226 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
SP
June 6, 2006
Deshamanya Sunil Mendis
Governor
Central Bank of Sri Lanka
The recently reported ATM scams in Singapore (Divaina – 25.05.2006) as well as other countries such as
New Zealand, indicate the likelihood of such practices spreading across the world.
It seems prudent to take precautionary measures to avert the possibility of such attempts being made
even in Sri Lanka, considering the particular danger of terrorist groups using them as means of creating
a sense of insecurity in a vital sector of the economy.
Accordingly, it may be worth taking early action to request the banks in the country to take the following
measures and any other, if they have so far not taken any initiatives in this regard.
1. Expedite the process of introducing tamper-proof micro chip Bank cards (being done in many
countries now).
2. Keep the customers remi nded at regular intervals the steps they should take in order to avoid
being victims of ATM robberies.
We hope you would understand that our observations and suggestions are guided by the fact that it is vital
to reduce the risk of any form of instability that would affect the Banks, their customers or the country.
Sincerely,
Sgd. Lalith Weeratunga
Secretary to the President


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  227
Ref. No. : 02  / 19 / 40110072  / 001
Bank Supervision Department
07 March 2006
To : CEOs of all Licensed Commercial Banks
Dear Sir,
REPORTING OF POST-TSUNAMI REMITTANCES RECEIVED THROUGH
NGOS AND NON-NGOS TO THE CENTRAL BANK OF SRI LANKA
We refer to our circular dated 13 May, 2005 on the above subject and hereby revise the format for
reporting of the information relating to the above remittances with ef fect from March 1, 2006.
In terms of the revised format, the banks are required to furnish the data in two tables attached
hereto (Table 1 & 2). The new table (Table 2) should contain details of NGOs, respective donors/
remitters, withdrawals and outstanding account balances on a monthly basis from March 2006 by
the 10th of the month following the reporting month. The banks are also requested to furnish the
information in Table 2 for the months of January and February, 2006 on or before 24 March, 2006.
The banks are requested to adhere strictly to the ‘Know Your Customer Guidelines’ and
implement adequate systems and controls to monitor all such remittances to ensure that customer due
diligence on transactions relating to such remittances is carried out. This is an imperative in the context
of the Anti-money Laundering legislation that has just been passed by Parliament and which will soon
be operative.
Your continued co-operation in this regard will be greatly appreciated.
Yours faithfully,
Controller of Exchange  Director of Bank Supervision
Table 1
Donations received by Government, Non-Governmental Organisations (NGOs) and Others (Non-NGOs)
Name of Commercial Bank:- .........................................
For the Period:- 26th December 2004 to .........................
ItemTsunami Non-Tsunami
Foreign DonationsLocal
Donations:
Sri Lankan
Rs.Foreign
Currency
AmountRs.
EquivalentForeign
Currency
AmountEquivalent
Amount of
Sri Lankan
Rs.
Donation Received by


EquivalentForeign
Currency
AmountEquivalent
Amount of
Sri Lankan
Rs.
Donation Received by
the Government
Donations Received by
Non-Governmental Organisations
(NGOs) (a)
Donations Received by
Others (Non-NGOs)
Total
(a)  Please provide detailed information as requested in Form 2


228 Directions, Determinations, and Circulars issued to Licensed Commercial BanksTable 2
Donations Received by Non-Governmental Organisations (NGOs)
Name of the Bank ....…………………………….
Reporting Month ....……………………………..
Name
and
Address of
NGO Account
No.Branch Remittances Received in Foreign
CurrencyLocal Donations
Withdrawals,
Rs.Balance
as at End
of Month,
Rs.Foreign
Currency
AmountRs.
EquivalentDonor /
Remitter: Name
& AddressAmount,
Rs.Donor/Remitter:
Name & Address
Notes:  Please provide above information in respect of donations received during each-reporting month, withdrawals and month-end balances relating to
accounts maintained by “NGOS”
 Y ou may liaise with Mr. G C A Ariyadasa, Asst. Director, Bank Supervision Department, (Tel. 4277110) in this regard.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  229
Directions issued by the Monetary Board of the Central Bank of Sri Lanka under Section 46(1) of the
Banking Act, No.30 of 1988, as amended.
Sgd. Nivard Ajith Leslie Cabraal
Governor
Colombo
26 December 2007
DIRECTIONS
BANKING ACT DIRECTION NO. 11 OF 2007
Corporate Governance for Licensed Commercial Banks in Sri Lanka
In the exercise of the powers conferred by Section 46(1) of the Banking Act, No.30 of 1988, last amended
by the Banking Act, No.46 of 2006, the Monetary Board hereby issues the following Directions on
Corporate Governance for Licensed Commercial Banks in Sri Lanka. These Directions may be cited as
the Banking Act, Direction No.11 of 2007. The Sections referred to in these Directions will be those of
the Banking Act, No. 30 of 1988, last amended by the Banking Act, No.46 of 2006.
1. Responsibilities and Empowerment under  the Banking Act and the Monetary Law Act
1(1) In terms of Section 46(1) of the Banking Act, No.30 of 1988 last amended by No.46 of 2006, in
order to ensure the soundness of the banking system, the Monetary Board has been empowered to
issue Directions to licensed commercial banks, regarding the manner in which any aspect of the
business of such banks is to be conducted.
1(2)  In terms of Section 5 of the Monetary Law Act, No.58 of 1949, the Central Bank of Sri Lanka
is charged with the duty of securing, as far as possible by action authorised by such Act, the two
objectives, namely, (a) economic and price stability and ( b) financial system stability.
1(3) In terms of Section 10( c) of the Monetary Law Act, the Monetary Board, in the exercise of its
powers, duties, functions and responsibilities, is empowered to make such rules and regulations
as the Monetary Board may consider necessary, in relation to any matter affecting or connected
with or incidental to the exercise, discharge, or performance of the powers, functions, and duties


with or incidental to the exercise, discharge, or performance of the powers, functions, and duties
of the Central Bank of Sri Lanka.
1(4) Under the provisions of the Monetary Law Act, No.58 of 1949, the supervision of banks has been
made a duty of the Central Bank on account of specific reasons as stated in John Exter’s Report
on the Monetary Law Act which states, inter-alia, as follows: “Banking is an economic activity
which affects the public welfare to an unusual degree; it touches in one way or another, almost
every phase of a country’ s economic life. Sound banking is essential to healthy and vigorous
economic development. Supervision of banks helps to protect the public against mismanagement,
bank failures, and loss of confidence in the banking system. It helps to protect depositors and
stock-holders against loss and frequently enables bank directors and officers to manage the affairs
of their banks more wisely and intelligently.”
1(5) Accordingly , in order to enhance the overall banking sector stability which is the fundamental to
financial system stability, the Monetary Board, hereby issues Directions under Section 46(1) of
the Banking Act, No.30 of 1988 to improve and sustain the corporate governance processes and
practices of the licensed commercial banks in Sri Lanka.


230 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
1(6) For purposes of this Direction, Corporate Governance processes and practices shall be deemed to
be the management framework that facilitates the conduct of the banking business in a responsible
and accountable manner so as to promote the safety and soundness of the individual banks, thereby
leading to the stability of the overall banking sector.
1(7) The rules of corporate governance as contained in Direction 3 of these Directions have, therefore,
been developed on the basis of certain fundamental principles as set out in Direction 2 of these
Directions with a view to facilitating the underlying supervisory responsibilities of the Central
Bank and to promote safety and soundness of the banking system.
2. The Principles upon which the rules of Corporate Governance have been based upon and
developed are the following:
 The principles set out in this Direction 2 should be referred to for explanatory purposes and/
or	for	clarification 	purposes 	only,	so	as	to	understand 	the	rationale 	for	the	rules	as	contained
in Direction 3 hereof. Hence, strict compliance under these Directions shall only be in respect
of the rules that are set out under Direction 3.
2(1) Principle: The Responsibilities of the Board
2(1)(i)  The board of directors should assume the overall responsibility and accountability in respect
of: (a) the management of the affairs of the bank, i.e., conduct of business and maintenance
of prudent risk management mechanisms; and ( b) the safety and soundness of the bank.
2(1)(ii)  T owards this end, the board should: ( a) determine the structure of the management of affairs
of the bank; (b) delegate business operations to key management personnel led by the chief
executive officer designated by the board; (c) assume policy making and risk management
for the business; and ( d) ensure the effective role of the key management personnel.


for the business; and ( d) ensure the effective role of the key management personnel.
Key management personnel shall mean such key executives of the bank as defined in the
International Accounting Standards.
2(1)(iii)  The overall responsibility of the board should not be construed as an obligation to undertake
the inspection of day-to-day activities, but should rather be understood as an obligation
to oversee and ensure that the key management personnel are carrying out the day-to-day
activities of the bank in a safe and sound manner in accordance with the policies set by the
board.
2(1)(iv)  Directors should understand the business and risk management mechanism of the bank and
take objective decisions in the interest of the bank’s depositors, creditors, shareholders and
other stakeholders. Further, they should ensure that the bank does not act in a manner that is
detrimental or prejudicial to the interests of, and obligations to, depositors and creditors.
2(1)(v)  The board should take the responsibility for compliance with accepted rules of corporate
governance. They should also ensure compliance with all regulatory and supervisory
requirements. Further, they should ensure that an effective combination of professionals
with practical experience in relevant subjects such as banking, finance, economics, business
management, human resource management, law, marketing, information technology or any
other discipline relevant or complementary to banking operations, is available in the bank to
undertake its operations and discharge its responsibilities.
2(1)(vi)  The directors should be aware of potential civil and criminal liabilities that may arise from
their failure to discharge their duties diligently. They should also understand that they
should act with due care and prudence. In addition, the directors of state owned banks
should be aware of the additional liabilities that arise from the status of such banks being


should be aware of the additional liabilities that arise from the status of such banks being
state enterprises and consequently being accountable to the public. It is, therefore, necessary
that directors commit sufficient time and energy to fulfilling the board’s responsibilities in
managing the affairs of the bank in a prudent manner.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  231
2(2) Principle: The Board’s composition
2(2)(i)  The board should be composed of a healthy mix of executive directors and non-executive
directors. Some of the non-executive directors should also be independent so that there is
strong independent element brought into the decision-making process.
2(2)(ii)  The board’s composition should ensure a balance of skills and experience as may be deemed
appropriate and desirable for the requirements of the bank.
2(2)(iii)  The banking industry worldwide is making tremendous progress and under going rapid
change with new innovations, instruments, technologies, products, systems and processes
being introduced regularly. It is vital therefore, that the directors should be persons
who would: (a ) be able to keep abreast with these changes, and ( b) provide continuous
contribution and guidance to the board decision-making process.
2(2)(iv)  There s hould be a gradual infusion of new ideas into the board. There should also be
assurance that the relationships between the directors amongst themselves as well as
between the directors and the key management personnel is at a level that does not suggest
the existence of excessive familiarity, undue influence or coercion. In this context, it should
be noted that very long-standing relationships could sometimes impair the high sense of
values, independence and objectivity that is needed in the discharge of the duties of a director
of a bank.
2(3)  Principle: Criteria to assess the Fitness and Propriety of Directors
2(3)(i)  In addition to the principles under the board’s composition in Direction 2(2) above, directors
should be fit and proper persons in order to be eligible to hold office as directors of a bank
and no person should serve as a director unless such person is a fit and proper person.


