Moody’s affirms ratings of three Sri Lankan banks; maintains negative outlook

Moody’s Investors Service has affirmed the long-term ratings of three banks in Sri Lanka (B1 negative). The rating actions follow the affirmation of Sri Lanka’s B1 sovereign rating.

The affected banks are Bank of Ceylon, Hatton National Bank Ltd. and Sampath Bank Plc. The baseline credit assessments (BCAs) and Adjusted BCAs of the three banks were affirmed at b1. The counterparty risk assessments (CRAs) of the three banks were affirmed at Ba3(cr)/NP(cr).

The outlook on the ratings of the three banks, where applicable, is maintained at negative.

The operating conditions for Sri Lanka’s banks have weakened because of the high loan growth over the last two years, driven by a loosening of underwriting standards. As a result, Moody’s has changed Sri Lanka’s Macro Profile to ‘Weak +’ from ‘Moderate –‘, and considered the new Macro Profile in the affirmation of the three Sri Lankan banks.

Ratings rationale

The affirmation of the three banks ratings and the maintained negative outlooks follow Moody’s affirmation of Sri Lanka’s B1 sovereign rating with a negative outlook on 12 December 2017.

The ratings and outlooks of banks typically follow the ratings and outlooks of their respective governments if the banks’ ratings are positioned at the same level as the sovereign rating, which is the case for Bank of Ceylon, Hatton National Bank Ltd. and Sampath Bank Plc.

Typically, such linkages between the sovereign credit profile and the credit metrics of the domestic banks are driven by the banks’ large investments in sovereign bonds, as well as by the common drivers of the underlying operating conditions.

The key factor driving the negative outlook on Sri Lanka’s sovereign rating is Moody’s view that persistently high government liquidity and external vulnerability risks continue to pressure Sri Lanka’s credit profile. 

Specifically, measures to build reserves and smooth the profile of external payments may be insufficient to stem imminent government liquidity and balance of payments pressures starting in 2019, when large international debt repayments come due and Sri Lanka’s three-year International Monetary Fund (IMF) Extended Fund Facility (EFF) program concludes.

Moody’s has also changed the Macro Profile for Sri Lanka to ‘Weak +’ from ‘Moderate –‘, reflecting Moody’s view that operating conditions have weakened for Sri Lankan banks. In particular, Moody’s has adjusted downwards the credit conditions score by one notch to reflect rapid credit growth in Sri Lanka over the last three years to end June 2017, growing at a compounded annual growth rate (CAGR) of 21%.

Due to the fact that Sri Lanka is an underpenetrated banking market, strong credit growth in itself is not necessarily a cause for concern. However, the current episode of strong credit growth has come against a backdrop of moderating economic growth. Thus, the credit growth multiplier (credit growth/nominal GDP growth) has increased rapidly to around 2x over the three years to end 2016. The negative adjustment to credit conditions reflects Moody’s concern that the divergence between credit growth and underlying economic conditions may be unsustainable.

The lowering of Sri Lanka’s Macro Profile to ‘Weak +’ from ‘Moderate –’ has no impact on the BCAs of the three Sri Lankan banks.