Banking sector asset quality and other performance metrics improve notably in 1Q

• Sector NPLs fall to 4.6% by end-March 2021, from 4.9% in Dec. 2020
• Return on equity jumps to 16.2%, from 11.4% in Dec. 2020 

Sri Lanka’s banking sector performance indicators, including the mostly watched asset quality, capital adequacy, liquidity and shareholder returns, improved substantially in the first quarter of this year. 

According to the fresh data, the sectoral asset quality, as measured by the gross non-performing loans (NPLs) ratio, fell to 4.6 percent by end-March 2021, from 4.9 percent in end-December 2020, reflecting the accelerated loan growth and the restoration of borrower cash flows made possible by a fast recovering economy, as seen from the higher than anticipated growth in the first quarter GDP.

However, the reported NPLs could mask a segment of loans, which were still under payment holidays and it is expected that the true asset quality could emerge with gradual unwinding of the relief extended to the affected borrowers. 

The Central Bank launched its fourth round of moratorium from May 15 through August 31, to provide relief to the borrowers affected by the third wave of the virus-related restrictions came about from April third week.  

While the fresh restrictions could stall the continuous improvement made in the asset quality, Fitch Ratings last week expected the credit costs or the provisions made against the possible bad loans could remain at least as high as in 2020, due to more pronounced asset quality deterioration that they envisage. 

Meanwhile, the banks also strengthened their capital buffers amid projected aggressive growth in loan books to take advantage of the increased appetite for loans under historically low interest rates and policy incentives to make liquidity widely available to resuscitate domestic enterprises, while staying on top of their own regulatory minimum capital levels. 

For instance, Hatton National Bank PLC is raising a fresh Rs.7.0 billion via a BASEL III-complaint bond for 10 years to refinance a debenture maturing in 2021, bolster its Tier II capital base and support its balance sheet growth. 

According to the data, the Tier I capital adequacy ratio of the banking sector rose to 13.3 percent, while the Tier II ratio rose to 16.6 percent in the March quarter, from 13.0 percent and 16.5 percent, respectively, in December 2020, despite the robust loan growth, as banks added more capital. 

The banking sector is largely expected to close in on its year-end growth targets despite the setback in 2Q21, while the Central Bank also believes in meeting its 12 percent growth target set for private sector credit. 
Due to continuously increasing deposit franchise and new capital, banks held their liquidity levels elevated, as the statutory liquid asset ratio of the domestic banking unit rose to 38.0 percent, from 37.3 percent in 2020. However, the ratio for the overseas banking unit slipped to 40.5 percent, from 43.2 percent in December 2020, albeit both ratios stood well above the regulatory minimums of 20 percent each. 

Meanwhile, Fitch Ratings observed that the downward trend witnessed in most banks’ loan-to-deposit ratio—another measure of liquidity reversing in 1Q21—was due to the expansion in their loan books. 

Further, the sector’s return on equity made the biggest jump on robust earnings reported in 1Q21, as the key profitability indicator rose from 11.4 percent in December 2020 to 16.2 percent, reaching the highest since the first quarter of 2018, when the ratio was 17.2 percent. 

Despite the slowdown in the growth during 2Q21 and the possible increase in credit costs, the banking sector is largely expected to outperform the 2020 results on loan growth and margin improvement, coming from deposit repricing happening at lower rates, something which the sector only just starting to enjoy from the beginning of 2021.