Sri Lanka's banks face dampened outlook for 2020

Announced regulatory policies aren’t enough to shield the sector from the pandemic’s punches.

Sri Lanka’s banking industry faces a negative outlook for 2020 with the pandemic dampening credit demand and pushing non-performing loans up, reported Fitch Ratings.

The pandemic is expected to cause considerable disruptions to key economic sectors such as services, which account for 59% of the country’s nine-month real GDP as of September 2019.

Economic growth is forecasted to remain weak despite the central bank’s multiple policy rate cuts—a 50bps reduction in late January and another 25bps cut in March. Full-year GDP growth is now expected to fall at 2.8%, down from the previous estimate of 3.5%.

Fitch noted that authorities took a range of measures since the Easter attacks in April 2019 to accelerate loan growth, including lending rate caps and policy rate cuts totalling 100bp, but Sri Lanka's gross loans only climbed 5.6% in 2019, the slowest rate since 2009.

Also read: Sri Lankan banks' bearish outlook to extend until end-2019

Credit demand is expected to remain muted in 2020, given a combination of these factors, according to Fitch. Non-performing loans (NPL) ratio is also expected to edge up higher this year.

“Any prolonged impact of the virus will intensify the asset quality pressure the banks are already facing, with the sector regulatory non-performing loan (NPL) ratio rising to 4.7% by end-2019 from 3.4% in 2018 even as the regulator and the government continued to announce policies to stimulate the economy,” the note read.

The series of expansionary monetary policy measures adopted by the regulator since April 2019 will also lead to margin pressure through lower interest rates and subdued credit demand. This, together with high levels of provisioning and credit losses, will negate the benefits to banks' profitability from lower taxes announced last year, added Fitch.

Banks with significant equity trading portfolios could also see large mark-to-market losses with Sri Lanka's main equity index declining around 25% year to date.

However, domestic funding and liquidity should remain supported by the expansionary monetary policy stance but sourcing wholesale or term foreign-currency funding could be challenging amidst the sharp increase in, the note added. As of end-2019, 23% of the sector's funding was in foreign currency with 14% in deposits and 9% in borrowings.

The spread of the virus to countries with a significant number of Sri Lankan migrant workers could also crimp remittance inflows and thereby banks' foreign-currency deposit base, Fitch further noted.