Fitch Ratings’ expectation of continued pressure on banks’ financial profiles due to the challenging operating environment as reflected in our negative outlook on the sector is being borne out in their results.
Heightened risks, largely on the macro front, are being manifested in the form of a sharp rise in non-performing loans (NPLs). The operating environment is of high importance to the ratings of Sri Lankan banks, and acts as a constraint on the Viability Ratings of some banks.
Slower Loan Growth: Our expectation is for loan growth to decelerate in 2019 (down by 0.4% in 1Q19) on muted private-sector credit demand. Loan growth remained subdued through 9M18 at 13%, but closed at 19.6% for 2018, due largely to increased state borrowings. Three large state banks contributed about half of the incremental lending in 2018 (2017: 42%).
NPLs Rising: We expect asset-quality pressures to linger in 2019, as seen in the increasing share of restructured loans across Fitch-rated banks.
Sector NPLs grew by 64% in 2018 – the sharpest increase since the pawning debacle in 2013 – driving the sector NPL ratio to 3.4% (2017: 2.5%).
This trend continued in 1Q19, with the sector NPL ratio rising further to 4.2% broadly in line with our expectations for 2019. The adoption of SLFRS 9 saw loan-loss allowances/gross loans increase to 3.7% (2017: 3%). Profits Subdued: Pressure on profitability is likely to remain in 2019 from rising credit costs, with SLFRS 9 implementation and weaker asset quality. In addition, the debt-recovery levy imposed in late 2018 should push effective tax rates for the Fitch-rated banks even higher (2018: 49%, 2017: 44%), squeezing profits further.
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