Zero risk on banks’ capital on loans given under CB credit guarantee schemes and Treasury undertaking

Banks have been spared from the need to risk weight against their capital on loans granted under the recently launched credit guarantee scheme by the Central Bank and the subsequent scheme to provide loans to the construction sector under Treasury guarantee. 

This special measure relieves the pressure on banks’ capital coming from a section of their new loans. Typically, loans carry a risk weight on the bank’s capital, unless otherwise stated, and the total growth in a bank’s loan portfolio is capped at a level, which is referred to as the minimum capital adequacy ratio, that measures the minimum level of capital required by a bank to absorb losses stemming from such loans. 

Such minimum capital levels and capital adequacy ratios against the loans of banks were raised under the BASEL III rules, which came into effect in Sri Lanka since 2017—which were adopted elsewhere earlier— in response to the global financial crisis in 2007 and 2008. 

Under Phase III of the Saubagya COVID-19 Renaissance Facility, the Central Bank introduced a credit guarantee scheme from the start of the month pledging to underwrite the credit risk or the default risk of the loan up to 80 percent depending on its size. 

Under an extraordinary regulatory measure by the Central Bank last week, to confront the economic pressures coming from the pandemic, the banks were sparred from the need to risk weight on such loans guaranteed under the Central Bank credit guarantee scheme against the bank’s capital. 

Meanwhile, the Treasury Department last week decided to issue the banks ‘letters of acceptance of payments of outstanding bills to contractors,’ to facilitate the construction sector to obtain loans under a special account opened with the contractor’s bank. 

The letters are issued to settle the outstanding for the contractors who have engaged in various State development projects.

Such loans are also spared from the need for risk weighting against the capital. The Central Bank said such loans would also, “qualify as acceptable risk mitigants for credit facilities granted against the same and shall be risk weighted at zero percent”. 

This provides more wiggle room for banks to expand their loan books as loans coming under the above two categories will not have a capital weightage. 

The Monetary Board earlier allowed licensed banks to draw down from the capital conservation buffer, which is built as part of additional capital buffers under BASEL III rules to withstand unforeseen economic shocks.