Private credit market shrinkage deepens as banks close lending spigots

• August private credit slumps Rs.59bn, falling for the fourth straight month

Banks refrained from loaning money to private creditors for the fourth consecutive month in August after the economic crisis triggered in March started showing sharp cracks in their asset quality after large swaths of borrowers fell into severe trouble from soaring rates and spiralling inflation.    
The data showed that in August the total outstanding private sector credit had slumped Rs.59.0 billion, after falling by Rs.41.0 billion in July in a reinforcing sign that the credit markets have virtually dried up. 

The direction of private credit also provides a close proxy for the broader economy, and thus the deepening shrinkage in the credit markets is a sign of how deep the economy is shrinking. All estimates point to over 8.0 percent contraction in the Sri Lankan economy this year, the worst decline ever to record in the country’s post-independence history.   
Despite the decline in absolute credit, total outstanding private sector credit as of August marked a 12 percent increase from a year ago levels after such credit set off to a sharp rise in 2021 stoked by the rates which fell to the lowest levels in history. However, the August year-over-year growth marked a declaration from the 15 percent growth through July. 

The cracks in private sector credit first began in March coinciding with the economy’s total collapse, which fired inflation through the roof after the rupee gave up nearly 50 percent of its value. This caused banks to get nervous about the wild ride the economy was about to set off. 
Meanwhile, the 7 percent jumbo rate hike which followed in April to contain the spiralling prices and also to anchor inflation expectations before reaching the hyper-inflationary levels shot up the lending rates, virtually bringing the curtain down on private credit markets. 

Excluding the rupee depreciation impact which artificially inflated bank’s balance sheets, the private sector credit in commercial banks fell by Rs.14.0 billion in March before rising by Rs.43.3 billion in April perhaps due to the disbursements of already approved facilities. Some borrowers may have also rushed to lock-in rates when they were on their way up. 
Thereafter in May, such credit fell by Rs.47.3 billion followed by Rs.14.3 billion decline in June before contraction deepened in July and August as higher rates started feeding through the credit markets faster. 

Banks have tightened their credit standards to fend off further fallout from the economic crisis on their earnings and asset quality which already has taken a massive toll from the heavier provisions made on account of investments they had made on government-issued foreign currency bonds.