and no person should serve as a director unless such person is a fit and proper person.
2(3)(ii)  There is strong need for commitment and effective contribution to the prudent management
of the affairs of the bank. It is very likely that the effectiveness of such commitment and
contribution would tend to decrease with advanced age of directors and more particularly,
if the age of such director is well beyond the normal age of retirement, as generally accepted
in the country.
2(4) Principle: Management functions delegated by the Board
2(4)(i)  The board should have a formal schedule of matters specifically reserved to it for decision.
The board should also give clear directions to key management personnel, as to the matters
that should be approved by the board before decisions are made by key management
personnel, on behalf of the bank.
2(5)  Principle: 	The	Chairman 	and	the	Chief	Executive 	Officer
2(5)(i)  There are two key aspects of the management of every bank, viz., (a) the overall governance
by the board, and ( b) the day-to-day management of the bank’s business by the CEO, in
line with board approved strategic objectives, corporate values, overall risk policy and risk
management procedures.
2(5)(ii)  There should be a clear division of these responsibilities at the board level and the executive
management level to ensure a greater balance of power and authority, so that powers are not
concentrated in any one individual.
2(5)(iii)  The board should appoint a chairman as well as a chief executive officer. The division
of responsibilities between the chairman and chief executive officer should be clearly
established and set out in writing.


232 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
2(6)  Principle: Board appointed Committees
2(6)(i)  The board should appoint separate board committees for audit, selection, remuneration,
integrated risk management and such other subjects as determined by the Board to ensure its
oversight and control over the affairs of the bank.
2(6)(ii)  Where the board appoints a committee, it should set out the authority of the committee,
and in particular, whether the committee has the authority to act on behalf of the board or
simply has the authority to examine a particular issue and report back to the board with
recommendations.
2(6)(iii)  Each committee should be chaired by a non-executive director who has some expertise in
the relevant subject, and who preferably should be independent too. The majority of the
members of the board committee should consist of non-executive directors with at least one
independent director in the committee. If a need arises, professionals from outside may be
invited or hired to serve in a committee. Bank staff may be present at the board committees
for advice or special assignments, on invitation.
2(7)  Principle: Related party transactions
2(7)(i)  The board should ensure that the bank does not engage in transactions with “related parties”
in a manner that would grant such parties “more favourable treatment” than that accorded to
other constituents of the bank carrying on the same business.
2(8) Principle: Disclosures
2(8)(i)  The objective of disclosure is the transparency of information relating to affairs and risk
management of banks which would help to promote market discipline of the respective
banks.
2(8)(ii)  Since market disclosure is the focus of the Pillar III of the risk management based capital
standard known as Basel II recommended by the Basel Committee on Banking Supervision
at the Bank for International Settlements, (which is the globally accepted body on


at the Bank for International Settlements, (which is the globally accepted body on
introducing international standards on Bank Supervision), the extent of disclosures should
be commensurate with the size, ownership structure, systemic importance, risk profile
and the business model of the bank. Accordingly, it should be noted that the adequate and
timely public disclosure of relevant information by banks would facilitate enhanced market
discipline and lead to better and more effective corporate governance.
2(8)(iii)  Disclosures by banks should generally include disclosures relating to capital adequacy, key
performance indicators, business concentrations, transactions with related parties, corporate
governance statements, financial statements, etc., and should be consistent with accounting
standards, regulatory requirements as well as with any other information disclosed on
voluntary basis.
3. The following rules of Corporate Governance shall be complied by all licensed commercial
banks in Sri Lanka and such compliance shall be as provided for in Direction 3(9)(i) hereof.
3(1)  The Responsibilities of the Board
3(1)(i)  The board shall strengthen the safety and soundness of the bank by ensuring the
implementation of the following:
 a) Approve and oversee the bank’s strategic objectives and corporate values and ensure
that these are communicated throughout the bank;
 b) Approve the overall business strategy of the bank, including the overall risk policy and
risk management procedures and mechanisms with measurable goals, for at least the
next three years;


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  233
 c ) Identify the principal risks and ensure implementation of appropriate systems to
manage the risks prudently;
 d) Approve implementation of a policy of communication with all stakeholders, including
depositors, creditors, share-holders and borrowers;
 e ) R eview the adequacy and the integrity of the bank’s internal control systems and
management information systems;
 f ) Identify and designate key management personnel, as defined in the International
Accounting Standards, who are in a position to: ( i) significantly influence policy;
(ii) direct activities; and (iii ) exercise control over business activities, operations and
risk management;
 g) Define the areas of authority and key responsibilities for the board directors themselves
and for the key management personnel;
 h) Ensure that there is appropriate oversight of the affairs of the bank by key management
personnel, that is consistent with board policy;
 i) Periodically assess the effectiveness of the board directors’ own governance practices,
including: (i) the selection, nomination and election of directors and key management
personnel; (ii) the management of conflicts of interests; and (iii ) the determination of
weaknesses and implementation of changes where necessary;
 j) Ensure that the bank has an appropriate succession plan for key management personnel;
 k) Meet regularly, on a needs basis, with the key management personnel to review policies,
establish communication lines and monitor progress towards corporate objectives;
 l) Understand the regulatory environment and ensure that the bank maintains an effective
relationship with regulators;
 m) Exercise due diligence in the hiring and oversight of external auditors.
3(1)(ii)  The board shall appoint the chairman and the chief executive officer and define and approve


the functions and responsibilities of the chairman and the chief executive officer in line with
Direction 3(5) of these Directions.
3(1)(iii)  The board shall meet regularly and board meetings shall be held at least twelve times a year
at approximately monthly intervals. Such regular board meetings shall normally involve
active participation in person of a majority of directors entitled to be present. Obtaining the
board’s consent through the circulation of written resolutions/papers shall be avoided as far
as possible.
3(1)(iv)  The board shall ensure that arrangements are in place to enable all directors to include
matters and proposals in the agenda for regular board meetings where such matters and
proposals relate to the promotion of business and the management of risks of the bank.
3(1)(v)  The board procedures shall ensure that notice of at least 7 days is given of a regular board
meeting to provide all directors an opportunity to attend. For all other board meetings,
reasonable notice may be given.
3(1)(vi)  The board procedures shall ensure that a director who has not attended at least two-thirds
of the meetings in the period of 12 months immediately preceding or has not attended
the immediately preceding three consecutive meetings held, shall cease to be a director.
Participation at the directors’ meetings through an alternate director shall, however,
be acceptable as attendance.
3(1)(vii)  The board shall appoint a company secretary who satisfies the provisions of Section 43 of the
Banking Act No. 30 of 1988, whose primary responsibilities shall be to handle the secretariat
services to the board and shareholder meetings and to carry out other functions specified in
the statutes and other regulations.


234 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
3(1)(viii)  All directors shall have access to advice and services of the company secretary with a view
to ensuring that board procedures and all applicable rules and regulations are followed.
3(1)(ix)  The company secretary shall maintain the minutes of board meetings and such minutes shall
be open for inspection at any reasonable time, on reasonable notice by any director.
3(1)(x)  Minutes of board meetings shall be recorded in sufficient detail so that it is possible to gather
from the minutes, as to whether the board acted with due care and prudence in performing
its duties. The minutes shall also serve as a reference for regulatory and supervisory
authorities to assess the depth of deliberations at the board meetings. Therefore, the minutes
of a board meeting shall clearly contain or refer to the following: ( a) a summary of data
and information used by the board in its deliberations; ( b) the matters considered by the
board; (c) the fact-finding discussions and the issues of contention or dissent which may
illustrate whether the board was carrying out its duties with due care and prudence; ( d) the
testimonies and confirmations of relevant executives which indicate compliance with the
board’s strategies and policies and adherence to relevant laws and regulations; (e) the board’s
knowledge and understanding of the risks to which the bank is exposed and an overview of
the risk management measures adopted; and ( f) the decisions and board resolutions.
3(1)(xi)  There shall be a procedure agreed by the board to enable directors, upon reasonable request,
to seek independent professional advice in appropriate circumstances, at the bank’s expense.
The board shall resolve to provide separate independent professional advice to directors to
assist the relevant director or directors to discharge his/her/their duties to the bank.


