Fitch forecasts tough times ahead for finance companies

Sector capitalization levels to come under pressure amid challenging operating conditions

SL has 47 finance companies which account for 8% of the financial system

Fitch says finance companies likely to opt for riskier products to sustain growth 

Sri Lanka’s overcrowded finance company sector may have to brace for tough times ahead as the sector capitalization levels are expected to come under pressure amid the operating conditions set to turn hostile, Fitch Ratings yesterday said.   

Affirming the entity and issuer ratings of 10 finance companies, the rating agency said the sector could face trying times, “as a result of asset quality pressures stemming from a challenging operating environment and unfavourable weather conditions and declining profitability due to higher funding and credit costs”, which could in return pressure their capitalization.

Lower profits help little to strengthen the capital base of these companies.  Sri Lanka operates with 47 finance companies, down from about 58 companies prior to 2015, as the Central Bank under the former regime pushed the sector for consolidation. 

But the exercise ground to a halt when the new regime rejected the move to forcefully consolidate them but welcomed shareholder-driven consolidation.

During the last two to three years, the sector, with an asset base of Rs.1.2 billion, thrived on vehicle import frenzy when the Central Bank under the Sirisena-Wickremesinghe coalition reduced the interest rates and the Finance Ministry slashed the taxes to make good on the promises during their 
election campaign.   

However, the sector growth now appears to have come to a standstill and the portfolio mix has shifted towards riskier segments for want of maintaining some form of growth, “given the slowdown in the vehicle financing segment following the increase in import tariffs, imposition of lower allowable loan-to-value ratios coupled with a high interest rate environment”.  

 
Hence, the portfolios of those finance companies, which were hitherto tilted towards vehicle financing, are seen increasingly engaging in term/working capital financing, “a segment that we believe is more risky due to larger transaction amounts and poor collateral such as third-party guarantees or post-dated cheques”, Fitch added. 

Besides the above, the sector faces fresh risks from microfinancing towards which they increased their exposure in recent times as growing delinquencies could hit the asset quality and thereby their bottom lines.   It was recently reported that more than one finance company have given micro-loans to a single household disregarding their capacity to repay, pushing them towards a web of debt.

Although micro-lending was meant to encourage entrepreneurship, a lot of these families have used the moneys for consumption and thus have been in the habit of taking a loan from another finance company to settle the previous one until it reached a point of no return.   

Although the Central Bank recently increased the minimum capital levels of the finance companies, the lax regulations compared to the banking sector have resulted in poor liquidity, poor management and unethical practices, which have resulted in loss of public confidence on many companies. 
This was evident from the recent finance company collapses.  

The sector, which comprises of licensed finance companies and specialized leasing companies, accounts for just 8.0 percent of the total financial system’s assets. This is in comparison to the banking sector, which accounts for 60 percent of the system.