Flushed with liquidity, finance firms settle debt at record pace

• NBFI sector borrowing falls to 34%, from 44% in 2017 
• Future liquidity stress not ruled out as depositors could shift to safer asset classes 
• Sector estimated to require Rs.20bn in fresh capital to meet regulatory floors in 2020 and 2021
• Current atmosphere conducive for industry consolidation, which could lead to sector stability  

Overabundance of liquidity caused by the lacklustre growth in loans in the sector, Sri Lanka’s non-bank lenders are settling vast sums of their borrowings to banks, with larger players leading the pack, as they appear to reduce their leverage in the absence of meaningful growth in the sector. 

According to First Capital Research (FCR), the non-bank finance institutions (NBFIs) may not reap the full benefits of the current uptrend in the demand for loans, with banks infiltrating into market segments earlier served by finance companies, amid extremely low interest rates, as the latter grew hungry for growth after recording sub-par growth for three years since 2017. 

Meanwhile, vehicle leasing, which accounted for more than two-thirds of the finance companies’ lending portfolio, has slumped due to import controls on vehicles. 

“Due to lacklustre growth in the sector, NBFIs were seen settling the bank borrowings while heavily depending on deposits for fund mobilisation,” said FCR, which is part of First Capital Holdings.

The borrowings, which accounted for 44 percent of the NBFI sector in 2017, has declined to 34 percent in 2020, as the liquidity surged while the lending remained weak, the data analysed by FCR showed.

The balance constitute of customer deposits, which are typically “susceptible to market events and less reliable in situations of market distress”. 

As a result, despite the recent build up of liquidity in the system, which may also have buttressed by the reprieve received from the Central Bank on mandatory liquid assets, the sector could face some stress on their liquidity at a later stage, as depositors could shift their moneys into safer asset classes. 

“Higher deposit dependence coupled with limited access to funding lines could create liquidity stress for finance companies, as depositors will tend to shift to safer asset classes during crisis periods,” FCR noted.

Meanwhile, the research house also estimated Rs.20 billion in fresh equity requirement for the sector by 2021—Rs.11.1 billion in 2020 and the balance in 2021— to stay in line with the regulatory-mandated minimum capital requirements under the extended timeline. 

At the onset of the pandemic, the Monetary Board extended the timeline for finance companies to meet their minimum core capital requirements of Rs.2.0 billion and Rs.2.5 billion by a year to December 31, 2020 and December 31, 2021, respectively, from their January 1 deadlines in each year. 

Further, the deadlines set for minimum capital adequacy requirements were also pushed by a year to July 1, 2021 and July 1, 2022.

The NBFI sector in Sri Lanka currently consists of 41 finance companies and three specialised leasing companies.

In the current context, FCR showed 18 companies already meeting the 2020 core capital requirement while 15 companies meeting the 2021 requirement with the assumption that others will not raise capital. 

“For companies that meet the minimum core capital and do not comply with the Tier 1 ratios, portfolios can be realigned to improve the capital ratios,” the research firm added. 

However, the current scenario provides a fitting atmosphere for financial sector entities to consolidate. Some of the companies have already found merger partners and are in the process of merging their operations.  

A consolidation in the industry will in most cases raise the merged entity’s capital up to the minimum required levels, raising the stability and the strength of the sector while enhancing the regulatory oversight of the sector.