3(5)(viii)  T he chairman shall facilitate the effective contribution of non-executive directors
in particular and ensure constructive relations between executive and non-executive
directors.
3(5)(ix)  T he 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)  T he 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 chairman 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:


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  181
(i) the 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 ) T he 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;
 II. whether 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
 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


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 committee 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.
 j ) T he committee shall take the following steps with regard to the internal audit
function of the bank:


182 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
 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 staf f 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 of ficer, 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.
 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


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 rules 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.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  183
 b ) The committee shall set goals and tar gets for the directors, CEO and the key
management personnel.
 c) The 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 committee 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 committee 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) The 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.
3(6)(v)  The following rules shall apply in relation to the Integrated Risk Management
Committee:


3(6)(v)  The following rules shall apply in relation to the Integrated Risk Management
Committee:
 a ) The committee 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 ) T he 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.


184 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
 e) The committee 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 committee 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 ) T he 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:


include the following:
 a ) The grant of any type of accommodation, as defined in the Monetary Board’s
Directions on maximum amount of accommodation,
 b) The 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:


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  185
 I. “Accommodation” shall mean accommodation as defined in the Banking Act,
Directions, No.8 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;
 d) Providing services to or receiving services from a related-party without an evaluation
procedure;
 e) Ma intaining 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


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.
  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.


186 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
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)  The 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.
 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


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.
 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.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  187
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 conflic t 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.


188 Directions, Determinations, and Circulars issued to Licensed Specialised 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 Specialised Banks  189
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


190 Directions, Determinations, and Circulars issued to Licensed Specialised 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 Specialised Banks  191
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 include:
 (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).


192 Directions, Determinations, and Circulars issued to Licensed Specialised 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.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  193
 (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.
 (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,


(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
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.


194 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
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.
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,


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
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.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  195
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:
 (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.


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).
 (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.


196 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
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.
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, staff 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.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  197
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.
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.


(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.
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.


198 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
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
the bank’s operations. It should be flexible while ensuring that the liquidity strategy approved
by the BOD can be effectively implemented.
2.2 Liquidity Measurement –  Liquidity measurement is a difficult task and can be measured
through stock or flow approaches.
 (a) Stock Approach – Under the stock approach, liquidity is measured in terms of key ratios
which portray the liquidity stored in the balance sheet. Banks should calculate and analyse
following ratios during their risk management process:
 i. Net loans to total assets
 ii. Loans to customer deposits
 iii. Liquid assets to short-term liabilities
 iv . Lar ge liabilities (minus) temporary investments to earning assets (minus) temporary
investments, where large liabilities represent wholesale deposits which are market
sensitive and temporary investments which are those maturing within one year and
those investments which are held in the trading book and are readily sold in the
market.
 v . Purchased funds to total  assets, where purchased funds include the entire


market.
 v . Purchased funds to total  assets, where purchased funds include the entire
inter-bank and other money market borrowings, including certificates of deposits and
institutional deposits.
 vi. Commitments to total loans, where the commitment in the nature of Letter of Credits
(LCs), guarantees and acceptances.
 (b) Flow approach –  Banks should prepare a statement of Maturities of Assets and Liabilities
(MAL) placing all cash inflows and outflows in the time bands according to the residual
time to maturity. A format for the MAL is attached. (Attachment – 1). The time bands may
be distributed as under:
 i. Up to one month
 ii. Over one month and up to 3 months
 iii. Over 3 months and up to 6 months
 iv . Over 6 months and up to 9 months
 v . Over 9 months and up to 1 year
 vi. Over 1 year and up to 3 years


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  199
 vii. Over 3 years and up to 5 years
 viii. Over 5 years
  (Assumptions to be made –  Some of the assets and liability items like overdraft, savings
and current deposits etc., lack any definite contractual maturity. Similarly, a part of
time deposits are also rolled over on maturity while the consumer loans are topped-up
at frequent intervals. Thus, while determining the likely cash inflows/outflows, banks
should make a number of assumptions according to the behaviour of assets and liabilities.
At least, assumptions should be validated, bi-annually. Such assumptions may be
fine-tuned, over a period, to facilitate near reality predictions about future behaviour of
on/off-balance sheet positions).
 (c) Net funding requirement –
 i. The difference between cash inflows and outflows in each time band, the excess or
deficit of funds, becomes a starting point for a measure of a bank’s future liquidity
surplus or deficit, at a series of points in time.
 ii. While the mismatches up to one year would be relevant as these provide early warning
signals of impending liquidity problems, the main focus should be on mismatches up
to three months.
 iii. Banks, however, are expected to fix prudential mismatch limits appropriate to the
size, complexity and financial conditions across all time bands.
 iv . The liquid ity position should be measured in all major currencies in which banks deal
at both individual and aggregate levels. Banks which are reliant on short-term funding
should, however, concentrate primarily on managing their liquidity in the very
short-term horizons and preferably on a day-to-day basis.
 (d) Alternate Scenarios –
 i. Banks should evaluate liquidity profile under different stress situations, viz. normal
situation, bank specific crisis and market crisis scenarios.
 ii. Under each scenario, banks should account for any significant positive or negative


