Sri Lankan banking sector outlook: Post-Budget

AKD with the banking sector CEOs in November 2024

Having served on the boards of multiple banks for over 25 years, I have witnessed several financial crises. However, the economic crisis of 2022 was the most severe. Sri Lanka’s economy totally collapsed that year amid a crippling foreign exchange crisis but defied expectations with a faster-than-anticipated recovery.

This turnaround was driven by a $ 2.9 billion International Monetary Fund (IMF) program secured in March 2023 and a successful $ 25 billion debt restructuring completed in December 2023. Fast forward to February 2025, and Sri Lanka’s banking sector is demonstrating remarkable resilience. The nation recorded real GDP growth of 5% in 2024, the highest in seven years marking a strong rebound from the economic turmoil of 2022.

Decline in Non-Performing Loans (NPLs)

The Central Bank of Sri Lanka (CBSL) reported a significant decline in non-performing loans in the third quarter of 2024. The NPL index dropped sharply from 7.2 in Q2 to -44.5 in Q3, driven by improving economic conditions, flexible payment options, and lower interest rates. This trend is expected to continue, with projections indicating a further decline to -33.8 in Q4. The improved asset quality reflects stronger borrower resilience and a more stable banking sector.

Monetary policy adjustments

In November 2024, the CBSL introduced a single policy rate of 8%, replacing the previous rate corridor. This move aimed to foster private sector credit growth, stimulate lending, and ensure economic stability. As a result, the Weighted Average Call Money Rate dropped by approximately 50 basis points, making credit more accessible for businesses and individuals.

Banking sector performance

Sri Lanka’s leading commercial banks have reported notable improvements in asset quality. For example, at Commercial Bank of Ceylon, the impaired loans (Stage 3) ratio improved to 4.08% as of September 30, 2024, down from 5.85% at the end of 2023. Additionally, the impairment coverage ratio for Stage 3 loans strengthened to 53.54%, up from 43.22% the previous year. These improvements indicate a healthier loan portfolio and greater financial stability across the sector.

Inflation and economic outlook

Inflation stood at -1.7% in December 2024 but is expected to return to positive territory by mid-2025. The CBSL aims to maintain inflation at around 5% in the long run. Meanwhile, the World Bank forecasts 4.4% economic growth for Sri Lanka in 2024, underscoring a steady recovery path. However, sustainable economic expansion will depend on prudent fiscal policies, investor confidence, and effective debt management strategies.

Conclusion

As of early 2025, Sri Lanka’s banking sector has emerged stronger after navigating one of its toughest financial crises. Strategic monetary policies, improved asset quality, and a stabilising economic environment have reinforced the sector resilience. While challenges remain, particularly in the SME sector, the AKD budget aims to address some of these concerns. The 2024 banking sector results, soon to be published, are expected to reflect this strong recovery. However, much work remains to ensure the long-term stability and growth of the financial sector. This includes recapitalising banks, consolidating finance companies, and further strengthening financial system stability by effectively managing the Statutory Reserve Ratio (SRR) and strengthening overall governance in the sector. 

References:

https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/about/speech_20241110_keynote_speech_hsbc_market_outlook_2024_e.pdf

https://www.mckinsey.com/industries/financial-services/our-insights/global-banking-annual-review