Sri Lanka banks to drop IMF, World Bank forecasts for loss calculation

ECONOMYNEXT – Sri Lanka banks have been given more discretion in assessing firms ability to repay loans which had already been re-structured amid a Coronavirus crisis and lenders should only use Central Bank economic projections to model losses, the regulator said.

“Licensed banks shall use forecasts and projections published by the Central Bank of Sri Lanka (CBSL) when adjusting credit provisioning models to reflect the economic conditions and forecasts, on a consistent basis,” the regulator said.

Under earlier guidelines issued for meeting Sri Lanka Financial Reporting Standards 09, banks were allowed to use International Monetary Fund and World Bank projections for ‘ Economic Factor Adjustment.’

“Licensed banks shall use the forecasts and projections published by CBSL, International Monetary Fund and/or World Bank in all instances where such projections are available when adjusting credit provisioning models to reflect the economic conditions and forecasts,” the earlier guideline said.

Sri Lanka’s central bank is forecasting a 1.7 percent contraction in the economy for 2020, while the IMF is forecasting a 4.6 percent fall and the World Bank 6.7 percent.

Banks would also be given more discretion in making ‘stage 03’ provisions for loans which had already been re-structured.

“Licensed banks may exercise judgment on case-by-case basis to determine whether to categorise such facilities as Stage 3 facilities or not, if a facility has been restructured more than twice due to adverse economic consequences of the COVID-19 outbreak or the Easter Sunday Attack.”

Banks were also asked to get guidance from the Institute of Chartered Accounts and auditors in calculating default probability of sovereign dollar bonds and loss given default and to follow the guideline already in place.

The amended directions are as follows:

Amendments to Circular No. 04 of 2018 on Guidelines to Licensed Banks on the Adoption of Sri Lanka Accounting Standards – SLFRS 9: Financial Instruments

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The Central Bank of Sri Lanka with a view to establishing consistent practices on the adoption of Sri Lanka Accounting Standards – SLFRS 9: Financial Instruments by licensed banks under COVID-19 environment, issues amendments to Circular No. 04 of 2018 dated 31 December 2018 as specified at Annex I. Further, the following clarifications are provided to licensed banks:

(1) In the case where direct temporary restrictions on economic activities are in place due to COVID-19 outbreak, licensed banks may exercise judgment on case-by-case basis, to determine whether to classify facilities as Stage 3 facilities or not, considering the borrower’s inability to revive the business and generate sufficient cash flows to repay the exposure once the restrictions on economic activities are removed;

(2) Licensed banks may consult CA Sri Lanka and Auditors in order to obtain further guidance in respect of computing Probability of Default for Foreign Currency denominated Sovereign instruments; and

(3) Licensed banks shall continue to follow the guidance prescribed in the Circular No. 04 of 2018 in respect to Loss Given Default (LGD) to be used when computing expected losses for exposures denominated in foreign currencies issued by sovereigns

The existing guideline on Probability of Default and Loss Given Default for sovereign credit:

Guidance for computation of the Probability of Default (PD) and Loss Given Default (LGD) to be used as a minimum for the calculation of expected credit losses is as follows.

2.5 With respect to exposures denominated in foreign currencies issued by the sovereigns, following shall be considered:

(a) Licensed banks shall compute PDs by using a sovereign PD which is linked to the external credit rating scale.

(b) A 20 per cent LGD shall be applied as a minimum when computing expected losses.
2.6 When calculating LGD for exposures guaranteed by the Government of Sri Lanka:

(a) An LGD of zero can be applied to exposures with the guarantee of the Government provided that the guarantee is fully covered with the interest and reported as liabilities of the Government.

(b) LGD for any other form of assurance other than in item 2.6 (a) above shall be computed instead of using a zero LGD.

(c) A minimum LGD of 20 per cent shall be applied for Government guarantees denominated in foreign currency.

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