• In conversation with DFCC Bank Senior Vice President (Treasury and Investment Banking) Prins Perera

Sri Lanka is slowly emerging from the crises it faced in the past two years with economic activity picking up. However, external headwinds persist and internal economic issues have not dissipated entirely. Businesses experience challenges with changes in the level of demand for products and services, supply chain disruptions, high interest rates on loans, exchange rate volatility, etc. 

This is where private sector banks must adapt their business models so they can do what banks are supposed to do – lend money, manage risks, support businesses and individuals, and execute other essential parts of doing business. Considering these facts, The Sunday Morning Business recently interviewed DFCC Bank PLC Senior Vice President (Treasury and Investment Banking) Prins Perera. He discussed push and pull factors in the banking sector and how DFCC Bank can allocate capital towards economic activities and step up its role in growth and recovery.

Following are excerpts:

Fitch Ratings has downgraded Sri Lankan banks, including DFCC Bank, and there were some media reports about a possible collapse of the banking sector. How concerned should the public be?

Fitch Ratings recently downgraded DFCC Bank to A- from A+, whereas 13 other banks were also subject to downgrades. You may recall that Fitch called it a ‘recalibration’ which reflected the changes in the relative creditworthiness among Sri Lankan issuers following Fitch’s downgrade of Sri Lanka’s Long-Term Local-Currency Issuer Default Rating (IDR) to ‘CC’ from ‘CCC’. 

This is more specific to the banks’ local currency-related exposures and having substantial exposure to Government securities. This was something that rating agencies were closely monitoring subsequent to the sovereign’s IDR revision. Fitch decided to downgrade DFCC by two notches in reflecting the impact of the sovereign on the overall banking industry, which was not a DFCC-centric move. 

Here, the banking sector’s response to the concerns of the general public is very straightforward. If the Government is engaged only in foreign debt restructuring and doesn’t consider local debt restructuring, there won’t be any systemic risk to the local banks. Therefore, the potential threat to the banks you read about in media reports is only a perception.

How has the economic crisis affected DFCC Bank’s treasury operations?

A couple of factors have impacted the overall banking sector. One of them is the capital position. Banks have been raising capital in line with their balance sheet expansion, but in the face of the extended impact of the Covid pandemic since the mid-2020, banks could not do this. For two to three years, banks could not raise Tier 1 capital or even Tier 2 capital while the balance sheets were growing marginally. This led to the deterioration of the capital position of many banks. 

But DFCC was an exception. We managed to raise over Rs. 3.5 billion Tier 1 capital in 2022. Impairments were substantially high compared to pre-pandemic levels, both of local and foreign currency. That also necessitated additional capital infusion to the balance sheet. Thirdly, the yields of local currency T-bills and bonds increased suddenly in the wake of policy adjustments in 2022, which also negatively impacted the capital position. 

Around the same time, the exchange rate depreciated to Rs. 360 from Rs. 200, creating an increased impact on the capital requirement because that amount repriced all our foreign currency assets. Our foreign currency loan book increased immediately, reflecting the steep deterioration in the exchange rate. There was an elevated level of credit in the bank books regarding foreign currency assets. 

As a result, the capacity of banks to lend to economic activities dwindled and SMEs especially had to withstand the worst of it. The Central Bank introduced a capital conservation buffer as a precautionary measure during the Covid period due to the heightened capital adequacy requirement of banks. 

How do you view the banking sector’s Non-Performing Loans (NPLs) to total gross loans as a percentage?

Given the circumstances, the gross NPLs industry-wide is relatively high – slightly higher than 10%. This can continue until mid-year, when it will probably decrease, and towards the end of the year the situation should improve further. The banks took care of all these negative factors by increasing their impairment provisions, therefore, banks are liquid enough and have adequately covered those elevated risks in the system. 

I would say that there isn’t any specific risk at this moment because banks are sufficiently liquid to continue their business. On the other hand, earnings from exports remained resilient during 2022, recording the highest-ever exports, while expenditure on imports declined significantly, with the merchandise trade deficit being recorded as the lowest since 2010. 

Those numbers, along with increased migrant worker remittances and encouraging tourism receipts, also had a favourable impact on the banks’ liquidity levels.

How does DFCC Bank create value in financial products for its customers who play a key role in the economy?

During the past two years, DFCC Bank’s offerings were very limited for the reasons we discussed. But now, we have started accommodating import transactions with the availability of US Dollars, especially in opening Letters of Credit (LCs) on a limited scale and facilitating import bills in DP/DA terms, bills of lading, etc. Thus we support the import trade in line with the existing policy. 

Regarding export trade, we facilitate short-term and mid-term financing for foreign currency, especially for pre-shipment and post-shipment credit on exports. In 2022, export growth was relatively strong, with the country achieving about $ 13 billion from export earnings. This was a result of the bank’s continued support in these areas. 

These are offerings that we are continuing, and in addition to that, we are looking at various other offerings, including interest rate risk management. Our customers face many risks outside their business, which require financial assistance from the banks, primarily to manage risks arising from interest rate movements in the market.

Similarly, the exchange rate risk arising from sudden deviations in the exchange rate is another volatility customers must manage. We help them address it significantly by offering special packages for their product range to mitigate the impact of this volatility. 

We plan to provide our customers with more long-term financing support this year with the anticipated drop in interest rates. We are keen to shift from short-term financing, predominant in the past two years, towards more empowering long-term funding, which is vital for economic recovery. As local currency liquidity has improved, we will continue making meaningful offerings to our retail customers.  

The $ 150 million facility the US International Development Finance Corporation (DFC) granted to DFCC Bank as a bilateral loan went towards the MSME sector and women-led enterprises in Sri Lanka. These funds were disbursed at relatively low rates because they came to DFCC at very concessionary terms. When the average lending rates were around 30%, those loans were offered at an interest rate of 14-15%. That was a specific offering we made during this period.

DFCC has begun to support exporters and importers to cover their foreign exchange risks by offering forward exchange contracts, which were unavailable in 2020-2021. That was an essential product we introduced in 2022. Furthermore, we provided concessionary financing to stock market investors in 2022. With the LIBOR-based pricing to discontinue from 30 June 2023, DFCC Bank will offer foreign currency financing based on Secured Overnight Financing Rate (SOFR) and fixed rates.

As banks and the business community have learned to navigate the unpredictable over the past two years, what are your assumptions about investment prospects?

It is bright as we see more and more economic activities taking place. However, it may take significant time for the economy to achieve positive growth. We are confident that foreign investors will look at Sri Lanka very positively because Sri Lankan assets are very reasonable due to the depreciated exchange rate. 

Once the IMF’s Extended Fund Facility starts being disbursed, we may see several other multilateral and bilateral loans. That will spur more economic activity in the country. The stock market is one asset class which underperformed in the past two years and it has immense potential to gain momentum because it is very affordable. Most bank stocks are also relatively inexpensive. Therefore, from foreign investors’ point of view, the depreciated currency is an excellent opportunity for them to invest. 

We are confident that there will also be some foreign inflows into Government securities. In the equity market, we already see that trend from January onwards. For them, the property market is relatively cheap too. With such possible foreign inflows, economic activity will be further stimulated and the support of the banks will continue on a much greater scale in 2023. In such a scenario, economic recovery will be faster in 2023.