Sri Lanka bank interest margins, profit seen narrowing

ECONOMYNEXT – Sri Lankan bank net interest margins and profits are likely to get squeezed with the recent increase in reserve requirements and rising deposit rates, analysts and bankers told an economic forum.

"NIMs (Net Interest Margins) will get squeezed in the banking sector," said Kanishka Perera, Head of Research of brokerage Asia Securities.

"We have seen a broad sell off in most banking stocks," he told a forum on the economic outlook held by Asia Securities in collaboration with Verité Research.

The sell-off was partly because of emerging market sales by international investors as well as frontier fund year-end sales.

Stock prices of top commercial banks listed on the Colombo bourse have fallen sharply over the past year.

"But we feel there’s still more room to fall because the market is not pricing in the NIMs squeeze," Perera said.

Banks that have foreign borrowings will also see interest rates going up if US rates go up, Perera said.

Increased borrowing by the private sector was a concern as global interest rates were going up, if local banks had lent on fixed terms.

Banks will be under more pressure if private sector borrowings are at fixed rates, with the statutory reserve ratio (SRR) being raised.

Perera said overall profits of banks could be hit 2.5 to 5.4 percent due to the SRR hike.





"Banks will be forced to raise rates to attract more funds. If they have lent at fixed rates, then the pressure fall on the banks with the SRR going up," Perera said.

The January 2016 hike in the statutory reserve ratio to 7.5 percent from 6.0 percent requires banks to keep a larger share of their deposits in the central bank.

In Sri Lanka’s past boom-bust cycles banks generally bought into short term government debt which were issued in larger quantities as deficits deteriorated.

As the pro-cyclical boom intensified the central bank also printed money buying up short term treasuries allowing banks and other investors to exit them.

At the peak of the cycle banks then bought longer term debt, which gave them capital gains when rates fell and the bust came.

This time however the government has issued large volumes of long term debt at the start of a boom, which some banks have bought heavily.

Former banker Nihal Welikala, now advisor to the Ministry of Public Enterprise Development, said there was a need to reposition banks to face new conditions.

The trend towards margin compression was a threat faced by the banking sector along with a still very high fixed cost base.

Indian banks in contrast have managed to cut down their cost-to-income ratios using information technology, he said.

Sri Lankan banks have been “profitable and stable through decades of upheaval,” Welikala said.

But they would need fresh capital to comply with new international banking rules as well as fund the massive infrastructure projects being planned while expanding lending to exporters and small businesses.

"The banking sector will be doing the heavy lifting with capital markets not playing the expected role," Welikala said. 

"But there are a few constraints as we’re a capital short economy with a deficit of nearly two billion dollars a year. So need to improve savings and think of how improve government sector dis-savings.”

For banks to increase lending they would need to scale up capital, Welikala said.

"Organic growth of capital would be too slow. So banks are likely to bring in new capital to exponentially grow their balance sheets.

This could raise ownership issues with a relook at the policy of having diversified ownership of banks.

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