assist the relevant director or directors to discharge his/her/their duties to the bank.
3(1)(xii)  Directors shall avoid conflicts of interests, or the appearance of conflicts of interest, in their
activities with, and commitments to, other organisations or related parties. If a director has a
conflict of interest in a matter to be considered by the board, which the board has determined
to be material, the matter should be dealt with at a board meeting, where independent
non-executive directors [refer to Direction 3(2)(iv) of these Directions] who have no material
interest in the transaction, are present. Further, a director shall abstain from voting on any
board resolution in relation to which he/she or any of his/her close relation or a concern in
which a director has substantial interest, is interested and he/she shall not be counted in the
quorum for the relevant agenda item at the board meeting.
3(1)(xiii)  The board shall have a formal schedule of matters specifically reserved to it for decision to
ensure that the direction and control of the bank is firmly under its authority .
3(1)(xiv)  The board shall, if it considers that the bank is, or is likely to be, unable to meet its obligations
or is about to become insolvent or is about to suspend payments due to depositors and other
creditors, forthwith inform the Director of Bank Supervision of the situation of the bank prior
to taking any decision or action.
3(1)(xv)  The board shall ensure that the bank is capitalised at levels as required by the Monetary
Board in terms of the capital adequacy ratio and other prudential grounds.
3(1)(xvi)  The board shall publish in the bank’s Annual Report, an annual corporate governance report
setting out the compliance with Direction 3 of these Directions.
3(1)(xvii)  The board shall  adopt a scheme of self-assessment to be undertaken by each director
annually, and maintain records of such assessments.
3(2) The Board’s Composition


annually, and maintain records of such assessments.
3(2) The Board’s Composition
3(2)(i)  The number of directors on the board shall not be less than 7 and not more than 13.
3(2)(ii)  (A) The total period of service of a director other than a director who holds the position of
chief executive officer shall not exceed nine years, and such period in office shall be
inclusive of the total period of service served by such director up to 01 January 2008.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  235
  (B) In this context, the following transitional provisions shall apply:
 a) In the event that there is only one director on the board who has served more than
nine years as at 01 January 2008, he/she shall be deemed to have vacated the office
as a director as at 31 December 2008.
 b) In the event that there are two or more directors on the board who have served more
than nine years as at 01 January 2008, the following provisions shall apply:
 I. Of those directors whose period of service has exceeded nine years, the longest
serving director, shall be deemed to have vacated office as a Director on
31 December 2008.
 II. Thereafter , at the end of each succeeding year, the remaining directors shall
be deemed to have vacated office in sequence, at least one director each year,
(on the basis of the longest to the shortest length of service as a director),
until all directors who have served a period in excess of nine years as at
01 January 2008, have been deemed to have vacated office. Provided also, that
all directors of the bank who have served more than nine years as at 01 January
2008 shall be deemed to have vacated their office by or before 31 December
2011.
 c) In the event there are any directors who are due to complete nine years of service
between 01 January 2008 and 31 December 2010, such directors shall also be
deemed to have vacated office, in sequence, at least one director each year,
(on the basis of the longest to the shortest length of service as a director), after the
directors as set out in Direction 3(2)(ii)(B)(b) have vacated their office as directors.
Provided, however, that all such directors covered by this sub-direction ( c) shall
also be deemed to have vacated their office by or before 31 December 201 1.
3(2)(iii)  An employee of a bank may be appointed, elected or nominated as a director of the bank


3(2)(iii)  An employee of a bank may be appointed, elected or nominated as a director of the bank
(hereinafter referred to as an “executive director”) provided that the number of executive
directors shall not exceed one-third of the number of directors of the board. In such an event,
one of the executive directors shall be the chief executive officer of the bank.
3(2)(iv)  The board shall have at least three independent non-executive directors or one third of the
total number of directors, whichever is higher. This sub-direction shall be applicable from
01 January 2010 onwards.
  A  non-executive director shall not be considered independent if he/she:
 a) has direct and indirect shareholdings of more than 1 per cent of the bank;
 b ) currently has or had during the period of two years immediately preceding his/her
appointment as director, any business transactions with the bank as described in
Direction 3(7) hereof, exceeding 10 per cent of the regulatory capital of the bank.
 c) has been employed by the bank during the two year period immediately preceding the
appointment as director;
 d) has a close relation who is a director or chief executive officer or a member of key
management personnel or a material shareholder of the bank or another bank. For this
purpose, a “close relation” shall mean the spouse or a financially dependant child;
 e)  represents a specific stakeholder of the bank;
 f ) i s an employee or a director or a material shareholder in a company or business
organization:
 I. which currently has a transaction with the bank as defined in Direction 3(7) of
these Directions, exceeding 10 per cent of the regulatory capital of the bank, or


236 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
 II. in which any of the other directors of the bank are employed or are directors or
are material shareholders; or
 III. in which any of the other directors of the bank have a transaction as defined in
Direction 3(7) of these Directions, exceeding 10 per cent of regulatory capital in
the bank;
3(2)(v)  In the event an alternate director is appointed to represent an independent director, the person
so appointed shall also meet the criteria that applies to the independent director.
3(2)(vi)  Non-executive directors shall be persons with credible track records and/or have necessary
skills and experience to bring an independent judgment to bear on issues of strategy,
performance and resources.
3(2)(vii)  A  meeting of the board shall not be duly constituted, although the number of directors
required to constitute the quorum at such meeting is present, unless more than one half of the
number of directors present at such meeting are non-executive directors. This sub-direction
shall be applicable from 01 January 2010 onwards.
3(2)(viii)  The independent non-executive directors shall be expressly identified as such in all corporate
communications that disclose the names of directors of the bank. The bank shall disclose
the composition of the board, by category of directors, including the names of the chairman,
executive directors, non-executive directors and independent non-executive directors in the
annual corporate governance report.
3(2)(ix)  There shall be a formal, considered and transparent procedure for the appointment of new
directors to the board. There shall also be procedures in place for the orderly succession of
appointments to the board.
3(2)(x)  All directors appointed to fill a casual vacancy shall be subject to election by shareholders at
the first general meeting after their appointment.


the first general meeting after their appointment.
3(2)(xi)  If a director resigns or is removed from office, the board shall: ( a) announce the director’s
resignation or removal and the reasons for such removal or resignation including but not
limited to information relating to the relevant director’s disagreement with the bank, if any;
and (b) issue a statement confirming whether or not there are any matters that need to be
brought to the attention of shareholders.
3(2)(xii)  A  director or an employee of a bank shall not be appointed, elected or nominated as a director
of another bank except where such bank is a subsidiary company or an associate company of
the first mentioned bank.
3(3) Criteria	to	assess	the	fitness	and	propriety 	of	directors
  In addit ion to provisions of Section 42 of the Banking Act, No.30 of 1988, the criteria set out
below shall apply to determine the fitness and propriety of a person who serves or wishes to
serve as a director of a bank. Non-compliance with any one of the criteria as set out herein shall
disqualify a person to be appointed, elected or nominated as a director or to continue as a director.
3(3)(i)  The age of a person who serves as director shall not exceed 70 years.
 (A) Where a director who is currently serving at a bank is over 70 years of age as at
01 January 2008, the following transitional provisions shall apply, subject however to
the provisions as set out in Direction 3(2)(ii) hereof.
 a) If a director is over 75 years of age as at 01 January 2008, such director may
continue to serve as a director for a further period that shall not extend beyond


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  237
31 December 2008, and shall be deemed to have vacated office on 31 December
2008;
 b ) If a director is between 70 and 75 years of age as at 01 January 2008, such
director may continue to serve as a director for a further period that shall not
extend beyond 31 December 2009, and shall be deemed to have vacated office on
31 December 2009.
(B) Where a director who is currently serving at a bank reaches the age of 70 years, between
01 January 2008 and 31 December 2009, such director may, subject to the provisions as
set out in Direction 3(2)(ii) hereof, continue to serve as a director for a further period
that shall not extend beyond 31 December 2010 and shall be deemed to have vacated
office on 31 December 2010.
3(3)(ii)  A  person shall not hold office as a director of more than 20 companies/entities/institutions
inclusive of subsidiaries or associate companies of the bank. Of such 20 companies/entities/
institutions, not more than 10 companies shall be those classified as Specified Business
Entities in terms of the Sri Lanka Accounting and Auditing Standards Act, No. 15 of 1995.
3(4) Management functions delegated by the Board
3(4)(i)  The directors shall carefully study and clearly understand the delegation arrangements in
place.
3(4)(ii)  The board shall not delegate any matters to a board committee, chief executive officer,
executive directors or key management personnel, to an extent that such delegation would
significantly hinder or reduce the ability of the board as a whole to dischar ge its functions.
3(4)(iii)  The board shall review the delegation processes in place on a periodic basis to ensure that
they remain relevant to the needs of the bank.
3(5) The	Chairman 	and	Chief	Executive 	Officer
3(5)(i)  The roles of chairman and chief executive officer shall be separate and shall not be performed
by the same individual.


by the same individual.
3(5)(ii)  The chairman shall be a non-executive director and preferably an independent director as
well. In the case where the chairman is not an independent director, the board shall designate
an independent director as the Senior Director with suitably documented terms of reference
to ensure a greater independent element. The designation of the Senior Director shall be
disclosed in the bank’s Annual Report.
3(5)(iii)  The board shall disclose in its corporate governance report, which shall be an integral part
of its Annual Report, the identity of the chairman and the chief executive officer and the
nature of any relationship [including financial, business, family or other material/relevant
relationship(s)], if any, between the chairman and the chief executive officer and the
relationships among members of the board.
3(5)(iv)  The chairman shall: ( a) provide leadership to the board; (b) ensure that the board works
effectively and discharges its responsibilities; and ( c) ensure that all key and appropriate
issues are discussed by the board in a timely manner.
3(5)(v)  The chairman shall be primarily responsible for drawing up and approving the agenda for
each board meeting, taking into account where appropriate, any matters proposed by the
other directors for inclusion in the agenda. The chairman may delegate the drawing up of the
agenda to the company secretary.
3(5)(vi)  The chairman shall ensure that all directors are properly briefed on issues arising at board
meetings and also ensure that directors receive adequate information in a timely manner.


