Banking sector woes to continue; but credit profiles broadly intact: Fitch

• Continues to maintain Negative Outlook as operating conditions remain challenging 
• Does not expect significant increase in NPLs despite risks to asset quality
• Expects higher credit costs to weigh on return on assets 

Sri Lanka’s banking sector woes will persist through the remainder of the year and possibly spill over into 2019, if the country’s wobbling economy continues to hurt the investment and consumer sentiments, according to Fitch Ratings. 

Sri Lanka’s banks are grappling with the rising bad loans amid moderate growth in new loans but Fitch Ratings expects their credit profiles to remain broadly intact.
“Fitch Ratings maintains a Negative banking-sector Outlook for Sri Lanka in 2018 as we expect the operating conditions to remain challenging. This is likely to put mild pressure on performance during the rest of 2018 and possibly 2019,” Fitch rating said in its quarterly bank report card.

The net profit growth in Sri Lanka’s banks decelerated to 10 percent in 2017, from 25 percent in 2016, amid higher credit costs and taxes, although there was considerable improvement in the performance at the pre-impairment level, the rating agency stated. 

Intensifying those pressures built up during 2017, Sri Lanka’s banks reported heavy impairment provisions and the non-performing loan ratio rose to a three-year high of 3.3 percent by June 2018.

For instance, Sampath Bank, which remained the benchmark for the asset quality among the licensed commercial banks, reported more than twice the loan-loss provisions during the first six months of 2018, against the same period in 2017 and the non-performing loan ratio rose to 2.96 percent, from 1.64 percent in 2017. Fitch said it expects the higher credit costs to weigh on the banking sector return on assets in 2018. 

Fitch also expects the non-performing loan (NPL) risk to remain during the remainder of the year after the absolute NPLs of the sector grew by as much as 25 percent during the first quarter alone.  

“There has also been an increase in rescheduled loans in 2017 and in 1Q18 across the Fitch-rated banks, indicating the ongoing pressure on asset quality. However, we do not expect a significant increase in NPL ratios in 2018,” the rating agency said.  

Fitch further expects the current moderate growth in private sector credit to continue during the remainder of the year but is of the opinion that the credit growth will remain under check as the Central Bank wants to tame the inflationary pressures and safeguard the economy against the risks stemming from possible fiscal slippages. 

As Sri Lanka’s banks get ready to face the elevated capital ratios under Basel III that is set to come in to full implementation from January 1, 2019, they have been seen beefing up their capital from 2017 onwards. 

The banks raised Rs.66 billion in fresh shareholder funds and another Rs.45 billion in Tier II capital since 2017, Fitch said, adding that further capital raising is likely during the remainder of 2018, although much of the shortfall had been bridged in 2017. 

Meanwhile, deposits remained the key funding source composing 83 percent of the total funding during the first quarter in 2018 but the shift seen in the low-cost funds, such as current and savings accounts (CASA), into higher yielding term deposits have resulted in higher cost of funds for the banks. 

Fitch estimates that the sector CASA had reduced to 34 percent of the total deposits from 37 percent in 2016. 

However, the loan-to-deposit ratio has eased to 87 percent by the end of the first quarter, demonstrating that deposits had funded bulk of the loans during this period.