Banks signal stronger credit appetite ahead of key CBSL policy decision

• Loan demand rises across all sectors amid stable rates and improved sentiment
• SOE credit demand driven by higher fuel financing needs linked to Middle East conflict
• Banks remain cautious over geopolitical tensions and supply-side disruptions in 2Q

With probably the most anticipated Monetary Policy Statement in recent times to be announced by the Central Bank of Sri Lanka (CBSL) today (26), it yesterday said banks continued to expand lending appetite and observed rising loan demand across most sectors during the first quarter of 2026, despite growing external risks from Middle East tensions and Cyclone Ditwah.

According to the ‘CBSL Credit Supply Survey: Trends in 1Q and Outlook for 2Q 2026,’ the banking sector’s willingness to lend increased further during the quarter compared to 4Q 2025, particularly across the Retail, Corporate, and Small and Medium Enterprise (SME) sectors, although lending appetite towards State-Owned Enterprises (SOEs) declined.

Banks...

Banks attributed the stronger lending appetite to the positive economic outlook, stable interest rates, favourable market and business conditions, improved asset quality, and stronger corporate earnings despite the impact of geopolitical tensions and weather-related disruptions.

The CBSL said banks expect willingness to lend to increase further during 2Q 2026, though at a slower pace, as geopolitical tensions and supply-side disruptions linked to the Middle East conflict continue to weigh on risk assessments.

“The spillover effects of geopolitical tensions causing supply-side disruptions for industries have led banks to maintain a cautious lending approach during 2Q 2026,” the survey noted.

Demand for loans also increased across all four sectors during 1Q 2026 compared to the previous quarter, supported by lower and stable interest rates, improved market sentiment, and favourable business conditions.

In the Retail sector, demand for housing loans, pawning facilities, and vehicle leases increased significantly, while sector-specific credit schemes, expansion projects, and new ventures contributed to higher credit demand within the Corporate and SME sectors.

The CBSL noted that loan demand from SOEs turned positive during the quarter, driven partly by increased financing requirements linked to rising fuel prices amid the ongoing Middle East conflict, as well as funding needs for development projects undertaken by SOEs.

Banks expect loan demand to increase further during 2Q 2026, supported by improving consumer demand and anticipated growth in working capital financing requirements. 

However, lenders also warned that prolonged geopolitical tensions could lead to weaker demand, higher borrower risk, and tighter lending conditions.

The survey also showed continued improvement in asset quality across the banking sector, with the overall number of non-performing loans (NPLs) declining across all sectors during 1Q 2026 compared to 4Q 2025.

Banks attributed the improvement in NPL conditions to intensified recovery efforts, stronger collection mechanisms, restructuring and rescheduling arrangements, improved borrower cash flows, and broader macroeconomic stability.

The CBSL said the downward trend in NPLs is expected to continue into 2Q 2026, although banks highlighted that external risks, including Middle East tensions and rising global costs, continue to pose risks to borrower performance.

Meanwhile, loan application rejections declined across the Corporate and SOE sectors during the quarter, supported by improved macroeconomic conditions and stronger quality lending proposals. However, rejection rates increased slightly in the Retail and SME sectors amid concerns over repayment capacity, collateral quality, and the impact of unexpected natural disasters.

Banks expect loan application rejections to decline across all sectors during 2Q 2026 amid expectations of stronger borrower cash flows, improved client canvassing, and enhanced credit evaluation processes.