The Central Bank has kicked off an asset quality review of the country’s banking sector to identify possible stresses in different pockets of banks’ balance sheets as they provide enormously on possible bad loans and other financial asset losses in 2022 with the final stretch of moratoria expiring early this year.

Despite remaining stable and resilient, Lankan banks are undergoing their most challenging operating conditions in their history with growth and profits faltering amid rising non-performing loans and capital risks.

Central Bank Deputy Governor Yvette Fernando recently said nine banks that have been identified as having asset quality stress will be reviewed soon.

Fitch Ratings warned that Sri Lanka’s banks are likely to face continued asset-quality pressure in 2022, as rising macroeconomic stresses stemming from the sovereign credit profile pose a threat to borrowers’ repayment capacity, alongside the conclusion of most relief measures in 2021.

“We believe Sri Lankan banks face added asset-quality pressure from their Government securities holdings, particularly those denominated in foreign currency which accounted for around 6.5% of Fitch-rated banks’ total assets at end-9M21,” the rating agency noted.

The Deputy Governor also said the review of the banks will be conducted in a phased manner. “We will review six banks in the first phase and another three banks thereafter,” Fernando added.

In April, Fitch Ratings again placed the National Long-Term Ratings of 13 Sri Lankan banks on Rating Watch Negative (RWN).

The banks include; People’s Bank, Commercial Bank of Ceylon PLC, Hatton National Bank PLC, Sampath Bank PLC, National Development Bank PLC, DFCC Bank PLC, Seylan Bank PLC, Nations Trust Bank PLC, Pan Asia Banking Corporation PLC, Union Bank of Colombo PLC, Amana Bank PLC, SANASA Development Bank PLC and Housing Development Finance Corporation Bank of Sri Lanka.

“We are looking at each bank for the potential risk that they could face going forward in rising NPLs, interest rate impact and exchange rate impact and if they are going to have any pressure on capital and liquidity,” said the Central Bank Governor. Nandalal Weerasinghe.

“Going forward that’s why one of the exercises we are doing is the ‘Asset Quality Review’, for us to understand the kind of stress the banks are going to face in the future. Based on the work we do with the banks, we can come out with recommendations on how to deal with that situation,” he said.

The Sri Lankan banking sector is witnessing record provisions against possible bad loans and other financial asset losses stemming from their exposure to sovereign bonds, which has undermined their profitability to a greater extent.

The risk of domestic debt restructuring remains an overhang, which could add enormous pressure on the capital Weerasinghe declined to comment on the possibility of a domestic debt restructuring claiming it’s too premature.

Meanwhile, a large number of borrowers are also falling behind their loan repayments after the interest rates rose at least three times from where they were before the economic crisis, with the Central Bank raising the key policy rates at a record pace to tamp down runaway prices.

Bangladesh is expected to get back the money, which was borrowed by Sri Lanka, from September this year as the country’s economic situation is improving, Bangladesh Foreign Minister AK Abdul Momen has said.

“Sri Lanka is gradually doing better. They are recovering slowly,” Foreign Minister AK Abdul Momen told reporters.

On January 12 this year, Bangladesh Bank granted Sri Lanka six more months to repay the loan after the Island nation requested to extend the repayment period due to its prolonged economic crisis.

In a friendly gesture, Bangladesh extended the loan to cash-strapped Sri Lanka under a currency swap arrangement in 2021.

Bangladesh remains hopeful that Sri Lanka will repay the debt of $200 million that it owes to the country by September 2023,and it was supposed to return in three instalments in February and March 2023.

Although Sri Lanka was due to make the repayment earlier, Bangladesh extended the deadline for repayment in light of the crippling economic crisis which had plagued Sri Lanka.

Bangladesh Bank, Bangladesh’s central bank, has in principle approved a $200 million currency swap agreement with Sri Lanka, which will help Colombo tide over its foreign exchange crisis, according to media reports from Bangladesh, quoting the bank’s spokesman.

Sri Lanka, staring at an external debt repayment schedule of $4.05 million last year year, is in urgent need of foreign exchange.

The two sides have to formalize an agreement to operationalize the facility approved by Bangladesh Bank. Dhaka decided to extend the facility after a request by Sri Lankan Prime Minister Mahinda Rajapaksa to Bangladesh’s Prime Minister Sheikh Hasina.

In this context, a currency swap was effectively a loan that Bangladesh has given to Sri Lanka in dollars, with an agreement that the debt will be repaid with interest in Sri Lankan rupees.

For Sri Lanka, this was cheaper than borrowing from the market, and a lifeline as is it struggles to maintain adequate forex reserves even as repayment of its external debts looms. The period of the currency swap will be specified in the agreement.

Bangladesh has not been viewed so far as a provider of financial assistance to other countries. It has been among the most impoverished countries of the world, and still receives billions of dollars in financial aid.

But over the last two decades, its economy has pulled itself up literally by the bootstraps, and in 2020, was the fastest growing in South Asia.

Bangladesh’s economy grew by 5.2 per cent in 2020, and was expected to grow by 6.8 per cent in 2021. The country has managed to pull millions out of poverty. Its per capital income just overtook India’s.

