• Successful debt restructuring to improve sovereign creditworthiness
• Stronger sovereign profile to benefit banks’ operating environment

Fitch Ratings expects that an improvement in Sri Lanka’s credit rating will alleviate sovereign-related pressures on the banks, improving the operating environment of the banks.

Accordingly, Fitch Ratings said that Sri Lankan banks’ operating environment (OE) assessment and overall credit profiles will be supported by any improvement in the sovereign’s credit profile following a completed debt restructuring.

“This is due to the strong link between sovereign financial health and banks’ operating conditions. We believe this would be positive for the National Ratings of Fitch-rated large Sri Lankan banks– albeit based on their creditworthiness relative to other Sri Lankan issuers,” it said.

Fitch Ratings also said that Sri Lankan banks’ current OE score of ‘ccc-’/stable is linked closely to the sovereign’s local-currency credit profile, given their predominant exposure to the domestic economy and government securities (local-currency treasury instruments: 33.4% of assets and foreign currency instruments: 3.4% at end-1H24) and lending to the broader public sector.

It added that the ratings of locally incorporated banks, excluding Cargills Bank PLC (A(lka)/Negative) which is driven by our expectation of extraordinary shareholder support, are based on their standalone credit profiles.

Fitch Ratings does not factor support into the ratings on the two state-owned banks, despite their strong state linkages, given the sovereign’s constrained ability to provide extraordinary support. However, a sustained improvement in the sovereign’s financial flexibility may lead to a reconsideration of state support.

Sri Lanka is close to completing its foreign-currency debt restructuring and according to Fitch Ratings a successful outcome, in line with the proposed framework for local bondholders, would be likely to significantly reduce the challenges faced by banks, improving their financial profiles.

“Pressures on foreign- and local-currency funding and liquidity have eased considerably due to better external sector flows and the banks’ efforts to preserve liquidity. We expect banks to regain access to foreign-currency wholesale funding, following the restoration of the sovereign’s creditworthiness,” it added.