Sri Lankan banks’ performance in 2020 and 1Q21 exceeded Fitch Ratings’ initial expectations, thanks to stimulus and regulatory relief measures. However, we believe risks to the banks’ performance and operating environment remain, due to pressures stemming from Covid-19 and the sovereign credit profile.
Sri Lankan banks’ loan growth in 2020 dipped below historical averages due to subdued private credit demand and reduced appetite for new lending. We expect moderately higher loan growth in 2021 as private credit demand picks up, alongside a possible resumption in economic activity combined with increased state borrowings.
Asset quality remains a key risk as regulatory relief measures are unwound. This should see credit costs in 2021 at least as high as in 2020, but overall profitability could rise from further deposit repricing and the likely pick-up in lending.
State banks’ capital buffers have come under pressure from rapid loan growth, while private banks’ remained broadly intact on the back of a faster pace of earnings retention and capital-raising by some banks.
Banks’ funding profiles remained largely unchanged, although the share of foreign-currency funding in total funding continued to decline, to 21% by end-1Q21 (2019: 23%). We expect foreign-currency funding in terms of both access and pricing to remain challenged in 2021.