Sri Lankan banks are likely to come under increased capital pressure from Basel III-related requirements that take full effect at the start of 2019, Fitch Ratings says.
Fitch expects that most banks will have to raise capital to meet the higher requirements, particularly if they are pursuing rapid growth.The sector’s capital needs could be exacerbated by deteriorating asset quality following aggressive lending in 2015/2016 to more vulnerable segments, such as retail and SMEs, the effects of the recent floods and weak internal capital generation. Our negative outlook on the Sri Lankan banking sector reflects these pressures, although banks have coped with the deterioration in the operating environment and loan book growth could keep non-performing loan ratios around current levels.
Capitalisation is thin at state banks due to substantial dividend pay-outs. In 2016, the three largest state banks (National Savings Bank, Bank of Ceylon and People’s Bank (Sri Lanka)) paid 76% of their profits as dividends. Their capital levels are vulnerable to dividend demands from the state, and continued high pay-outs in the absence of capital infusions could leave them struggling to meet regulatory capital requirements.
Rapid loan growth by the private banks exceeding their rate of internal capital generation has weakened capital ratios. The sector’s average Tier 1 capital ratio declined to 11.4% at end-2016 from 13.0% at end-2015, following high loan growth of 21.1% and 17.5% in 2015 and 2016, respectively, despite several contractionary monetary policy measures.
Sri Lankan banks may start issuing Basel III-compliant debt instruments once clarification on the tax treatment of interest from listed debt securities is obtained.
The government proposed removing this tax relief in its November 2016 budget, but a final decision has not been made.
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