Banking sector capital levels slip amid record private credit in 2016

By Chandeepa Wettasinghe
Record levels of private credit extended in 2016 has resulted in further slippage in capital adequacy ratios (CARs) of the Sri Lankan banking sector ahead of 
the implementation of the first stage of higher CARs under the Basel III requirements this July.
The latest Central Bank data indicated that the total CAR—which compares regulatory capital to risk weighted assets such as loans—of the country’s banking system stood at 14.3 percent at the end of 2016, down from 15.4 percent Year-on-Year (YoY) and significantly below the 17.6 percent recorded in 2013.
Core capital, which pits shareholder funds such as stated capital and reserves against risk weighted assets, fell to 11.4 percent from 13 percent YoY.
The complete CAR requirements under Basel III will take effect by January 2019, with a 12.50 percent total CAR for 
smaller banks, and 14 percent total CAR for larger banks. 
There may not be an immediate cause for alarm in general, since the first stage of Basel III implementation only requires 11.25 percent of total CARs for small banks with less than Rs.500 billion in assets, and 11.75 percent for larger banks by July 1, 2017, against the current 10 percent.

Banks are required to maintain capital adequacies in order to protect depositors from losses up to a certain extent.
Sri Lanka’s two largest banks, the state-owned Bank of Ceylon and People’s Bank had only 12.3 percent and 12.1 percent, respectively, in total CARs by the end of 2016. 
However, these banks are considered quasi-sovereign given their systematic importance and they are aptly assisted by the General Treasury, the solder shareholder of these banks, in times of need.
Yet, the fellow state-owned, National Savings Bank, which is the country’s third largest lender, had a 14.7 percent CAR, while the three largest privately-held banks, Commercial Bank of Ceylon PLC, Hatton National Bank PLC and Sampath Bank PLC also had healthy CAR levels.
Bank of Ceylon and People’s Bank extended unnaturally high levels of credit reaching 30 percent and 32 percent, respectively, in 2016, compared to levels below 20 percent by private and foreign banks, which were in line with the Central Bank’s private credit growth target, which was revised to 20 percent from the initial 15 percent.
Private banks were seen carrying out rights issues and debentures throughout 2016 and early 2017 to strengthen their CARs due to the high interest environment stemming from a 125 basis point increase over the past 12 months.
Debenture issues from banks witnessed a marked increase last year, with Rs. 58.49 billion being raised via debentures compared to Rs. 39.41 billion in 2015.
Depositors too haven’t helped reduce the pressure on banks to find cheaper financing, with more funds being placed on fixed deposits due to attractive interest rates, evident in just 37.1 percent of funds present in current and savings account in 2016, compared to 40.3 percent in 2015. 
While credit has grown in spite of higher interest rates, non-performing loans in the Sri Lankan banking system decreased to 2.6 percent from 3.2 percent YoY.
Hatton National Bank PLC Managing Director Johnathan Alles recently said that his bank has now started outsourcing collection of smaller loans and a specialized unit has been set up within the bank for larger loans while strengthening processes.
However, banks are likely to start extending credit to customers, which it may have rejected in the past, in order to keep up with the record levels of profits posted last year.
Alles admitted that his bank has now started lending to some of the customers it had turned away previously.