Fitch Ratings-Colombo-27 June 2019: Sri Lankan banks face further increases in non-performing loans (NPLs) this year as the macro-economic environment remains difficult, Fitch Ratings says in new reports. Weaker asset quality and earnings will add to pressure on capital, and many small and medium-sized banks still need to raise equity capital to meet enhanced regulatory capital requirements by the end of 2020. 

However, they face execution risks since recent rights issues by Sri Lankan banks have been significantly undersubscribed, with investors deterred by macroeconomic instability. Our outlook for the sector remains negative.

NPLs rose by 64% in 2018, the sharpest increase since 2013, when banks that had grown rapidly in gold-backed loans were exposed to steep falls in gold prices. The sector NPL ratio rose to 3.4% at end-2018 from 2.5% at end-2017 and the trend has accelerated this year, with the ratio deteriorating to 4.2% at end-1Q19. 

Sector net profit declined by 9% in 2018 as impairment charges more than doubled and this trend is likely to continue this year due to declining asset quality. In addition, a debt-recovery levy imposed in late 2018 will push effective tax rates higher, further squeezing profits.

Sri Lanka's small and medium-sized banks are under the greatest pressure. Their capital buffers are thin due to aggressive loan growth, muted earnings and rising credit risks, and their predominant exposure is to the retail and SME segments, which we believe are more vulnerable to economic downturns. Their median impaired loans/gross loans ratio (based on SLFRS 9 stage 2 loans) was 7.4% at end-2018, higher than that of the larger banks (6.9%).

The report "Sri Lanka Banks' Results Dashboard" is available at www.fitchratings.com or by clicking the link above.