Fitch revises banking sector outlook to Negative on COVID-19 fallout

• Says growth will be significantly slower than 3.5% projected earlier 
• Despite CB action, expected credit growth to be muted 
• Credit grew 5.6% in 2019, slowest since 2009 
• Despite moratorium, NPL ratios expected to grow in 2020
• Warns borrowings for debt repayment could be costly 

Fitch Ratings has revised Sri Lanka's banking sector outlook for 2020 to Negative, as the COVID-19 pandemic poses increased risks to the anticipated expansion in the economy and credit demand, which will adversely affect the performance of the banks. 

Operating conditions are more challenging, affecting asset quality and profitability recovery, the rating agency said in a statement yesterday. This will add to rating pressure as the rating outlook for the Sri Lankan banking sector is already Negative, following the revision in Sri Lanka's sovereign rating outlook to Negative in December 2019. Fitch expects to perform a complete review of all ratings assigned to Sri Lankan banks in the near term, which will include an assessment of the likely impact. “We believe the pandemic could cause considerable disruptions to key economic sectors such as services, which accounted for 59% of nine-month real GDP at end-September 2019, through its impact on sub-sectors such as trade, transportation, tourism and manufacturing (16% of real GDP), and hamper our previously anticipated pickup in economic activity. We now expect Sri Lanka's GDP growth to slow significantly from our original estimate of 3.5% for 2020, after provisional growth of 2.8% in 2019.”

Fitch believes demand for credit will remain muted in 2020 due to the weaker economic growth outlook, despite the multiple policy rate cuts by the Central Bank - 50bp in late January 2020 and another 25bp in March 2020 - along with a 1% reduction in statutory reserve requirements (SRR). Authorities took a range of measures to accelerate loan growth since the Easter Sunday attacks in April 2019, including lending rate caps and policy rate cuts totalling 100bp, but Sri Lanka's gross loans rose just 5.6% in 2019, the slowest rate since 2009.

Any prolonged impact of the virus will intensify the asset quality pressure the banks are already facing, with the sector regulatory non-performing loan (NPL) ratio rising to 4.7% by end-2019 from 3.4% in 2018 even as the regulator and the Government continued to announce policies to stimulate the economy. The regulator granted loan moratoriums to sectors such as tourism and provided a credit support scheme for SMEs after the Easter bombings. 

“We believe sectors such as trading (16% of Fitch-rated banks loans at end-September 2019), and tourism (direct exposure of 4%) are likely to be directly affected by the outbreak while other sectors such as consumption (18%), manufacturing (10%) and construction (15%) could face an indirect impact due to higher unemployment, supply-chain disruptions and weaker demand.”

The regulator, following an order from the Sri Lankan President, directed banks to implement a debt moratorium on capital plus interest for six months for businesses in several sectors affected by the coronavirus. This may soften the impact in the near term, but Fitch expects the sector NPL ratio to rise in 2020.

The series of expansionary monetary policy measures adopted by the regulator since April 2019 will lead to margin pressure through lower interest rates and subdued credit demand. Fitch believes that this, together with high levels of provisioning and credit losses, will negate the benefits to banks' profitability from lower taxes announced last year. Furthermore, banks with significant equity trading portfolios could see large mark-to-market losses with Sri Lanka's main equity index declining around 25% year to date.

Domestic funding and liquidity should remain supported by the expansionary monetary policy stance but sourcing wholesale or term foreign-currency funding could be challenging, both in terms of accessibility and pricing, amid the sharp increase in yields for emerging markets such as Sri Lanka. At end-2019, 23% of the sector's funding was in foreign currency with 14% in deposits and 9% in borrowings. The spread of the virus to countries with a significant number of Sri Lankan migrant workers could also crimp remittance inflows and thereby banks' foreign-currency deposit base.

The support measures announced by the regulator so far in 2020 are as follows:

The reduction in policy rates and SRR

n Debt moratorium (capital and interest) as follows:

A six-month moratorium on the leasing rentals of all three-wheelers, school vans, lorries, small goods transport vehicles and buses operated by the self-employed; a moratorium until end-May 2020 on personal loans granted to all private sector non-executive employees; a three-month moratorium for all personal loans and leasing rentals of value less than Rs. 1 million; a six-month debt moratorium for affected industries in SME, tourism, apparel, plantations, information technology and related logistic providers

nFinancial institutions to provide working-capital requirements at an interest rate of 4% and to waive interest payments for at least six months for the above mentioned sectors. An interest subsidy will be included in refinancing

nInterest on local credit card transactions of value of up to Rs. 50,000 capped at 15%, minimum monthly payments reduced by 50%, repayment of credit card balances below the limit of LKR50,000 to be extended until end-April 2020

nLicensed banks to extend the validity period of cheques valued at less than Rs. 500,000 till end-April 2020

The President also announced the following, but formal instructions have not yet been issued to the banks:

n Bank of Ceylon (B/Negative), People's Bank (Sri Lanka) (AA+(lka)/Negative), and National Savings Bank (B/Negative), together with other State-owned financial institutions, to jointly invest in Treasury bonds and bills to stabilise the money market interest rate at 7%