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Thursday December 8th, 2022

Sri Lanka’s SDB ‘BB+(lka)’ rating confirmed by Fitch amid strong credit growth

ECONOMYNEXT – Fitch Ratings has confirmed a ‘BB+ (lka)’ domestic rating of Sri Lanka’s Sanasa Development Bank’s (SDB) with a stable outlook, saying the bank has high loan growth but has boosted its capital.

“Our assessment of the high-risk appetite also captures SDB’s aggressive loan growth, which was at 19.5 per cent in 2020 relative to the sector’s 11.9 per cent and the peer median of 8.9 per cent,” the rating agency said.

The bank has raised 3.6 billion rupees of capital in August 2021 through a secondary public offering and 1.5 billion rupees in equity capital in December 2020.

“The capital infusions were prompted by the need to replenish the bank’s capital buffers,” Fitch Ratings said.

“We do not expect near-term pressure on SDB’s liquidity as the bank has not fully utilized the proceeds from the recent fund raising.”

The bank’s capital consumption is high compared with its peers due to loan growth that has outpaced internal capital generation, which, together with its exposure to more vulnerable customer segments, could exert pressure on capital buffers.

“That said, we believe SDB’s capital buffers are likely to remain adequate to absorb credit cost shocks in the near term, supported by its gradually improving profitability through increasing operating scale, which will likely benefit its income generation and cost efficiency,” Fitch said.

The bank had boosted credit despite weak operating conditions in the economy.

SDB’s stage 3 impaired loan-to-gross loan ratio fell to 6.4 per cent by end-2020 from 7.0 per cent at end-2019 due to strong loan growth.

SDB’s operating profit/risk weighted assets has increased to 2.1 per cent in 2020 from 1.6 per cent at end-2019 due to low impairment charges, supported by regulatory leniency on bad-loan classification.

“Continuing regulatory relief from the extended moratorium by the Central Bank of Sri Lanka could push the recognition of impairment into 2022,” Fitch said.

SDB has also moved in to digital channels to reach its customer segments, which Fitch says should help the bank to reduce its high cost-to-income ratio, which fell to around 63 per cent by end-June 2021 from 69 per cent. at end-2019.

Read the full statement:

Fitch Ratings – Colombo – 29 Sep 2021: Fitch Ratings (Lanka) Limited has affirmed
the National Long-Term Rating of SANASA Development Bank PLC (SDB) at
‘BB+(lka)’. The Outlook is Stable.

KEY RATING DRIVERS

SDB’s rating is highly influenced by Fitch’s assessment of the operating
environment and its high risk appetite as reflected in the bank’s larger-than-peer exposure to SMEs, which are highly susceptible to interest rate cycles, as a product of its business model.

Our assessment of the high risk appetite also captures SDB’s aggressive loan growth, which was at 19.5% in 2020 relative to the sector’s 11.9% and the peer median of 8.9%.

The operating environment for Sri Lankan banks remains challenging. Real GDP
contracted by 3.6% in 2020 as key economic sectors were severely disrupted by the
Covid-19 pandemic and the lockdowns that followed. We expect economic growth
to rebound to 3.8% in 2021 and 3.9% in 2022, but this forecast is highly uncertain and depends on the path of the pandemic.

We estimate SDB’s common equity Tier 1 ratio (CET1) was around 13.4% at endAugust 2021 (including the profit for the period) after a LKR3.6 billion capital infusion through a secondary public offering. The bank also raised LKR1.5 billion in equity capital in December 2020, which lifted its CET1 ratio to 9.9% from 8.2%. The capital infusions were prompted by the need to replenish the bank’s capital buffers.

SDB’s capital consumption is high compared with its peers due to loan growth that
has outpaced internal capital generation, which, together with its exposure to more vulnerable customer segments, could exert pressure on capital buffers.

That said, we believe SDB’s capital buffers are likely to remain adequate to absorb credit cost shocks in the near term, supported by its gradually improving profitability through increasing operating scale, which will likely benefit its income generation and cost efficiency.

We expect SDB’s profitability to improve in the medium term, underpinned by better income generation and cost efficiency.

SDB has increased its reliance on digital channels to increase its penetration into its customer segments, which should help the bank to reduce its high cost-to-income ratio, which fell to around 63% by end-June 2021 from 69% at end-2019.

SDB’s operating profit/risk-weighted assets increased to 2.1% in 2020 from 1.6% at end-2019 due to low impairment charges, underpinned by regulatory forbearance on bad-loan classification.

The ratio dropped to 1.9% by end-1H21 as the bank increased its provisioning amid a re-imposition of lockdown measures.

