A summary of the FSR 2025 and the financial stability outlook is given below:

The resilience of the financial sector improved during the first half (H1) of 2025 compared to H1 of 2024. This was supported by favourable developments in domestic macroeconomic conditions amidst heightened global uncertainty and lingering effects of the economic crisis experienced in the recent past.

• Amidst the improvement in domestic macrofinancial conditions, credit granted by financial institutions, particularly to the private sector, increased during the period under review. This was supported by the easing pressure on balance sheets of households and firms with the expansion in economic output and subdued price levels.
• Although credit granted by banks and Finance Companies (FCs) increased, private sector Credit-to- GDP remained below the pre-crisis level, indicating room for further expansion, particularly given the reduced demand for credit by the public sector.
• Nevertheless, the private sector Credit-to-GDP Gap widened within the expansionary phase of the credit cycle, suggesting the need for continuous monitoring of any build-up of systemic risk.
• Meanwhile, financial intermediation, as reflected through the Credit-to-Deposit ratio of the banking sector, also remained at subdued levels.

• Amidst these developments in credit expansion, the tilt in exposure towards the Government and public corporations continued to decline, reflecting the impact of ongoing revenue-based fiscal consolidation measures and cost-reflective pricing.
• In terms of interest rate movements, although rates have been declining, the spread between lending and deposit rates remained elevated relative to its pre-crisis average, highlighting room for further improvement of the domestic interest rate structure.

The stress in the financial markets as reflected by the Financial Stress Index (FSI), remained subdued during the eight months ending August 2025 as overall market conditions improved compared to the corresponding period of 2024.

• The stock market recorded a strong performance with historically high price indices, and this development was underpinned by the participation of domestic Conversely, foreign investor interest in the domestic stock market continued to decline during this period. Amidst the upward trajectory in price indices, market volatility increased, while an upward movement was observed in the Price to Book Value (PBV) ratio during the first eight months of 2025.
• In the Government securities market, the yield curve shifted downward and remained relatively stable, supported by fiscal consolidation measures and accommodative monetary Although yields fell, the demand for Government securities continued, as reflected by the increase in the subscription for Government securities at the primary auction. Moreover, this increase was driven by Treasury bonds while the stock of Treasury bills declined, depicting the desire of investors towards longer term securities to lock in higher yields.
• Meanwhile, the domestic foreign exchange market witnessed an improvement in liquidity, supported by inflows in the form of workers’ remittances and tourist earnings. While liquidity conditions improved as reflected by narrowing bid-ask spreads, the Sri Lanka rupee depreciated against the US dollar during the first eight months of the year following two consecutive years of appreciation.
• Domestic money market transaction volumes reached an all-time high in August 2025 and monthly repo market volumes consistently outpaced the monthly call money market volumes during the period, reflecting more active involvement by market participants in securitised lending. Meanwhile, money market liquidity remained positive during the review period, due to surplus liquidity positions of state owned banks and foreign banks.

Amidst the recovery in macroeconomic conditions, the resilience of the banking sector improved as reflected through profitability, capital adequacy, efficiency, asset quality, and resilience to market risk indicators. This was reflected in the performance of the Banking Soundness Index.

• However, the Stage 3 Loans ratio¹ of the banking sector, remained elevated despite recording a declining trend.

• Liquidity levels of the banking sector, as measured in terms of the Rupee Liquidity Coverage Ratio (LCR), remained well above the regulatory minimum requirements, albeit with a modest decline amidst the continued credit A similar trend was observed in the Net Stable Funding Ratio (NSFR) as well, indicating adequate liquidity levels to support continued credit expansion in the economy at the current juncture.
• Meanwhile, profitability of the sector improved during H1 of 2025 with the increase in net interest
• With increased profitability and Tier-2 capital, the Total Capital Adequacy Ratio (CAR) also improved by end Q2 of 2025 compared to the corresponding period of 2024.

The FCs sector recorded a strong credit expansion during H1 of 2025. Increase in credit growth of the sector was driven by the expansion in vehicle and gold backed facilities amidst removal of restrictions on vehicle imports, increased gold prices, and lower market interest rates.

• Thus, the credit portfolio of the sector was predominantly backed by few asset categories, resulting in higher collateral risk.
• Reflecting the significant expansion of the credit portfolio of the FCs sector, the Stage 3 Loans ratio of the sector declined considerably by end Q2 of 2025 compared to end Q2 of 2024.
• Meanwhile, liquid assets of the FCs sector recorded a decline for four consecutive quarters, on a y-o- y basis, although remaining above the minimum regulatory requirement.
• Similar to the banking sector, profitability of FCs also reported a significant increase supported by the increased net interest income during the period under review.
• Meanwhile, CAR of the sector remained well above minimum regulatory requirements, although a marginal decline was observed due to an increase in Risk Weighted Assets (RWA) of the sector in line with the credit expansion.
• In the insurance sector, Gross Written Premium (GWP) of both long term and general insurance subsectors witnessed an increase, amidst a marginal improvement in insurance penetration of the

Credit to both Household² and Institutional³ sectors reported an expansion during H1 of 2025. This growth in credit was supported by lower market interest rates and improvement in macroeconomic conditions.

