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By Nisthar Cassim
The Government has included finance and leasing companies in the scheme to provide immediate relief to the small and medium enterprises (SMEs), which are the economy’s backbone, by way of freezing capital repayment for one year to kick-start growth via key sectors.
“Finance and leasing companies will be included in the scheme on the same basis,” the Prime Minister’s Senior Advisor on Economic Affairs Ajith Nivard Cabraal told the Daily FT yesterday.
The Finance Ministry said President in a statement on Friday that President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa, who is also the Minister of Finance, Economy and Policy Development, have issued directives to Chairmen and CEOs of all banks to suspend recovery of loans obtained by the SME sector. On Monday and Tuesday, the banking sector along with Central Bank officials had meetings to discuss the way forward following the directive. Cabraal, who chaired the meeting on Tuesday at Temple Trees, said the Monetary Board under the new Governorship of Prof. W.D. Lakshman will discuss and formally approve the support scheme for SMEs at its meeting today, and Directors in charge of Bank Supervision and Non-Bank Financial Institution Supervision will issue relevant directives officially thereafter.
Whilst the directives will clearly spell out the modalities, during the meetings of the banking sector, it was agreed to extend freeze on capital repayment for one year for loans below Rs. 300 million taken by SMEs.
The qualifying turnover threshold is Rs. 750 million per annum.
All interested SMEs will be required to submit applications by 15 January to avail themselves of this relief under the Government’s support initiative. It was maintained that SMEs which are successful may be wiser to opt out of the scheme, in order to be debt free sooner than later, as freeze on capital repayment means the interest component will remain intact, as against a lower figure on a receding balance.
Loans taken by SME owners under their personal name to finance their business will be considered for the scheme as well.
As a further support, Non-Performing Loans (NPLs) over which legal action is being taken to sell pledged assets, will be suspended if such borrowers have been servicing interest on a satisfactory basis.
“At the meeting, Bank CEOs also agreed to withhold the auctioning of any properties belonging to borrowers, in instances where borrowers service the interest payments diligently, in accordance with the scheme,” Cabraal said, adding that such NPLs will be considered for restructuring by the banks.
He also said that the accounting and reporting issues arising from the scheme were also discussed and resolved at Tuesday’s meeting.
Cabraal told bankers that this support scheme will assist to kick-start and revive businesses that had faced difficulties in the past few years, thereby making a positive contribution to the economy once again.
Bankers present at the meeting also acknowledged that the industry is keen to extend support in line with the Government’s decision.
Some analysts, however, were wary of the move, saying across the board relief of this nature could make SMEs complacent, thereby jeopardising the stability and soundness of the banking sector.
However, Cabraal said to safeguard soundness and profitability of banks, the freeze was only on capital repayment, and with the economy being re-energised via crucial SMEs and key sectors, banking sector stand to benefit in the long term.
In its original announcement on Friday, the Finance Ministry said the recently announced tax reform initiatives provide substantial savings to all banks, including the Central Bank.
The Government expects the banks to use part of such savings to revive the SME sector on a priority basis.
As part of the overall stimulus, the Government removed the 2% NBT on banking, financial services and
Insurance as well as 7% Debt Repayment Levy, paid by banks and other financial institutions. Overall tax rate on Banking & Finance companies would reduce by 9% from 52% to 43%, thereby having a positive impact on banks and finance companies.
However, though the Government reduced the VAT rate to 8%, the rate applicable on supply of Financial Services is being continued at 15%.
Fitch Ratings last month warned that pressure on banks’ financial profiles due to challenging operating conditions - as reflected in the 2019 negative banking-sector outlook for Sri Lanka - became more apparent in the banks’ 1H19 results.
The sector’s non-performing loans (NPLs) continued to rise rapidly, up 39% in 1H19 (64% in 2018) and 46% for 8M19. The deterioration in asset quality reflects the challenging operating conditions, the aftermath of high loan growth, and the impact of the Easter Sunday attack in April 2019. The gross NPL ratio for the sector continued to rise, to 4.8% in 1H19 from 4.2% at end-1Q19 and 3.4% at end-2018. In addition, the stock of rescheduled loans has also been growing, indicating that asset quality could continue to remain weak.
The sector’s loan growth is muted, after strong loan expansion during 2015-2018. It rose by only 1.3% in 8M19, reflecting weak borrower sentiment and subdued economic activity. Fitch believes loan growth could remain muted, particularly until the upcoming election cycle has concluded in 2020. The loan/deposit ratio for the sector decreased to 87% by end-1H19 from 91% at end-2018, indicating that funding and liquidity pressure has eased.
After-tax profit for Fitch-rated banks in 1H19 dropped, with net income of Rs. 41 billion (1H18: Rs. 56 billion; 2018: Rs. 114 billion), amid slower loan growth, increased credit costs and higher effective taxes. Recent capital-raising has faced execution risks, with issuance being undersubscribed. Still, further capital issuance is planned for 2H19 and capital raisings are likely to continue due to ongoing capital needs. Basel III capital standards came into full effect in 2019, with banks being able to comply with the minimum requirements.
With regard to finance and leasing companies, Fitch said FLCs credit profiles are likely to remain under pressure in the medium term due to the high asset-quality risks and weakening profit buffers amid a prolonged slowdown in economic activity.
“We see capital-impairment risk as more acute across the small- to mid-sized FLCs due to pre-impairment operating profit buffers which are already weak; a small absolute capital base; and a high share of unprovisioned non-performing loans (NPLs). The large FLCs are likely to withstand the asset-quality risk, underpinned by their solid capital buffers,” Fitch said.
Asset-quality pressure is likely to persist into FY20. Furthermore, higher credit costs under IFRS 9 amidst rising NPLs would remain a drag on FLCs’ profitability in the medium term. This is likely to become a further burden on FLCs that require additional capital to meet the Sri Lankan regulator’s enhanced capital requirement of LKR2.5 billion by 1 January 2021. It exposes these companies to regulatory risks, which include deposit caps, lending caps and issuance of Notice of Cancellation of the License by the Central Bank of Sri Lanka.
The ratings of standalone-driven Fitch-rated FLCs in Sri Lanka are more susceptible to significant capital impairment risk - among other things - as a result of a sustained deterioration in asset quality. Therefore, an inability to arrest further slippage in asset quality could exert downward pressure on their ratings - as reflected in the rating sensitivities, Fitch added.
