agree with item 20.2.8.0.0.0 of Part 1 (B)                                               |          |
| 20.1.3.0.0.0 | **Total Risk Weighted Assets Amount**<br>Total risk-weighted assets are determined by adding the resulting figures to the sum of risk-weighted assets for credit risk and operational risk. |          |
| 20.1.3.1.0.0 | **Risk Weighted Assets Amount for Credit Risk**<br>The amount must agree with item 20.3.0.0.0.0 of Part 2 (A)                     |          |
| 20.1.3.2.0.0 | **Risk Weighted Assets Amount for Operational Risk**<br>The amount must agree with item 20.6.3.0.0.0 of Part 2 (D)                 |          |
| 20.1.4.0.0.0 | **Core Capital (Tier 1) Ratio, %**<br>(20.1.1.0.0.0/20.1.3.0.0.0) *100                                                       |          |
| 20.1.5.0.0.0 | **Total Capital Ratio, %**<br>(20.1.2.0.0.0/20.1.3.0.0.0) *100                                                                |          |

### Part 1 (B) - Computation of Total Capital

| Code       | Item                                                                                                                                                                                                                                                                                                                                 |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------