ii. Under each scenario, banks should account for any significant positive or negative
liquidity swings that could occur on account of factors that are both internal (bank
specific) and external (market-related).
 i ii. In this regard, banks must assign the timing of cash flows for each type of asset
and liability by assessing the probability of the behaviour of those cash flows under
alternative scenarios.
 iv . For each funding source, banks would have to decide whether a liability would be
(a) repaid in full at maturity, (b) gradually run off over the next few weeks or
(c) virtually certain to be rolled over or available, if tapped.
 (e) Contingency Plan –
 i. Banks should prepare liquidity contingency plans to measure their ability to withstand
bank-specific or market crisis scenarios.
 ii. The blue-print for assets sales, market access, capacity  to restructure the maturity and
composition of assets and liabilities should be clearly documented and alternative
options of funding in the event of the bank’s failure to raise liquidity from existing
sources should be clearly articulated.


200 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
 i ii. Liquidity from CBSL, as the lender of last resort, should not be reckoned for
contingency plans.
 iv . A vailability of back-up liquidity support in the form of committed lines of credit,
reciprocal arrangements, liquidity support from other external sources, liquidity of
assets etc. should also be clearly established.
F. Inter est Rate Risk Management
1. Management Oversight
 Management of interest rate risk should be one of the critical components of market risk management
of banks. The BOD should clearly articulate interest rate risk management policies, procedures,
review mechanisms and reporting systems.
 Policies and prudential limits should include the following.
(a) Clear policies with regard to volume, maximum maturity, holding period, duration, position
limits, stop loss, rating standards, etc. for classifying securities in the trading book.
(b) Bank-wide VaR exposure limits to the trading portfolio (including Forex derivatives and
commodities, if any, etc .).
(c) Loss making tolerance limits for trading book.
2. Risk Management
2.1 Forms of Risk –  The Net Interest Income (NII) or Net Interest Margin (NIM) of banks are
dependent on the movements of interest rates. Any mismatches in the cash flows (fixed rate
assets or liabilities) or re-pricing dates (floating rate assets or liabilities) expose banks’ NII
or NIM to variations. As financial intermediaries, banks encounter interest rate risk in many
forms:
 (a) Gap or Mismatch Risk
 (b) Basis Risk
 (c) Embedded Option Risk
 (d) Y ield Curve Risk
 (e) Price Risk
 (f) Reinvestment Risk
 (g) Net Interest Position Risk
2.2 Measuring Risk – Before the interest rate risk (IRR) is to be managed, same should be
identified and quantified. In this regard, banks need to adopt an IRR measurement system which
should:
 (a) Address all material sources of interest rate risk including gap or mismatch, basis,


should:
 (a) Address all material sources of interest rate risk including gap or mismatch, basis,
embedded option, yield curve, price, reinvestment and net interest position risks,
exposures associated with assets, liabilities and off-balance sheet positions.
 (b) T ake into account the specific characteristics of each individual interest rate sensitive
position.
 (c) Capture the full range of potential movements in interest rates, in detail.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  201
 (d) Use dif ferent techniques, ranging from the traditional maturity Gap Analysis (to measure
the interest rate sensitivity of earnings), Duration (to measure interest rate sensitivity of
capital), Simulation and VaR.
 (e) Match on a daily basis the potential loss in Present Value Basis Points (PVBP) vis-à-vis
prudential limits for trading book.
 (f) Undertake scenario analysis with specific possible stress situations by linking hypothetical,
simultaneous and related changes in multiple risk factors present in the trading portfolio
to determine the impact of moves on the rest of the portfolio.
 (g) Adopt VaR as an analytical tool for measuring and managing currency risk in the Banking
Book.
2.3 Measuring Techniques –
 (a) Maturity Gap Analysis – The simplest analytical technique for calculating IRR exposure
begins with Maturity Gap analysis that distributes interest rate sensitive assets, liabilities
and off-balance sheet positions into a number of pre-defined time-bands according to
their residual term to maturity (fixed rate) or residual term for their next re-pricing
(floating rate). Gaps may be identified in the following time bands:
 i. Up to one month
 ii. Over one month and up to 3 months
 iii. Over 3 months and up to 6 months
 iv . Over 6 months and up to 1 year
 v . Over 1 year and up to 2 years
 vi. Over 2 years and up to 3 years
 vii. Over 3 years and up to 4 years
 viii. Over 4 years and up to 5 years
 ix. Over 5 years and up to 7 years
 x. Over 7 years and up to 10 years
 xi. Over 10 years and up to 15 years
 xii. Over 15 years and up to 20 years
 xiii. Over 20 years
 xiv . Non-sensitive
  V arious items of rate sensitive assets and liabilities and off-balance sheet positions may be
classified in line with their sensitivity to interest rates. A reporting format for Sensitivity of


classified in line with their sensitivity to interest rates. A reporting format for Sensitivity of
Assets and Liabilities (SAL) for interest rate sensitive assets and liabilities is also attached
(Attachment – 2).
 (b) Duration Gap Analysis –  Matching the duration of assets and liabilities, instead of
matching the maturity or re-pricing dates, is a more effective way to protect the economic
values of banks from exposure to IRR than the simple gap model.
 (c) Simulation – Simulation is a popular tool among banks to gauge the effect of market
interest rate variations on reported earnings/economic values over different time zones.
Simulation techniques attempt to overcome the limitation of gap analysis and duration
approach by computer modelling the bank’s interest rate sensitivity.


