Banking sector capital adequacy levels weaken

„„By Chandeepa Wettasinghe Sri Lanka’s banking s e c t o r c a p i t a l adequacy levels came under pressure due to the aggressive expansion of their loan books in 2015, which reached record high levels, the Central Bank annual report data showed. Sri Lanka’s demand for private credit peaked to a historical high of Rs.691 billion, more than thrice the amount in 2014. This resulted in a higher growth in the risk-weighted assets (loans), which dented the capital adequacy levels of the banking sector, but remained above the required regulatory minimum.

The Central Bank data showed that the commercial banks’ regulatory Tier I and Tier II capital adequacy ratios (CARs) have fallen to 11.9 percent and 14.2 percent, respectively, from 14.1 percent and 16.6 percent a year ago. The regulatory minimums are 5 percent and 10 percent, respectively. Speaking to Mirror B u s i n e s s S o f t l o g i c Stockbrokers (Pvt.) Ltd Research Head Dhanushka Samarasinghe said when there’s a significant credit growth, the capital adequacy naturally goes down. Capital adequacy is an indicator that measures the bank’s ability to withstand unexpected shocks with the existing capital and still remain solvent.

After many financial institutions considered to be too big to fail filed for bankruptcy during the 2007/8 financial crisis, the regulators around the world began to tighten the capital rules. Sri Lanka’s private credit soared in 2015 due to the monetary and fiscal stimulus extended by the good governance regime. But the cheaper bank credit fuelled the imports – particularly vehicles and other consumption goods – which busted the rupee from 135 to 145 against the US dollar, plunging the country into a balance of payment crisis. However, with the reversal to tight monetary and fiscal policies, Sri Lanka’s private credit growth is likely to remain below 15 percent this year, much lower than the 25 percent growth recorded in 2015. Apart from the extensive growth in credit, the mark-tomarket and realized losses made on government securities portfolios by the banks too had a negative impact on the capital levels as such losses dented the bottom lines.

The accumulated profit forms part of equity capital and thus higher profits cushion the Tier I capital. While raising Tier II capital could be relatively easier via debenture issues, raising Tier I may be extremely challenging for such banks as Sri Lanka’s the equity market is heading south. Further speaking on the possible impact on the asset quality, Samarasinghe said there could be a slight upward movement in the non-performing loan ratios of banks as the fixed-income borrowers might find the circumstances challenging to service their debt.