Proposed debt restructuring plan should trim risks for NBFIs: Fitch Ratings

• Says restructuring plan avoids direct impact on local-currency govt. debt holdings of NBFIs and commercial banks
• Does not expect latest proposal to prompt a loss of depositor confidence in banking system
• Cautions resistance from other govt. debt holders could raise fresh doubts about domestic financial system

Sri Lanka’s proposed government debt restructuring plan should reduce funding and liquidity risk for the non-bank financial institutions (NBFIs), Fitch Ratings said. 

The rating agency said the restructuring plan avoids direct impact on the local-currency government debt holdings of the NBFIs and commercial banks, easing uncertainty over the entities’ capital, funding and liquidity profiles. 
“Nonetheless, the proposal is only one aspect of the sovereign’s debt sustainability plan and the weak economic environment continues to pose a downside risk to the sector,” it said in a statement yesterday. 

The government debt holdings of the Sri Lankan NBFIs mainly comprise local-currency treasury securities, to meet the regulatory liquid asset requirements and for investment returns. 

The finance and leasing companies (FLCs) have boosted the government debt securities holdings amid a weak economic outlook, lacklustre lending opportunities and a preference for stronger liquidity buffers, at a time of extreme market uncertainty. 

Fitch noted that such holdings are not excessive, at around 8 percent of sector assets in end-March 2023 (end-March 2020: 5 percent) but any direct impact from a government restructuring plan would have added to asset quality and earnings pressure arising from Sri Lanka’s difficult economic backdrop. 

“These securities also comprise a larger proportion of banking sector assets and any losses arising from a restructuring could have further constrained the banks’ capacity and willingness to provide funding to the NBFI sector,” the agency said. 

Foreign currency-denominated Sri Lanka Development Bonds will be subject to restructuring but Fitch-rated the NBFIs have no exposure to these instruments. 

Fitch added that it also does not expect the latest proposal to prompt a loss of depositor confidence in the banking system that would raise contagion risk for the NBFIs’ deposits and bank funding lines. 

Meanwhile, the rating agency said it expects economic conditions to remain difficult, particularly for the FLCs’ largely sub-prime customer base, despite a modest improvement in inflation, interest rate and exchange rate trends in recent weeks. 

Further, capital markets are likely to stay volatile, despite the recent positive moves, keeping the financial prospects of securities firms less predictable in the near term. 

“Any resistance from other government debt holders could also hold back the proposal and raise fresh doubts for the domestic financial system,” it cautioned.