Moody’s Investors Service has maintained its stable outlook on Sri Lanka’s banking system, as moderate economic growth and reduced external volatility should keep operating conditions for the country’s banks stable.
“Continued strong loan growth may put downward pressure on asset quality and liquidity conditions, but nonperforming loan (NPL) ratios will remain at low levels,” said Srikanth Vadlamani, a Vice President – Senior Credit Officer at Moody’s.
“We therefore expect a degree of asset quality deterioration consistent with the current credit profiles of Sri Lankan banks,” he said.
Moody’s conclusions are contained in its just-released report “Banking System Outlook -- Sri Lanka: Stable Operating Environment Drives Stable Outlook.” The outlook expresses Moody’s expectation of how bank creditworthiness will evolve in Sri Lanka over the next 12-18 months.
Despite external funding challenges, the rating agency expects economic growth to remain stable at about 5.0% in 2017, a marginal improvement over the 4.7% expected in 2016.
The stable outlook on the banking system differs from the negative outlook on the B1 long-term foreign currency issuer rating assigned to the Government of Sri Lanka. Sri Lanka’s B1 sovereign credit rating outlook was changed to negative from stable on June 20, 2016, driven primarily by the sovereign’s high level of government debt and implementation risks surrounding planned fiscal reforms.
Moody’s Investors Service has maintained its stable outlook on Sri Lanka’s banking system, as moderate economic growth and reduced external volatility should keep operating conditions for the country’s banks stable.
Moody’s expects asset quality will deteriorate as a result of the relatively rapid 16% loan growth year-on-year at end-September 2016, a key driver of which has been growth of construction loans. The weakening in asset quality will come from a generally low 2.9% nonperforming loan ratio for the system at end-September 2016, which are close to the lowest level for the last decade.
Capital levels are also likely to remain largely stable as pressure on liquidity and funding cause loan growth to moderate. Loan-to-deposit ratios have increased to about 91%.
Positively, though, the banks’ profitability will remain stable, with the firm interest rate environment supporting net interest margins. Cost-to-income ratios may also continue to improve, although only marginally, driven by positive operating leverage.
Finally, government support to banks should remain stable, with the rating agency expecting government support for individual banks to be forthcoming if needed.
Moody’s conclusions are contained in its just-released report “Banking System Outlook -- Sri Lanka: Stable Operating Environment Drives Stable Outlook.” The outlook expresses Moody’s expectation of how bank creditworthiness will evolve in Sri Lanka over the next 12-18 months.
Despite external funding challenges, the rating agency expects economic growth to remain stable at about 5.0% in 2017, a marginal improvement over the 4.7% expected in 2016.
The stable outlook on the banking system differs from the negative outlook on the B1 long-term foreign currency issuer rating assigned to the Government of Sri Lanka.
Sri Lanka’s B1 sovereign credit rating outlook was changed to negative from stable on June 20, 2016, driven primarily by the sovereign’s high level of government debt and implementation risks surrounding planned fiscal reforms.
Moody’s expects asset quality will deteriorate as a result of the relatively rapid 16% loan growth year-on-year at end-September 2016, a key driver of which has been growth of construction loans.
The weakening in asset quality will come from a generally low 2.9% nonperforming loan ratio for the system at end-September 2016, which are close to the lowest level for the last decade.
Capital levels are also likely to remain largely stable as pressure on liquidity and funding cause loan growth to moderate. Loan-to-deposit ratios have increased to about 91%, close to the peak reached in 2012, driven by the strong loan growth over the last 18 months.
Positively, though, the banks’ profitability will remain stable, with the firm interest rate environment supporting net interest margins. Cost-to-income ratios may also continue to improve, although only marginally, driven by positive operating leverage.
Finally, government support to banks should remain stable, with the rating agency expecting government support for individual banks to be forthcoming if needed.
Moody expects government support of individual banks would be forthcoming if needed.
With assets at 68% of GDP, the government considers the banking system to be of highly important for economic growth.
However, the government’s capacity to support the banks with new capital is only moderate, as highlighted by the country’s fiscal constraints and budget deficit.
In this context, liquidity support from the central bank will likely be the preferred support mechanism for the banks
in case of need., recent Moody report showed.
Sri Lanka has a track record of providing systemic support to banks when needed.
When privately owned Pramuka Savings and Development Bank failed in 2002, the government transferred its assets and liabilities to a new state-owned bank. When Seylan Bank (unrated), also privately owned, faced a run on its deposits in 2008 due to liquidity concerns at an affiliated corporation, the central bank asked BOC to provide liquidity support until Seylan raised fresh capital.
The central bank has also had to deal with several instances of liquidity stress at non-bank financial institutions. In 2010, it introduced a deposit insurance scheme and about 90% of the rupee value of system deposits are currently insured.
Also, given the meaningful exposure of large banks such as BOC (56% of gross loans at end-2015) to SOEs, a reform of SOEs would be positive for overall systemic stability.
One of the key objectives of the IMF’s EFF program is to improve oversight and financial discipline of SOEs in order to ensure their commercial viability.
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