Banking sector to unlock next chapter with declining interest rates, pickup in economic activity

The Sri Lankan banking sector is ready to unlock the next chapter in banking benefitted by declining interest rates and pickup in economic activity, which is expected to boost banking sector via expansion in loan book, and fee and commission incomes.

First Capital Research says that furthermore, with minimum capital expenditure allocations of 25.0% across all banks, commercial banks in Sri Lanka are preparing themselves for the next phase of digitalization.

This is expected to drive down operating costs of banks in the medium term, increasing profitability during the coming years. The Sri Lankan banking sector has struggled during post-covid period, impacted by slowdown in business volumes, rising impairments and GoSL defaulting on outstanding debt.

“However given the favorable outlook for banks in the coming months, we expect the overall banking sector to reiterate up and trade at its past 10Yr PBV multiple of 1.0x by 2024 end.”

Aggressive policy actions undertaken by the CBSL via three rate cuts totaling to 550bps have prompted private sector credit to grow consecutively for 3 months to Aug-23. “FCR expects private sector credit to rebound enabling loan book expansion during 2H2023. Gross loans in the banking sector are expected to record a tepid growth of 5.0% in 2023E, with growth largely driven during the second half of 2023 end.

Stage 3 non-performing loans in the banking sector are expected to decline from current high levels to 13.5%-11.0% between 4Q2023E-2025E.

“The improvement in NPL ratio is largely attributable to the improved recoveries as well as the broadening of the loan base, due to the expected recovery of the economy.”

The Banking sector performance, which is a proxy to the economic performance, recorded a 27.0%YoY decline in profitability while the economy contracted by 7.8%YoY in 2022. “The recovery in the economy is expected to boost the outlook for the listed banking sector, targeting profits to grow at 40% in 2023E and 60% in 2024E.”

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