Fitch says banks’ capital impairment risk manageable due to higher earnings retention

Although Sri Lankan banks could confront capital impairment risks, Fitch Ratings said it is “mostly manageable,” as most private banks have healthy capital buffers and the relatively muted lending prospects could be offset by earnings retentions, bolstering their core capital buffers further. 

In a special report released on the banking sector, the rating agency said it expects some of the smaller banks to raise capital next year, as they want to be above the minimum capital required before the deferred deadline approaches.

“Fitch believes that pressure on Sri Lankan banks’ capital buffers is mostly manageable. Muted lending prospects are likely to be outpaced by earnings retention, which should provide stability to common equity Tier 1 (CET1) ratios, despite the earnings pressure and credit weakening,” the rating agency said. 

“Only three banks, COMB, SDB and NDB, raised or are planning to raise equity in 2020, but we expect some of the smaller banks to raise capital in 2021 to reach the minimum capital level of Rs. 20 billion ahead of the extended regulatory deadline of end-2022,” it added. 

Sri Lankan banks raised billions of rupees from foreign funding lines and from the local capital market since the end of lockdowns in May as they sensed the unprecedented level of dovish monetary policy could trigger a heavy spike in growth for loans, which would stay longer than in previous rounds. 

While the banks received some reprieve on capital and liquidity as a precursor for tough times created by COVID, they remain largely unscathed as seen from their performance in the three months ended in September. 
Their capital is strong and liquidity is stronger and are awaiting to deploy such money as private sector credit appears to be gathering pace. 

However, Fitch Ratings cautioned that, “ if risks to capital buffers could increase, should the downturn be much worse than our base case. The net impaired loans/CET1 ratio for Fitch-rated banks has already risen to 51 percent by end- 9M20 from 45 percent at end-2019, but we believe that the availability of tangible collateral in most cases could reduce potential losses”. 

The rating agency further added that State banks such as Bank of Ceylon (BOC) and People’s Bank could be vulnerable to potential capital impairment risks given their already thin capitalisation, “despite lower risk weights on some exposures”.

On the contrary, the two State lenders BoC and National Savings Bank (NSB) recently raised billions via equity-like bond issuances, which were snapped up with much interest.