While assets held by Sri Lankan banks will likely retain their value over 2012, these assets, and especially those related to export and tourism, could still be negatively effected by the heightened volatility in the global economy. As such, banks should prepare by shoring up their Tier 1 capital buffers, says ratings agency Fitch.
According to the agency; "While the Tier 1 ratios of Sri Lankan banks have remained above the 5% regulatory [minimum], Fitch believes that profit retention and capital raising will be needed to support strong loan growth. The sector's Tier 1 ratio stood t 13.4% at end-Q211. Assuming annual growth of 20% in the sector's risk-weighted assets in 2010-2014, the agency estimates that about Rs. 75 billion (US$ 0.66 billion) would be required over the next three years to maintain a comfortable capital adequacy ratio (CAR) of 9%. While a substantial portion of this could be raised via profit retention, further capital raising would be required in view of current growth."
This measure would also likely counter Fitch's stated concerns regarding the "Sri Lankan banking system's ability to manage a sustained level of above-average loan expansion."
This was revealed in Fitch's recently issued "2012 Outlook: Sri Lankan Banks" report, where the agency, referring to the country's banking sector overall, opined that "healthy profitability could continue to be delivered in 2012, supported by strong loan demand, manageable credit costs and reduced taxes." However, it also stressed that banks' net interest margins (NIMs) would "continue to come under pressure due to intensifying competition." The report also stated that "NIMs of Sri Lankan banks have already begun to contract due to rising funding costs, which are the result of competition for deposits amidst diminishing liquidity."
This 2012 Fitch report also signalled that the local banking sector "experienced strong loan growth of about 24% (annualised) in 6M11 and Fitch forecasts loan growth to remain above 25% in 2012 supported by strong economic growth. The loans to GDP ratio increased marginally in H111 to 36% from 35% at end-2010, which is still below the 41% average from 2006-2008.
Fitch expects the focus to remain on lending to SMEs and the consumer / retail segment in search of higher NIMs. Although this could deliver greater diversification of loan books to more granular exposures, there could be challenges in terms of the need for improvement in risk management processes and systems, particularly for those banks that are relatively new to lending to this segment. Credit concentrations to corporate customers are likely to continue in the absence of a developed corporate debt market.
While Fitch expects all banks to benefit from better lending prospects through 2012, the two largest and state-owned banks are likely to continue to dominate, given their presence across the country and ability to source business from the state sector (state and state-owned entities)."