The impact of the COVID-19 pandemic is expected to “weigh heavily” on Sri Lankan banks’ assets quality this year, First Capital Research warned.

“The greatest initial impact is likely to be in loans to industries most affected by the disruption and consumer caution," the research firm said in its latest report.

"In particular, banks' lending to SME and to individuals employed in these sectors, are likely to record the largest increase in loan delinquency” it added.

The research firm slashed private sector credit growth by more than half to 6% for 2020 as moratoriums may avert banks from expanding loans while the general demand for loans will also stay muted amid weak economic growth.

At the same time the research firm expects the non-performing loans to spike to 7.2% during 2020 and ease off in 2021 to 5.1% amid the possible recovery period.

First Capital Research further in its report stated that the adverse business impacts and the potential business disruptions are likely to negatively impact the financial services segment causing medium term stress.

"Market disruptions are expected to inject severe stress on the economy specifically during 2Q & 3Q,” it said.

“Introduction of Debt Moratoriums may reduce stress on businesses, but causes a bane for banks. Lack of growth + Moratoriums, may avert banks from expanding lending,” it added.

The research house also noted that for the first time in two decades bank profitability may decline for the third consecutive year.

The research firm also revised Average Weighted Prime Lending Rate (AWPR) expectations downwards in line with the recent dip in bond market yields.

“We expect AWPR to dip to 9.0% and range from 9.0%-11.0% over next 2-year period supporting a gradual improvement in credit growth over the medium term (more towards 2021E) despite the challenges,” the research firm said.

Meanwhile, Despite the measures by the Monetary Board to provide some respite for the banks to stay afloat, the research firm is of the belief that the profitability would take ‘a massive beating’.

First Capital Research therefore downgraded the banking sector to ‘hold’ from ‘buy’.