BOC likely to face capital deficiencies having to absorb losses from FC assets 

Bank of Ceylon (BOC) is likely to run into capital deficiencies from the losses stemming from foreign currency (FC) denominated government securities after the country defaulted on most of its foreign currency denominated debt in April, according to Fitch Ratings.    

Sri Lanka’s banks are facing heightened pressure on their capitalisation levels after having to account for heavier losses arising from foreign currency denominated government securities such as International Sovereign Bonds. While many banks are able to withstand the shock coming from heavier provisions made on account of such foreign currency assets due to their years of capital enhancements made as part of BASEL III rules,

Bank of Ceylon is likely to confront some challenges, specially at a time when the government, being its sole shareholder is also constrained in many ways to provide the bank with capital support. 

“We maintain capitalisation and leverage score at ‘ccc’/negative, as we believe that capital deficiencies may arise in a very likely scenario that the bank has to absorb a haircut on its foreign currency government securities exposure, thus requiring a capital injection,” Fitch Ratings said while downgrading the bank’s foreign currency Issuer Default Ratings to RD or Restricted Default scale after missed payments by the bank on its foreign currency obligations. 

While the bank’s rupee liquidity has also tightened following the excessive lending to the State in 2021, the rating agency expects the local currency liquidity to be much more manageable than foreign currency, supported by its strong domestic franchise as well as its ability to access Central Bank liquidity. 

The fact that the government is also constrained in its ability to provide fresh capital will make the situation more challenging to the bank. 

However, the Central Bank maintains that the banking sector remains well capitalised and liquid with only stress seen in the foreign currency side and is committed to provide liquidity support to banks even as the lender of the last resort should the situation demands.

By the end of March 31, 2022 BOC had its Tier I and Tier capital ratios at 11.90 percent and 14.93 percent respectively against the regulatory minimums of 10.0 percent and 14.0 percent.

The bank’s liquidity measured by the Statutory Liquid Asset Ratio in the domestic banking unit was at a comfortable 30.45 percent against the regulatory minimum of 20 percent. 

In the three months to March 2022, the bank reported an after-tax profit of Rs.5.46 billion, down from Rs.12.9 billion in the corresponding period in 2021 as the bank made provisions against possible losses of Rs.55.08 billion, a missive increase from Rs.4.79 billion provided in the same period in 2021. 

“In terms of impairment for investments in foreign currency denominated sovereign instruments, the bank made Rs. 12.6 billion due to downgrade of country rating adjusting ECL to 12 percent as mentioned before and Rs. 8.6 billion due to increase in exchange rate aggregating the total impairment provision made for investment during the period to Rs. 21.2 billion,” BOC said in its March quarter earnings release.