238 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
3(5)(vii)  The chairman shall encourage all directors to make a full and active contribution to the
board’s affairs and take the lead to ensure that the board acts in the best interests of the bank.
3(5)(viii)  The chairman shall facilitate the ef fective contribution of non-executive directors in
particular and ensure constructive relations between executive and non-executive directors.
3(5)(ix)  The chairman, shall not engage in activities involving direct supervision of key management
personnel or any other executive duties whatsoever.
3(5)(x)  T he chairman shall ensure that appropriate steps are taken to maintain effective
communication with shareholders and that the views of shareholders are communicated to
the board.
3(5)(xi)  The chief executive officer shall function as the apex executive-in-charge of the day-to-day
management of the bank’s operations and business.
3(6) Board appointed Committees
3(6)(i)  Each bank shall have at least four board committees as set out in Directions 3(6)(ii), 3(6)(iii),
3(6)(iv) and 3(6)(v) of these Directions. Each committee shall report directly to the board.
All committees shall appoint a secretary to arrange the meetings and maintain minutes,
records, etc., under the supervision of the chairman of the committee. The board shall present
a report of the performance on each committee, on their duties and roles at the annual general
meeting.
3(6)(ii)  The following rules shall apply in relation to the Audit Committee:
 a) The chair man of the committee shall be an independent non-executive director who
possesses qualifications and experience in accountancy and/or audit.
 b) All members of the committee shall be non-executive directors.
 c) The committee shall make recommendations on matters in connection with: ( i) the
appointment of the external auditor for audit services to be provided in compliance


appointment of the external auditor for audit services to be provided in compliance
with the relevant statutes; (ii) the implementation of the Central Bank guidelines issued
to auditors from time to time; (iii ) the application of the relevant accounting standards;
and (iv) the service period, audit fee and any resignation or dismissal of the auditor;
provided that the engagement of the Audit partner shall not exceed five years, and that
the particular Audit partner is not re-engaged for the audit before the expiry of three
years from the date of the completion of the previous term.
 d ) The committee shall review and monitor the external auditor’s independence and
objectivity and the effectiveness of the audit processes in accordance with applicable
standards and best practices.
 e) The committee shall develop and implement a policy on the engagement of an external
auditor to provide non-audit services that are permitted under the relevant statutes,
regulations, requirements and guidelines. In doing so, the committee shall ensure
that the provision by an external auditor of non-audit services does not impair the
external auditor’s independence or objectivity. When assessing the external auditor’s
independence or objectivity in relation to the provision of non-audit services, the
committee shall consider:
 I. whether the skills and experience of the audit firm make it a suitable provider of
the non-audit services;
 I I. wh ether there are safeguards in place to ensure that there is no threat to the
objectivity and/or independence in the conduct of the audit resulting from the
provision of such services by the external auditor; and


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  239
 III. whether the nature of the non-audit services, the related fee levels and the fee
levels individually and in aggregate relative to the audit firm, pose any threat to
the objectivity and/or independence of the external auditor.
 f ) The committee shall, before the audit commences, discuss and finalise with the
external auditors the nature and scope of the audit, including: ( i) an assessment of the
bank’s compliance with the relevant Directions in relation to corporate governance
and the management’s internal controls over financial reporting; (ii) the preparation
of financial statements for external purposes in accordance with relevant accounting
principles and reporting obligations; and (iii ) the co-ordination between firms where
more than one audit firm is involved.
 g) The committee shall review the financial information of the bank, in order to monitor
the integrity of the financial statements of the bank, its annual report, accounts and
quarterly reports prepared for disclosure, and the significant financial reporting
judgments contained therein. In reviewing the bank’s annual report and accounts and
quarterly reports before submission to the board, the committee shall focus particularly
on: (i) major judgmental areas; (ii) any changes in accounting policies and practices;
(iii) significant adjustments arising from the audit; (iv) the going concern assumption;
and (v) the compliance with relevant accounting standards and other legal requirements.
 h) The comm ittee shall discuss issues, problems and reservations arising from the interim
and final audits, and any matters the auditor may wish to discuss including those
matters that may need to be discussed in the absence of key management personnel,
if necessary.
 i ) The  committee shall review the external auditor’s management letter and the
management’s response thereto.


management’s response thereto.
 j) The committee shall take the following steps with regard to the internal audit function
of the bank:
 I. Review the adequacy of the scope, functions and resources of the internal audit
department, and satisfy itself that the department has the necessary authority to
carry out its work;
 II. Review the internal audit programme and results of the internal audit process
and, where necessary, ensure that appropriate actions are taken on the
recommendations of the internal audit department;
 III. Review any appraisal or assessment of the performance of the head and senior
staff members of the internal audit department;
 IV . Recommend any appointment or termination of the head, senior staff members
and outsourced service providers to the internal audit function;
 V . Ensure that the committee is appraised of resignations of senior staff members
of the internal audit department including the chief internal auditor and any
outsourced service providers, and to provide an opportunity to the resigning
senior staff members and outsourced service providers to submit reasons for
resigning;
 VI. Ensure that the internal audit function is independent of the activities it audits and
that it is performed with impartiality, proficiency and due professional care;
 k ) The committee shall consider the major findings of internal investigations and
management’s responses thereto;
 l) The chief finance officer, the chief internal auditor and a representative of the external
auditors may normally attend meetings. Other board members and the chief executive
officer may also attend meetings upon the invitation of the committee. However, at
least twice a year, the committee shall meet with the external auditors without the
executive directors being present.


240 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
 m) The committee shall have: ( i) explicit authority to investigate into any matter within
its terms of reference; ( ii) the resources which it needs to do so; ( iii) full access to
information; and ( iv) authority to obtain external professional advice and to invite
outsiders with relevant experience to attend, if necessary.
 n) The committee shall meet regularly, with due notice of issues to be discussed and shall
record its conclusions in discharging its duties and responsibilities.
 o ) The board shall disclose in an informative way , (i) details of the activities of the
audit committee; (ii) the number of audit committee meetings held in the year; and
(iii) details of attendance of each individual director at such meetings.
 p) The secretary of the committee (who may be the company secretary or the head of
the internal audit function) shall record and keep detailed minutes of the committee
meetings.
 q ) The committee shall review arrangements  by which employees of the bank may,
in confidence, raise concerns about possible improprieties in financial reporting,
internal control or other matters. Accordingly, the committee shall ensure that proper
arrangements are in place for the fair and independent investigation of such matters
and for appropriate follow-up action and to act as the key representative body for
overseeing the bank’s relations with the external auditor.
3(6)(iii)  The following rule s shall apply in relation to the Human Resources and Remuneration
Committee:
 a ) The committee shall determine the remuneration policy (salaries , allowances and
other financial payments) relating to directors, Chief Executive Officer (CEO) and key
management personnel of the bank.
 b ) The committee shall set goals and tar gets for the directors, CEO and the key
management personnel.
 c ) T he committee shall evaluate the performance of the CEO and key management


c ) T he committee shall evaluate the performance of the CEO and key management
personnel against the set targets and goals periodically and determine the basis for
revising remuneration, benefits and other payments of performance-based incentives.
 d ) The CEO shall be present at all meetings of the committee, except when matters
relating to the CEO are being discussed.
3(6)(iv)  The following rules shall apply in relation to the Nomination Committee:
 a) The committee shall implement a procedure to select/appoint new directors, CEO and
key management personnel.
 b) The comm ittee shall consider and recommend (or not recommend) the re-election of
current directors, taking into account the performance and contribution made by the
director concerned towards the overall discharge of the board’s responsibilities.
 c) The committee shall set the criteria such as qualifications, experience and key attributes
required for eligibility to be considered for appointment or promotion to the post of
CEO and the key management positions.
 d) The committee shall ensure that directors, CEO and key management personnel are fit
and proper persons to hold office as specified in the criteria given in Direction 3(3) and
as set out in the Statutes.
 e) The comm ittee shall consider and recommend from time to time, the requirements of
additional/new expertise and the succession arrangements for retiring directors and key
management personnel.
 f ) T he Committee shall be chaired by an Independent Director and preferably be
constituted with a majority of Independent Directors. The CEO may be present at
meetings by invitation.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  241
3(6)(v)  The following rules shall apply in relation to the Integrated Risk Management Committee:
 a) The comm ittee shall consist of at least three non-executive directors, chief executive
officer and key management personnel supervising broad risk categories, i.e., credit,
market, liquidity, operational and strategic risks. The committee shall work with key
management personnel very closely and make decisions on behalf of the board within
the framework of the authority and responsibility assigned to the committee.
 b ) The committee shall assess all risks, i.e., credit, market, liquidity, operational and
strategic risks to the bank on a monthly basis through appropriate risk indicators
and management information. In the case of subsidiary companies and associate
companies, risk management shall be done, both on a bank basis and group basis.
 c) The committee shall review the adequacy and effectiveness of all management level
committees such as the credit committee and the asset-liability committee to address
specific risks and to manage those risks within quantitative and qualitative risk limits
as specified by the committee.
 d) The committee shall take prompt corrective action to mitigate the effects of specific risks
in the case such risks are at levels beyond the prudent levels decided by the committee
on the basis of the bank’s policies and regulatory and supervisory requirements.
 e) The comm ittee shall meet at least quarterly to assess all aspects of risk management
including updated business continuity plans.
 f)  The committee shall take appropriate actions against the officers responsible for failure
to identify specific risks and take prompt corrective actions as recommended by the
committee, and/or as directed by the Director of Bank Supervision.
 g) The comm ittee shall submit a risk assessment report within a week of each meeting to


g) The comm ittee shall submit a risk assessment report within a week of each meeting to
the board seeking the board’s views, concurrence and/or specific directions.
 h) The committee shall establish a compliance function to assess the bank’s compliance
with laws, regulations, regulatory guidelines, internal controls and approved policies
on all areas of business operations. A dedicated compliance officer selected from
key management personnel shall carry out the compliance function and report to the
committee periodically.
3(7) Related party transactions
3(7)(i)  The board shall take the necessary steps to avoid any conflicts of interest that may arise from
any transaction of the bank with any person, and particularly with the following categories
of persons who shall be considered as “related parties” for the purposes of this Direction:
 a) Any of the bank’ s subsidiary companies;
 b) Any of the bank’ s associate companies;
 c) Any of the directors of the bank;
 d) Any of the bank’ s key management personnel;
 e) A  close relation of any of the bank’s directors or key management personnel;
 f) A  shareholder owning a material interest in the bank;
 g) A  concern in which any of the bank’s directors or a close relation of any of the bank’s
directors or any of its material shareholders has a substantial interest.
3(7)(ii)  The type of transactions with related parties that shall be covered by this Direction shall
include the following:
 a) The grant of any type of accommodation, as defined in the Monetary Board’s Directions
on maximum amount of accommodation,


