Sri Lanka’s banking, finance, insurance and real estate sector (financial sector) will have a bleak outlook for 2013 on the back of low credit growth and deteriorating asset quality, an equities research report by a leading securities trading firm said.

JB Securities said in its report, the poor performance of the financial sector would be further aggravated by the falling net interest margins (NIMs) due to timing mismatches in reprising assets and liabilities and the absence of one off translation gains from a large depreciation of the currency.

Despite two rounds of monetary easing since last December, private sector credit growth has remained subdued. By end-April 2013, credit to the private sector grew only by 10.2 percent, followed by a 9.0 percent growth in May, notably below the Central Bank’s full year target of 18.5 percent.

It was only last month that C T Smith Stockbrokers alerted a possible deterioration in the asset quality of the gold-backed loans (pawning portfolio) to around 3 percent from around 1 percent if gold prices fall below US $ 1,000 an ounce.

By April 2013, pawning as a percentage of total rupee lending stood at 22.8 percent, slightly elevated from 2012’s level of 22.6 percent. However, JB Securities expects a contraction in pawning advance for the balance part of the year because of the lower gold prices, coupled with lower loan-to-value ratio.

Meanwhile, the economists too pointed out the penal rate cut, which came into effect since August 1, would also give an incentive for the borrowers to default and thus affecting the asset quality negatively.

According to TKS Securities (Private) Limited, the cap on penal rates will negatively impact the banks because the banks have to cut rates from current 5.0 percent - 6.0 percent to 2.0 percent.

However, a banking sector analyst said on condition of anonymity that the policy directive could even turn out to be positive to the overall economy because despite yields coming down, borrowers would be encouraged to repay in larger volumes, leaving more funds for relending, leading to credit growth.

The financial sector accounts for 30 percent of the market capitalization and 37 percent of the total earnings in the Colombo Stock Exchange.