202 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
G. Str ess Testing
1. Management Oversight
(a) BOD or a committee formed under the Board with delegated authority should put in place a
‘Stress Testing Framework’ as a part of integrated risk management system with approved
‘Stress Testing Policy’, procedures to be followed and the methodology to be adopted.
(b) BOD and the Senior Management should regularly review the results of stress tests, including
major assumptions that underpin them.
(c) BOD and Senior Management should put in place appropriate fall-back mechanisms for
mitigating tail-end risks, considering an organised approach to manage extreme systemic risks.
1.1 Stress Testing Policy should include the following aspects:
 (a) Frequency and procedure for identifying the principal risk factors, which affect the bank’s
portfolio and required to be stressed.
 (b) Methodology for constructing stress tests.
 (c) Procedure for setting the stress tolerance limits.
 (d) Process of monitoring the stress loss limits.
 (e) Necessary remedial/trigger actions to be taken at various risk levels as revealed by the
stress tests.
 (f) Delegation of authority to ensure timely execution of remedial/trigger action.
1.2 Roles and responsibilities of the persons involved in the exercise must be defined by well
constituted organisational structure and they should be independent.
1.3 An effective Management Information System (MIS) is necessary to ensure flow of information
to take necessary measures to avoid certain difficult conditions by the Senior Management.
2. Fr equency of Stress Testing
 Banks may apply stress tests at varying frequencies dictated by their respective business
requirements, relevance and cost. In general, stress tests on market-sensitive portfolios should be run
more frequently (eg.: daily, weekly). These may include trading portfolios in marketable securities,


foreign exchange and interest rate exposures. Other portfolios which are less volatile in nature could
be stress-tested at longer intervals ( eg.: monthly, quarterly). Further, ad-hoc  stress tests may be
warranted when there are any special circumstances.
3. Scope of Str ess Tests
 Stress testing can and should be applied to the full range of material risks that a bank runs both at
business unit level and on an aggregated group basis. Stress testing can be commonly used for interest
rate, equity, liquidity, foreign exchange, credit and market instruments. Further, it is also important to
introduce stress testing for operational risk. There are three different hypothetical scenarios that can
be used in stress testing:
(a) Major Level Shocks: It involves large shocks to all the risk factors and is also defined for
separately for each risk factor.
(b) Moderate Level Shocks: It involves medium level shocks and the level is defined for each risk
factor separately.
(c) Minor Level Shocks: It involves small shocks to risk factors.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  203
4. Methodology and Calibration of Shocks
4.1 Credit Risk
 Stress test for credit risk assesses the impact of increase in the level of non-performing loans of
the bank on Capital Adequacy Ratio (CAR). This involves three types of shocks, namely;
 (a) T ype One deals with the increase in the Non-Performing Loans (NPLs) and the respective
provisioning.
 (b) T ype Two deals with the negative shift in the NPL categories and hence the increase in
respective provisioning.
 (c) T ype Three deals with the fall in the Forced Sale Value (FSV) of mortgaged collateral.
4.2 Liquidity Risk
 Stress test for liquidity risk evaluates the resilience of the banks towards the fall in liquid
liabilities. The ratio “liquid assets to liquid liabilities” should be calculated before and after
the shocks by dividing the liquid assets with liquid liabilities. They include cash and balances
with banks, call money lending, lending under repo and investment in government securities.
Liquid liabilities include deposits and borrowings.
4.3 Equity Price Shock
 Stress test for equity price risk assesses the impact of the fall in the stock market index.
The impact of resultant loss should be calculated after shocks on current market value of all the
on-balance sheet and off-balance sheet securities listed on stock exchanges including shares,
mutual funds, etc. and it should be calibrated in terms of the CAR.
4.4 Exchange Rate Risk
 Stress test for exchange rate assesses the impact of change in exchange rate on the value of
equity. To model direct foreign exchange risk, only, the overall Net Open Position (NOP) of the
bank including the on-balance sheet and off-balance sheet exposures should be given adverse
shocks. The overall NOP is measured by aggregating the sum of net short positions or the sum
of net long positions, whichever is greater regardless of sign. The impact of the respective


