Sri Lanka’s financial system remained resilient during the first quarter of 2026 despite heightened tensions in the Middle East, exchange rate volatility and growing global economic uncertainty, according to the Central Bank of Sri Lanka (CBSL).
In its latest Financial Stability Review, the CBSL said domestic macrofinancial conditions remained broadly supportive during the first three months of the year, with lending activity accelerating and financial intermediation continuing to recover.
The report noted that credit growth strengthened across both banks and finance companies, driven mainly by increased private sector borrowing. As a result, lending exposures shifted further toward the private sector while exposure to the Government and state-owned enterprises moderated slightly.
However, the Central Bank cautioned that the widening credit-to-GDP gap signals a potential build-up of systemic risks within the financial sector.
“The financial system remained resilient during the first quarter of 2026 amidst challenging global and domestic conditions arising from heightened tensions in the Middle East and global uncertainties,” the report said.
The banking sector recorded a 24.4% year-on-year increase in credit at the end of the first quarter, compared with 7.9% growth a year earlier. Non-performing loans also continued to decline, with the Stage 3 loan ratio improving to 9.4% from 12.7% a year earlier.
Although liquidity buffers and capital adequacy ratios declined slightly due to strong lending growth, they remained comfortably above regulatory requirements, the CBSL said.
Meanwhile, profitability in the banking sector eased during the quarter, with profit after tax declining by 7.1% year-on-year, mainly due to higher operating expenses.
The finance company sector also recorded strong growth, with total credit expanding by 52.4% year-on-year. The increase was largely driven by vehicle financing and gold-backed lending, which grew by 52.8% and 69.2%, respectively.
The CBSL said finance companies maintained satisfactory liquidity and profitability levels despite a slight moderation in capital adequacy.
Financial markets, however, faced increased pressure during the first five months of the year. The Colombo Stock Exchange experienced heightened volatility, while foreign investors continued to withdraw funds from the market. Net foreign outflows from equities reached US$103.4 million by the end of May.
Government securities yields also rose during the period, particularly after the Central Bank increased policy interest rates in late May.
The Sri Lankan rupee remained volatile amid external sector pressures, while surplus liquidity persisted in the domestic money market.
In response to rapid growth in collateral-based lending and increased asset price volatility, the Central Bank introduced new macroprudential measures in May. These include a maximum loan-to-value ratio of 70% for gold-backed loans and tighter lending limits for vehicle financing.
Looking ahead, the CBSL warned that elevated energy prices, commodity market volatility, adverse weather conditions, exchange rate pressures and rising inflation could pose risks to financial stability.
The report stressed that continued fiscal consolidation, stronger external buffers and close monitoring of emerging risks will be essential to safeguarding the stability of the financial system. (Newswire)
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