242 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
 b ) T he creation of any liabilities of the bank in the form of deposits, borrowings and
investments,
 c) The provision of any services of a financial or non-financial nature provided to the bank
or received from the bank,
 d ) The creation or maintenance of reporting lines and information flows between the
bank and any related parties which may lead to the sharing of potentially proprietary,
confidential or otherwise sensitive information that may give benefits to such related
parties.
3(7)(iii)  The board shall ensure that the bank does not engage in transactions with related parties
as defined in Direction 3(7)(i) above, in a manner that would grant such parties “more
favourable treatment” than that accorded to other constituents of the bank carrying on
the same business. In this context, “more favourable treatment” shall mean and include
treatment, including the:
 a) Granting of “total net accommodation” to related parties, exceeding a prudent percentage
of the bank’s regulatory capital, as determined by the board. For purposes of this
sub-direction:
 I .  “Accommodation” shall mean accommodation as defined in the Banking Act
Directions, No.7 of 2007 on Maximum Amount of Accommodation.
 II. The “total net accommodation” shall be computed by deducting from the total
accommodation, the cash collateral and investments made by such related parties
in the bank’s share capital and debt instruments with a maturity of 5 years or
more.
 b) Char ging of a lower rate of interest than the bank’s best lending rate or paying more
than the bank’s deposit rate for a comparable transaction with an unrelated comparable
counterparty;
 c) Providing of preferential treatment, such as favourable terms, covering trade losses
and/or waiving fees/commissions, that extend beyond the terms granted in the normal
course of business undertaken with unrelated parties;


course of business undertaken with unrelated parties;
 d) Providing services to or receiving services from a related-party without an evaluation
procedure;
 e) Maintaining reporting lines and information flows that may lead to sharing potentially
proprietary, confidential or otherwise sensitive information with related parties, except
as required for the performance of legitimate duties and functions.
3(7)(iv)  A  bank shall not grant any accommodation to any of its directors or to a close relation of such
director unless such accommodation is sanctioned at a meeting of its board of directors, with
not less than two-thirds of the number of directors other than the director concerned, voting
in favour of such accommodation. This accommodation shall be secured by such security as
may from time to time be determined by the Monetary Board as well.
3(7)(v)  a) Where any accommodation has been granted by a bank to a person or a close relation
of a person or to any concern in which the person has a substantial interest, and such
person is subsequently appointed as a director of the bank, steps shall be taken by
the bank to obtain the necessary security as may be approved for that purpose by the
Monetary Board, within one year from the date of appointment of the person as a
director.
  b) Where such security is not provided by the period as provided in Direction 3(7)(v)
(a) above, the bank shall take steps to recover any amount due on account of any
accommodation, together with interest, if any, within the period specified at the time of
the grant of accommodation or at the expiry of a period of eighteen months from the
date of appointment of such director, whichever is earlier.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  243
  c) Any director who fails to comply with the above sub-directions shall be deemed to have
vacated the office of director and the bank shall disclose such fact to the public.
  d) This sub-direction, however , shall not apply to a director who at the time of the grant of
the accommodation was an employee of the bank and the accommodation was granted
under a scheme applicable to all employees of such bank.
3(7)(vi)  A  bank shall not grant any accommodation or “more favourable treatment” relating to the
waiver of fees and/or commissions to any employee or a close relation of such employee or
to any concern in which the employee or close relation has a substantial interest other than on
the basis of a scheme applicable to the employees of such bank or when secured by security
as may be approved by the Monetary Board in respect of accommodation granted as per
Direction 3(7)(v) above.
3(7)(vii)  No accommodation granted by a bank under Direction 3(7)(v) and 3(7)(vi) above, nor any
part of such accommodation, nor any interest due thereon shall be remitted without the prior
approval of the Monetary Board and any remission without such approval shall be void and
of no effect.
3(8) Disclosures
3(8)(i)  The board shall ensure that: ( a) annual audited financial statements and quarterly financial
statements are prepared and published in accordance with the formats prescribed by the
supervisory and regulatory authorities and applicable accounting standards, and that
(b) such statements are published in the newspapers in an abridged form, in Sinhala, Tamil
and English.
3(8)(ii)  T he board shall ensure that the following minimum disclosures are made in the Annual
Report:
 a) A  statement to the effect that the annual audited financial statements have been prepared
in line with applicable accounting standards and regulatory requirements, inclusive of
specific disclosures.


specific disclosures.
 b) A  report by the board on the bank’s internal control mechanism that confirms that the
financial reporting system has been designed to provide reasonable assurance regarding
the reliability of financial reporting, and that the preparation of financial statements for
external purposes has been done in accordance with relevant accounting principles and
regulatory requirements.
 c ) The external auditor’s certification on the effectiveness of the internal control
mechanism referred to in Direction 3(8)(ii)(b) above, in respect of any statements
prepared or published after 31 December 2008.
 d) Details of directors, including names, fitness and propriety, transactions with the bank
and the total of fees/remuneration paid by the bank.
 e) T otal net accommodation as defined in 3(7)(iii) granted to each category of related
parties. The net accommodation granted to each category of related parties shall also
be disclosed as a percentage of the bank’s regulatory capital.
 f) The aggregate values of remuneration paid by the bank to its key management personnel
and the aggregate values of the transactions of the bank with its key management
personnel, set out by broad categories such as remuneration paid, accommodation
granted and deposits or investments made in the bank.
 g ) The external auditor’s certification of the compliance with these Directions in the
annual corporate governance reports published after 01 January 2010.
 h) A  report setting out details of the compliance with prudential requirements, regulations,
laws and internal controls and measures taken to rectify any material non-compliances.


244 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
 i) A  statement of the regulatory and supervisory concerns on lapses in the bank’s risk
management, or non-compliance with these Directions that have been pointed out by
the Director of Bank Supervision, if so directed by the Monetary Board to be disclosed
to the public, together with the measures taken by the bank to address such concerns.
3(9) Transitional and other general provisions
3(9)(i)  Compliance with this Direction shall commence from 01 January 2008 onwards and all
licensed commercial banks shall fully comply with the provisions of this Direction by or
before 01 January 2009 except where extended compliance dates have been specifically
provided for in this Direction.
3(9)(ii)  In respect of the banks that have been incorporated by specific statutes in Sri Lanka, the
boards as specified in such statutes shall continue to function in terms of the provisions of the
respective statutes, provided they take steps to comply with all provisions of this Direction
that are not inconsistent with the provisions of the respective statutes.
3(9)(iii)  This Direction shall apply to the branches of the foreign banks operating in Sri Lanka to
the extent that it is not inconsistent with the regulations and laws applicable in such bank’s
country of incorporation. The branch of a foreign bank shall also publish its parent bank’s
annual corporate governance report together with its annual report and accounts of the
branch operations in Sri Lanka.
3(9)(iv)  In the event of a conflict between any of the provisions of this Direction and the Articles of
Association (or Internal Rules) pertaining to any bank, the provisions of this Direction shall
prevail. However, if the Articles of Association of an individual bank set a more stringent
standard than that specified in this Direction, such provisions in the Articles of Association
may be followed.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  245
Directions issued by the Monetary Board of the Central Bank of Sri Lanka under Section 46(1) of
the Banking Act, No.30 of 1988 as amended.
Sgd. Nivard Ajith Leslie Cabraal
Chairman of the Monetary Board and
Governor of the Central Bank of Sri Lanka
Colombo
15 August 2008.
DIRECTIONS
BANKING ACT DIRECTION NO. 5 OF 2008
AMENDMENTS TO DIRECTIONS ON CORPORATE GOVERNANCE FOR
LICENSED COMMERCIAL BANKS IN SRI LANKA
In the exercise of the powers conferred by Section 46(1) of the Banking Act, No.30 of 1988, last amended
by the Banking Act, No.46 of 2006 and in terms of the Supreme Court order delivered on July 8, 2008,
the Monetary Board hereby issues the following Directions in lieu of Direction No.1 of 2008 dated
April 23, 2008, issued by the Monetary Board of the Central Bank of Sri Lanka. These Directions may
be cited as the Banking Act, Direction No.5 of 2008.
1. The Banking Act Direction No. 1 of 2008 dated April 23, 2008 described as “Provisions regarding
executive directors and transitional provisions for founding directors, incumbent chairmen and
executive directors”, is hereby revoked.
2. The following new Direction shall replace the present Direction 3(2)(ii) (B) of the Banking Act,
Direction No.11 of 2007.
3(2)(ii)  (B)   In this context, the following general exemption shall apply:
A director who has completed nine years as at January 1, 2008, or who completes such
term at any time prior to December 31, 2008, may continue for a further maximum
period of 3 years commencing January 1, 2009.
3. The following new Direct ion shall replace Directions 3(3)(i)(A) and 3(3)(i)(B) of the Banking Act,
Direction No.11 of 2007.
3(3)(i) (A)  In this context, the following general exemption shall apply:
A director who has reached the age of 70 years as at January 1, 2008 or who would
reach the age of 70 years prior to December 31, 2008 may continue in office for a further


reach the age of 70 years prior to December 31, 2008 may continue in office for a further
maximum period of 3 years commencing January 1, 2009.
4. The following new Direction shall be included immediately after Direction 3(3)(ii) of the Banking
Act, Direction No.11 of 2007.
3(3)(ii) (A)  In this context, the following general exemption shall apply:
If any person holds posts in excess of the limitation as above, such person shall within a
maximum period of three years from 1 January 2009 comply with the above-mentioned
limitation and notify the Monetary Board accordingly.
5. The following new Direct ion shall be included immediately after Direction 3(9)(iv) of the Banking
Act, Direction No.11 of 2007.
3(9)(v)  If for any reason such as ill health or other incapacity, the Monetary Board considers
that exemptions referred to in Directions 3(2)(ii)B, 3(3)(i)A and 3(3)(ii)A should not be
availed of, such ground may be notified to the person by the Monetary Board, and after
a hearing, the Monetary Board may limit the period of exemption.