of net long positions, whichever is greater regardless of sign. The impact of the respective
shocks should be calibrated in terms of the CAR. The revised CAR should be calculated after
adjusting total loss from the risk-weighted assets of the bank.
4.5 Interest Rate Risk
 I nterest rate risk is the potential that the value of the on-balance sheet and the off-balance
sheet positions of the bank would be negatively affected with the change in the interest rates.
The vulnerability of an institution towards the adverse movements of the interest rate can be
gauged by using duration gap analysis. Banks should follow the under mentioned steps in
carrying out the interest rate stress tests.
 (a) Estimate the market value of all on-balance sheet rate sensitive assets and liabilities of the
bank to arrive at market value of equity.
 (b) Calculate the durations of each class of asset and the liability of the on-balance sheet
portfolio.
 (c) Arrive at the aggregate weighted average duration of assets and liabilities.
 (d) Calculate the duration gap by subtracting aggregate duration of liabilities from that of
assets.
 (e) Estimate the changes in the economic value of equity due to change in interest rates on
on-balance sheet positions along the three interest rate changes.


204 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
 (f) Ca lculate surplus/(deficit) on off-balance sheet items under the assumption of three
different interest rate changes, i.e., 1%, 2%, and 5%.
 (g) Estimate the impact of the net change (both for on-balance sheet and off-balance sheet) in
the market value of equity on the CAR.
 (h) Market value of the assets or liabilities should be assessed, by calculating its present value
discounted at the prevailing interest rate. The outstanding balances of assets and liabilities
should be taken along with their respective maturity or reprising period, whichever is
earlier.
4.6 Interpretation of Stress Testing Results
 (a) Before interpretation of stress testing results, it is important to the banks to be aware of
its limitations as stress testing is influenced by the judgment and experience of the risk
managers designing the stress tests. Therefore, the effectiveness of the stress tests will
depend upon whether banks have identified their major risks and they have chosen the
right level of stress/stress scenarios.
 (b) Senior Management should review the results of the various stress tests and report to the
Board. It is important to document the results of each of the sensitivity tests and scenario
analysis undertaken and should also document, as part of the details of those tests and
analyses, the key assumptions including the aggregation of the results. These should be
preserved for a considerable period as mentioned in the policy document.
4.7 Review & Update
 (a) Regular review  and updating is important to ensure effectiveness of the stress testing
programme of the bank.
 (b) Such review should be done at least once a year or more frequently if the portfolio or the
environment changes are significant. Following should be covered in the review process.
 i. The integrity of the management information system.
 ii. Completeness and accuracy of the data used.


ii. Completeness and accuracy of the data used.
 iii. Consistency , timeliness and reliability of data sources.
 iv . The approval process for the stress testing programme.
 v . Integration of stress testing into risk management.
 vi. Interpretation of stress testing results.
H. Disclosur e Requirements
1. Principles
1.1 Banks should adopt a formal disclosure policy approved by the BOD that addresses the bank’s
approach for determining what disclosures to be made and internal controls over the disclosure
process.
1.2 Banks should implement a process for assessing the appropriateness of their disclosures,
including validation and frequency of them.
1.3 In order to enhance the role of market discipline, banks should take into account the following
norms to improve their disclosure practices.
 (a) A  balance between quantitative and qualitative disclosures - Disclosures should be
consistent with banks’ own risk management practices.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  205
 (b) Banks should endeavour to disclose information about inter -period exposures –
particularly in the form of high, median and low observations – which could provide a
more meaningful view of licensed banks’ risk profile than period end data alone.
1.4 Banks should decide relevant disclosures based on the materiality concept.
1.5 Qual itative disclosures such as bank’s risk management objectives and policies, reporting
systems and definitions set out here should be made at least bi-annually .
2. Disclosur e Requirements
2.1 Risk Exposure and Assessment
 (a) General Qualitative Disclosure Requirement
  For each separate risk area viz. credit, market, operational, liquidity etc.. Licensed banks
should describe their risk management objectives and policies, including:
 – strategies and policies;
 – structure and nature of the relevant risk management function;
 – scope and nature of risk reporting and/or management system;
 – policies for hedging and/or mitigating risk and strategies and processes for monitoring
the continuing effectiveness of hedges / mitigants.


