Sri Lankan banks can overcome capitalisation hurdle: S&P

Sri Lanka’s banking industry will face several challenges in the coming year but should fare well nonetheless, according to a report titled ‘Despite Some Bumps, Sri Lanka’s Banks Should Have A Steady Ride In 2018’, published last week by S&P Global Ratings.

“Sri Lanka’s banks will have to shore up capital to meet the needs of aggressive growth and increasing regulatory requirements,” said S&P Global Ratings credit analyst Deepali Seth Chhabria. “These banks will also need more capital to prepare for implementation of IFRS 9 and to budget for a rise in credit costs.”

As per the Central Bank’s direction on Basel III, local banks with assets of less than Rs. 500 billion ($ 3.3 billion) will be required to maintain a total capital ratio of 12.5% as of 1 January 2019, compared with 14% for banks with assets of more than Rs. 500 billion (the latter are considered domestic systemically important banks).

This 12.5% total capital requirement is a whopping 200 basis points higher than the global standard. Many large banks are currently below or near the new regulatory requirement.

“We expect the Sri Lankan banking system’s profitability and asset quality to weaken somewhat but only gradually,” said Chhabria. “However, the rise in nonperforming loans is unlikely to be sharp because we continue to expect Sri Lanka’s growth prospects to be favourable. Also we believe that in the medium to long run, the banking system would benefit by having good capital buffers to absorb unexpected losses.” 

Some of the hurdles we see Sri Lanka’s banking system facing in 2018 are transitionary and could actually strengthen the system eventually. In our base case, we assume that most of the large banks would be able to meet their capital requirements without major disruptions in the banking system.

Only a rating committee may determine a rating action and this report does not constitute a rating action.