Monetary easing buffers banks’ funding and liquidity risks despite weaker operating environment: Moody’s

Swift measures by the Central Banks in easing monetary policy will help banks in Sri Lanka to have access to funding requirements and liquidity although the operating context is turning more dour, said Moody’s 
Investors Service.  

In a special report which assessed the efficacy of the policy stimulus by the economies in the Asia-Pacific on companies and banks, the rating agency however cautioned that even though the loan repayment delays announced would provide temporary relief to the borrowers, such could lead to even greater build up of credit losses once the moratoriums are lifted.

The Moody’s report on the Asia-Pacific sovereigns concluded that although the policy stimulus will cushion the economic and financial fallout of the COVID-19 pandemic, it might not fully offset 
the damage.

Since March 16 when the lockdowns went into effect, the Monetary Board of the Central Bank took a number of swift measures to bring the interest rates of the economy down, cut banks’ reserve requirement and assured of emergency liquidity to both banks and finance companies should they need it. 

“Monetary loosening will support banks’ access to funding and mitigate system liquidity risks despite a weaker operating environment. Most Asian central banks have already cut policy rates since the start of the year in response to the crisis,” Moody’s said.

However, the rating agency doesn’t expect neither the policy rate cuts nor the reserve rate cut to result in a major expansion of lending and economic activity because, “banks will generally favour capital preservation over lending to higher-risk SMEs in a weak economic environment”. 

Since March 16 the Monetary Board cut key policy rates twice and reduced the banks’ mandatory reserve ratio on rupee deposits by 100 basis points to 4.00 percent.  

On April 15 the Monetary Board cut the bank rate by 500 basis points to 10 percent signalling that emergency liquidity is available when banks require it. 

While acknowledging that the repayment delays will provide temporary relief to the borrowers, Moody’s also cautioned that such relief measures could build up credit losses once the moratoriums are lifted. 

“These measures also could lead to an even greater build-up of credit losses once the moratoriums are lifted. This risk will increase substantially if the economic downturn, and measures to contain the spread of the coronavirus, persist for longer than expected,” Moody’s said. 

However the rating agency expects the government support is likely on systematically important banks in the event of a heightened banking sector distress. 

“We view government support as stable in most of the banking systems that we monitor, reflecting our expectation of extraordinary support, should it be required, to avert financial contagion,” it added.