ECONOMYNEXT- Sri Lanka's banks are expected to borrow more from foreign markets, which could lower profitability due to bigger hits from rising interest global interest rates and currency depreciation Standard & Poor (S&P), a rating agency said.
"As the political situation in Sri Lanka stabilizes, banks are likely to seek more external funding because local deposits may prove insufficient to meet their growth needs," S&P said in a new report.
"Sri Lankan banks' dependence on external funding has increased over the years due to loan growth regularly outpacing deposit growth and the government encouraging banks to tap overseas sources of funding," it said.
"The proportion of external funding had declined in recent years but should increase again," it said.
There had been some recent repayments foreign loans taken to expand, S&P said.
Local interest rates, which had been kept artificially low, and cheap foreign funding had led banks to borrow from international markets and lend locally.
Local credit growth went up to 25.1 percent in 2015 and 21.9 percent in 2016 compared to Central Bank guidance of 15 percent.
This credit growth has since declined, along with a slowdown in banks' foreign borrowings due to repayment of loans, S&P said.
"We expect the share of external funding to rise again on an immediate basis as banks tap external funding to lend to the government to meet its repayment requirements."
"In 2019, we believe large state-owned banks may be required to tap the external markets at higher costs to finance the sovereign's bond repayments."
The Central Bank has announced that state banks would be seeking funding from Middle East markets for sovereign repayments.
However, interest rates have risen in the global market.
"Sri Lankan banks are already seeing higher pricing for their external funding, which could affect profitability," S&P said.
Local political upheavals that affect the currency could also hit banks, S&P said.
"In a low-probability and high-impact downside scenario, if the political turmoil escalates or prolongs, uncertainty could spread to the banking sector and cause funding stress or liquidity outflows," it said.
However, the direct exposure of banks to exchange rate risk should be limited, the ratings agency said.
"The banking sector's direct exposure to exchange-rate risk should be limited because of a moderate aggregate net open position," it said.
"We expect the net open position of Sri Lankan banks to decline further, given that these banks are likely to hedge interest and foreign exchange risks."
However, S&P said indirect foreign exchange risk may rise from lending in foreign currency to customers. (Colombo/Feb12/2019 - SB)