Banks get additional Rs.53bn for lending from eased capital rules

• Fitch believes further relaxation in liquidity rules in pipeline
• Says such measures could weaken cushion against shocks  
• March 16 RSS cut by 100 bps released another Rs.50-60bn to banks
• “Risks to the banking sector have increased”- Fitch

The Monetary Board’s decision to ease certain capital rules on banks in response to the coronavirus pandemic will release over Rs.50 billion from capital buffers for new lending, which otherwise would have been left idling. However, on the flip side, this could weaken the cushion against shocks such as the current one from COVID-19, Fitch Ratings warned. 

Last week, the Monetary Board decided to offer regulatory forbearance on a number of areas, including capital adequacy, minimum capital level, recognition of non-performing loans, impairments and also gave more time to file returns and publish quarterly financial statements.

The above measures were taken to alleviate the heightened pressure on banks, caused by the economic fallout of the pandemic.

Under eased capital adequacy requirements, the banks were allowed to draw down from their capital conservation buffers by 100 basis points and 50 basis points based on their Domestic Systematically Important Bank (D-SIB) and non-D-SIB status. Until then, the banks were required to hold 250 basis points of their risk weighted assets as additional capital buffer on top of their regulatory Tier I and Tier II capital ratios.  

“This would release around Rs.53 billion of capital for lending purposes, based on banks’ reported capital ratios at end-2019; however, it will also reduce buffers against potential deterioration in asset quality,” Fitch Ratings said in its latest note to highlight the persisting risks on the banking sector, despite the regulatory measures.

However, according to the BASEL III rules, the prime intention of introducing a capital conservation buffer after the global financial crisis in 2008 was to promote building capital in good times that can be drawn down in periods of stress. 

Consequent to this, Fitch said banks could now operate below their current Tier regulatory minimum of 10 percent applicable on bucket two D-SIBs, such as Bank of Ceylon and Commercial Bank PLC. 

The banks in the bucket one D-SIB, such as People’s Bank and Hatton National Bank, can operate below 9.5 percent and 8.5 percent for non-D-SIB.  

Fitch Ratings on March 26 revised Sri Lanka’s banking sector outlook to Negative, from Stable, for 2020 and said it would start assessing the impact on each bank under its rating watch shortly. 

Although the extraordinary regulatory measures by the Central Bank should relieve immediate pressure on the banks’ financial profiles, Fitch said those would not prevent 
medium-term deterioration.  

The earlier reduction in the Statutory Reserve Ratio (RSS) on March 16 by 100 basis points to 4 percent was expected to have released at least another Rs.50 to Rs.60 billion as extra liquidity to the banking sector.
Fitch Ratings believes there could be further support in the liquidity front for the banks in the areas of eased liquidity coverage ratio, considering the non-payment of loans and possible deposit outflows. 

Banks are currently mandated to maintain 100 percent coverage on both local and all currency ratios, where it is mandated under BASEL III to maintain a stock of high-quality liquid assets to withstand net cash outflows over the next 30 days. 

“Notwithstanding such measures, the risks to the banking sector have increased, with the weaker operating environment exerting pressure on banks’ loan quality and profitability. Fitch expects weaker profitability to also weigh on capitalisation over the next 12 months,” Fitch added.