This may be the first time that Bangladesh is extending a helping hand to another country, so this is a landmark of sorts.

Bangladesh’s forex reserves were a healthy $45 billion. Despite fears that the pandemic would hit remittances, Bangladeshis living abroad sent over $21 billion. It is also the first time that Sri Lanka has borrowed from a SAARC country other than India.

Sri Lanka’s commercial banks are now faced with debt default issues of borrowers hit by unprecedented income tax and corporate tax hike with Non-Performing Loans (NPLs) increasing beyond its control, several general managers of banks complained.

On top of these grave financial issue the Central Bank Governor Nandalal Weerasinghe says that Sri Lanka’s banks should explore restructuring loans of high income earning employees hit by progressive tax, Central Bank Governor Nandalal Weerasinghe said as progressive income taxes were imposed at lower thresholds amid high inflation following a sovereign default

The Central Bank of Sri Lanka (CBSL) forecasts Non-Performing Loans (NPLs) as a percentage of all bank loans to reach 8% in 2022, from 4.5% in 2021, while it expects the economy to contract by around 8%, in a revision to its previous forecast of a 7.5% contraction.

CBSL is working with banks to minimize the economic contraction’s impact on the banking sector as NPLs will rise as a result of the contraction, and added that the NPL ratio is forecasted to be 8% for 2022.

He said the economy would contract by around 8% 2022, surpassing the CBSL’s previous forecast of a 7.5% contraction.

He added that a sharper contraction of the economy means recovery can be faster from next year onwards, as Sri Lanka could start to recover in the second half of 2023, with attention to external factors such as a possible global recession, and the possibility of Sri Lanka maintaining normal economic conditions while sectors such as tourism make a fast recovery

Weerasinghe noted that picketing state enterprise executives have made complaints along with other workers of such agencies such as Sri Lanka Port Authority that high progressive taxes were resulting in making their bank accounts into overdraft after loan installments were deducted.

“Yes, they have mentioned that,” Governor Weerasinghe said responding to questions from reporters.

“We have told the banks earlier as well. Because the interest rates are high and their business being reduced, the SME sector, the repaying capability has reduced.

“We have told them to explore their repaying capabilities and restructure their loans in order to safeguard both sides. At this time also we are asking the banks to do that.”

Further some state owned enterprises used to pay the Pay-As-You-Earn tax, of salaried employees in the past.

It is not clear whether the volumes of loans involved were large enough to cause concerns.Bad loans of the banking system overall had risen after the rupee collapsed, reducing the spending power in the economy, while rates also went up as money printing was scaled back, foreign funding stopped and the budget deficit widened.

Sri Lanka’s revenue in January is far below the expected increase of 69 percent due tax increases and not sufficient to meet all current expenditures except those payments pertaining to salaries, pensions, welfare, pharmaceuticals and debt servicing, official sources said.

Sri Lanka’s government revenues were Rs.158.7 billion rupees in January 2023 but expenditure and debt service remained high, In January 2022 total revenues were Rs.104.5 billion without any tax increases according to central bank data,

Comparatively there was an increase of Rs 54.2 billion in January 2023 considering the January 2022 revenue of Rs.104.5 billion where there were no tax revisions at that time, economic analysts said adding that the revenue collection authorities should have been collected Rs.230.83 billion to meet the target.

Without making unnecessary structural adjustment and streamlining the tax administration, the government will not be able to collect the tar getted revenue this year, they said.

The budget has aimed at increasing tax revenue by 69 percent to Rs. 3,130 billion in 2023 from this year’s Rs.1,852 billion while bringing down the budget deficit to 7.9 percent in 2023 from this year’s revised 9.8 percent

President Ranil Wickremesinghe has notified the Cabinet that the Government revenue for the month of January 2023 is far below the monthly expenditure estimates, and instructed all relevant authorities to curtail Government expenditure.

He further noted that the General Treasury too, is finding it challenging to meet all current expenditures except those payments pertaining to salaries, pensions, welfare, pharmaceuticals and debt servicing, the President’s Media Division (PMD) reported.

Sri Lanka’s tax revenues have risen sharply amid an inflationary blow off which had boosted nominal GDP while President Ranil Wickremesinghe has also raised taxes.

Departing from a previous strategy advocated by the IMF expanding the state and not cutting expenses, called revenue based fiscal consolidation, he is attempting to do classical fiscal consolidation with spending restraint, the pointed out

According to a note presented by President Wickremesinghe to the cabinet, public sector salaries cost Rs.87.4 billion.Pensions and income supplements (Samurdhi program) were Rs.29.5 billion Other expenses were Rs. 10.8 billion.Capital spending was Rs.21 billion.

Debt service was Rs. 377.6 billion for January which has to be done with borrowings from Treasury bills, bonds and a central bank provisional advance of Rs. 100 billion.

This more recent drop in income from taxation along with a failure to acknowledge and re-structure the mounting debt earlier are the causes behind the current crisis, and not as some believe consequences of current global economic pressures relating to the Covid-19 pandemic and the war in Ukraine.

Equally, this is not a trap set by China to ensnare Sri Lanka, they claimed.