206 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
Table - 1
Credit Risk – General Disclosures
Qualitative
Disclosures(a) Definition of past due and  impaired (for LKAS 32 & 39 purposes).
(b) Description of approaches followed for specific and general loan loss provisioning
and statistical methods.
(c) Discussion of the bank’ s credit risk management policy.
(d) Policies and processes for, and an indication of the extent to which the bank makes
use of, on-balance sheet and off-balance sheet netting.
(e) Policies and processes for  collateral valuation and management.
(f) A  description of the main types of collateral taken by the bank.
(g) Main types of guarantor/c redit derivative counterparty and their creditworthiness.
(h) Information about (market or credit) risk concentrations within the mitigation taken.
Quantitative
Disclosures(a) Total gross credit risk exposures, plus average gross exposure over the period broken
down by major types of credit exposure.
(b) Geographic distribution of exposures, broken down in significant areas by types of
credit exposure.
(c) Industry or counter -party type distribution of exposures, broken down by major types
of credit exposure.
(d) Residual contractual maturity breakdown of the whole credit portfolio, by major types
of credit exposure.
(e) By major industry or coun terparty types:
   – Amount of past due loans and if available impaired loans, provided separately ,
   – Specific and general loan loss provisioning, and
   – Char ges for specific loan loss provisions and charges-offs during the reporting
period.
(f) Amount of past due loans and, if available, impaired loans provided separately broken
down by significant geographic area including the amount of specific and general loan
loss provisions related to each geographical area.
(g) Reconciliation of changes  in the provisions for loan losses/impairment.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  207
Table - 2
Market Risk – General Disclosures
Qualitative
Disclosures (a) The general qualitative di sclosure requirement described in Para 2.1( a) above.
(b) Dif ferentiation between holdings on which capital gains are expected and those
taken under other objectives including for relationship and strategic reasons.
(c) Discussion of important policies covering the valuation and accounting of equity
holdings in the Banking Book. This includes the accounting techniques and
valuation methodologies used, including key assumptions and practices affecting
valuation as well as significant changes in these practices.
Quantitative
Disclosures(a) Interest rate risk, including Interest Rate Sensitivity Gap Analysis of local and
foreign currency denominated assets and liabilities in the format given in Attach -
ment – 1&2.
(b) Equity position risk –
• V alue disclosed in the balance sheet of investments, as well as the fair value
of those investments; for quoted securities, a comparison to publicly quoted
share value where the share price is materially different from fair value.
• T ypes and nature of investments, including the amount that can be classified
as:
– Publicly traded; and
– Privately held.
• The cumulative realised gains (losses) arising from sales and liquidations in
the reporting period.
• T otal unrealised gains (losses).
• T otal latent revaluation gains (losses).
• Any amounts of the above included in Tier 1 and/or Tier 2 capital.
(c) Foreign exchange risk, including statements of foreign exchange position
(Attachment – 3), Maturity Gap Analysis of foreign currency denominated assets
and liabilities.
(d) Commodity risk.


208 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
Table - 3
Operational Risk – General Disclosures
Qualitative
Disclosures (a) The general qualitative di sclosure requirement described in Para 2.1( a) above.
(b) Description of the use of insurance for the purpose of mitigating operational risk.
(c) Details of activities that have been outsourced together with parties and basis for
payment for such services.
(d) Details of investment in appropriate information technology, if any, and other risk
mitigation techniques taken during the reporting period.
(e) Details of due diligence te sts of third party service providers.
(f) Details of a contingency p lan in place to handle failure situations.
Quantitative
Disclosures(a) Major operational viz. system or human, failures and financial losses incurred by
the bank due to such failures during the reporting period.

Table - 4
Liquidity Risk – General Disclosures
Qualitative
Disclosures (a) The general qualitative di sclosure requirement described in Para 2.1( a) above.
(b) Details of a liquidity contingency plan in place to bridge unforeseen liquidity
difficulties.
Quantitative
Disclosures(a) T rends in the following indicators:
• Net loans to total assets
• Loans to customer deposits
• Liquid assets to short term liabilities
• Lar ge liabilities (minus) temporary investments to earning assets (minus)
temporary investments
• Purchased funds to total assets.
• Commitments to total loans.
(Please refer to  Section 1.4 of Appendix for definitions)
(b) Maturities of Assets and Liabilities (MAL) in the format given in Attachment-1.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  209
Attachment 1
Maturities of Assets and Liabilities (MAL)
(Currency ..................) *
Heads of Accounts Upto 1
month1–3 months 3–6 months 6–9 months 9–12 months 1–3 years 3–5 years Over 5 years
Sr. Item
A Inflows
1.Cash on hand
2.Deposits with CBSL
3.Balances due from Head Office, Affiliates and Own Branches
4.Balances due from Other Banks
5.Investments (Net of provisions)
6.Bills of Exchange
7.Overdraft
8.Loans and Advances
9.NPLs
10. Net Inter-Branch Transactions
11. Other Assets
12. Lines of credit committed from institutions
13. Other – Please Specify ,
Total (a) xx xx xx xx xx xx xx xx
B Outflows
1.Demand Deposits
2.Savings Deposits
3.Balances due to Head Office / Affiliates / Own Branches
4.Balances due from Other Banks
5.Time Deposits
6.Certificates of Deposits, Borrowings and Bonds
7.Net Inter-branch Transactions
8.Bills Payable
9.Interest Payable
10.Provisions other than for loan losses and depreciation in the
value of investment portfolio
11. Other Liabilities
12. Lines of credit committed to institutions
13. Unutilized portion of Overdraft, Loans and Advances
14. Letters of Credit / Guarantees / Acceptances
15. Repo / Bills Rediscounted / Swaps / Forward contracts
16. Other – Please Specify
Total (b) xx xx xx xx xx xx xx xx
Gap = (a) - (b) xx xx xx xx xx xx xx xx
Cumulative Gap xx xx xx xx xx xx xx xx
Cumulative Liabilities xx xx xx xx xx xx xx xx
Cumulative gap as a % of cumulative liabilities x% x% x% x% x% x% x% x%
* Separate returns for LKR, USS and all other major currencies should be prepared.( …… Million )