246 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
Directions issued by the Monetary Board of the Central Bank of Sri Lanka under Section 46(1) of
the Banking Act, No.30 of 1988, as amended.
Sgd. Nivard Ajith Leslie Cabraal
Chairman of the Monetary Board and
Governor of the Central Bank of Sri Lanka
Colombo
24 October 2008
DIRECTIONS
BANKING ACT DIRECTION NO. 7 OF 2008
AMENDMENTS TO DIRECTIONS ON CORPORATE GOVERNANCE FOR
LICENSED COMMERCIAL BANKS IN SRI LANKA
In the exercise of the powers conferred by Section 46(1) of the Banking Act, No. 30 of 1988, last amended
by the Banking Act, No. 46 of 2006 and in terms of the Supreme Court order delivered on September 1,
2008, the Monetary Board hereby issues the following Direction amending Direction No. 5 of 2008 dated
August 15, 2008, issued by the Monetary Board of the Central Bank of Sri Lanka. This Direction may be
cited as the Banking Act, Direction No. 7 of 2008.
1. The following new Direction shall replace Direction No. 5 of the Banking Act, Direction No. 5 of
2008, dated August 15, 2008.
3(9)(v)  If for any reason such as ill health or any incapacity as provided in the Banking Act, the
Monetary Board considers that exemptions referred to in Directions 3(2)(ii)B, 3(3)(i)
A and 3(3)(ii)A should not be availed of, such ground may be notified to the person by
the Monetary Board, and after a hearing, the Monetary Board may limit the period of
exemption.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  247
Directions issued by the Monetary Board of the Central Bank of Sri Lanka under Section 46(1) of the
Banking Act, No.30 of 1988, as amended.
Sgd. Nivard Ajith Leslie Cabraal
Chairman of the Monetary Board and
Governor of the Central Bank of Sri Lanka
Colombo
12 April 2013
BANKING ACT DIRECTION NO. 3 OF 2013
AMENDMENTS TO DIRECTIONS ON
CORPORATE GOVERNANCE ISSUED TO
LICENSED COMMERCIAL BANKS IN SRI LANKA
In the exercise of the powers conferred by Section 46(1) of the Banking Act, No. 30 of 1988,
last amended by the Banking (Amendment) Act, No. 46 of 2006, the Monetary Board hereby issues
the following Directions amending Direction 3(3)( ii) of the Banking Act, Direction No. 11 of 2007,
dated 26 December 2007 on Corporate Governance for Licensed Commercial Banks in Sri Lanka.
1. This Direction may be cited as the Banking Act, Direction No. 3 of 2013.
2. The following new Direction shall replace Direction 3(3)( ii) of the Banking Act, Direction No. 11
of 2007, dated 26 December 2007.
‘3(3)(ii)  A  person shall not hold office as a director of more than 20 companies/entities/institutions
inclusive of subsidiaries or associate companies of the bank.’


248 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
Requirement of
the Framework.Directions issued by the Monetary Board of the Central Bank of Sri Lanka in terms of Sections 46(1) and
76(J)(1) of the Banking Act, No.30 of 1988, as amended.
Sgd. Nivard Ajith Leslie Cabraal
Chairman of the Monetary Board and
Governor of the Central Bank of Sri Lanka
Colombo
05 October 2011
BANKING ACT DIRECTION NO. 7 OF 2011
INTEGRATED RISK MANAGEMENT FRAMEWORK FOR
LICENSED BANKS
In order to ensure the soundness of the banking system, Sections 46(1) and 76( J)(1) of the Banking
Act, No. 30 of 1988, last amended by the Banking Act, No. 46 of 2006, empowers the Monetary Board
to issue Directions to licensed banks regarding the manner in which any aspect of the business of such
banks is to be conducted. Accordingly, the Monetary Board issues this Direction to all licensed banks
on integrated risk management as management of risks on banking business operations in an integrated
manner would promote the soundness of banks and the banking system.
1. All licensed banks shall adopt a specific Integrated Risk Management (IRM)
framework in compliance with guidelines annexed to this Direction in addition
to risk management principles and rules required in regulatory and supervisory
procedures and other market best practices of bank risk management.
2. The IRM framework which shall be documented shall cover various potential
risks, possible sources of such risks, mechanism of management information and
reporting to identify and monitor such risks, effective measures to control and
mitigate risks at prudent levels and relevant officers and committees responsible
for such control and mitigation.
3. The IRM framework shall be approved by the Board of Directors (BOD) and
reviewed and updated at least annually.
4. Through the IRM framework, the BOD shall assess the integrated risk profile


4. Through the IRM framework, the BOD shall assess the integrated risk profile
of the bank and its management at least quarterly and be responsible for overall
oversight of the orderly implementation of the IRM framework.
5. All banks shall implement the IRM framework within 6 months from the date
of this Direction.
6. In the event of any material lapses in the IRM framework in the opinion of the
Director of Bank Supervision, the fitness and propriety of those who are found to
be responsible for such lapses will be re-assessed under the relevant provisions
of the Banking Act. Nature of the
Framework.
Oversight of
the Borad.
Steps to secure
Compliance.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  249
Annexure
INTEGRATED RISK MANAGEMENT SYSTEMS IN BANKS
A. Integrated Risk Management
1. Introduction
1.1 Banks are exposed to various risks during their business operations. Under the Basel II
framework, the major categories of risks are credit, market and operational risks. However, the
banks are also facing other risks such as liquidity, interest rate, foreign exchange rate, legal,
regulatory, reputational etc. All these risks are highly interdependent.
1.2 Risk management is a complex function, which requires specialised skills and expertise.
Internationally, banks have been moving towards the use of sophisticated models for measuring
and managing risks in an integrated manner with a view to ensuring a comprehensive Internal
Capital Adequacy Assessment Process (ICAAP) under Pillar 2 of the Basel II framework.
1.3 The capital adequacy ratio prescribed by the Central Bank of Sri Lanka (CBSL) under the Pillar
– I of the Basel II framework is the regulatory minimum level, which addresses only credit,
market and operational risks on an average basis. Thus, the need for banks to have their own
assessment of various integrated risk exposures and maintain adequate capital as a cushion for
such risks has become an urgent necessity.
1.4 The objec tive of these guidelines is to encourage banks to develop integrated risk management
techniques for monitoring and managing their risks and to assure CBSL that adequate capital is
held to meet various risks to which they are exposed.
2. Integrated Risk Management oversight
2.1 Board and Senior Management –  The responsibility of understanding the risks assumed by
the bank and ensuring that the risks are appropriately managed should be vested with the Board
of Directors (BOD). The Board should:
 (a) Ensure that the bank has established a robust and pervasive risk culture and clear policies


(a) Ensure that the bank has established a robust and pervasive risk culture and clear policies
that define risk management as the responsibility of each bank’s senior management,
subject to the oversight of the Board.
 (b) Establish risk limits based on risk appetite of the bank.
 (c) Ensure that the Senior Management of the bank:
 i . establishes an integrated framework in order to assess and appropriately manage
various risk exposures of the bank;
 i i. develops a system to monitor the bank’s risk exposures and to relate them to the
bank’s capital;
 i ii. e stablishes a method to monitor the bank’s compliance with internal policies,
particularly with regard to risk management; and
 iv . ef fectively communicates all relevant policies and procedures throughout the bank.
 (d) Adopt and support strong internal controls.
2.2 Integrated Risk Management Committee (IRMC) – The overall risk management should
be assigned to an independent Integrated Risk Management Committee (IRMC) of the BOD,
established as per Rules 3(6)(v) of the Banking Act Directions Nos.11&12 of 2007 on Corporate
Governance for Licensed Banks in Sri Lanka with the responsibilities stated therein.
2.3 Internal Audit –  Integrated risk management policies and procedures as well as the
functionalities at various levels of the risk management function should be reviewed by


250 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
the internal audit function of banks on an on-going basis while the external audit makes an
independent review at least on an annual basis.
2.4 Operational Level – Risk management in operational areas viz. front office, loan origination
function etc. should be confined to the operational procedures and guidelines set forth by the
BOD and the Senior Management.
3. Integrated Risk management framework priorities and pr ocesses
3.1 Given the diversity of balance sheet profile of banks in Sri Lanka, it is neither prudent nor
desirable to adopt a uniform framework for management of risks. The architecture of an
integrated risk management function should be bank-specific, dictated by the size, complexity
of functions, operating environment and technical expertise of staff.
3.2 All relevant factors that present a material source of risk should be incorporated in a
well-developed integrated risk management system.
3.3 All measurements of risk incorporate both quantitative and qualitative elements, but to the
extent possible, a quantitative approach should form the foundation of a bank’s measurement
framework.
3.4 Quanti tative tools can include the use of large historical databases; when data are scarcer,
a bank may choose to rely more heavily on the use of stress testing and scenario analyses.
3.5 Banks should understand when measuring risks that measurement error always exists, and in
many cases the error itself is difficult to quantify. In general, an increase in uncertainty related
to modelling and business complexity should result in a larger capital cushion.
3.6 Qua ntitative approaches that focus on most likely outcomes for budgeting, forecasting, or
performance measurement purposes may not be fully applicable for capital adequacy because
the ICAAP under Pillar 2 of the Basel II framework should also take less likely events into
account.


