Banking sector asset quality plunges to multiyear lows

• Overall banking sector Stage 3 loans ratio at 10.9% by end 3Q, up from 8.9% in 2Q
• Commercial banking sector Stage 3 loans ratio at 11.2, up from 9% in June

The banking sector asset quality deteriorated further in the third quarter of the year reflecting the profound stresses the sector is undergoing in their loans portfolios on top of the pressures that have mounted from the record level provisions against the government bonds they hold and also the de-growth they experience amid the surge in interest rates.  Data compiled by the Central Bank showed that the banking sector asset quality measured by the Stage 3 loans to total loans and advances, which is referred to as gross non-performing loans in banking parlance, climbed to 10.9 percent as at end of September, 2022, from 8.9 percent in the second quarter. 

Under the new financial reporting standards, which came into place, the term was changed to Stage 3 loans ratio to identify the loans which are overdue for more than three months. 

The sector entered the year with a non-performing loans ratio of 4.6 percent, and more than doubling of the loan delinquency ratio within a span of 9 months reflects the magnitude of the cracks in their asset quality.

This situation has got even worse for the licensed commercial banking sector, which otherwise has remained resilient in previous downturns, as the Stage 3 loans ratio rose to 11.2 percent from 9.0 percent in June 2022. 
The banking sector, which even navigated through the  pandemic showed cracks in 2022 in its asset quality, profits, growth, liquidity and capital when the economy collapsed prompting the government to default on its loans causing banks which held sovereign assets to provide entirely for the total value of these financial assets from profits.

This was followed by the sharp increase in interest rates which pushed existing borrowers into the brink.
Although there are widespread expectations for the rates to come down by next year, the economy is set to contract as there will still be less inclination for consumption, business activity and investments due to the lingering macro-economic challenges. 

The current deal with the International Monetary Fund still remains in limbo even after four months into the staff level agreement as Sri Lanka is yet to make a breakthrough in the talks with its creditors to obtain financing assurances. 

The longer it takes, the harder the conditions could become for businesses and households.
Meanwhile, the data also showed the licensed specialised banking sector Stage 3 loans ratio rising moderately to 8.7 percent as at September 30, 2022, from 7.9 percent in the previous quarter. 

Typically, specialised banks have weaker asset quality than the commercial banks, but this time around the situation has changed given the change in circumstances.