Lankan banks told to be ruthless with borrowers if NPLs continue to rise

The Sri Lankan banks may still be far from a full-blown non-performing loan (NPL) crisis. But cracks are appearing in the asset quality with the rise in sour loans, hindering the banking sector’s future growth prospects.  

If the negative development persists, Brian McEnery, a Director at Ireland’s specialist non-performing loan bank, NAMA—the world’s biggest ‘bad bank’—advises Sri Lankan banks to become “ruthless with the borrower”.

“Sri Lanka’s banks are nowhere near a crisis. Nonetheless, what every bank needs to do is what I would call ‘a ruthless branch review of (all) of their lending’. And it needs to be done at a very granular level,” McEnery said during a brief chat with Mirror Business, last week, in Colombo.  Sri Lanka’s banking sector’s reported non-performing loans have been rising since end-2017 in response to the tightened monetary and fiscal policies and the demand for new loans has become weak due to higher rates, lower disposable incomes and not so favourable investment climate characterised by political volatility. 

The reported gross NPL ratio of the banking sector reached 3.3 percent by end-May 2018, from 2.5 percent in December 2017 and 3.2 percent in 2015. 

The last time the reported gross NPL ratio reached such proportions was in 2014, when the ratio hit 4.2 percent in the aftermath of the gold-back loan crisis, which eroded billions of profits and capital from their books. 

While the reported NPL ratio hovers around the 3.3 percent level, the Central Bank is of the view that the potential NPL ratio could be much higher in the range of 4.5 percent, including the rescheduled loans.  The rescheduled loans have recorded a steep increase since November 2017, whereby the growth accelerated from a sheer 5.0 percent on a year-on-year basis to 45 percent in May 2018. 
When asked what exactly the Sri Lankan banks should do to arrest the situation before it snowballs into a crisis, McEnery said the banks need to undertake stress testing at a very granular level, to identify which sectors are particularly vulnerable and which facilities are in trouble. 

After identifying those loans, the banks need to start provisioning against the profit, which however erases the bank’s capital base, he said. 

McEnery, who is also the former President of the Association of Chartered Certified Accountants, stressed that the banks need to strike a balance between the capitalisation and lending and pointed out the importance of sticking to the new Basel III rules on capital and leverage and the new accounting standard on financial instruments, IFRS 9. 

The new IFRS 9, which came into effect this year, will require the banks to provide for possible bad loans on the basis of expected credit loss model rather than the incurred loss model under the existing accounting standard, which naturally raises the loan-loss provisions of the banks.

McEnery called for regular reviews of the problematic facilities at this stage of NPLs in Sri Lankan banks and asked them to be ruthless with the borrowers in problem sectors. “The objective is to try and prevent a crisis”, he added.   

Mcenery is also a Partner at BDO Ireland specializing in corporate recovery and insolvency and was appointed as a Board Director of Ireland’s specialist non-performing loan bank, NAMA, by Ireland’s finance minister, which was created in late 2009 in response to the Irish financial crisis.

Irish financial crisis was triggered by a property bubble created through excessive lending  to the property sector by Irish banks and at the height of the crisis in 2012, the sector NPLs reached 27 percent from a mere 0.629 percent in 2007. 

Recently, Sri Lanka too showed some uneasiness in their property sector loans and the banks themselves were seen cutting their exposures into new developments. 

At the height of the crisis, NAMA acquired 74 billion euro worth of properties loans held by the five systematically-important Irish banks and issued sovereign guaranteed NAMA bonds worth of 33 billion euros to these banks, which then reissued those bonds to the European Central Bank to generate liquidity. 

The Irish government bought stakes in these banks injecting a further 64 billion euros to bridge the hole in the balance sheets of these banks.   

In 2018, NAMA completed the deleveraging of its loans and is set to make a profit of between three to four billion euros. It has also been described as the best-performing – non-performing loan bank in the world. 

The Government of Ireland is seeking to use the experience and track record of NAMA to deal with some other crises in the banking system in Ireland, such as the provision of credit for residential housing. 

In 2016, with the onset of Brexit, the Irish finance minister asked NAMA to use its lands in Dublin to develop office accommodation. This was very important as many financial service firms have taken up that space as they seek centres in Europe outside London.