SL to borrow US$ 150mn from WB to bolster financial sector safety net

Cabinet of Ministers has approved a proposal to borrow US$ 150 million from the World Bank (WB) to strengthen the financial and institutional capacity of the country’s financial sector safety net with a focus on Sri Lanka Deposit Insurance and Liquidity Support Scheme (SLDIS).

President Ranil Wickremesinghe in his capacity as the Minister of Finance, Economic Stabilisation and National Policies sought the approval of the Cabinet of Ministers to obtain the loan as an Investment Project
Financing (IPF).
The initiative which is named as Sri Lanka Financial Sector Safety Net Strengthening Project is expected to be appraised by the World Bank on May 5 and to be presented for World Bank Board approval on July 6.

Amid the economic crisis, the World Bank had noted that Sri Lanka’s banking sector along with non-bank financial institutions are faced with growing stability issues.
Official non-performing loans (Stage 3 loans) of the banking sector reached 10.9 percent in 3Q-2022, up from 7.6 percent at end 2021, despite continued regulatory forbearance, while banks’ capital adequacy was reported at 15.3 percent in Q3-2022, down from 16.2 percent a year ago.
In addition, increasing deposit rates are also driving up banks’ cost of funding and are eating into their profits and ultimately capital buffers. 

As of 3Q-2022, banks were reporting decreasing profitability, with return on assets and returns on equity dropping to 8.5 percent and 0.7 percent respectively as compared to 14.5 percent and 1.2 percent in 2021.
Similarly, NPLs for non-bank financial institutions (NBFIs) stood at 16.8 percent in 3Q-2022 (up from 12.8 percent a year ago). Provisioning of NPLs also remains low among NBFIs, covering only around 30 percent of NPLs in 3Q-2022. 

However, capitalisation reached 21.7 percent in 3Q-2022, mainly due to infusion of new capital to meet the Central Bank’s tightened regulatory requirements following the failure of several LFCs in 2020/2021.

In this context, the World Bank pointed out that the SLDIS is one of the weakest pillars of the financial sector safety net.
“The scheme has been collecting premiums from member institutions since its establishment under CBSL auspices in 2010, and it conducted several payouts for failed LFCs in recent years. However, as established by the World Bank’s recent assessment of SLDIS against the Core Principles of International Association of Deposit Insurers (IADI CPs), to effectively fulfill its mandate, the deposit insurance system must be strengthened institutionally and financially, and its systems and procedures should be urgently enhanced,” the World Bank said.

According to the World Bank, the proposed project is expected to lead to improvements in the financial and institutional capacity of SLDIS in the direction of greater compliance with the Core Principles of IADI CPs with the results expected in two areas. 
Firstly, it would ensure adequate financial inflows into the SLDIS during the course of the project, in order to achieve a targeted funding ratio in the absence of payouts (e.g., at least double the current level). 

Secondly, the project is expected to improve the institutional capacity of the SLDIS to perform its legally mandated functions (deposit payout and contributing to resolution), as evidenced, inter alia, by the reduction in time required for reimbursement.
“The proposed US$ 150 million operation will finance the increase in SLDIS’ capitalisation and strengthen its institutional capacity. The proposed instrument is an Investment Project Financing (IPF) with Performance Based Conditions (PBCs) and Technical Assistance (TA) components, drawing on experience from successful World Bank projects supporting deposit insurance schemes in other emerging markets and developing economies over the past decade,” the World Bank said.