CBSL releases Financial Stability Review 2024 and outlook

The Central Bank of Sri Lanka yesterday released the Financial Stability Review for the Year 2024, providing an assessment of the stability of the financial system, identifies and evaluates the associated risks and vulnerabilities, and outlines the policy measures implemented by the Central Bank and other regulatory authorities.

The Central Bank noted that this statutory report was released in terms of Section 70(1) of the Central Bank of Sri Lanka Act, No. 16 of 2023. The report covers data up to June 2024. However, more updated selected developments are also reported in the publication. 

The electronic version of the publication can be accessed through the Central Bank website. (https://www.cbsl.gov.lk/en/publications/economic-and-financial-reports/financial-system-stability-review)

In terms of the outlook for financial stability, the report said the financial system is expected to perform better with envisaged improvements in asset quality and build-up of capital buffers while prudently managing risks, as the economy further stabilises and advances amidst continuing challenges.

Although the unprecedented gravity of the crisis created deep macro financial imbalances within the economy, these imbalances are gradually correcting with prudent policy measures and reforms along with behavioural responses thereby supporting financial system stability. Hence, while the progress of the financial sector thus far while managing the spillover from the economic crisis has been commendable, the sector needs to continuously strive towards assuring financial stability in the medium to long term.

It envisages improvement in economic output would invariably create the demand for financial services, amidst relatively stable price levels, supporting improvements in financial intermediation. However, as credit expansion shifts towards the private sector, financial institutions would have to consider managing of potential pressures on credit quality and capital adequacy, in the backdrop of elevated NPL ratios and caps on large exposures. Moreover, while attracting funds amidst low deposit rates could be challenging, continued downward pressure on lending rates could narrow the net interest income of financial institutions thereby affecting profitability. 

In addition, the high level of sovereign exposure of financial institutions particularly in the form of Government securities, which led to significant returns in the recent past, may also gradually subside. Further readjustment of imbalances in the external sector and the fiscal sector particularly due to suppressed import demand and delaying of meeting selected sovereign debt obligations may also need to be cautiously handled to ensure the stability of the financial system. Nevertheless, the finalisation of external debt restructuring would pave the way for accessing further financial resources from the external sector albeit in a prudent manner. Accordingly, challenges will persist as the benefits experienced through the recovery in macro financial conditions supported by the favourable base effect are diminishing.

Within this backdrop, realisation of the outlook depends on an array of macro financial factors particularly in terms of sustaining the fiscal consolidation path, efficient management of external sector imbalances with normalisation of external demand along with low and stable price levels that would create a conducive environment for economic expansion. Furthermore, the higher propensity towards risk taking during the expansionary phase of the credit cycle is also likely to heighten the build-up of vulnerabilities, highlighting the continued need for proactive management of risks within the financial sector. Thus, the Central Bank as the macro prudential authority along with the Financial System Oversight Committee will continue to assess the build-up of any systemic risks in the financial sector and recommend macro prudential policy measures to address such risks. Moreover, all stakeholders should remain committed to implement timely and well-sequenced policy measures and reforms to ensure sustained stability of the financial system.