Banking sector credit-to-deposit ratio tops 70% for first time in three years

• CBSL flags credit outpacing deposits, widening credit gap as systemic risk
• Bank credit up 23.6% YoY at end-2Q from 11.4% a year earlier; retail funding grows only 6.7%
• Pawning up 49.2%, personal loans 21.3%; vehicle, gold-backed loans rise to 12.9%, 12% of financial sector credit
• Rupee LCR falls to 272.5% from 328.5% as banks shift from Govt. securities to private lending
• Loan demand rises across retail, corporate, SME, SOE sectors in 2Q, though slower than 1Q

Sri Lanka’s banking sector Credit-to-Deposit Ratio (CDR) has exceeded 70% for the first time in three years, reaching 74.0% by end June 2026 and surpassing its long-term average, with the Central Bank of Sri Lanka (CBSL) flagging credit growth outpacing deposits and a widening credit gap as potential sources of systemic risk.

In its recent Financial Stability Review 2026, the CBSL said financial intermediation, the channelling of deposits into loans by banks, strengthened during the review period on the back of continued credit expansion. The CDR, which maintained the upward momentum that emerged in early 2025, rose from 63.9% at end 2024 and 69.9% at end 2025.

Banking sector credit grew 23.6% year-on-year at end Q2 of 2026, more than double the 11.4% recorded a year earlier, while retail funding, comprising demand, savings and term deposits, increased by only 6.7%. The CBSL said credit accelerated markedly amid the continued economic recovery and the accommodative monetary conditions that prevailed during much of the period, while deposit growth remained comparatively moderate. Notably, the rise in the CDR occurred alongside broadly stable GDP growth, suggesting that the recovery in credit demand outpaced changes in overall economic activity.

Even so, the CDR remained below pre-crisis levels, having stood at 82.7% at end 2021, indicating that the increase partly reflected the normalisation of financial intermediation from the exceptionally subdued levels recorded during 2023 and 2024.

However, a sustained widening of the gap between credit and deposit growth could increase funding pressures and contribute to a gradual erosion of liquidity buffers if credit expansion continued to significantly outpace growth in stable deposit funding, the CBSL warned. That erosion is already visible: the banking sector’s Rupee Liquidity Coverage Ratio (LCR), which measures high quality liquid assets against 30-day net cash outflows, fell to 272.5% at end Q2 of 2026 from 328.5% a year earlier, while the share of high quality liquid assets in total assets declined to 29.5% from 33.8% at end 2025. The CBSL attributed the decline mainly to banks shifting assets from Government securities to private sector lending, though liquidity ratios remained well above regulatory thresholds.

The private sector credit cycle continued to progress within the expansionary phase, with the private sector credit-to-GDP ratio rising throughout the period. Consumption loans, the banking sector’s largest credit segment, grew 29.1% year-on-year at end Q2 of 2026, against 11.0% a year earlier, driven by pawning facilities, which rose 49.2%, and personal loans, which grew 21.3%, including loans for vehicle purchases. The CBSL attributed the surge in pawning to rising gold prices, warning of market and collateral risks should global gold prices correct sharply.

Across the financial sector, comprising banks and finance companies (FCs), motor vehicle related credit rose to 12.9% of total credit by end June 2026 from 9.8% at end 2024, following the relaxation of vehicle import restrictions in early 2025. Gold-backed lending rose to 12.0% from 9.8% over the same period. Total credit extended by banks and FCs accelerated from 14.0% year-on-year in June 2025 to a peak of 27.9% in March 2026, before easing marginally to 26.4% by June 2026.

At the same time, the Credit Gap, which measures how far credit deviates from its long-term trend relative to GDP, remained in positive territory and widened further. While a positive gap was consistent with the recovery in lending after the prolonged contraction of 2022 to 2024, its continued widening alongside rapid private sector credit growth warranted close monitoring, the CBSL said. A sustained expansion significantly above trend could lead to a buildup of borrower leverage, increased risk-taking and sectoral credit concentrations if not matched by growth in borrowers’ income and repayment capacity. Six sectors accounted for 72.9% of banking sector credit at end Q2 of 2026, up from 71.1% a year earlier.

In response, the CBSL raised the Overnight Policy Rate (OPR) by 100 basis points to 8.75% on 26 May 2026, its first policy rate increase since June 2023. It also tightened loan-to-value (LTV) limits, which cap the size of a loan relative to the value of the asset financed. In two rounds, in November 2025 and May 2026, the maximum LTV for new commercial vehicles was cut from 80% to 60% and for other new vehicles to 40%, while the limit for used vehicles was lowered from 70% to 60%. A maximum LTV of 70% on gold-backed credit took effect on 25 May 2026, alongside tighter risk weights. As these measures transmit with a lag, their impact on the pace and composition of credit growth would require continued monitoring, the CBSL said.

Meanwhile, the CBSL’s Credit Supply Survey showed loan demand continued to strengthen in Q2 of 2026 across the retail, corporate, SME and state-owned enterprise (SOE) sectors, although at a more moderate pace than in Q1. The expansion was largely supported by higher working capital requirements, demand for short-term loans and a revival of investment activity.

Banks expected both lending activity and credit demand to remain positive in Q3 of 2026. However, their willingness to lend is expected to increase at a slower pace, reflecting a more cautious outlook amid anticipated inflationary pressures, rising operating costs, exchange rate volatility and geopolitical uncertainties.