Fitch Ratings has raised concerns about the financial health of Sri Lanka’s state-owned banks, warning that their capital levels remain weak despite strong profits in 2024. This is mainly due to a mandatory capital reserve they must maintain to cover risks from restructured foreign loans given to the government.
According to Fitch, the Central Bank has instructed banks to set aside a special reserve equal to 15% of their outstanding foreign currency loans and bonds to the government, which were recently restructured.
This reserve is not counted as part of the banks’ capital, directly affecting their capital adequacy ratios. The rule applies for six months from the end of 2024, but Fitch expects further regulatory measures to follow.
This move hits state banks hardest, particularly Bank of Ceylon (BOC) and People’s Bank (PB), which together had to allocate 72% of their profits—equal to 2.2% of risk-weighted assets—toward this special reserve. Without this requirement, their capital ratios would have increased by about 2 percentage points.
Fitch noted that over two-thirds of these restructured loans originated from a state-owned enterprise, and they accounted for around 14% of the banks’ combined loan books and 7% of their total assets. These loans were restructured as part of the broader sovereign debt restructuring completed in 2024.
Despite the financial strain, state banks are not expected to fail. Their high exposure to the government—more than half of their assets—continues to tie their financial health closely to the state. However, Fitch warns that if the risk weights on these foreign loans were raised to 100%, the Tier 1 capital levels of BOC and PB could fall below 10%, a potentially worrying threshold.
With this in mind, attention is now turning to the government’s 2023 budget, which allocated Rs. 450 billion for possible support to state banks and other sectors. There is growing speculation that a portion of this amount could be infused into BOC and PB during 2025 to shore up their capital base and help meet regulatory buffers.
Fitch said the long-term pressure on these banks will ease if lending shifts more toward the private sector and less toward the government. However, in the short term, state support may be necessary to keep them compliant and stable.
The strong national ratings of the state banks still reflect their dominant market share—over one-third of sector assets and deposits—and solid funding through wide branch networks and close government ties. But Fitch made it clear: without capital infusion or regulatory relaxation, their vulnerability will remain a key concern.
In contrast, large private banks like Commercial Bank and Hatton National Bank faced a much smaller impact, as their exposure to government debt—mostly through international sovereign bonds—was lower, making up just 3.2% of assets.Private banks were also able to reverse some provisions set aside earlier for potential losses from government bond exposure. Initially, they had provisioned about 52% of their holdings, but after the final losses turned out to be only around 30%, the excess was written back, boosting profits
