Sri Lanka credit guarantee positive for pawning loans: Fitch
Tuesday, 3 June 2014 01:56
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A Central Bank-backed guarantee scheme for bank lending secured against gold (pawning advances) should help to reduce the build-up of NPLs in Sri Lanka’s banking system, says Fitch Ratings. Gold-backed lending peaked at about 19% of total banking sector loans at end-2012, but the decline in gold prices in 2013 has subsequently contributed to a rapid deterioration of asset quality.
Aggregate system NPLs rose to 5.6% of total lending at end-2013 (from 3.7% at end-2012) with 75% of the increase accounted for by gold-backed loans. In response, Sri Lankan banks have tightened lending requirements, reducing loan-to-value ratios and raising interest rates for gold-backed credit.
Details regarding the implementation of the program and the extent of its coverage have yet to be released, but the Central Bank of Sri Lanka (CBSL) aims to increase loan-to-value ratios to a maximum of 80% (from 65%) and cap interest rates at 16% per year. This is part of a broader goal to support economic activity in agriculture and SMEs, which are the primary sectors that have historically taken advantage of pawning advances.
The scheme is credit positive in the short term, and will benefit banks directly in two principal ways. First, by sharing credit risk with the central bank, it will enable the banking sector to reverse a rapid decline in gold-backed lending - pawning advances fell by 17% in 2013 on the back of falling gold prices and tightened credit conditions. Second, it is likely to improve overall bank asset quality by reducing the build-up in NPLs.
The short-term effects of a credit guarantee scheme are positive for Sri Lankan bank asset quality, while we highlight that the existing regulations concerning gold-backed lending lead to unrealistic assessments of credit risk. In our view, the 0% risk-weight applied to gold-backed credit exposures under Sri Lankan regulations mischaracterises the risk associated with such loans – which may be ‘low risk’ but are not risk free. A significant share of gold-backed loans lie on the books of the country’s largest State banks, whose reported capital adequacy ratios would be much lower if a higher risk weight were applied.
