- Measure to further hurt bank profitability already hit by rising credit costs and higher effective tax rate
The Central Bank’s move to slap the lending rate caps on the licensed commercial banks (LCBs) will further strain the profitability of Sri Lanka’s banking sector, which is already hit by the rising credit costs and higher effective tax rate, Moody’s Investors Service said in a brief note.
The Central Bank last week ordered all LCBs to cut the lending rates on all rupee-denominated loans at least by 200 basis points by October 15, from the rates prevailed on April 30, 2019.
The Central Bank said this measure was taken with a view to supporting economic activity amid well-contained inflation and inflation expectations.
“The lower lending rates will compress Sri Lankan banks’ net interest margins (NIMs) and add to their existing profitability challenges.
We expect the banks’ NIMs to narrow after the lending rate cut since the cut’s immediate effect more than offsets a more gradual decline in funding costs because of the time lag in the repricing of time deposits.
Narrower margins will strain bank profitability, which is already weakened because of the rising credit costs and a higher effective tax rate,” Moody’s said.
The rating agency also said that among the three Sri Lankan banks it rates, the negative effect from the development will be more on the margins and profitability of state-owned Bank of Ceylon (BOC) because its asset yields are lower than Hatton National Bank PLC and Sampath Bank PLC.
“Furthermore, a modest NIM reflects BOC’s already weak profitability, while its poor asset quality has contributed to high credit costs,” Moody’s noted.
Sri Lankan banks’ credit costs have increased substantially since 2018 because of systemwide deterioration in asset quality amid weaknesses in the agriculture and construction sectors.
The country’s weak operating conditions, following a constitutional crisis and the 2019 Easter Sunday terrorist bombings that killed 259 people, exacerbated the banks’ profitability challenges.
In addition, the government introduced a temporary debt repayment levy in October 2018, which raised the banks’ effective tax rate to more than 50 percent from 2019-21, further weighing on the banks’ bottom line.
With the lending rate cut, the Central Bank aims to stimulate economic activity and boost credit growth, which the country’s weak economy has dampened.
The Central Bank’s move comes amid an accommodative monetary policy in the past year, which did not lead to a reduction in lending rates.
Since late 2018, the Central Bank adopted several measures to lower the lending rates through a combination of lower reserve requirements, policy rate cuts and the introduction of a cap on deposit rates, which the monetary authority removed shortly after the lending rate cut.
The Central Bank also ordered the banks to reduce the average weighted prime lending rate by 250 basis points by December 27, 2019, from the rates as of April 26, 2019.
The Central Bank also introduced several other measures to curb the lending rates, including a ceiling on the rates charged on credit card advances, prearranged temporary overdrafts and penalty interest rates.