The report, titled "Uncertainty Over Sri Lanka's Policy Direction Could Affect Bank Consolidation,"
Standard & Poor's believes the consolidation plan announced earlier offers an opportunity to increase the resilience of the financial system and could lead to more effective oversight. Nevertheless, questions remain as to whether the consolidation plan can be successfully implemented, given the short implementation time frame and execution risks.
"The consolidation plan had sought to create a strong and stable financial sector by mid-2015. However, the new government seems to have put the plan on hold till the parliamentary elections are over," said Standard & Poor's credit analyst Deepali Seth Chhabria.
Credit growth in Sri Lanka's banking industry is likely to recover to 15%-17% in 2015 after annual growth of 13.7% in 2014. However, banks should maintain their funding profiles because of a similar growth in deposits.A sharp pickup in credit growth above Standard & Poor's base case could weaken capitalization levels for Sri Lanka's banks, the report notes. The Tier 1 ratio for the banking industry has declined steadily to 13.1% as of Dec. 31,2014, compared with 14.9% in 2013. While this ratio is well above the regulatory minimum of 5%, we believe it's overstated because of the absence of a capital charge on a key sector like pawning.
Standard & Poor's believes the asset quality for Sri Lankan banks has bottomed out after deteriorating in the first half of 2014.
"We expect the asset quality of Sri Lanka's banks to improve on the back of favorable economic conditions, low domestic interest rates, the credit guarantee scheme for pawning loans, and relatively stable gold prices," said Chhabria.