IMF tells Sri Lanka to devise plan to recapitalise banks

• IMF estimates banking sector recapitalisation requirement at 6% of 2022 GDP
• CB told to finalise roadmap for financial sector restructuring and recapitalisation by July 2023
• Govt.  expected to determine conditions for any potential use of public funds to support the roadmap by October 2023

Sri Lanka will have to devise a plan taking into account the possibility of a domestic debt restructuring as the International Monetary Fund (IMF) points out that its programme envisages measures to adequately recapitalise the banking system.

Local banks so far have vehemently opposed a DDR as the endeavour would result in a serious erosion of their capital. 
Although not affirming that a domestic debt restructuring will become a reality, the IMF in its staff report released to the public domain yesterday urgedthe island nation to be ready with a banking system recapitalisation plan.

The IMF estimates the banking sector recapitalisation requirement at 6 percent of 2022 GDP, “arising from impairments on banks’ exposures to the public sector through debt restructuring and to the private sector through adverse macro developments.”
“The estimate is sensitive to the design of the restructuring,” the staff report stated.

The Fund asserted that maintaining a sound and adequately capitalised banking system as well as addressing banking sector vulnerabilities is crucial to safeguarding financial stability.
“Financial stability hinges on a well recapitalised banking system and strengthened legal framework. Informed by a thorough diagnostic exercise, banks’ exposure to the sovereign and loans under forbearance will need to be closely monitored along with intensified supervision,” the staff report stated. 

“A plan with binding deadlines for financial sector recapitalisation will be needed to address capital and FX-liquidity shortfalls and support the economic recovery,” it added, while pointing out that efforts to strengthen financial supervision and crisis management framework are crucial to enhance resilience and prepare Sri Lanka’s financial system for time of stress.
A diagnostic exercise, including a comprehensive asset quality review (AQR) is currently underway for nine major banks. The Central Bank has hired two internationally reputable independent specialist firms to conduct the exercise.
To support the diagnostic exercise, the authorities will provide the assessors with guidance on the expected impact of the debt restructuring.

By July 2023, the Central Bank is expected to finalise a roadmap for financial sector restructuring and recapitalisation to address capital and forex liquidity shortfalls (identified through the diagnostic exercise), and to intervene in banks assessed to be non-viable (structural benchmark).
By October 2023, the government is expected to determine conditions for any potential use of public funds to support the roadmap and to close capital shortfalls at viable banks (structural benchmark). A coordination committee on financial stability will be established as soon as possible to manage current and future risks to financial stability, the IMF said.