Small, mid-sized Sri Lankan banks under pressure with thin capital, high risk: Fitch

ECONOMYNEXT- Sri Lanka’s small and mid-sized banks (SMBs) are facing higher pressure due to thin capital buffers and higher risk appetites, ratings agency Fitch said.

"SMBs’ capital buffers are likely to remain thin from aggressive loan growth, muted earnings and lingering credit risks," the ratings agency said.

Smaller banks have given more loans to retail and small and medium-sized enterprises, which are more vulnerable to economic cycles.

Bad loans at SMBs were higher at 7.4 percent at end-2018, compared to 3.4 percent at larger banks, Fitch said.

Deposits at smaller banks are relatively weak, hitting liquidity and funding and would have to raise equity to meet capital requirements in 2020, the ratings agency said.

The full Fitch statement is reproduced below:

Thin Capital Buffers Amid High Risk Appetite Exert Pressure on Sri Lanka’s SMBs

Fitch Ratings assesses the ratings of Sri Lanka’s small and mid-sized banks (SMBs) as driven mainly by their high risk appetite and modest loss-absorption buffers.

Other features are a small franchise, as reflected in a combined market share of 7% of total assets at end-2018 compared with 82% for the nine larger Fitch-rated banks in the country.

Ratings on NTB, PABC, UB, SDB, HDFC and Amana reflect their standalone strength, while CBL’s rating captures Fitch’s expectation of extraordinary support from its ultimate parent.

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Fitch reviewed the ratings of seven Sri Lankan SMBs on 23 May 2019 (please see Fitch Upgrades Union & Cargills Banks; Affirms 5 Small & Mid-Sized Sri Lanka Banks)

What to Watch

Thin Capital Buffers: SMBs’ capital buffers are likely to remain thin from aggressive loan growth, muted earnings and lingering credit risks.

The median Fitch Core Capital ratio has remained higher than that of larger rated banks, although we view capital buffers as not being commensurate with the high risk appetite.

Capital-raising is likely to continue across most SMBs.

PABC, HDFC, Amana and CBL need to raise equity capital to meet enhanced regulatory capital requirements by end-2020.

Higher Risk Appetite: SMBs’ predominant exposure is to the retail and SME segments, which we believe are more vulnerable to economic cycles.

Loan growth at these banks has also been above the sector average, which could continue in the medium term as they pursue scale.

High Asset-Quality Risks: SMBs’ relatively high risk appetite, against a backdrop of a more challenging operating environment, exposes these banks to greater asset-quality pressure than their larger counterparts.

SMBs’ median impaired loans/gross loan ratio (based on SLFRS9 stage 2 loans) of 7.4% was significantly higher than 3.4% for the larger banks’ at end-2018.

Pressure on Operating Profit: SMBs’ profitability is likely to remain subdued in the medium term, similar to the banking sector, due to rising credit costs. SMBs’ lower median risk-adjusted profitability ratio than that of the larger banks reflects SMBs’ higher operating cost structures.

Weaker Funding and Liquidity Profile: SMBs’ relatively weak deposit franchises exert pressure on their funding and liquidity profiles. SMBs’ median loan/deposit ratio is likely to remain higher versus the larger banks, while their share of CASA remains low at 18.3%. (Colombo/Jun25/2019)

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