Sri Lanka’s banking sector asset quality further deteriorates

• Non-performing loan ratio up to 3.4% in July from 3.3% in May and June
• Re-scheduled loans also show significant YoY increase 
• Manufacturing and IT sectors reflect high stress with non-performing loan ratios above 5%

There appears to be no end in sight to the rising sour loans in the Sri Lanka’s banking sector as the non-performing loans continue to head north while the Central Bank expects further gloom in the picture ahead. 

After three years of aggressive growth in new loans which was made possible through excessive money printing to keep interest rates artificially low, Sri Lankan banks now face a moment of truth as customers default loans and the growth in new loans has slowed after the Central Bank tightened monetary conditions in the aftermath of the 2016 Balance of Payment crisis. According to the latest statistics, Sri Lanka’s banking sector non-performing loan ratio has inched up to 3.4 percent in July from 3.3 percent in May and June – the highest reached in over three years. However the Central Bank expects the reported non-performing loan ratios to rise further and said the potential ratio which captures the re-scheduled loans should be at 4.9 percent of total loans granted.

When a borrower finds it difficult to service the facility or facilities taken, the bank may re-schedule such facilities to give him easy payment terms or extend loan tenors to ensure the loan still remains as performing. According to the data, re-scheduled loans in the Sri Lankan banking sector account for 2 percent of the total loans and the year-on-year growth in re-scheduled loans have also increased significantly. 

The growth in the re-scheduled loans in recent times accelerated from around 5.0 percent in November 2017 to almost 65 percent by end July 2018. 
By the end of 2017, Sri Lanka’s banking sector non-performing loan ratio was 3.0 percent has risen ever since. 

Last week Moody’s Investors Service maintained its ‘negative’ rating outlook on the Sri Lankan banking sector due to deteriorating asset quality and the limited capacity of the government to support banks due to the latter’s fiscal weaknesses. 

The rating agency also said the Sri Lankan corporates which borrowed heavily leading up to the crisis are now facing debt serviceability weaknesses and cautioned that the higher interest rates could add further to their woes. 

Moody’s estimated that around 40 percent of Sri Lankan corporates will have debt interest coverage ratios below 2 under a stressed scenario which reflects a serious financial risk for the firms. 

Meanwhile tourism, manufacturing and information technology sectors reflect high stress as they have non-performing loan ratios above 5.0 percent. 

The construction sector which was once considered to be a risky segment has a non-performing loan ratio of 3.4 percent in line with the industry. 

Consumption loans have a much lower non-performing loan ratio of 2.3 percent. 

However the credit card non-performing loans have trended upwards in recent times. 

Despite the rise in loan losses, Sri Lanka’s banking sector remains resilient with stronger capital and liquidity buffered than in the past.