Fitch: Stable outlook for Lankan banks

Fitch Ratings Lanka says that its Outlook for the majority of Sri Lankan banks is stable, underpinned by improved earnings prospects due to post-war growth in the domestic economy as well as the government’s capacity to support the banking system. However, rapid loan growth will test the banks’ risk management systems and funding profiles.

A significant revision of government economic policy, macroeconomic shocks, or rapid lending that undermine liquidity, earnings or asset quality and lead to significant capital impairment could be negative for the outlook and/or ratings of Sri Lankan banks. Conversely, structural changes such as improvements to risk management and enhanced capital buffers could be positive for the outlook and/or ratings.

Real GDP growth should drive strong credit demand and licensed commercial banks are best-placed to meet this demand. However, Fitch expects a policy response from the authorities to rein in credit demand should inflation increase significantly.

Fitch questions the Sri Lankan banking system’s ability to manage above-average loan expansion on a sustained basis. However, the agency believes that any deterioration in asset quality may not be as severe as that seen in 2008 and 2009.

Fitch expects net interest margins to remain under pressure from intensifying competition. However, the agency believes this could be mitigated by strong loan demand, manageable credit costs and lower effective taxes to allow continued robust profitability in 2012.

Fitch notes that heightened competition and diminishing liquidity are being reflected in rising interest rates on deposits.

While the agency expects deposits to remain the main source of funding for Sri Lankan banks, strong lending could result in a rising share of non-deposit funding.

Capital ratios could come under pressure from continued strong credit growth. Fitch believes that capital planning to maintain an adequate buffer is important in light of loan growth levels, credit concentrations, loan loss reserve coverage and exposure to macroeconomic volatility.

The report, entitled ‘2012 Outlook: Sri Lanka Banking Sector’, is available at www.fitchratings.com, or by clicking on the link above.