SDB’s asset-quality risk is likely to persist, similar to its peers, stemming from our assessment of the operating environment. Continuing regulatory relief from the extended moratorium by the Central Bank of Sri Lanka could push the recognition of impairment into 2022.

This will be exacerbated by SDB’s fast loan growth, particular to SMEs, which may lead to a significant increase in impaired loans as the portfolio seasons.

SDB’s stage 3 impaired loan-to-gross loan ratio fell to 6.4% by end-2020 from 7.0% at end-2019 due to loan growth that exceeded the absolute increase in impaired loans.

Loan-loss allowance covered around 48.8% of stage 3 loans at end-2020 (2019: 46.8%), which compared well with the peer median of 42%, reflecting SDB’s collateral-backed lending.

We do not expect near-term pressure on SDB’s liquidity as the bank has not fully
utilised the proceeds from the recent fund raising.

Its loan/deposit ratio remained flat at 113.4% at end-1H21 (2020: 113.6%), which is higher than its peer median of 89.4%, reflecting SDB’s lower-than-peer deposit
share in the funding mix (1H20: SDB 79% versus peer median 89%).

Nonetheless, the share of deposits from Sanasa societies and co-operatives of around 31% was significant as of end-2020. These deposits are likely to remain a stable source of funding for SDB.

The bank has accessed funding from foreign development-finance agencies to support its business model of serving the rural and underbanked
communities in Sri Lanka.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to a positive rating
action/upgrade:

An upgrade of SDB’s rating is contingent on a sustained improvement in its credit
profile relative to the universe of Sri Lankan rated entities.

Sustained improvement in SDB’s capital buffers commensurate with its high-risk appetite, particularly through improved internal capital generation, alongside an enhanced market share, would lead to positive rating action.

Moderation in SDB’s risk appetite, particularly through a slowdown in loan expansion into highly vulnerable market segments, would also be positive for the rating.

Factors that could, individually or collectively, lead to negative rating
action/downgrade:

SDB’s rating could be downgraded if capital buffers were to be substantially eroded due to weakening asset quality, higher under-provisioned impaired loans or
prolonged rapid loan growth in the more vulnerable customer segments, which
indicates a significantly higher risk appetite.

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Sri Lanka in deep talent drain in latest currency crisis

ECONOMYNEXT – Sri Lanka businesses are facing a drain of talent, top business executives said as the country suffers the worst flexible exchange rate crisis in the history of its intermediate regime central bank and people lose hope.

“We are seeing a trend towards migrating,” Krishan Balendra, Chairman of Sri Lanka’s John Keells Holdings told an economic policy forum organized by the Ceylon Chamber of Commerce.

“We have seen an impact mainly on the tourist hotels side, quite an exodus of staff (migrating) to countries we have not seen in the past. 

“We have seen people go to Scotland, Ireland. It has usually been the Middle East and Maldives. Australia seems like a red hot labor market at the moment.”

Sri Lanka’s rupee collapsed from 200 to 360 to the US dollar after macro-economists printed money to suppress rates.

Sri Lanka operates a ‘flexible exchange rate’ where errors in targeting interest rates are compensated by currency depreciation especially after the 1980s.

Classical economists and analysts have called for the power to mis-target rates and operate dual anchor conflicting monetary regimes should be taken away to prevent future crisis.

Currency crises are problems associated with flexible exchange rate central banks which are absent in hard pegs and clean floats.

“Something new we are seeing is that older people, even those in their 50s, which was a surprise, are looking at migrating,” Balendra said.

Businesses are trying to retain talent as real wages collapse.

Balendra said as businesses they see some stability returning and based on past experience growth is likely to resume, and they were communicating with the workers.

“We have a degree of conviction that the economy should get better, its the stability phase now and it will get better going forward so without the way our businesses are placed we should see good growth,” Balendra said.

“We can’t chase compensation that’s just not practical and we are not trying to do that especially if people are looking to immigrate but what we can do is show the career opportunities in the backdrop of the situation that people would rather stay here because its home.” 

Sri Lanka unit of Heineken says it is also trying to convince workers not to leave, with more success.

“We are all facing the effects of brain drain and it’s not just the lower levels… What we are doing is a balance of daring and caring,” Maud Meijboom-van Wel – Managing Director / CEO, Heineken Lanka Ltd told the forum.

“Why I say daring is, you have to be clear in what you can promise people, when you make promises you have to walk the talk. So with the key talents and everyone you need to have the career and talent conversations.

“I am a bit lucky because I am running a multinational company so my career path goes beyond Sri Lanka so I can say if you acquire certain skills here, then you can move out of here and then come back too, that is a bit easier for me but it starts with having a real open conversation with walking the talk – dare and care.” (Colombo/Dec7/2022)

 

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Despite losses, Sri Lanka to resume “park & ride” transport after complaints  

ECONOMYNEXT –  Sri Lanka’s state-run Transport Board will resume its loss-making City Bus service from January 15, 2022 Cabinet Spokesman Bandula Gunawardena said, after the service abruptly discontinued with the state-run firm’s director board citing losses.