210 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
Attachment 1 (A)
Maturities of Assets and Liabilities
Guidelines 	on	Classification 	of	Assets	and	Liabilities 	into	Time	Bands
Sr. Heads of Accounts Details sought
AInflows
1.Cash on Hand Up to one-month time band.
2.Deposits with CBSL While the excess balance in the Clearing Account over the
required statutory reserves could be placed under the ‘up to
one-month’ time band, the statutory reserve against deposit should
be distributed amongst various time bands, corresponding to the
behavioral maturity profile of deposits.
3.Balances due from the Head
Office,	Affiliates 	and	own
branches Demand balances may be placed under the ‘up to one-month’
time band, all other balances should be distributed across the time
bands as per the respective residual maturities.
4.Balances due from Other
BanksRespective maturity time bands.
5.Investments
(Net of provisions)Respective residual maturities. Investment ‘held-for-trading’ may
be placed in the first three time bands, on the basis of liquidity
profile of the instruments, irrespective of their residual maturities.
6.
7.
8.Advances (performing)
(a) Bills of Exchange and
promissory notes
(b) Overdraft
(c) Loans and Advances
(a) Respective residual maturities bands.
(b) 7.5% each of the outs tanding should be distributed under
one-month, 1-3 months, 3-6 months, 6-9 months, and
9-12 months time bands, respectively and the balance 62.5%,
being the core component, should be shown equally under
1-3 years, 3-years and over 5 years time bands, respectively.
(c) Respect ive residual maturities. However, 50% of the consumer
loans, including credit cards, should be shown under over
5 years time band. The balance amount of 50% should be
shown under respective time bands, on the basis of residual
maturities.
9.NPLs 25% and 75% of the balances, net of reserved interest and specific


maturities.
9.NPLs 25% and 75% of the balances, net of reserved interest and specific
loan loss provisions should be shown in the 9-12 months and over
five years time bands, respectively.
10. Net Inter-Branch
TransactionsUp to one-month time band.
11. Other Assets As per pattern of cash flows. However, intangible assets and assets
not representing cash receivables should be shown in over five
years time band.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  211
Sr. Heads of Accounts Details sought
BOutflows
1. Demand Deposits 75% of the balances in demand deposits should be distributed
under the first five time bands, at the rate of 20%, 20%, 15%,
10% and 10%, respectively and the balance of 25% in over 5
years time band.
2.Savings Deposits 25% of the saving deposits should be distributed equally under
one-month, 1-3 months, 3-6 months, 6-9 months, and 9-12
months, respectively, and the balance of 75%, being the core
component, should be shown equally under 1-3 years, 3-5 years
and over 5 years time bands, respectively.
3.Balances 	due	to	Head	Office/
Affiliates/Own 	BranchesRespective residual maturity time bands.
4.Balances due to other Banks Respective residual maturity time bands.
5.Time Deposits 30% of the time deposits from individual depositors and pension
funds, irrespective of their residual maturities, should be shown
under over 5 years time band. The balance amount of 70%
should be shown under respective time bands, on the basis of
residual maturities.
6.Certificates 	of	Deposits,
borrowings and Bonds
(including subordinated debts)Respective residual time bands. Where call/put options are
built into the issue structure of any instrument/s, the call/put
date/s should be reckoned as the residual maturity date/s and
the balance should be shown in the respective residual maturity
time bands.
7.Net Inter-branch Transactions Up to one month time band.
8.Bills Payable Up to one month time band.
9.Interest Payable Respective residual maturity time bands.
10. Provisions other than for loan
losses and depreciation in the
value of investment portfolioRespective residual maturity time bands depending on the
purpose.
11. Other Liabilities Respective maturity time bands. Items not representing cash
payables ( i.e., income received in advance etc.) should be placed
over 5 years time band.


