International ratings agency Moody’s reaffirmed Sri Lanka’s banking sector with a stable outlook, due to continuous economic growth, healthy asset quality and profitability.
“Our stable outlook, in place since July 2014, reflects our expectations that the operating environment for banks in Sri Lanka will remain healthy and that asset quality and profitability will be stable over the next 12-18 months, offsetting some moderate deterioration in funding and liquidity,” a Moody’s report said.
The 2016 Budget presented recently placed more taxes on banks, while restricting them from pawning and leasing activities.
Local research and equity brokerage firms said that this would adversely impact the sector.
However, in an earlier report Moody’s said that the restrictions would make banks more creditworthy as it would shed weaker assets.
“The gross nonperforming loan (NPL) ratio has improved over the past 18 months, coming down to 4.0 percent in September 2015 from 5.6 percent in December 2013. Problems in the pawning sector – the key reason for the pick-up in NPLs in the recent past – have been addressed,” Moody’s said.
The rating agency added that the underwriting standards have improved over the last two years, with the loan growth being moderate despite the rapid economic growth.
“Profitability will be stable overall. On the one hand, net interest margins will remain under pressure, primarily due to the low interest rate environment. On the other hand, Sri Lankan banks have already made significant investments in their branch networks and personnel,” it said.
The report noted that the branch networks will bring in faster loan growth to reduce the cost-to-income ratios.
“Some banks will also benefit as elevated credit costs associated with pawning NPLs are no longer required,” it added.
The report further said that despite the real gross domestic product (GDP) growth would decline to 6.8 percent in 2015 and 6.5 percent in 2016, compared to 7.4 percent in 2014, the growth would be robust enough to support the banking sector.
“An accommodative monetary policy supports the growth outlook. In addition, investments are likely to have more participation from the private sector, compared with the public-sector-led approach of the past few years, a shift which should provide an impetus to loan growth,” it said.
However, Moody’s said that funding and liquidity conditions will tighten despite the banks following a statutory liquidity ratio in the domestic book at 36 percent.
“However, liquidity should tighten over the outlook horizon, as we expect annual loan growth of around 20 percent, faster than deposit growth of 16 percent,” it said.
Moody’s added that this would make banks rely on more expensive sources of borrowing including those denominated from foreign currencies.
The ratings agency said that the risks for Sri Lanka’s banking sector is low, as the government has a proven track record of providing systemic support to banks when needed.
It noted that Sri Lankan banks need to comply with Basel III capital norms, as well as liquidity coverage ratio (LCR) norms from January 2016.