On 30 September 2024, the Central Bank of Sri Lanka (CBSL) issued the “Banking Act Direction No. 5 of 2024” (“the New Direction”), setting out a comprehensive framework for corporate governance in licensed commercial and specialized banks.
Effective from 1 January 2025, the new Direction has been implemented, thereby revoking all previously issued Directions and Circulars on the subject matter, effective from the same date.
Key Updates:
1. Responsibilities of Board of Directors
The New Direction has expanded the responsibilities of the Board of Directors with the objective of enhancing the safety and stability of the Banks by implementing a strong compliance and risk governance framework to define and monitor the risk appetite aligned with the bank’s strategy.
Accordingly, The Board of Directors are expected to assess the Board’s governance practices regularly and agree on the criteria for annual director self-assessments.
The New Direction, keeping abreast with global developments, underscores the pivotal role of the Board of Directors in relation to sustainability. It emphasizes the Board’s responsibility to integrate environmental, social, and governance (ESG) considerations into the organization’s strategic decision-making processes, ensuring that sustainable practices are embedded at the highest levels of governance.
2. Board Composition, Independence & Diversity
The New Direction requires licensed Banks to strengthen their Boards by ensuring a balanced composition of executive and independent non-executive directors, with a renewed emphasis on director independence to safeguard objective decision-making.
Additionally, it also encourages board diversity by stimulating varied skills, experiences, and gender representation to enhance governance quality to empower Boards to effectively oversee management, integrate ESG considerations into strategic decisions, and reinforce the stability and sustainability of the banking sector.
New structural requirements under the New Direction:
| Requirement | New Direction (2024) |
|---|---|
| Board Size | 7 to 13 members |
| Independent Non-Executive Directors | at least 50% of the board by 1 January 2027 |
| Gender Diversity | At least one female director by end-2025; if the board exceeds 10 members two female directors by end of 2026 |
| Requirement | New Direction (2024) |
| Tenure & Retirement Age | The total tenure of a director (excluding those serving as CEO or in key management positions) shall not exceed nine years. The mandatory retirement age for directors is set at 70 years. |
| Cooling-off Period | A Director or CEO of a licensed Bank must observe a six-month cooling-off period after leaving their position before joining another licensed bank in the country. Exceptions for restructuring needs require prior approval from the Central Bank of Sri Lanka. |
3. Mandatory Separation of Chairperson and CEO Roles
The New Direction clearly defines the responsibilities of the Chairperson of the Board and the CEO which enable the Banks to establish a healthy system of checks and balances in the governance of the Banks. This is re-enforced by requiring the Chairperson to be an independent non-executive director, though transitional relief allows current non-independent chairs to remain until 31 December 2027.
4. Mandatory Board Committees
Banks are now required to establish the five mandatory committees, each with clearly defined duties and independence criteria to promote transparency in the governance structure, accountability, and effective risk management.
The formation of these committees is aligned with the best international practices applicable to good corporate governance structures. Each committee is expected to play a critical role in reviewing the applicable governing frameworks, oversight on risk management and ensuring compliance of the regulatory framework applicable to Banks.
A noteworthy development is the obligation imposed on the Human Resources and Remuneration Committee to introduce a policy on “claw-back arrangements” for performance-based payments made to the CEO and key management personnel under certain circumstances, such as fraud or misappropriation of funds, to the extent of the financial loss caused to the licensed bank.
All committees are chaired by Non-Executive Directors, preferably independent, to reinforce objectivity and impartiality. The mandatory committees are:
- The Audit Committee
- The Integrated Risk Management Committee
- The Nomination and Governance Committee
- A Related Party Transactions Review Committee
- Human Resources & Remuneration Committee
5. Strengthened Risk, Compliance, and Audit Functions
Risk, Compliance, and Audit functions are formalized under the New Direction and are expected to operate independently within the bank’s governance ecosystem:
Risk ManagementLed by a Chief Risk Officer (CRO), to be part of key decision-making and independent from business lines.
| Function | Key Features Under New Direction |
|---|---|
| Risk Management | Led by a Chief Risk Officer (CRO), to be part of key decision-making and independent from business lines. |
| Compliance | Led by a Chief Compliance Officer (CCO), empowered to report directly to board committees and assess compliance risk proactively. |
| Internal Audit | Overseen by a Chief Internal Auditor (CIA), reporting to the Audit Committee, with full access to internal systems, and charged with reviewing the overall risk culture. |
6. Enhanced focus on Ethics, Transparency, and Sustainability
The New Direction brings a stronger focus on ethical conduct, transparency, and responsible banking. Licensed banks are required to adopt a comprehensive Code of Conduct that clearly outlines expectations around confidentiality, managing conflicts of interest, and fair treatment of customers.
One such significant step is to imposing compulsory requirements on having a formal whistleblower policy to, empower employees to report their concerns without any undue pressure, including through direct channels to regulators, where necessary.
The New Direction introduces specific obligations for foreign banks operating in Sri Lanka, emphasizing enhanced transparency and regulatory alignment with the introduction of the New Direction, Foreign banks come under its application to the extent that it does not conflict with the laws and regulations of their country of incorporation and imposes governance and compliance reporting function ensuring that their local operations meet the same supervisory standards as domestic.
For further information, please contact:
Aloka Nandasena, D.L.&F. DE SARAM
aloka@desaram.com
