Banks worry over what rising market rates mean for their NPLs

• Sri Lanka ended its era of single digit interest rates in January 2022 after 12-month run
• Borrowers coming off of years long moratoria while economic conditions turning sourer by the day
• Banks among other industries came off pretty robust during both years of the pandemic in 2020 and 2021

Banks are scrambling to gauge how far the market interest rates would increase and to what extent that could have implications on their asset quality, as the borrowers are coming off of years long moratoria while economic conditions are turning sourerby the day. 

Sri Lankan banks are among other industries that came off pretty robust during both years of the pandemic in 2020 and 2021 with higher growth, earnings and better than anticipated asset quality on the back of ultra low interest rates. However the overall economy did languish. 

“What we are concerned mostly about is how far these borrowers would be able to withstand the rising interest rates, specially when the payment holidays are expiring,” said a top Chief Financial Officer of a leading Sri Lankan bank. 

Sri Lanka ended its era of single digit interest rates in January 2022 after a 12-month run and is bracing for a wild run in both interest rates and foreign exchange rate after authorities were forced to let go both during the last two weeks. 

The latest data available through last week showed the average weighted prime lending rate, the benchmark rate used to price short-term loans to banks’ most prime customers, rose to 9.46 percent, after adding 33 basis points during the last week alone. 

Mirror Business last week showed that the average weighted lending rate had breached the 10.0 percent level in January this year reaching 10.12 percent, the highest since December 2020. 

Economists and analysts expect a further 100 basis point hike in key policy rates by the Central Bank when they meet on April 7 to determine the adequacy of its actions to tame prices and foreign exchange outflows.  

Meanwhile, the recent floating of the rupee, which shed its value by approximately 40 percent against the United States dollar year-to-date, is expected to bring positive financial results to banks that have positive net open positions in foreign currency. 

Further, banks, which have offshore banking units, are expected to generate higher profits due to the rupee weakness. 

However as all these are non-cash translational gains devoid of the core banking business, these will have less significance to the banking business, he said.  

Meanwhile, requesting anonymity, the top executive urged the authorities to lay out a clear framework to manage the foreign debt pile and also to bring down the fiscal deficit gradually for an acceptable level for a more sustainable and predictable business climate for everyone. 

Banks have already provided a substantial amount from their profits for the sovereign and Sri Lanka Development Bond holdings as risks mounted over the country’s ability to honour these liabilities when they fall due. 
However, Central Bank Governor Ajith Nivard Cabraal last week reiterated that the coming foreign bond retirements would be honoured and the country would have an economic soft landing out of the recent policy measures. 

However, the floating of the currency without the support of some sizable inflows have created total chaos in markets and prices of almost every commodity has risen by between 30 to 40 percent as a result of the float.