Banks provide even for loans under moratoria taking extra guard for possible losses

Sri Lankan banks became extra cautious and extremely prudent when accounting for the losses that might arise from the possible bad loans on the facilities that were on moratoria through March 31, 2021, when they closed their books for the last financial year, making them better guarded should such loans fall bad. 

As part of the broader package of relief to the financial sector to deal with the pandemic-induced stresses, the banks were asked to hold off categorising loans under moratoria as impairments or non-performing loans. 

Further, in October, the Central Bank issued guidelines asking the banks to exercise judgement when determining facilities exposed to COVID-hit sectors as ‘Stage 3 facilities’, a term used in the International Financial Reporting Standard 9 for non-performing loans. 

However, the banks did more than what was required and provided for even such loans, which were under moratoria through March 31, 2021, as they had adequate profits to absorb even higher losses. 

“… given the sluggish movement in the overall advance portfolio and the debt moratoriums extended during the year 2020 and also considering the potential impact that could arise once the debt moratorium phase II lapses in 
March 2021, it was decided to recognise a material impairment provision as an allowance for overlay, in 2020,” Sampath Bank PLC in relation to its financial accounts for the year ended on December 31, 2021 said.

“Taking into consideration the loans under moratoria and the impact once the moratorium period ends in March 2021, a significant allowance for overlay was taken into account,” said Hatton National Bank PLC in its annual report. 

At the onset of the pandemic, the international credit rating agencies and a large chorus of analysts warned of a significant increase in non-performing loans in the Sri Lankan banking system.  However, as the first round of the moratoria, the banks fared well in their asset quality as they managed to bring down their non-performing loan ratios.  The banking sector gross non-performing loans ratio fell from 5.4 percent in June 2020 to 5.3 percent in September and further to 4.9 percent by 
December 2020. 

This was also when the loans under moratoria out of total loans fell to only a fraction, from high levels in April 2020.  For instance, Commercial Bank of Ceylon PLC, the largest private lender in the country, said nearly 35 percent of its loans under moratorium fell to 16 percent by the year-end. Making its highest ever provision for credit costs to the tune of Rs.21.5 billion, which was a 94.2 percent increase from 2019, Commercial Bank said that its total impairments “include additional provisions made for expected credit losses as a management overlay of Rs.5.189 billion to account for potential losses that the existing impairment models may not be capturing due to high level of uncertainty and volatility created by the 
COVID-19 pandemic”.  

At National Development Bank, loans under moratorium, which were at 40 percent of the total loan book at the second quarter, fell to 26 percent by the end of the year, “mainly due to settlement of revolving facilities”. 

The banks assumed the worst case macroeconomic outlook when measuring collective impairments under the Expected Credit Loss model, resulting in higher impairment provisions. Hence, a resurgent economy with normalising cash flows at the micro and small business levels, will lead to some of these provisions to reverse, giving a windfall for the bank profits 
in 2021.