Rocky path ahead for Sri Lanka’s small and mid-sized lenders, says Fitch

Sri Lanka’s small and medium-sized banks (SMBs) will have to brace for a turbulent period ahead, stemming from the weaker asset quality and pressure on profits among a host of other problems in a hobbling economy, Fitch Ratings said in a brief note on the club of seven banks.

Fitch Ratings, which analysed the profiles of the small and mid-sized banks operating in Sri Lanka, observed their high risk appetite and modest loss absorption buffers as key issues they are faced with, relatively to their larger counterparts. 

The rating agency noted that they are also preoccupied with their constant need to raise shareholder funds to beef up capital, to remain in line with the regulatory minimums, at a time when the performance fails to keep up with higher capital. 

“Other features are a small franchise, as reflected in a combined market share of 7 percent of total assets at end-2018, compared with 82 percent for the nine larger Fitch-rated banks in the country,” the rating agency stated.

Among the Fitch-rated SMBs are Nations Trust Bank PLC, Cargills Bank, Pan Asia Bank PLC, Union Bank PLC, Sanasa Development Bank, HDFC Bank and Amana Bank PLC. 
It was only last week Mirror Business showed how the asset quality had deteriorated among the Sri Lankan banks, reflecting a hard choice faced by them between growth and improving the asset quality in a bad economy. 

The Monetary Board this month cut the key policy rates by 50 basis points, sending a strong indication that it would remain dovish to stimulate growth through increased lending by the banks. 

The banks are currently between the devil and deep blue sea, as further growth comes at a further cost to their asset quality, since business and consumer sentiments still remain sour. 
However, Fitch stated that small and mid-sized banks pursuing scale have a higher risk appetite than their larger counterparts. 

But their predominant exposure to retail and SME segments, which are believed to be more susceptible to economic cycles, are expected to leave them more vulnerable. 
“Small and mid-sized banks’ relatively high risk appetite, against a backdrop of a more challenging operating environment, exposes these banks to greater asset-quality pressure than their larger counterparts,” the rating agency said.

Their relatively thin capital buffers, compared to larger banks, would also make matters more challenging for them. 

“Capital raising is likely to continue across most small and medium banks. 

Pan Asia Bank, HDFC Bank, Amana and Cargills Bank need to raise equity capital to meet the enhanced regulatory capital requirements by end-2020,” Fitch stated. 
The rating agency nevertheless talked about “an aggressive” loan growth at a time banks brace for a more muted or de-growth in their portfolios. 

“Small and medium-sized banks’ capital buffers are likely to remain thin from aggressive loan growth, muted earnings and lingering credit risks. The median Fitch Core Capital ratio has remained higher than that of larger rated banks, although we view capital buffers as not being commensurate with the high risk appetite.” 

Fitch also forecast pressure on the operating profits of the small and mid-sized banks, resulting from the rising credit costs while the funding and liquidity profile would remain weaker than that of the larger counterparts, due to the weak deposit franchise. 

“Small and medium-sized banks’ lower median risk-adjusted profitability ratio than that of the larger banks reflects SMBs’ higher operating cost structures,” the rating agency noted.