The Central Bank says Sri Lanka’s households are increasingly getting enmeshed in a vicious debt spiral as a result of heavy consumption borrowings, which are neither productive nor sustainable, hence vowed to squeeze such lending flows.
According to Central Bank Governor Dr. Indrajith Coomaraswamy this was one of the reasons why they decided to end the ceilings on personal lending products such as credit cards and housing loans effective from July 1.
“One of the reasons why the Central Bank felt comfortable about removing the cap is because we have seen a significant increase in personal borrowings.
The indebtedness of households has been increased to the point where in our view there were grounds to kind of put some sands in the wheels to slow that down a little bit.Because there is really a very sharp increase in personal loans”, Dr. Coomaraswamy said.
In a circular issued in late May, the Central Bank removed the 24 percent interest rate cap hitherto applicable on credit card outstanding balances and temporary overdrafts and the 16 percent cap applicable on housing loans while removing the caps on penal interest rates. Following this development, the banks rushed to raise credit card interest rates up to 28 percent and some of the players even went on to the extent of raising their late payment fees by as much as 33 percent effective from July 1.
The Central Bank believes that lifting the caps will enable the banks to price their personal lending products to reflect their risk profiles and thus would discourage the consumption related borrowing.
When the good governance regime came to power in 2015, Lankan banks got into a lending spree as both the monetary and the fiscal policies was loosened in what could be termed as a highly myopic policy move.
The banks heavily lent to retail and small and medium enterprise segments, which are highly susceptible to changes in operating conditions and got their MPI score (Macro-prudential Risk Indicator) revised down to ‘2’ from ‘1’ reflecting elevated sector risk from ‘low’ to ‘moderate.’
The MPI score in a country’s banking sector gets revised when the banks record over 15 percent growth in credit for two years consecutively stoking fears of possible bubbles.
“So, this increase in credit card rates etc. should help to contain that because that is not very productive lending.
If the price of that goes up and then the money is redirected to more productive activity, clearly that’s better for the economy”, Dr. Coomaraswamy added.
However, the outstanding credit card balance account for between 3 to 4 percent of total outstanding private credit, the data from the Central Bank showed.
Meanwhile, the January-March earnings quarter saw some business sectors recording sluggish growth due to higher interest rates, taxes and inflation. The players in the consumer durables sector forecasted some tepid business in to the future.
Although rising interest rates could have some impact on banks’ asset quality, the Central Bank ruled out any drastic deterioration as banks know how to manage their non-performing loans. “That doesn’t necessarily have to be the case. The banks will have to act prudently and do their due diligence on their lending”, Dr. Coomaraswamy said.