- Fitch places 13 banks on Rating Watch Negative before potential downgrading
Fitch Ratings has revised the outlook on Sri Lanka’s banking sector to ‘Deteriorating’ from ‘Neutral’ as the fallout from the weakening sovereign credit profile and the worsening macro-economic conditions are expected to spillover into the banking sector.
In the second week of April, Sri Lanka tightened its monetary policy by an unprecedented 700 basis points to arrest inflation. A few days later the government announced that it would default on most of its foreign currency debt obligations.
Considering this massive fallout stemming from the weakening sovereign credit profile and the worsening macro challenges, Fitch last week placed 13 Sri Lankan banks on Rating Watch Negative (RWN) and took separate actions on State-owned Bank of Ceylon.
“The RWN reflects heightened near-term downside risk stemming from constrained access to foreign-currency funding and the resulting indications of stress experienced by the banks in the system,” the rating agency stated. “This risk is exacerbated by the sovereign’s credit profile (Long-Term Foreign-Currency Issuer Default Rating (IDR): CC, Long-Term Local-Currency IDR: CCC) and the ensuing risks to the stability of the financial system”, it added. The rating agency is of the view that there would be mounting currency stress increasing the likelihood of restrictions being placed on banks’ ability to service their obligations in foreign currency, barring HDFC, which does not have any outstanding foreign currency obligations. While the RWN would remain for the next six months, the rating agency said it would re-look at the banks’ funding and liquidity positions which “could result in multiple notch downgrades”, unless progress has been made.
The sector had 18 percent of its loans and 17 percent of its deposits in foreign currency as at the end of 2021.
Further, the rating agency also revised their outlook on Sri Lanka’s banking sector in 2022 to ‘Deteriorating’, from ‘Neutral’ considering the fallout which they will have to confront by way of sharp deterioration in asset quality and thereby the earnings.
“Macroeconomic challenges are likely to be greater than we initially anticipated which could result in a sharp deterioration in asset quality and impaired profitability metrics that expose the banks to capital deficiencies,” the rating agency said.
The banking sector analysts expect the gross non-performing loans ratio to reach between 10 to 15 percent by the end 2022 after the Central Bank jacked up rates by 700 basis points, which could potentially translate into 10 to 20 percent increase in lending rates.
There would be a double whammy on the borrowers as the higher rates kill the demand and thereby their incomes while sending the loan servicing costs through the roof causing a wave of bankruptcies in small and medium enterprise sector, killing the spirits for innovation, production and job creation - the typical playbook of the mainstream economists to arrest inflation.
