Fitch revises SL’s banking sector outlook to ‘Negative’
Fitch Ratings has revised Sri Lanka’s banking sector outlook for 2020 to negative as the coronavirus pandemic poses increased risks to the anticipated expansion in the economy and credit demand, which will adversely affect the performance of the banks.
Operating conditions are more challenging, affecting asset quality and profitability recovery. This will add to rating pressure as the rating Outlook for the Sri Lankan banking sector is already Negative following the revision in Sri Lanka’s sovereign rating Outlook to Negative in December 2019.
Fitch expects to perform a complete review of all ratings assigned to Sri Lankan banks in the near term, which will include an assessment of the likely impact.
We believe the pandemic could cause considerable disruptions to key economic sectors such as services, which accounted for 59% of nine-month real GDP at end-September 2019, through its impact on sub-sectors such as trade, transportation, tourism and manufacturing (16% of real GDP), and hamper our previously anticipated pickup in economic activity. We now expect Sri Lanka’s GDP growth to slow significantly from our original estimate of 3.5% for 2020, after provisional growth of 2.8% in 2019.
Fitch believes demand for credit will remain muted in 2020 due to the weaker economic growth outlook despite the multiple policy rate cuts by the central bank – 50bp in late January 2020 and another 25bp in March 2020 – along with a 1% reduction in statutory reserve requirements (SRR). Authorities took a range of measures since the Easter attacks in April 2019 to accelerate loan growth including lending rate caps and policy rate cuts totalling 100bp, but Sri Lanka’s gross loans rose just 5.6% in 2019, the slowest rate since 2009.
Any prolonged impact of the virus will intensify the asset quality pressure the banks are already facing, with the sector regulatory non-performing loan (NPL) ratio rising to 4.7% by end-2019 from 3.4% in 2018 even as the regulator and the government continued to announce policies to stimulate the economy.
The regulator granted loan moratoriums to sectors such as tourism and provided a credit support scheme for SMEs after the Easter bombings. We believe sectors such as trading (16% of Fitch-rated banks loans at end-September 2019), and tourism (direct exposure of 4%) are likely to be directly affected by the outbreak while other sectors such as consumption (18%), manufacturing (10%) and construction (15%) could face an indirect impact due to higher unemployment, supply-chain disruptions and weaker demand.
The regulator, following an order from the Sri Lankan president, directed banks to implement a debt moratorium on capital plus interest for six months for businesses in several sectors affected by the coronavirus. This may soften the impact in the near term, but we now expect the sector NPL ratio to rise in 2020.
The series of expansionary monetary policy measures adopted by the regulator since April 2019 will lead to margin pressure through lower interest rates and subdued credit demand. Fitch believes that this, together with high levels of provisioning and credit losses, will negate the benefits to banks’ profitability from lower taxes announced last year.
Furthermore, banks with significant equity trading portfolios could see large mark-to-market losses with Sri Lanka’s main equity index declining around 25% year to date.
Domestic funding and liquidity should remain supported by the expansionary monetary policy stance but sourcing wholesale or term foreign-currency funding could be challenging, both in terms of accessibility and pricing, amid the sharp increase in yields for emerging markets such as Sri Lanka. At end-2019, 23% of the sector’s funding was in foreign currency with 14% in deposits and 9% in borrowings.