Moody’s extends negative outlook on Lankan banking sector on coronavirus stress

• Says asset quality toweaken further; predicts slower growth in new loans and profits 
• However, strong capitalization, liquidity to provide buffer against stress 

The coronavirus-induced economic pain will weaken the operating environment for Sri Lankan banks, dampening the demand for loans and triggering widespread defaults in 2020, said Moody’s Investors Services extending its negative outlook for the sector in to next 12 to 18 months. 

However, alleviating worries of any immediate danger, Moody’s expects the strong capitalisation levels and liquidity in the sector,as a result of stringent regulatory requirements, to provide cushion against these stresses. 

There was some easing on mandatory capital requirements on banks lately to give them more latitude to extend more loans, but the rating agency is of the view that, such relaxation in capital rules is unlikely to result in higher lending due to weak demand for credit in the pandemic-stricken economy. Hence, the rating agency expects the regulatory capital ratios to stay well above minimum requirements providing buffers against unexpected losses. 
The extended negative outlook on the sector was premised on the further deterioration in asset quality, weaker growth in new loans and anemic profitability in the sector stemming from a battered economy. 

A month ago, Fitch Ratings revised the banking sector outlook for 2020 to Negative from Stable citing similar reasons. 

Earlier in the week, First Capital Research trimmed Sri Lanka’s banking sector loan growth to 6 percent, less than half of what looked possible at the beginning of the year and the forecast for the non-performing loans ratio to rise to 7.2 percent in 2020. 

Moody’s said banks are exposed to risks from both small and medium enterprises, which tend to have weak liquidity, and large conglomerates due to the banks’ concentrated exposures to them. 

“The hotel, retail and export-oriented sectors are some of the sectors most severely hit, with small and medium-sized enterprises (SMEs) being particularly vulnerable,” the rating agency said. 

“Although governments have put in place measures to shore up the financial position of businesses and soften the negative impact on employment and households, these will not be sufficient to fully offset the adverse impact of the coronavirus-induced downturn on banks,” it added.  

While acknowledging the loan repayment delays announced by  the Monetary Board could provide some respite to the banking system, Moody’s cautioned of even greater build up of credit losses once the moratoriums are lifted and the outbreak prolongs.  “While loan moratoriums and restructuring will provide temporary relief, they could raise risks for banks in the longer term, especially in the event of a prolonged outbreak.”

Meanwhile, the rating agency expects the profitability of the sector to be impacted by narrower margins, slower loan growth and increases in loans that are restructured or under moratoriums, although there could be some respite from the regulatory forbearance on recognition of credit costs and lower taxes. 

In an update on Sri Lanka’s banking system along with two other frontier banking systems in the Asia Pacific, which includes Mongolia and Bangladesh, the rating agency nevertheless cautioned of significant credit impact on banks from the rating perspective should the disruption from the coronavirus outbreak extend beyond the first half of the year.

Moody’s changed its outlook of the Mongolian banking system to negative while maintaining negative outlooks on the Bangladeshi banking system along with Sri Lanka’s. Moody’s cautioned the Sri Lankan banking system of further rating action should the situation aggravates or prolongs.  

“In the event that the coronavirus outbreak in Sri Lanka worsens and leads to a deeper, more prolonged economic slowdown, the credit-negative impact for banks will amplify,” Moody’s said.  

Although the funding and liquidity will stay stable, Moody’s said the government’s capacity to support the banks would be weakened. 

“The government’s debt burden will increase amid tightening financial conditions and weak economic growth, while unprofitable State-owned enterprises will continue to pose large contingent liabilities to the sovereign,” it said.