Moody’s says Sri Lankan banking system outlook is negative

Sept 05, 2018 (LBO) – Moody’s Investors Service says that the outlook for Sri Lanka’s banking system is negative, as the economy remains weak and asset quality is deteriorating.

“The economy will only exhibit a modest rebound as the government’s high debt burden and reliance on foreign borrowings continue to limit public investment and pose the risk of capital outflows,” says Tengfu Li, a Moody’s Analyst.

“Credit growth was very high over the last two years, with the credit multiplier (credit growth/GDP growth) peaking at more than 2.5 times,”

“As loans disbursed over this period begin to mature, asset quality will deteriorate, and higher borrowing costs due to a tighter monetary policy implemented earlier will add to the debt burden of corporates.”

Moody’s conclusions are contained in its just-released “Banking System Outlook: Sri Lankan banks, Macroeconomic risks, and deteriorating asset quality drive negative outlook”.

The outlook expresses Moody’s expectation of how bank creditworthiness will evolve in this system over the next 12 to 18 months.

With the key drivers, Moody’s assesses the operating environment as stable; asset risk as deteriorating; capital as stable; profitability and efficiency as stable; funding and liquidity as stable; and government support as deteriorating.

Moody’s notes that capital has strengthened as the banks successfully raised capital and reduced cash dividends to comply with their Basel III requirements.

While the transition to SLFRS 9 will substantially increase loan provisions, the capital impact is likely to be limited as the regulator allows provisions to be staggered over a prescribed period. Profitability supported by interest income growth will offset the increase in credit costs.

Funding pressure on the banks will improve with the recent slowdown in loan growth. Sri Lankan banks hold sizeable liquid assets to cover their liquidity needs and movements in deposits, thereby providing an adequate buffer.

Last but not least, a high debt burden and contingent liabilities relating to state-owned enterprises will continue to limit the government’s capacity to support the banks.