Banks see light at the end of the tunnel as asset quality concerns peak amid economic recovery

• Stage 3 loans ratio reported at 13.3% in 2Q, up from 12.9% in March

Banks’ asset quality issues appeared to have peaked in the second quarter as they looked past the worst of the crisis that hit the economy last year, as the country is looking to stage a mild rebound in the second half of the year after bottoming out in the first.
The data showed that banks’ asset quality, measured by the stage 3 loans to total loans and advances, which is called non-performing loans in accounting parlance, climbed to 13.3 percent by the end of June 2023, up from 12.9 percent in March.
When broken down between licensed commercial banks and licensed specialised banks, the former recorded a ratio of 13.7 percent, up from 13.2 percent in the first quarter, and the latter recorded ratios of 9.3 percent and 9.0 percent in the second and first quarters respectively.

Despite last year’s foreign currency shock still reverberating through the economy by way of prolonged economic contraction, loss of jobs, incomes, and sky-high prices of energy and other commodities, the banks were seen taking some comfort from the fact that the worst is behind them.
The consumer prices, which peaked at nearly 70 percent last year, decelerated sharply to 1.3 percent last month, largely due to the higher base effects seen a year ago. What is following, although lagging, are the interest rates, which are still hovering near 20 percent for small business loans. The weighted average new lending rate in August was at 17.89 percent, down from 19.30 percent in July and 24.18 percent a year ago.

However, banks are seen gradually opening up their lending taps after more than a year of being apprehensive about new lending. Green shoots of lending activity picking up were seen from July when the licensed commercial banks saw their total outstanding private sector credit had risen by Rs. 13.2 billion.
However, the economy still remains under the grip of tight monetary and fiscal policies as the higher rates and taxes have undermined consumer and business confidence and spending. If unleashed, this could quicken the economic recovery as the country looks past the foreign exchange troubles when the remittances and tourism flows started flowing in, albeit with some weakness in apparel exports due to softening demand in the West.

Sri Lanka could not reach a Staff Level Agreement with the visiting International Monetary Fund delegation last week due to still underwhelming state revenues compared to targets and the limited progress made on restructuring foreign currency debt.
But the delay in releasing the second tranche is unlikely to affect the ongoing economic recovery.