account.
3.7 Stress testing and scenario analysis can be effective in gauging the consequences of outcomes
that have low probability of occurrence but would have a considerable impact on safety and
soundness of the banks.
3.8 T o the extent that risks cannot be reliably measured with quantitative tools – for example, where
measurements of risk are based on scarce data or unproven quantitative methods – qualitative
tools, including experience and judgment, may be more heavily utilised.
3.9 Banks should be cognisant that qualitative approaches have their own inherent biases and
assumptions that affect risk assessment; accordingly, banks should recognise the biases and
assumptions embedded in, and the limitations of the qualitative approaches used.
4.	 Risk	aggregation 	and	diversification 	effects
4.1 An ef fective risk management system should assess risks across the entire bank. A bank
choosing to conduct risk aggregation among various risk types or business lines should
understand the challenges in such aggregation.
4.2 In addi tion, when aggregating risks, banks should ensure that any potential concentrations
across more than one risk dimension are addressed, recognizing that losses could arise in
several risk dimensions at the same time, stemming from the same event or a common set of
factors.
4.3 In considering the possible effects of diversification, management should be systematic and
rigorous in documenting decisions, and in identifying assumptions used in each level of risk
aggregation.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  251
4.4 Assumptions about diversification should be supported by analysis and evidence. The bank
should have systems capable of aggregating risks based on the bank’s selected framework.
For example, a bank calculating correlations within or among risk types should consider data
quality and consistency, and the volatility of correlations over time and under stressed market
conditions.
5. Disclosure
 CBSL strongly considers that the market discipline could play an important role in maintaining
financial system stability. However, market discipline could be achieved only through meaningful
disclosures by licensed banks which would also provide a more meaningful picture of the extent and
nature of various risks that banks are exposed to and of the efficiency of banks’ risk management
practices.
B. Cr edit Risk Management
1. Management Oversight
 The BOD should put in place and periodically review the credit risk strategy and significant credit
risk policies of the bank.
1.1 The strategy shall includee:
 (a) a statement of the bank’ s willingness to grant loans based on the type;
 (b) identification of tar get markets and business sectors;
 (c) preferred levels of diversification and concentration;
 (d) the cost of capital in granting credit and bad debts; and
 (e) the cyclical aspects and the resulting shifts in the composition and quality of the loan
portfolio. This strategy should be viable in the long run and across business cycles.
1.2 The credit risk policies and procedures shall be consisted with following elements, at a
minimum.
 (a) W ritten policies that define target markets, risk acceptance criteria, credit approval
authority, credit origination and maintenance procedures and guidelines for portfolio
management and remedial management.
 (b) Proactive credit risk management practices such as annual/half yearly industry studies and


(b) Proactive credit risk management practices such as annual/half yearly industry studies and
single borrower reviews, periodic credit calls and customer visits that are documented,
and carry out at least quarterly management reviews of troubled exposures/ weak credits.
 (c) V esting accountability with the business managers for managing risk and, in conjunction
with the credit risk management framework, for establishing and maintaining appropriate
risk limits and risks arrangement procedures.
 (d) Delegation of lending powers to individual credit officers based upon a consistent set of
standards of experience, judgment and ability.
 (e) Requirement for higher level of authority to approve credit limits as risk ratings worsen.
 (f) Requirement for every extension of credit, other than small value consumer/retail loans
to be approved by at least two authorized credit officers, one of whom must be an officer
from business and another invariably from an independent Credit Risk Management
Department (CRMD).


252 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
 (g) Requirement for every obligor and facility to be assigned a risk rating.
 (h) Consistent standards for the origination, documentation and maintenance of documents
for extensions of credit.
 (i) Consistent approach towards early problem recognition, classification of problem
exposures, and remedial action.
 (j)  Emphasis on maintaining a diversified portfolio of risk assets in line with the capital
desired to support such a portfolio.
 (k) Credit risk limits by obligor , concentration, industry or geography.
 (l) Responsibility of the credit function to report the comprehensive set of credit risk data into
the independent risk system.
1.3 The credit risk strategy and policy should be approved and periodically reviewed by the BOD.
These documents should be effectively disseminated throughout the banking organisation. All
relevant personnel should clearly understand the bank’s approach to granting credit and should
be held accountable for complying with established policies and procedures.
2. Risk Management
2.1 Structure –  In a well functioning integrated risk management framework, credit risk
management is vested with an independent unit and each bank should, depending on the size
of the organisation or loan book, constitute a high level Credit Policy Committee (CPC) also
called Credit Risk Management Committee or Credit Control Committee with the following
responsibilities:
 (a) The committee should be headed by the Chief Executive Officer (CEO)/General Manager
(GM) and should comprise Heads of Credit Departments, including Consumer Banking,
Treasury and CRMD.
 (b) The committee should, inter alia , formulate clear credit policies including standards on
presentation of credit proposals, financial covenants, rating standards and benchmarks,
delegation of credit approving powers, prudent limits on large credit exposures, assets


delegation of credit approving powers, prudent limits on large credit exposures, assets
concentrations and lending to related parties, standards for loan collateral, portfolio
management, loan review mechanism, risk concentrations, risk monitoring and evaluation,
pricing of loans, provisioning, regulatory/legal compliance, etc. for BOD’s approval.
 (c) The committee will be responsible for the setting up of CRMD which should lay down
risk assessment systems, monitor quality of loan portfolio and prudential limits set by
CPC, identify problems and correct deficiencies, develop management Information
System (MIS) and undertake loan review/audit.
2.2 Prudential Limits –  Credit risk can be mitigated to a great extent by stipulating prudential risk
limits on various risk parameters. Banks should consider stipulating:
 (a) Benchmark financial ratios, with flexibility for deviation in deserving cases. The
conditions subject to which deviations are permitted and the authority for permitting such
deviations should be clearly spelt out in the Credit Policy.
 (b) Single/related party borrower limits, which could even be more stringent than the limits
prescribed by CBSL, to provide a filtering mechanism.
 (c) Substantial exposure limit, i.e., aggregate of large exposures should not exceed a
percentage of the Tier – II capital of the banks, depending upon the degree of concentration
risk the bank is exposed to.
 (d) Maximum exposure limits to industry, regions, country, etc. There must also be systems
in place to evaluate the exposure at reasonable intervals and the limits should be adjusted
especially when a particular sector or industry faces a slowdown or other specific problem.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  253
 (e)  Maturity and currency profile of the loan book, keeping in mind the market risk inherent
in the balance sheet, risk management capability, liquidity etc.
2.3 Risk Rating – Banks should develop a robust internal credit-risk grading system that serves as
a single point indicator of diverse risk factors of counterparty and for taking credit decisions
in a consistent manner while communicating the default risk associated with an exposure.
The risk rating, in short, should:
 (a) reflect the underlying credit risk of the loan book ; and
 (b) be drawn up in a structured manner, incorporating both quantitative (financial ratios) and
qualitative standards (industry, payment history, credit reports, management, purpose of
the loan, quality of financial information, facility characteristics etc.).
2.4 Risk Pricing – Risk pricing is a fundamental tenet of credit risk management. Thus, banks
should:
 (a) evolve scientific systems to price the credit risk, which should have a bearing on the
expected Probability of Default (PD); and
 (b) establish the maximum expected loss in each product line and linking the capital to this
loss, thus making it possible to compare products of different risk levels.
2.5 Portfolio Management –  The need for credit portfolio management emanates from the
potential adverse impact of concentration of exposures and necessity to optimise the benefits
associated with diversification. In this regard, banks should consider the following measures to
maintain the portfolio quality:
 (a) Stipulate quantitative ceilings on aggregate exposure in specified rating categories,
i.e., certain percentage of total advances in the rating category 1 to 4 or to 6 etc.
 (b) Evaluate the rating-wise distribution of borrowers in various industries, business, personal
segments, etc .
 (c) Expos ure to one industry/sector should be evaluated on the basis of overall rating


(c) Expos ure to one industry/sector should be evaluated on the basis of overall rating
distribution of borrowers within the sector/group. In cases where portfolio exposure to
a single industry/segment is performing badly or the concentration of borrowers is in
the lower notches of ratings, the bank may increase the quality standards for the specific
industry or group.
 (d) T arget rating-wise volume of loans, probable defaults and provisioning requirements
as a prudent planning exercise. For any deviation/s from the expected parameters,
an exercise for restructuring the portfolio may immediately be undertaken and if
necessary, the entry-level criteria could prudently be enhanced to insulate the portfolio
from further deterioration.
 (e) Undertake rapid portfolio reviews, stress tests and scenario analyses when the external
environment undergoes rapid changes (rise in oil prices, global/country specific
slowdowns, international/market risk events, extreme liquidity conditions, war situation
etc.).
 (f) Introduce discriminatory time schedules for review/renewal of borrower exposures.
Lower rated borrowers whose financials show signs of weakness should be subject to
renewal control twice/thrice a year.
2.6 Risk models – Credit risk models offer banks a framework for quantifying, aggregating and
managing risk across geographical and product lines in a timely manner. Therefore, banks
should evaluate the utility of various models with suitable modifications to the environment
in Sri Lanka and build up adequate internal expertise and databases to facilitate the models
utilisation.


