Economic crisis will test resilience of Sri Lanka’s biggest banks – Reuters

  • Fitch warns of pressure on banks’ earnings, asset quality, capital and liquidity

The current economic crisis, the worst Sri Lanka has ever faced in its post-independence history, would test the resilience of the country’s biggest banks, as Fitch Ratings said on Monday that the quality of their assets, earnings, their capitalization and liquidity could come under enormous pressure when operating conditions deteriorate.

The rating agency said the sovereign credit default in April and the rapidly deteriorating broader macroeconomic environment, where soaring interest rates, runaway inflation and currency depreciation have reduced flexibility operational banks, which in turn would stunt growth, trigger defaults and increase operating costs, putting huge pressure on profits.

Banks indeed expect their loan portfolios and therefore their balance sheets to contract in 2022 and 2023, with profits expected to fall sharply in line with the economy, which is on track to lose 20% of its value compared to at its peak. in 2018.

Meanwhile, some banks expect their non-performing loan ratios to reach an all-time high of 10-15% during this period, as corporate and household balance sheets have come under enormous pressure from the economic downturn, which hampers their ability to manage their facilities. .

While the broader concessions program announced last week to affected borrowers could limit the rise in bad loans, Fitch Ratings said it would mask the real loans under stress.

The ratings agency expressed those sentiments by examining the credit ratings of the People’s Bank, Commercial Bank and Hatton National Bank, which form the nation’s second, third and fourth largest commercial lenders by assets.
Fitch Ratings maintained their long-term national rating at AA-, with a rating watch at Negative, due to potential deterioration in their creditworthiness, compared to other entities in the Sri Lankan national rating scale , given the strains on bank funding and liquidity. as well as their significant sovereign exposure through investments in foreign currency instruments which increase risks to their overall credit profile. In the case of the Banque Populaire, the bank has significant exposure to the sovereign through its foreign currency loans, in addition to its investments in foreign currency bonds.

“We believe PB’s capitalization is highly vulnerable to even moderate shocks to asset quality, particularly if it has to absorb credit losses related to its currency exposure to government and state-owned enterprise loans.” , the rating agency said.

Heightened risks of capital depreciation also persist for Commercial Bank and Hatton National Bank, given pressure from weak internal capital generation, due to earnings pressure, “mark-to-market losses and from deteriorating loan quality, combined with inflated risk-weighted assets from sustained rupee depreciation,” which will put pressure on capitalization matrices.

“We believe capital shortfalls could arise in a very likely scenario where the bank has to absorb a haircut on its foreign currency government securities,” Fitch said of Hatton National Bank.

Meanwhile, the Commercial Bank has the second largest exposure among domestic banks to government securities denominated in foreign currencies, exposing the bank’s capital to the risk of restructuring these instruments, the risk is somewhat mitigated by the increase in the provisioning made by the bank over the last few quarters.

The capitalization risk on banks is somewhat mitigated, given weak loan growth or potential declines in their loan portfolios for the rest of the year, which could also extend into 2023.

This could, however, potentially offset or offset earnings pressure, due to tighter margins from rising rates, which in turn leads to higher borrowing costs and higher operating costs, due to hyperinflation amid the contraction in their expected growth.

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