Local banks’ Return on Equity surges on strong earnings in first half

• Sector ROE at 16.5% as at end-June 2021, up from 16.4% three months ago and 11.4% six months ago
• June 2021 ROE is the highest recorded by the banking sector since 2018 first quarter

Sri Lanka’s banking sector Return on Equity (ROE) hit the highest levels in more than three years supported by the robust earnings during the first half of this year, as banks rode on the heightened demand for loans, made possible by the lowest ever interest rates. 

According to the most recent industry data made available by the Central Bank, the banking sector reported a ROE of 16.5 percent by the end of June 2021, up from 16.4 percent in March 2021 and 11.4 percent by end of 2020. 

However, June marked the highest ROE recorded by the banking sector since 2018 first quarter when the sector reported a ROE of 17.2 percent before the ratio started gradually descending and settled around 10 percent levels due to lackluster growth in loans experienced by the sector in response to higher interest rates and the weak business sentiments which engulfed the period due to bad economic policy, management and 
political uncertainty.  

The decline in ROE was also partly caused by the continuous equity injected into the sector since mid 2017 to stay above the BASEL III capital adequacy requirements, which were implanted, in a 
phased approach.

When banks are mandated to keep aside higher amounts of their equity and other forms of capital in relation to their asset base under BASEL regulations, which became more stringent to make the sector more shock proof, such capital however stays idle, weighing on the banking sector earnings as unlike in other businesses, the banks are unable to deploy their entire capital 
into full use.   

  
While the earnings in absolute terms matter, ROE matters the most because that metric demonstrates how attractive an investment in the banking sector is, compared to other sectors and other investment opportunities elsewhere. 

The sector ROE hovered around 10 percent levels in the whole of 2019 and most of 2020 before breaking that resistant level in the final quarter due to earnings driven by growth in loans. 

The ratio calculated separately for the licensed commercial banking sector and the specialised banking showed the former maintaining its ROE at 15.8 percent levels between the March and June quarters while the latter had a ROE of 24.7 percent, up from 23.3 percent in March and 16.7 percent in 2020 end. 

The current pace of growth coupled with the upward pressure on interest margins could further bode well for banking sector ROEs in the ensuing period of the year. 

However, the nagging impact from the pandemic induced economic malaise and the likely provisions which may have to be set aside for possible bad loans could dampen such prospects of banks.