The rapid growth seen in bank loans during the period from June 2014 to June 2017 have pressurized both the funding and liquidity profiles of Sri Lankan banks as the deposits failed to keep up with the loan growth, according to Moody’s Investors Service (Moody’s).
However, some respite is expected during the next 12 to 18 months as the loans could slow to mid-teens as interest rates remain high and asset quality concerns could worsen.
“Deposit growth has lagged loan growth over the past three years, growing at a compounded annual growth rate of 16 percent against average loan growth of 20 percent”, Moody’s said while revising Sri Lanka’s banking sector rating outlook to ‘Negative’ from ‘Stable’ amid expected pressures in asset quality and profitability.
Banks’ loan-to-deposit ratio (LDR) or total loans granted against it deposits tightened to a high of 92 percent by this June from 82 percent in June 2014.
While there is no regulatory cap or an ideal ratio for LDR, a ratio over 100 percent reflects that loans are higher than deposits.
This condition also reflects a broader national economic issue of “persistent savings-investment gap”, where the country is forced to borrow—mainly from overseas—to create its capital goods.
However, the risk and return depends on how the banks maintain their funding cost as some banks prefer cheaper borrowings over deposits, which could push their LDR above 100 percent, yet result in higher margins and profits.
During 2015 and 2016, Sri Lankan banks loaned record Rs.692 billion and Rs.755 billion respectively, creating cheaper bank credit causing a balance of payment crisis as bulk of such loaned moneys were exported to foreign country’s for local consumption, impacting the rupee and the foreign reserves.
As most of these loans are beginning to season now, Moody’s predicts higher defaults—particularly in the areas of property and construction—leading to higher credit costs and delinquency ratios.
It is believed that this mainly led to Moody’s recent rating action.
Meanwhile, the foreign currency LDRs of Sri Lankan banks have tightened to 105 percent from 90 percent during the same period, “reflecting the system’s higher dependence on confidence-sensitive external debt”, and the majority of these foreign currency loans have been taken by the state-owned banks on behalf of state-owned enterprises.
“Market volatility may hamper refinancing of these foreign-currency liabilities”, Moody’s cautioned.
The rating agency also said that despite funding pressure, “Sri Lankan banks hold sizeable liquid assets to cover liquidity needs and deposit movements”.
“Liquid assets are good quality and are mainly in the form of government securities and cash”, it further said.