Fitch: Higher gold-loan risk weights to have manageable impact on lenders’ capital

• Banks expected to see only modest capital erosion despite tighter capital treatment
• Finance companies with large gold-loan books face sharper impact, though buffers remain adequate
• New rules seen strengthening sector resilience amid rapid growth in gold-backed lending

Fitch Ratings has said the Central Bank of Sri Lanka’s decision to tighten capital requirements for gold-backed lending will have a largely manageable impact on the capital positions of banks and finance companies while improving the sector’s overall risk profile.

In a report released yesterday, the rating agency said the impact would be more pronounced for finance companies than banks, given the significantly higher concentration of gold-backed loans in their portfolios and more aggressive underwriting practices in recent years.

Under the revised framework, which takes effect from 1 September, gold loans with loan-to-value (LTV) ratios below 70% will attract a 10% risk weight for both banks and finance companies, compared with zero previously. 

Risk weights on higher-LTV exposures have also been increased, raising the average risk density of gold-loan portfolios to around 12% for Fitch-rated banks and 26% for finance companies, from 1% and 5%, respectively.

Fitch estimates the impact on banks’ Common Equity Tier 1 (CET1) capital ratios will range from just 2 to 35 basis points based on end-March 2026 exposures.

Among rated banks, People’s Bank is expected to experience the largest impact due to gold loans accounting for around 20% of its gross loan book, although Fitch said the effect would remain limited because of the bank’s relatively conservative LTV profile.

The rating agency said the effect would be more significant for several finance companies. Regulatory Tier 1 capital ratios could decline by between one and slightly over five percentage points for some lenders.

Asia Asset Finance PLC is expected to be the most affected, with gold-backed lending accounting for more than two-thirds of its loan portfolio. Gold loans comprise about one-third of the portfolios of LB Finance PLC and Mahindra Ideal Finance PLC, resulting in an estimated capital impact of one to two percentage points.

UB Finance PLC could also face a reduction of around one percentage point despite gold loans representing less than one-fifth of its portfolio.

Fitch noted that the revised framework would add pressure to already constrained capital positions at HNB Finance PLC and Merchant Bank of Sri Lanka & Finance PLC (MBSL). HNB Finance’s total capital ratio could move close to the regulatory minimum, while MBSL remained below minimum Tier 1 and total capital requirements as of end-March 2026.

The rating agency said fresh capital injections and sustained capital accumulation would be important for both institutions to rebuild adequate buffers above regulatory thresholds.

Fitch observed that gold-backed lending expanded rapidly following vehicle import restrictions, as favourable capital treatment made the product particularly attractive to lenders.

The agency described the new framework as credit-positive from a prudential standpoint, particularly when combined with the lower LTV limits introduced by the Central Bank in May to curb aggressive expansion in the segment.

However, it expects lenders to continue favouring gold-backed lending given its lower capital intensity relative to most other retail lending products.

Fitch added that the ultimate impact could be lower than currently estimated if lenders adjust their portfolios before the new rules take effect. Nevertheless, a sharp decline in gold prices remains the key downside risk for institutions with high concentrations of gold loans, as falling collateral values could increase LTV ratios and place additional pressure on capital.

Despite the changes, Fitch said it does not expect the new directive to trigger rating actions, as the most affected institutions either benefit from external support or maintain sufficient capital buffers to absorb the impact.