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The Central Bank has renewed its call for consolidation within the banking sector to address existing weaknesses and boost resilience, although the sector saw higher growth in assets, deposits and profits in 2020.
In its 2020 Annual Report, the monetary authority said with respect to enhancing lending capacities of financial institutions in the context of envisaged high economic growth and the low interest rate environment, the possibilities of financial sector consolidation should be actively pursued.
“Such consolidation would enhance the resilience of the domestic financial sector, while also addressing the existing weaknesses in the sector through the creation of a large capital base, enhancing its potential to finance large-scale transactions and attract foreign investment, widening the range of financial services, and thereby improving the efficiency and profitability of the overall financial sector in the economy,” the Central Bank said.
It added that most importantly, stronger balance sheets of financial institutions would enable improved credit flows to needy and productive sectors, while increasing capacity to service the growing financing needs of the economy.
By end 2020, the banking sector comprised 30 banks – 24 Licenced Commercial Banks (LCBs), including 11 branches of foreign banks, and six Licensed Specialised Banks (LSBs).
During the year 2020, the bank said the stability of Sri Lanka’s financial system was preserved amidst challenging domestic and global market conditions posed by the COVID-19 pandemic.
The sector exhibited moderate growth in terms of loans and advances, investments, and deposit base. However, deterioration in credit quality, sovereign rating downgrades and decreased foreign inflows due to the pandemic, exerted pressure on the banking sector operations.
Having identified the importance of reviving adversely affected sectors in the economy, the Central Bank implemented several extraordinary regulatory measures to provide flexibility to LCBs and LSBs in supporting businesses and individuals affected by the pandemic.
The banking sector asset base increased by Rs. 2.1 trillion during the year, surpassing Rs. 14.6 trillion by end December 2020, recording a year-on-year growth of 17.1% compared to that of 6.2% reported as at end 2019.
Despite the challenging economic and business environment due to the ongoing pandemic, growth in investments and credit contributed to the assets growth. Growth in loans and advances improved from 5.6% in 2019 to 11.9% to Rs. 9 trillion in 2020. Deposits rose by 21.6% to Rs. 11.1 trillion in 2020 as against a growth of 8%.
The sector’s profit before corporate tax was Rs. 190 billion in 2020, which was Rs. 17 billion higher than the previous year. Profit after tax of the banking industry rose by 21.7% to Rs. 136.0 billion during 2020 due to changes in tax policies commencing from year of assessment 2020/21.
The Central Bank said the increase in profits was commensurate with the increase in assets and was reflected in Return on Assets (ROA) – before tax remaining static at 1.4% as at end 2019 and end 2020. Return on Equity (ROE) – after tax improved from 10.3% to 11.4%. The decrease in operating costs resulted in the improvement of the efficiency ratio from 52.6% in 2019 to 51.8% in 2020.
The Central Bank also said the banking sector was in compliance with the capital requirements during 2020. The regulatory capital of the banking sector reported a growth of 3.3% during the year, of which Tier I capital contributed to 63.2%.
The Central Bank also said considering the difficulties faced by borrowers due to COVID-19 pandemic, moratoria were introduced initially for different segments of the economy and further extended for certain sectors considering the longer recovery period of those sectors affected by the COVID-19 pandemic. Classification of loans to non-performing categories were frozen during the period under moratorium and normal classification rules will be applied upon cessation of the moratorium.
Despite the freezing of classification of credit facilities under moratorium, NPLs increased by Rs. 66.4 billion during 2020 compared to an increase of Rs. 118.5 billion during 2019, stemming from the challenging business environment that prevailed for a substantial period in 2020, resulting in an increase in gross NPL ratio to 4.9% by end 2020.
However, the migration of NPLs to categories requiring higher provisions had reduced the net NPL ratio during 2020. Nevertheless, the actual NPL position will only be reflected subsequent to cessation of the moratoria which are still in effect for certain sectors of the economy.
During 2020, total provisions increased by Rs. 74.9 billion, of which specific provisions accounted for 93.5%. Despite the growth in NPLs, higher increase in provisions resulted in increases in specific and total provision ratios.
Although 73.1% of credit was mainly concentrated in six economic sectors, individual banks have diversified their businesses among various sectors in the economy. Out of the main sectors, manufacturing, wholesale and retail trade, agriculture, forestry and fishing, tourism, and construction sectors reported NPL ratios higher than the total banking sector average of 4.9% as at end 2020.
Despite the increase in NPL ratios during 2020, they are still at a manageable level as the banking sector operated with sufficient provisions and capital buffers to absorb any adverse impact.