254 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
2.7 Loan Review Mechanism (LRM) –  LRM is an effective tool for constantly evaluating the
quality of the loan book and bringing about qualitative improvements in credit administration.
In this regard, banks should formulate a loan review policy under the review of BOD, annually.
The policy should, inter alia , address:
 (a) Qualification 	and	Independence 	– Loan Review Officers should be independent in
reporting to the BOD and have sound knowledge of the credit appraisal, lending practices
and loan policies of the bank.
 (b) Frequency and Scope of Reviews –  Reviews of high value loans should be undertaken
usually within three months of sanction/renewal, or more frequently when factors indicate
a potential for deterioration in the credit quality. The scope of the review should cover all
performing loans above a cut-off limit. At least 30% – 40% of the loan portfolio should
be subjected to LRM each year to provide reasonable assurance that all major credit risks
embedded in the balance sheet have been tracked.
 (c) Depth of Reviews – Loan reviews should focus on: the approval process, accuracy and
timeliness of credit ratings assigned by loan officers, adherence to internal policies and
procedures, and applicable laws/regulations, compliance with loan covenants, post-
sanction follow-up, sufficiency of documentation, portfolio quality and recommendations
for improving portfolio quality.
2.8 Risk in Investment banking – A significant degree of credit risk, in addition to market risk,
is inherent in investment banking. Therefore, banks should stipulate entry level minimum
ratings/quality standards, industry, maturity, duration, issuer-wise, etc. limits in investment
proposals as well, to mitigate the adverse impacts of concentration and risk of illiquidity.
2.9 Inter-Bank Exposure –  A suitable framework should be evolved to provide a centralised


2.9 Inter-Bank Exposure –  A suitable framework should be evolved to provide a centralised
overview on the aggregate exposure to other banks. Bank-wise exposure limits could be set on
the basis of external or internal ratings.
2.10 Risk in Off-balance sheet exposure –  Mechanics involved in the assessment of non-funded
lines should be similar to the assessment of funded lines. Utmost care must be taken whilst
extending these facilities. Banks should, therefore, evolve adequate frameworks for managing
their exposure in off-balance sheet products such as Forex forward contracts, forward rate
agreements, swaps, options, futures etc . as a part of credit appraisal, limits and monitoring
procedures.
C. Market Risk Management
1. Management Oversight
 The BOD should clearly articulate market risk management policies, procedures, prudential risk
limits, review mechanisms and reporting and auditing systems.
1.1 policies should address the following:
 (a) as sessment of bank’s exposure on a consolidated basis, considering issues related to
interest rate, currency, equity price and liquidity risks; and
 (b) ris k measurement systems capture all material sources of market risk and assess the
effects on bank’s capital.
1.2 The BOD should ensure that bank’s overall market risk exposure is maintained at prudent levels
and consistent with the available capital. The operating prudential limits and the accountability
of line management should also be clearly defined.
2. Risk Management
2.1 Structure – Each bank should establish an organizational set up for market risk management,
including the following:


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  255
 (a) Asset-Liability Management Committee (ALCO) – The ALCO, consisting of the bank’s
senior management, including the CEO/GM must function as the top-end operational unit
for managing the balance sheet within the performance/risk parameters laid down by the
BOD. The ALCO should also articulate the bank’s view on various market variables and
base its decisions for future business strategy.
 (b) Middle	Office	– The banks should set up an independent Middle Office to track the
magnitude of market risk on a real time basis. The Middle Office should:
 i. consist of experts in market risk management, economists, statisticians and general
bankers and may be functionally placed directly under the ALCO; and
 i i. be  separated from the Treasury Department and should not be involved in the
day-to-day management of the treasury;
 i ii. appri se the top management/ALCO/Treasury about adherence to prudential/risk
parameters and also aggregate the total market risk exposures assumed by the bank at
any point of time.
2.2 Foreign Exchange (Forex) Risk –  Forex risk could be mitigated through fixing appropriate
limits on open positions, gaps, adopting risk measurement methods and monitoring exposures.
In this regard, the banks are encouraged to adopt the following measures:
 (a) Fix appropriate limits (even less than the limits set by CBSL) depending upon the capital
position, overall risk profile and risk management capabilities.
 (b) Fix appropriate limits on individual and aggregate gaps on major currencies, linked to
capital.
 (c) Adopt the Value at Risk (VaR) technique to measure the risk associated with exposures.
 (d) Monitor Forex risk exposures with the preparation of the statement of Maturity of Assets
and Liabilities (MAL) (Attachment -1), statement of Sensitivity of Assets and Liabilities
(SAL) (Attachment – 2) and statement of Forex Position (FXP) (Attachment – 3).


(SAL) (Attachment – 2) and statement of Forex Position (FXP) (Attachment – 3).
 (e) Ensure clear-cut and well-defined division of responsibility between front, middle and
back offices.
2.3 Foreign Currency Liquidity Risk Management – In running multi currency balance sheets,
and particularly when domestic currency assets are funded with foreign currency liabilities,
banks are exposed to another layer of complexity to liquidity management. Banks should,
therefore, be vigilant in creating understandable currency mismatches to avoid liquidity crises.
D. Operational Risk Management
1. Management Oversight
 An effective operational risk management strategy requires that BOD should recognise that
operational risk is distinct and controllable, and should put in place appropriate risk management
policies, procedures and practices and an independent audit and review mechanism.
1.1 BOD should put in place well defined policies on operational risk management. These policies
and procedures should be based on common elements across business lines or risks. The policy
should address:
 (a) product review processes;
 (b) business involved;
 (c) risk management; and
 (d) internal control functions.


256 Directions, Determinations, and Circulars issued to Licensed Commercial Banks
2. Risk Management
2.1 Structure – Taking into account institution-specific factors, banks should consider establishing
an independent bank-wide Operational Risk Committee or Unit under Integrated Risk
Management Committee (IRMC) or Chief Risk Officer, with the following responsibilities:
 (a) Establish consistent definitions for operational risk across business units.
 (b) Develop policies, procedures and practices.
 (c) Report and review risk exposures.
 (d) Oversee and ensure the integrity of risk management procedures.
 (e) Allocate and maintain economic capital.
 (f) Develop strategies for risk mitigation techniques.
2.2 Risk Measurement – Since, there is no uniformity of approach in measuring operational risk in
the banking system, and a number of breakdowns in internal controls and corporate governance
evidenced lately, need for more advanced techniques for allocating capital in this regard has
become an important issue. Therefore, during the measurement of operational risks, banks
should:
 (a) Consider both internal factors (such as complexity of structure, nature of activities, quality
of personnel, organisational changes and employee turnover) and external factors (such as
fluctuating economic conditions, changes in the industry and technological advances) that
could adversely affect the banks’ stated objectives.
 (b) Make clear distinction between controllable and uncontrollable operational risk events.
 (c) Assess their operational activities against a menu of operational risk events ( i.e., internal
and external frauds, employment practices and work place safety, clients, products and
business practices, damage to physical assets, business distribution and system failures,
execution, delivery and process management, etc.).
 (d) Review key risk indicators such as failed trades, staf f turnover rates, frequency and/or


(d) Review key risk indicators such as failed trades, staf f turnover rates, frequency and/or
severity of errors and omission to track the magnitude of risk concerns, with thresholds or
limits set on key risk indicators.
 (e) Develop simple benchmarks based on an aggregate measure of business activity such
as gross revenue, fee income, operating costs, total assets adjusted for off-balance sheet
exposures or a combination of these variables, in the event the bank does not have so far
evolved any scientific methods for quantifying the risk.
 (f) Carry out  Business Impact Analysis (BIA) with its Recovery Time Objectives (RTO)
under the proposed Business Continuity and Disaster Recovery Plan.
2.3 Risk Monitoring – The operational risk monitoring system should:
 (a) Focus on operational performance measures such as volume, turnover, settlement facts,
delays and errors.
 (b) Monitor operational loss directly with an analysis of each occurrence and description of
the nature and causes of the loss.
 (c) Integrate internal controls into the bank’s operations and produce regular reports to the
Senior Management.
 (d) Undertake compliance reviews by the Internal Audit and the Risk Management
Department, separately.


Directions, Determinations, and Circulars issued to Licensed Commercial Banks  257
2.4 Internal Control –  Banks should adopt well-established internal control systems, which
include segregation of duties, clear management reporting lines and adequate operating
procedures in order to mitigate operational risks. As per Directions Nos. 3(8)( ii)(b)&(c) of the
Banking Act, Direction Nos. 11 & 12 of 2007 on Corporate Governance for licensed banks:
 (a) a report by the Board should be included in the Annual Report on the bank’s internal
control mechanism that confirms that the financial reporting system has been designed
to provide reasonable assurance regarding the reliability of financial reporting and that
the preparation of financial statements for external purposes has been done in accordance
with relevant accounting principles and regulatory requirements; and
 (b) the external auditor’s certification on the effectiveness of the internal control mechanism
referred to in ( a) above, in respect of any statements prepared or published.
 A  proper internal control system should:
 (a) promote ef fective and efficient operation;
 (b) provide reliable financial information;
 (c) safeguard assets;
 (d) minimise the operating risk of loss from irregularities, fraud and errors;
 (e) ensure ef fective risk management systems; and
 (f) ensure compliance with relevant laws, regulations and internal policies.
2.5 Risk Mitigation Techniques –  Risk mitigation techniques or tools should be used to contain
the severity of operational risk events. Investment in appropriate information technology under
Business Continuity and Disaster Recovery Plan is also important for risk mitigation.
2.6 Insurance Policies – Innovative insurance policies could be used to externalise the risk of ‘low
frequency and high severity losses’, which may occur as a result of events such as errors and
omissions, physical loss of securities, frauds and natural disasters.


omissions, physical loss of securities, frauds and natural disasters.
2.7 Outsourcing –  Banks should establish sound policies for managing risks associated with
outsourcing activities in line with the Banking Act, Directions Nos. 7 & 8 of 2010 on
Outsourcing of Business Operations.
2.8 Contingency Plan – An enterprise-wide contingency plan should be in place to handle failures
and switch to alternative service providers at short notice.
E. Liquidity Risk Management
1. Management Oversight
(a) Managing liquidity is no longer purely the responsibility of the treasury function. Effective
oversight by the BOD and the Senior Management is a critical element of the liquidity risk
management process.
(b) The ALCO should be mandated to execute liquidity management policies, procedures and
practices approved by the BOD, effectively.
(c) The BOD should, however, periodically monitor the liquidity profile to assess the liquidity risk
more frequently where significant funding concentrations have been observed.
2. Risk Management
2.1 Structure – Liquidity risk management could either be centralized or decentralized, or a
combination of the two. The structure should be commensurate with the size and complexity of