Sri Lanka’s banking industry risk profile is stable on improving economic prospects and regulation, despite non-performing loans being expected to rise in 2018, S&P, a rating agency said.
Banks will experience some fallout from aggressive growth in the past few years with non-performing loans expected to rise in 2018, but the risk profile remains stable with economic prospects seen improving, the rating agency said in a report.
Sri Lanka’s economic risk trend has been revised to stable from negative.
“Aggressive growth in the past has led to rising economic imbalances, but we do not expect an escalation,” S&P Global Ratings said in a statement.
Sri Lanka’s banking non-performing loans could deteriorate as fallout of aggressive growth of the last few years followed by drought in 2016 and floods in 2017,” it said.
However, the rise in non-performing loans is not expected to be sharp and industry risks will be stable as Sri Lanka’s growth prospects are seen improving despite a recent weakening of banks’ funding profile.
The banking regulator Central Bank’s role is seen improving although weaker than peers.
Excerpts of Standard and Poor’s statement are as follows:
“We classify the banking sector of Sri Lanka in group ‘8’ under our Banking Industry Country Risk Assessment (BICRA).
“Our bank criteria use our BICRA economic risk and industry risk scores to determine a bank’s anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating only in Sri Lanka is ‘bb-‘.
“In our view, the Sri Lankan banking sector’s resilience is weak and is affected by the country’s low income levels. Credit risk is high, in our opinion, given relaxed lending and underwriting standards as well as evolving risk management practices.
“We have revised Sri Lanka’s economic risk trend to stable from negative. We believe that aggressive growth in the past has led to a rise in economic imbalances, but we do not expect further escalation in economic imbalances. While we expect loan growth to remain higher than nominal GDP growth, the gap has narrowed, reducing risks of a further build-up of economic imbalances. Moreover, the sovereign external position continues to stabilize.
“Sri Lankan banks’ funding profiles benefit from a good level of stable core customer deposits. In addition, we believe the large number of banks relative to the economy’s size has not led to any significant instability in the competitive environment. However, the dominance of government-owned banks and directed lending to the agricultural sector somewhat distort the competitive environment, in our view.
“In our opinion, the Sri Lankan central bank’s regulation and supervision have strengthened over the years, although they remain weaker than that of international peers. The Central Bank of Sri Lanka is taking several measures that we believe will help strengthen capital positions of banks’ and non-banks in the next few years. The measures would benefit the banking system in the longer term by providing good capital buffers to absorb unexpected losses. Nevertheless, most of the banks will have to step up capital (including hybrid) issuances in 2018.
“The banking system’s nonperforming loans (NPLs) could continue to deteriorate in 2018. This is a fallout of banks’ aggressive growth in the past few years and Sri Lanka’s drought in 2016 and flooding in 2017, which disturbed the agriculture sector and agro-based industrial activity. However, the NPL rise is unlikely to be sharp because we continue to expect Sri Lanka’s growth prospects to be favorable.
“We assess the trend for industry risk as stable. We expect Sri Lankan banks to largely use deposits to meet their funding needs, despite a recent weakening in the banking industry’s funding profile. We believe that larger banks with strong franchises will continue to dominate the sector”.