Sri Lanka bank forex funding pressures, bad loans to rise after Covid-19: Fitch

ECONOMYNEXT – Bad loans in Sri Lanka’s banks will worsen after a Coronavirus pandemic, pressure on foreign loan funding could intensify and Interest margins would be squeezed amid weak loan growth, Fitch, a rating agency has said.

“Refinancing foreign-currency (FC) liabilities will be a challenge for Sri Lankan banks due to the sovereign’s weak credit profile, a slowdown in FC worker remittance inflows and worsening global funding conditions,” Fitch Ratings said in a report.

“FC liabilities accounted for 23.0 percent of total sector funding as of end-2019.”

Sri Lanka printed unprecedented volumes of money in March and April, firing state and private credit amid a widening deficit and putting pressure on the rupee. Data showed that private credit has slumped in April.

It is not clear whether credit will pick up after June putting renewed pressure on the rupee from excess liquidity and Zimbabwe style printed money re-finance fund. The central bank has been ordered to triple the fund to 150 billion rupees.

Meanwhile severe import controls have been slammed after money printing in a Nixon-shock style move, hitting supply chains and revenues of business and as well potential taxes.

It is no clear what role import controls will play in worsening bad loans in companies which has imported inputs, but controls will hit fee income of banks, analysts say.

“Sri Lankan banks’ operating environment and financial profiles face escalating risks from the economic fallout of the Coronavirus,” Fitch Ratings said.

“The weakened operating environment will compound the existing threat to the banks’ financial profiles through elevated asset quality and earnings pressure although the sector’s adequate capital buffers should help it withstand the near-term risks.”

Bad loans had risen to 4.7 percent of gross loans by end 2019 from 3.4 percent a year earlier, and Fitch expected bad loans at banks rated by the agency to peak at 13.2 percent in 2021, after rising to10.9 percent from the current 9.4 percent.

“Sri Lankan banks will face heightened risks to their asset quality due to the pandemic,” Fitch said.

“We expect asset quality to deteriorate for all the banks in 2020 and 2021, with a more pronounced decline for banks with higher exposure to SMEs and the more affected corporate sectors, such as tourism, apparel and retail.

“Nevertheless, we believe the near-term extent of the deterioration will be masked by the repayment moratoriums and regulatory permission for banks to apply flexibility in impairment recognition for regulatory and financial reporting.”

After each balance of payments crisis triggered by pro-cyclical rate cuts and liquidity injections Sri Lanka’s bad loans rise as domestic demand slows or shrinks along with the currency collapse, leaving businesses in trouble.

After the 2011/2012 currency collapse bad loans peaked at 6.2 percent and in the 2008/2009 currency crisis bad loans peaked at 8.8 percent but there was very steep recovery as the currency was allowed to appreciate and the country recovered from a war amid stimulus from the US.

Meanwhile Fitch said interest margins on banks would be pressure in 2020 as bad loan provisioning picked up.

“We expect protracted low interest rates and subdued loan growth to weigh on the sector’s net interest income, leaving the banks vulnerable to a sharp increase in loan-impairment charges in 2020 and 2021,” Fitch said.

Growth of the sector’s net interest income slowed to 8 percent by end-2019 from 16 percent at end-2018, squeezing the banks’ net interest margins (NIM). Among Fitch rated banks average NIMs will fall by 35 basis points.

Fitch said most banks had enough pre-impairment profits (PPOP) to absorb loan loss charges without running into losses.

In 2018 about 28 percent of profits were wiped out by credit losses in 2019, compared to an 18 percent average from 2015 to 2018.

Most Sri Lanka banks had capital buffers to absorb losses as the central bank had asked banks to build up capital before the crisis. A recent income tax cut would also help preserve capital.


Meanwhile the central bank has also relaxed some capital and liquidity rules giving banks some leeway with liquidity as well as loan loss recognition. (Colombo/June16/2020)

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