Manageable Impact on Sri Lankan Lenders’ Capital from Higher Gold-Loan Risk Weights: Fitch Ratings

Fitch Ratings believes the Central Bank of Sri Lanka’s tighter capital treatment for gold-backed lending will have a mostly manageable impact on rated banks’ and finance companies’ capital ratios, while supporting risk profiles. The impact on Fitch-rated finance companies is likely to be larger than on banks because gold-backed lending accounts for a larger share of their loan books and underwriting has been more aggressive.

Banks and finance companies will adopt similar risk weightings under the new directive. Gold loans with loan-to-value (LTV) ratios below 70% will carry a 10% risk weight for both sectors, up from zero. For exposures in the 70%-100% LTV band, banks will apply 40% risk weight, up from 20%, while finance companies will also apply 40% to the full exposure, instead of 100% only on the portion above 70% LTV. Exposures above 100% LTV will remain risk weighted at 100% for both. This raises average risk density in gold-backed lending portfolios to about 12% for Fitch-rated banks and 26% for finance companies, from 1% and 5%, respectively.

We expect only a modest effect on banks’ capital ratios due to their lower gold-loan exposures. We estimate the impact on their common equity Tier 1 ratios at 2bp to 35bp, based on end-March 2026 exposures. People’s Bank (Sri Lanka) (AA-(lka)/Stable) had the largest exposure, with gold loans at about 20% of gross loans, versus below 10% for peers. Even so, the capital impact should be limited due to the bank’s conservative LTV profile.

The effect will be more pronounced for four Fitch-rated finance companies, but should remain manageable given buffers over the regulatory minimum. We estimate their regulatory Tier 1 capital ratios could decline between 1pp and a little over 5pp. Asia Asset Finance PLC (A+(lka)/Stable) is likely to be most affected, as gold-backed lending forms more than two-thirds of its loan book. Gold loans formed a third of loans at LB Finance PLC (A-(lka)/Stable) and Mahindra Ideal Finance PLC (AA-(lka)/Stable), implying moderate capital pressure of 1pp-2pp. UB Finance PLC (BB(lka)/Negative) may also face roughly 1pp impact, despite gold loans forming less than 20% of its portfolio. Other rated issuers should see more limited effects of 5bp-80bp.

For HNB Finance PLC (HNBF, A(lka)/Stable) and Merchant Bank of Sri Lanka & Finance PLC (MBSL, A(lka)/Stable), these changes will add pressure to already strained capital bases, while Mercantile Investments and Finance PLC’s (BBB-(lka)/Stable) regulatory capital buffers would also decline. HNBF’s total capital ratio could approach the regulatory minimum while MBSL was already below minimum Tier 1 and total requirements at end‑March 2026. Capital infusions at HNBF and MBSL, alongside sustained capital accretion, would be key to restoring adequate buffers above regulatory requirements.

Lenders expanded gold-backed loans rapidly following vehicle import restrictions, as low risk weights made the product capital-efficient. While the revised framework is credit-positive from a prudential perspective and complements lower LTV caps introduced in May 2026 to curb aggressive growth, lenders are still likely to favour gold loans, which have lower capital intensity than other products.

The final impact on banks and finance companies may be lower than estimated if lenders rebalance portfolios before the changes take effect on 1 September 2026, provided gold prices do not drop materially. Gold loans’ short tenor also supports this. For lenders with high gold-loan concentrations, a sharp fall in gold prices remains the main downside risk, as this could raise LTVs, weaken collateral coverage and increase capital pressure.

We do not expect rating impact due to the new directive, as the most affected issuers are either support driven or have adequate capital buffers.