The budget’s proposal to limit commercial banks’ exposure to gold backed loans and leasing activities will reflect positively on these lenders as such an action will minimize exposure to higher-risk loans, the global credit ratings agency, Moody’s Investors Service (Moody’s) said.
“The proposal is credit positive for Sri Lankan banks because it will limit their exposure to these higher-risk loans,” said a Moody’s report which analysed the budget implications on the banking sector.
However the banking sector analysts argues that such restrictions would slow down the growth in banks significantly while bottom-lines will also be negatively impacted as these loans fetch relatively higher margins as opposed to other loans.
It is uncertain as to how Moody’s arrived at their conclusion as leasing is a collateralized lending business with the option to re-possess the vehicle in case of the lessee fail to finance the lease, hence relatively lower risk.
“We believe this proposal would be a serious challenge not only to banks, but to the consumer as well. Leasing; motor leasing in particular is preferred way to drive loan book growth, due to attractive yields, asset backed, active second hand market and good asset quality as domestic banks refrain providing facilities to the subprime market,” said Bartleet Religare Securities in a note on the budget.
According to Moody’s, limiting the pawning loans to 5 percent of a bank’s loan book will reduce the risks banks run, as pawning loans are directly linked to volatile gold prices.
After the crash in world’s gold price in late 2012, the Sri Lankan banks cut their exposure to pawning from as high as around 35 percent (in certain instances) to below 5 percent.
As of September 30, 2015, exposure to pawning by many banks were below 5 percent, with the exception of the two State owned lenders, Bank of Ceylon and People’s Bank with 7 percent and 14.1 percent (June 30, 2015) respectively, from their loan books.
“Problem loans for Sri Lanka’s commercial banks increased materially in 2013 following a 27 percent decrease in gold prices that year. The asset quality of Sri Lankan banks has stabilized as banks shrank their pawning loan books to 5.2 percent of gross loans as of the end of June 2015, from 14.4 percent at the end of 2012,” the report added.
The budget had also banned banks from engaging in leasing activities. Moody’s said that the risk of consumer leasing can be seen with the weaker asset quality of non-banking financial institutions.
“Consumer finance firms had a 6.9 percent problem-loan ratio at the end of 2014, versus 3.6 percent for the commercial banks. Such loans are provided to individuals and are typically higher risk and unsecured,” Moody’s said.
It noted that leasing made up around 5 percent of the loan book of the 5 largest banks engaged in consumer lending.
“For those banks, the growth in this segment has been rapid, averaging a compounded annual growth rate of 44 percent over the past four years, compared with 24 percent growth in gross loans excluding consumer finance,” Moody’s said.
It added that the Central Bank is likely to implement the proposals, as the regulator would want to limit banks from engaging in high-risk sectors.
Moody’s said that the Central Bank would likely support the budget proposal for credit growth to other sectors of the economy, such as agriculture, small and midsize enterprises, the young and women.