212 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
Sr. Heads of Accounts Details sought
CContingent 	Liabilities/Lines 	of	credit	committed/available 	and	other	in-flows	&	out-flows
12. Lines of Credit Committed
to institutions and other
borrowersUp to one month time band
13. Unutilized portion of
Overdraft, Loans and
AdvancesProbable disbursements should be shown in the respective time
bands on the basis of historical databases.
14. Letters of credit /guarantees /
acceptancesProbable funding obligations should be shown in the respective
time band on the basis of past experiences.
15. Repo / Bills Rediscounted /
Swaps / Forward contracts
(LKR against Other
Currencies)Respective maturity bands.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  213
Attachment 2
Sensitivity of Assets and Liabilities (SAL)
(Currency*)
Name of Bank  : ………………………………………………………………
Period Ended  : ………………………………………………………………
No. Assets and OBSUp to
1 month1 – 3
months3 – 6
months6 – 12
months1 – 2
years2 – 3
years3 – 4
years4 – 5
years5 – 7
years7 – 10
Years10 – 15
years15 – 20
yearsOver
20 yearsNon
SensitiveTotal
1. Cash on Hand
2. Deposits with CBO
3. Balances due from HO / Affiliates / Branches
4. Balances due from Other Banks
5. Investments
6. Bills of Exchange and Promissory Notes
7. Overdrafts
8. Loans and Advances
9. Non Performing Loans
10. Fixed Assets
11. Net Inter-branch Transactions
12. Accrued Interest
13. Other Assets
14. Reverse Repos
15. FRAs
16. Swaps
17. Futures
18. Options
19. Others (Specify)
Total
Liabilities and OBS
1. Demand Deposits
2. Savings Deposits
3. Time Deposits
4. Other Deposits
5. Balances due to HO / Affiliates / Branches
6. Balance due to other Banks
7. Certificate of Deposits
8. Other Borrowings
9. Net Inter-branch Transactions
10. Bills Payable
11. Interest Payable
12. Provisions (others)
13. Capital
14. Reserves
15. Retained Earnings
16. Subordinated Debts
17. Other (Specify)
18. Repos
19. FRAs
20. Futures
21. Swaps
22. Options
Total
Gap
*  Separate returns for LKR, US$ and all other major currencies should be prepared.( …… Million )


214 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
Sensitivity of Assets and Liabilities
Guidelines 	on	Classification 	of	Assets	and	Liabilities 	into	Time	Bands
Sr. Heads of Accounts Rate Sensitivity and Time Band
AInflows
1.Cash on Hand Non-sensitive
2.Deposits with CBSL Non-sensitive
3.Balances 	due	from	head	office,
Affiliates 	and	Own	branches 	Interest payable portion is sensitive and should be shown
under the time band corresponding to the remaining term
to maturity or repricing. The non-interest paying portion is
non-sensitive.
4.Balances due from Other Banks Interest payable portion is sensitive and should be shown
under the time band corresponding to the remaining term
to maturity or repricing. The non-interest paying portion is
non-sensitive.
5.Investments (Net of provisions)
(a) Fixed rate/Zero coupons.
(b) Floating rate
(c) Shares and investments in
units(a) Se nsitive and should be shown under the time band
corresponding to residual term to maturity.
(b) Se nsitive and should be shown under the time band
corresponding to residual term to maturity.
(c) Non-sensitive.
6.
7.
8.Advances (performing)
(a) Bills of Exchange and pr om-
issory notes
(b) Overdraft/loans (Fixed
rates)
(c) Overdraft/ Loans and
Advances (Floating rates)
(a) Sensitive on maturity .
(b) S ensitive and should be shown under the time bands
corresponding to the interim and final cash flows.
(c) Se nsitive and should be shown under the time band
corresponding to the interim and final cash flows.
9.NPLs
(a) Special mentioned
(b) Substandard
(c) Doubtful
(d) Loss(a) Over 1-2 years time band
(b) Over 3-5 years time bands
(c) Over 5 years time band
(d) Non-sensitive
10. Fixed Assets Non-sensitive
11. Net Inter-Branch Transactions Non-sensitive
12. Accrued interest Non-sensitive
13. Other Assets
(a) Leased assets
(b) Other(a) Sensitive on interim and final cash flows. The amount
should be distributed to the respective maturity bands


should be distributed to the respective maturity bands
corresponding to the cash flows.
(b) Non-sensitive
14. Reverse repos, Swaps, (Buy/sell),
and bills discountedSensitive on maturity.Attachment  2(A)


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  215
15.
16.
17.FRAs
Futures
OptionsThese instruments should be treated as a combination of loan
(assets) and short (liabilities) positions. The maturity of a
Future or a FRA will be the period until delivery or exercise
of the contract. The corresponding positions should undergo
changes with passage of time.
Swaps should be treated as two notional positions with
relevant maturities. For e.g. an interest rate swap under
which a bank is receiving floating rate of interest and paying
fixed will be treated as long floating rate position of maturity
equivalent to the period until the next interest fixing and a
short position of maturity equivalent to the residual life of
the swap.
The notional underlying of the given option should be placed
under the respective time band.
Sr. Heads of Accounts Rate Sensitivity and Time Band
1.Demand Deposits Non-sensitive
2.Savings Deposits Sensitive and reprices when interest rate is reset.
3.
4.
7.Time Deposits,
Certificate 	of	Deposits, 	and
Other DepositsSensitive and reprices on maturity. The amounts should be
distributed to different time bands on the basis of remaining
term to maturity. However, in case of floating rate term
deposits, the amounts should be shown under the time band
when deposits contractually become due for repricing.
5.Balances 	due	to	Head	Office	/
Affiliates/Own 	BranchesInterest payable portion is sensitive and should be shown
under the time band corresponding to the remaining term
to maturity or repricing. The non-interest paying portion is
non-sensitive.
6.Balances due to other Banks Interest payable portion is sensitive and should be shown
under the time band corresponding to the remaining term
to maturity or repricing. The non-interest paying portion is
non-sensitive.
8.Borrowings
(a) Fixed rate borr owings
(b) Floating rate borr owings
(c) Zer o Coupon borrowings


