First Capital sees upside for banking sector; revises outlook to ‘Buy’

First Capital Research foresees tremendous upside for Sri Lanka’s banking sector in 2020 with a 42 percent return yielding over a year and revised its ‘Hold’ advice to ‘Buy’ with Commercial Bank, Hatton National Bank and Sampath Bank cited as favourites. 

“With the recovery in economic activity and improved private credit, we expect an upward trend in the banking sector while getting breathing space after hefty taxes. 

“Considering the short-mid term positive impact, we upgrade our outlook on the banking sector from ‘Hold’ to  ‘Buy’,” First Capital Research,  a unit of First Capital Holdings investment banking group, said. The company believes the recent tax cuts and the monetary easing would add a strong flywheel to banking sector earnings, which is projected to grow by 19 percent every year in the two years to 2021.

“The profitability of the banking sector was hampered during the last couple of years, primarily by the economic slowdown, increase in taxes, implementation of Basel III requirements and adoption of SLFRS 9. However, banking sector showed resilience despite the challenges while maintaining higher liquidity ratios, through cautious lending. 

“Post an era of fiscal tightening and country is once again on track towards building a period of robust growth.  Pickup in economic activities and confidence will provide fertile bedrock for the growth in private credit, thereby positively affecting the banking sector,” First Capital Research added. 

The research firm projects banking sector private credit to grow 14 percent in 2020, largely in line with Central Bank’s expectations.

Besides low rates and taxes, First Capital Research stated that Central Bank’s reclassification of Domestic Systematically Important Banks (DSIB) versus the rest provided some leeway for the banks to expand their asset bases without the need for more capital. 

“Previous regulation on Basel III capped the credit growth by imposing capital requirements on banks. However, CBSL recently introduced a multi-factor model to determine DSIBs while providing more leeway with regard to capital requirements of banks”, it stated. 

However, the research company believes that the extent to which the banks are able to improve efficiency levels by way of containing cost-to-income ratio would play a part in improving future profitability. 

And in such a journey, the successful embrace of digitisation and financial technology would be key.  “Moreover, cost to income(C/I) is expected to be a critical factor in the future in improving the profitability of banks and many banks have already started to embrace the digital technology over brick and mortar methods. 

Banks in the industry started to significantly invest in digital initiatives to fortify digital leadership,” First Capital Research noted.