Fitch says capitalisation in banking sector needs to be shored up

Nov 24, 2016 (LBO) – Sri Lanka’s Fitch Ratings said that capitalisation in the banking sector needs to be shored up and certain regulatory forbearances have contributed to bank undercapitalisation.

Releasing a statement the rating agency said they are of the view that the reported capital adequacy ratios of banks in Sri Lanka continue to benefit from certain exposures that do not attract a capital allocation under local regulations.

2017 budget proposed to increase the minimum capital of licensed commercial banks to 20 billion rupees from 10 billion rupees and licensed specialised banks to 7.5 billion rupees from 5 billion rupees.

“Of the 15 domestic banks rated by Fitch, six did not meet this requirement based on reported core capital as at 1H16,” Fitch said.

“Of these six, three do not even meet the existing, lower capital requirements. This underscores Fitch’s view that capitalisation in the sector needs to be shored up.”

Banks were initially expected to adhere to the current lower minimum capital requirement from 1 January 2016.

However, the Central Bank of Sri Lanka granted extensions to some banks to meet this requirement by 1 January 2018 with specified interim targets.

Fitch believes banks could face challenges in raising capital, particularly as the operating conditions in Sri Lanka remain difficult , as signalled by Negative Outlook on the sovereign rating, which was downgraded to ‘B+’ from ‘BB-‘ in February 2016.

Full statement is reproduced below.

Fitch: Proposal to Raise Capital Floor to Benefit Sri Lanka Bank Sector

Fitch Ratings-Colombo-24 November 2016: A proposal to increase the minimum capital requirements for banks in Sri Lanka should help to strengthen the capitalisation of some banks and appears aimed at bringing about consolidation in the banking sector, which should raise systemic stability of the sector in the long term, Fitch Ratings says.

The Sri Lanka government in its 2017 draft budget proposed to increase the minimum capital of licensed commercial banks to LKR20bn from LKR10bn and licensed specialised banks to LKR7.5bn from LKR5bn. Of the 15 domestic banks rated by Fitch, six did not meet this requirement based on reported core capital as at 1H16. Of these six, three do not even meet the existing, lower capital requirements. This underscores Fitch’s view that capitalisation in the sector needs to be shored up.

Banks were initially expected to adhere to the current lower minimum capital requirement from 1 January 2016. However, the Central Bank of Sri Lanka granted extensions to some banks to meet this requirement by 1 January 2018 with specified interim targets. Fitch believes that such regulatory forbearance has contributed to bank undercapitalisation and could undermine the authorities’ objective of consolidation.

Fitch is of the view that the reported capital adequacy ratios of banks in Sri Lanka continue to benefit from certain exposures that do not attract a capital allocation under local regulations. Fitch has long highlighted that capitalisation of major state banks is thin on an adjusted basis. Internal capital generation at these banks is constrained by dividends to the government and they are likely to continue to be dependent on the state for core capital infusions. Capitalisation of most non-state banks has also been decreasing amid rapid credit expansion. The sector has not also raised much core capital through capital infusions from shareholders. Fitch believes banks could face challenges in raising capital, particularly as the operating conditions in Sri Lanka remain difficult , as signalled by Negative Outlook on the sovereign rating, which was downgraded to ‘B+’ from ‘BB-‘ in February 2016.

There could be greater urgency for banks to build their capital buffers if the Central Bank of Sri Lanka implements Basel III capital standards in the near future as expected. Fitch believes that this could pose a challenge to some of the banks that do meet the enhanced minimum capital requirements because they would need to have sufficient capital to fulfil additional requirements.

A previous plan to bring about financial sector consolidation under the “Master Plan for the Consolidation of the Financial Sector” did not significantly reduce the number of banks. There are 25 licensed commercial banks and seven licensed specialised banks in Sri Lanka.