8.Borrowings
(a) Fixed rate borr owings
(b) Floating rate borr owings
(c) Zer o Coupon borrowings
(d) Borr owings from CBSL(a) Sensitive and reprices on maturity. The amounts should
be distributed to different time bands on the basis of
remaining term to maturity.
(b) Se nsitive and reprices when interest rate is reset. The
amounts should be distributed to the appropriate time
bands, coinciding with the contracted repricing date.
(c) Sensitive and reprices on maturity. The amounts should
be distributed to the respective maturity bands.
(d) Up to one month time band.
9.Net-inter branch transactions Non-sensitive
10. Bills Payable Non-sensitive
11. Interest Payable Non-sensitive


216 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
12. Provisions Non-sensitive
13. Capital Non-sensitive
14. Reserves Non-sensitive
15. Retained earnings Non-sensitive
16. Sub-ordinated debts Please refer to Item (8) above.
17. Reverse Repos, and other
derivatives instrumentsReprices only on maturity and should be distributed to
respective maturity bands.
Sr. Heads of Accounts Details sought
CContingent 	Liabilities 	/	Lines	of	credit	committed 	/	available 	and	other	inflows	&	out	flows
3.Lines of Credit Committed to
institutions and other borrowersUp to one month time band.
4.Unutilized portion of Overdraft,
Loans and Advances.Probable disbursements should be shown in the respective
time bands on the basis of historical databases.
5.Letters of credit / guarantees /
acceptancesProbable funding obligations should be shown in the
respective time band on the basis of past experiences.
6.Repo / Bills Rediscounted /
Swaps / Forward Contracts
(LKR against other currencies)Respective maturity bands.


Directions, Determinations, and Circulars issued to Licensed Specialised Banks  217
(Rs. million)Attachment 3
Foreign Exchange Position
Bank  : …………………………………………
As at end of  ………………………………………… :
Currency
(1)Spot Forward (a)Net
Open
Position
(8)Net
position
in other
exchange
contracts
(b)
(9)Overall
exposure
in respec-
tive foreign
currency
(10)Overall
exposure in
Sri Lankan
rupees(d)
(11)Assets
(2)Liabilities
(3)Net
(4) = (2) -
(3)Assets
(5)Liabilities
(6)Net
(7) = (5) -
(6)
US Dollars
Pound Sterling
Euro
Japanese Yen
Indian Rupee
Australian Dollar
Canadian Dollar
Other currencies(c)
Total Exposure (e)
Total capital funds as per the latest audited financial statements
Total exposure as a % of total capital funds as per the latest audited financial statements (should not exceed 30%) X%
(a) Unsettled tom and spot transactions also should be included under  forward operations
(b) Report the net for eign exchange position in other foreign exchange contracts such as currency options, futures etc.
(c) The Sri Lankan rupee equivalent of other  currencies should be shown under column 11.
(d) Column 1 1 should show the Sri Lankan rupee equivalent of column 10.
(e) The exposur e indicated against each currency in column 11 should be added ignoring signs to arrive at exposure under (e).


218 Directions, Determinations, and Circulars issued to Licensed Specialised Banks
BANKING ACT NO. 30 OF 1988
AS AMENDED BY BANKING (AMENDMENT) ACT NO. 33 OF 1995
The directions issued by the Monetary Board of the Central Bank of Sri Lanka under Section
76J(1) of the Banking Act, No.30 of 1988 as amended by the Banking (Amendment) Act, No.33
of 1995.
Sgd. A. S. Jayawardena
Governor
Colombo
21-11-1997.
DIRECTIONS UNDER 76J(1)
DISQUALIFICATION FOR APPOINTMENT AS MANAGER,
SECRETARY OR OTHER OFFICIAL OF A LICENSED SPECIALISED BANK
1. No person shall be appointed as Manager, Secretary or other official of a licensed
specialised bank and any person appointed as Manager, Secretary or other official of such bank
shall be removed from office if he –
1.1 is a person who, having been declared insolvent or a bankrupt under any law in Sri
Lanka or in any other country, is an undischarged insolvent or bankrupt; or
1.2 is serving or has served a sentence of imprisonment imposed by any court in Sri Lanka
or by any other country; or
1.3 has been convicted of any act which is of a fraudulent or illegal character .
2. No person who has been a director or has been a chief executive of ficer of a licensed
specialised bank which has been would up by an order of court shall, without the written approval
of the Central Bank, act as a director or chief executive officer of a licensed specialised bank.
3. No licensed specialised bank shall employ or be managed by a managing agent other than
an employee of such licensed specialised bank.