Higher funding cost and gloomy outlook could upend bank balance sheets, blunt private credit growth: ICRA Lanka

• Says state banks could see “moderate” growth in assets due to government’s financing needs 
• August private credit swelled by 15% to Rs.134bn recording highest monthly growth in recent years

The rising funding costs and long shadow casted over the economy, due to the pandemic, may slow the pace of bank credit to the private sector and could upend the balance sheets of banks, according to ICRA Lanka Limited.
However, the rating agency said state banks could see some “moderate” growth in their assets, due to the financing needs of the government.  Sri Lanka’s banks fared well particularly from the beginning of 2021 through the first half, due to the regulatory intervention in ameliorating the full impact of the pandemic on the sector, extremely high liquidity and historically low interest rates, which sparked the demand to result in one of the strongest spells of private sector credit growths. 

For instance, during the first seven months of this year, the licensed commercial banks alone lent Rs.491 billion in new credit to the private sector, logging a robust 14.3 percent from a year ago, well surpassing the total private sector credit in 2019 and 2020 each.  Meanwhile, for the month of August, private credit swelled by 15 percent to Rs.134 billion, recording the highest monthly growth in recent years.

However, ICRA Lanka suspects that this spell could soon lose its steam after the Monetary Board reversed its easy monetary policy in August, which was in effect for slightly over two years.

“The financial sector may face higher funding costs moving forward, altering the balance sheet composition in the next few months,” the rating agency said in a note on the economy in the aftermath of the change of monetary policy.  “This, in combination with gloomy outlook, points to a slowdown in credit to the private sector,” it added.  The Central Bank expects to expand the private sector credit for the full year between 12 to 14 percent from where it ended in 2020. 

While there could be some deceleration in the pace of credit amid the uptick in interest rates in the domestic market, following the policy rate hike on August 19, the appetite for credit by the economic actors and the desire for lending by banks are unlikely to be significantly affected in the ensuing period, according to other economic analysts. 

1 This is because banks are still operating with a sizeable amount of excess liquidity in their balance sheets, which await allocation into high-yielding assets such as loans. Further, the demand for loans, which got off around the last quarter in 2020, has still more room to run its course because the pandemic, which returned around April this year, took away much of its steam.  From a risk management perspective, there is a case for banks to be more risk averse by way of parking their excess liquidity in government securities, of which the yields are rising quite rapidly as of late, while the pandemic has also left borrowers, specially the small and medium-scale businesses, in a vulnerable shape, due to loss of business for a prolong period.  Hence, banks could turn more cautious on new lending, amid pressure on their asset quality matrices.