Credit rating agency Fitch has upgraded the outlook on Sri Lanka's banking sector to stable from negative.

"We have revised our outlook on Sri Lanka's banking sector to stable from negative, reflecting brighter prospects for loan growth, although the environment is still challenging following a cyclical trough," Fitch said in a statement.

The sector outlooks on most Asia-Pacific (APAC) banking systems are stable, says Fitch Ratings in two reports published on Monday (02). However, most banks are increasing their risk appetite in response to pressure on profitability, while the outlooks on four of the region's developed-market banking systems and three of the emerging-market banking systems are negative, Fitch added.

full statement reproduced below:

Fitch Rtgs: Most APAC Bank Sector Outlooks Stable, but Risk Appetite Rising

Fitch Ratings-Hong Kong/London-02 December 2019: The sector outlooks on most Asia-Pacific (APAC) banking systems are stable, says Fitch Ratings in two reports published today. However, most banks are increasing their risk appetite in response to pressure on profitability, while the outlooks on four of the region's developed-market banking systems and three of the emerging-market banking systems are negative.

Our outlook on Japan's banking sector is now negative. It has become harder for banks to boost earnings without taking extra risk, given the challenges to their business models and tougher overseas conditions. Downside risk to financial performance has also increased in Australia, Hong Kong and Singapore, where common headwinds include weaker economic growth, lower interest rates and strong competition.

We have revised our outlook on Sri Lanka's banking sector to stable from negative, reflecting brighter prospects for loan growth, although the environment is still challenging following a cyclical trough. The three emerging-market systems where we have a negative sector outlook are China, India and Indonesia, all of which continue to face asset-quality challenges. China and India are also under pressure to boost earnings and capital to support growth.

Ratings are more resilient than the direction of financial trends in 2020, with the vast majority of banks' Issuer Default Ratings on a stable outlook. For most banks in APAC emerging markets, this reflects our assumption that the banks would receive sovereign or institutional support, if needed. Elsewhere, it typically reflects rating headroom to absorb some likely deterioration in the banks' financial profiles. Rating headroom is generally thinnest in Australia and Japan. Any rating action on the largest Australian banks would have knock-on consequences for their support-driven New Zealand subsidiaries.

The most striking trend in recent years is banks increasing their risk appetite incrementally to support profitability in the face of lower interest rates, compression in net interest margins, softer growth prospects, strong competition and higher costs, especially in development markets. We expect this trend to continue in 2020.

Additional risk-taking is appearing in various channels, including expansion into riskier markets, higher loan concentrations in certain sectors, M&A, and holding higher-yielding investments. Banks have supported asset growth by selectively relaxing underwriting standards, notably for consumer finance and SMEs, with cheaper loan pricing or lower collateral coverage. Banks are also raising their exposure to property, both directly and indirectly, via lending to non-bank financial entities.

Downside risk to ratings could increase if banks do not strengthen their loss-absorption buffers in line with this additional risk-taking, even though the implications may not become evident until the operating environment becomes less benign. In some emerging markets, bank credit profiles could come under pressure not just from higher credit risk but also from greater liquidity risk, particularly in China and Vietnam, although we view smaller, unrated banks as most vulnerable. Regulatory pressure to strengthen loss-absorption buffers appears to have eased in most markets, except for Australian banks and their New Zealand subsidiaries.