The City Bus service was introduced in 2021, under the government of former President Gotabaya Rajapaksa, from Makubura to Pettah and Bambalapitiya.

The service was started to reduce the number of automobiles travelling to and from Colombo and suburbs by providing a comfortable, convenient and safe public bus transportation for passengers and riders who use cars and motorcycles as their means of transportation.

During the time period in which the service was initiated, there were 800 hundred vehicles that would be parked and would use the system, Gunawardena, who is also the Transport Minister, said.

The service was later collapsed due to inconsistencies in scheduling and it was completely stopped after

“Without informing the Secretary or the Minister of the relevant Ministry, the Board of Directors have come to a conclusion that this is loss making route and must be halted,” Gunawardena said.

“The users of the City Bus service brought to our notice and therefore I gave the Secretary to the Ministry of Transport the approval to start the City Bus service from January 15.”

“If we stop all loss making transport services then massive inconveniences will occur to the people in far parts of the island.”

The chairman of the state run Ceylon Transport Board has been asked to handover the resignation letter by the Minister Gunawardana citing that the head has failed to implement a policy decision approved by the government. (Colombo/ Dec 06/2022)

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Sri Lanka may see rates falling next year: President

ECONOMYNEXT – Sri Lanka’s interest rates are high and hurting small businesses in particular but interest rates are required to maintain stability, President Ranil Wickremesinghe said.

“One is, all of you want to know what’s going to happen to the interest rates?,” President Wickremesinghe told an economic policy forum organized by the Ceylon Chamber of Commerce.

“I wish I know. The governor has told me that the inflation has peaked. It’s coming down. You all understandably want some relief with the interest rates to carry business on.”

“I understand that and appreciate the viewpoint. It’s not easy to carry business on with such high interest rates. On the other hand, the Central Bank also has to handle the economy. So maybe sometimes early next year we will have a meeting of minds of both these propositions.”

Sri Lanka’s interest rates are currently at around 30 percent but not because the central bank is keeping it up. The central bank’s overnight policy rate is only 15.5 percent but the requirement to finance the budget deficit and roll over debt is keeping rates up.

Rates are also high due to a flaw in the International Monetary Fund’s debt workout framework where there is no early clarity on a whether or not domestic debt will be re-structured.

After previous currency crises, rates come down after an IMF deal is approved and foreign loans resume and confidence in the currency is re-stabilished following a float.

This time however there has been no clear float, though the external sector is largely stable and foreign funding is delayed until a debt re-structure deal is made.

Sri Lanka’s external troubles usually come because the bureaucrats do not believe market rates are correct when credit demand picks up and mis-uses monetary tools given in 1950 by the parliament to suppress rates, blowing the balance of payments apart.

The result of suppressed rates by the central bank are steep spikes in rates to stop the resulting currency crisis.

A reserve collecting central bank has little or no leeway to control interest rates (monetary policy independence) without creating external troubles, which is generally expressed as the ‘impossible trinity of monetary policy objectives’.

However, it has not prevented officials from trying repeatedly to suppress rates, perhaps expecting different results.

After suppressed rates – supposedly to help businesses – trigger currency crises, the normalization combined with a currency collapse leads to impoverishment of the population.

The impoverishment through depreciation leads to a consumption shock, which also leads to revenue losses in businesses.

The suppressed rates then lead to bad loans.

In the 2020/2022 currency crisis the sovereign default has also led to more problems at banks. Several state enterprises also cannot pay back loans.

“…[T]he bad debt that is being carried by the banks is mainly from the private sector or the government sector,” President Wickremesinghe said.

“Keep the government sector aside. We’re dealing with it. How do you handle it? Look, one of our major areas of are the small and medium industries. You can’t allow them to collapse, but they’re in a bad way.”

Classical economists and analysts have called for new laws to block the ability to central bank to suppress rates in the first place so that currency crises and depreciation does not take place in the first place.

Then politicians like Wickremesinghe do not have to take drastic and unpopular measures to fix crises and there will be stability like in East Asia.

Sri Lanka had stability until 1950 when the central bank was created by abolishing an East Asia style currency board. The currency board kept the country relatively stable through two World Wars and a Great Depression.

In 1948 after the war (WWII) was over “we stood second to Japan” Wickremesinghe said.

“But we started destroying it from the sixties and the seventies,” he said. :We started rebuilding an economy, which was affected by a (civil) war, and thereafter the way we went, is best not described here.”

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