Credit to the Household sector reported a notable uptick compared to the modest growth during H1 of 2024. While the banking sector continued to be the main source of formal funding for the Household

sector, the share of funding from the Non-Bank Financial Institutions (NBFIs) increased, particularly with the removal of restrictions on vehicle imports.

• The Institutional sector also reported a strong credit growth during the period and the banking sector accounted for a significant portion of credit to the sector.
• Credit quality, as reflected by the time bound Non-Performing Loans (NPL) ratio, depicted a gradual improvement from Q2 of 2024.
• The listed Non-Financial Corporates⁴ (NFCs) recorded a healthy performance with a significant increase in profitability, while a modest expansion in revenue during the period under review was observed. Amidst these developments, creditworthiness of the listed NFC sector Thus, these developments highlight the listed NFC sector’s enhanced financial resilience during the period under review.

The Central Bank took an array of policy measures to support financial system stability during the period.

• Macroprudential policies aimed at securing financial system stability included the designation of Domestic Systemically Important Banks (D-SIBs) and the introduction of revised Loan to Value (LTV) caps for credit facilities granted in respect of motor vehicles.
• The Central Bank also issued directions on corporate governance for licensed banks and further strengthened the regulatory framework of FCs in terms of improving risk management practices.
• Moreover, amidst the observance of rising incidence of financial frauds and scams along with cybersecurity threats, the Central Bank implemented proactive policy measures to strengthen financial consumer protection, enhance digital payment security, and promote public awareness.
• In addition, steps to strengthen the country's resolution framework and boost the operational preparedness of financial institutions were also taken during the period.
• Alongside these policies, the Central Bank implemented a range of other measures related to financial literacy, financial inclusion, and AML/CFT⁵ initiatives to further strengthen the stability of the financial system.
• Moreover, amidst the increasing risks of climate change faced by the financial sector, the Central Bank in collaboration with relevant financial sector stakeholders launched the Sustainable Finance Roadmap 2.0 in May 2025, which extends the scope of the roadmap to the social aspect as well.

Financial Stability Outlook

The momentum in macroeconomic recovery along with ongoing fiscal consolidation is expected to improve the stability of the financial sector.

• Amidst the uptick in domestic output, low levels of inflation and interest rates along with fiscal consolidation measures, expansion in credit granted by financial institutions is expected to persist, particularly with continued private sector lending.
• Moreover, the pressure on balance sheets of households and firms could continue to ease with increasing output and stable price levels, thereby supporting credit quality of financial institutions.
• However, as the economy progresses through the expansionary phase of the credit cycle amid still elevated Stage 3 Loans, close monitoring and implementation of proactive measures to address potential vulnerabilities and emerging risks would be a crucial factor in sustaining financial system
• Moreover, downside risks to financial stability in terms of macrofinancial conditions also exists, particularly in the form of external sector developments. As a small open economy highly dependent on external trade, the country is susceptible to global uncertainties, particularly in terms of potential constrains on export earnings amidst an uptick in imports.
• While continued favourable progress of macrofinancial conditions would support the developments in capital markets, concerns persist in the form of limited foreign investor participation, low transactions in the secondary market for Government securities, and trade and geopolitical uncertainties.

The performance of both banks and FCs is also expected to improve with the envisaged increase in credit supporting productive economic activities while credit quality of the sector and impairment coverage for Stage 3 Loans requires close monitoring to strengthen the resilience of the sector.

• However, attracting funding through deposits to sustain credit expansion may pose challenges going forward in the current low-interest rate environment while current excess liquidity levels could also be impacted through the expected credit expansion.
• Moreover, although both capital and profitability are currently at favourable levels, continued maintenance of capital buffers would be important in ensuring resilience of the financial sector.

Thus, going forward, financial system stability is expected to be maintained, with continued improvements in the macroeconomic conditions.

• An integral part of this would be the maintenance of external sector stability along with continued measures ensuring fiscal consolidation.
• While credit expansion is likely to support in strengthening economic output, a continued widening of the credit gap could further heighten the buildup of potential risks within the financial sector.

Thus, the Central Bank will continue to monitor and assess the stability of the financial sector in conjunction with activities within the broader economy and take measures to implement proactive and timely policies in collaboration with relevant stakeholders to ensure continued stability of the financial system, thereby facilitating an effective transmission of monetary policy, protecting savings of the public and supporting sustained high economic growth.