The banking sector earnings, which once looked almost immune to economic cycles, have indicated some signs of weakness in recent times, as the sector is facing multiple headwinds, which are putting its resilience to test.  

The most recent data seen by Mirror Business signalled a possible decline in sector profits, which for over a year were plagued by a number of problems from higher credit costs to slowdown in demand for fresh loans.

The government has also slapped higher taxes on the banking sector, which is looked at as a cash cow to be milked every time the government coffers run dry. 

The data for the first eight months showed that although the interest income of the banking sector had increased by Rs.87.8 billion from the same period in 2017, the after tax profits had increased by only Rs.300 million. 

The banking sector reported after tax profits of Rs.86.9 billion in total during the first eight months in 2018, on an interest income of Rs.716.4 billion. 

In a note released on the banking sector performance in September, Fitch Ratings predicted a mild pressure on the performance during the rest of 2018 and possibly in 2019, due to the challenging operating conditions. 

Fitch Ratings is maintaining a ‘Negative’ outlook on the sector as the operating conditions continue to be difficult against a challenging macroeconomic backdrop, which is expected to pressure the banks’ performance in the short to medium term.  Sri Lanka’s banking sector asset quality fell to a new low in August this year, as the reported gross non-performing loan (NPL) ratio rose to 3.6 percent, from 3.4 percent in July and 2.5 percent in 2017. 

However, the Central Bank believes the potential NPL ratio to be over 5.0 percent, as most banks are believed to have rescheduled the troubled loans to show a better picture. 

The rescheduled loans have increased by a staggering Rs.155 billion by end-August 2018, from Rs.93 billion a year ago, an increase of 66 percent. 

Higher credit costs or provisions for possible bad loans are also on the rise, denting the profits further. New taxes and higher tax rates have increased the banking sector effective tax rate to over 50 percent in most cases, making the industry the heaviest taxed in any country. 
As a result, the return on equity, the commonly watched investor ratio, which gauges the sector attractiveness, has declined by 310 basis points during the eight months, to 14.5 percent. 

This is also partly due to the new capital raised by the banks since 2017 to remain compliant with the full implementation of the BASEL III capital ratios coming into effect from January 1, 2019. 

Sri Lankan banks have raised Tier I capital of Rs.66 billion and Tier II capital of Rs.45 billion since 2017, ahead of the full implementation of BASEL III in 2019, Fitch Rating said. “This includes Rs.10 billion of equity by the large state-licensed commercial banks. Further capital raising is likely in 2018, although much of the shortfall was bridged in 2017,” the rating agency noted. 

Despite the weakness in earnings, the Sri Lankan banks remain relatively strong and well capitalized to withstand shocks after 
capital raisings. 

Banks will start filing their third quarter earnings from next week onwards. Analysts expect higher provisions and slowdown in new loans to decelerate earnings growth.