Stable outlook for SL banking system driven by continued GDP growth: Moody’s

Dec 04, 2015 (LBO) – Continued GDP growth is driving the stable outlook for Sri Lanka's banking system, Moody's Investors Service said. "While seeing some slowdown compared to the growth rates seen in 2013-14, GDP growth in Sri Lanka should remain healthy at 6.



7% over 2015-16. And an accommodative monetary policy should support this growth outlook," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.



"In addition, greater participation from private sector in investments, compared to what was seen over the past few years, should provide an impetus to loan growth," adds Vadlamani. Vadlamani was speaking on Moody's annual outlook update for Sri Lanka's banking system, titled "Banking System Outlook -- Sri Lanka: Continued Growth Drives Stable Outlook" According to Moody's, asset quality will stabilize at their current levels. Asset quality has improved over the past 18 months, with the gross nonperforming loan ratio coming down to 4.

3% in June 2015 from 5.6% in December 2013. Problems in the pawning sector -- the key reason for the pick-up in nonperforming loans in the recent past -- have been addressed. At the same time, banks' underwriting standards have been fairly tight over the past two years, as reflected in loan growth of only 14% over 2013-14. Moody's says profitability will remain stable over the next 12-18 months, despite moderate pressure on net interest margins.



On the one hand, net interest margins will remain under pressure, primarily due to the low interest rate environment. On the other hand, banks will benefit from positive operating leverage as loan growth picks up, leading to an improvement in their cost-to-income ratios.



Some banks will also benefit from lower credit costs as the higher credit costs associated with pawning NPLs may no longer be required.

Moody's also expects a deterioration in funding and liquidity conditions. Although the current level of liquidity in the system is adequate with the statutory liquidity ratio in the domestic book at 36%, liquidity should tighten over the outlook horizon, as Moody's expects annual loan growth of around 20%, faster than deposit growth of 16%. As a result, banks' funding profiles will be under pressure, as they need to increase their dependence on more expensive sources of borrowing, including foreign-currency borrowings.



Finally, Moody's expects government support of individual banks will be forthcoming, if needed.