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“Banking stocks expected to re-rate upwards”

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With Sri Lanka’s economic conditions expected to improve with the support of the IMF-driven reforms and fundamentally sound economic policies in place, the banking stocks are expected to re-rate upwards and trade more in line with the historical trading multiples.

Banks are currently trading an attractive valuation with the banking sector’s Price to Book Value (PBV) ratio at 0.6x and Price Earnings Ratio (PER) at 4.8x.

The post-covid economic environment and uncertainties regarding external debt restructuring have weighed on investor sentiment; resulting in the banking entities trading at the presently low valuations.

“We expect banking stocks to re-rate to a PBV ratio of 0.8x-1.0x in the near term,” says SC Securities in their Banking Sector, ‘Recent Developments and Outlook June 2024’ report providing a detailed overview of the banking industry in Sri Lanka. The Sri Lankan Banking Industry has grown from humble beginnings since the 1800s into a well-developed industry consisting of 30 banks (24 licensed commercial banks, 6 licensed specialized banks), regulated by the Central Bank of Sri Lanka (CBSL). The BASEL III framework (which strengthened capital adequacy of banks and reduced industry risk) was the recent regulatory standard adopted by the Banks under the guidance of the CBSL.

The Covid-19 pandemic slowed down economic performance and laid stress on the banking industry. During the two-plus years following the onset of COVID-19, the CBSL undertook a variety of measures to support the banking industry and its customers, such as extended debt moratoriums, reduction in policy interest rates and the statutory reserves ratio (SRR), and allowing licensed commercial banks (LCBs) to draw down on capital buffers. These measures enabled the banking sector to weather the pandemic and its ripple effects.

Further, the CBSL is encouraging consolidation of the banking sector whereby the weaker entities would merge with the larger entities, to further strengthen the financial resilience of the sector. In Q4 CY2023, the bank and branch network for LCBs stood at 6,814, whereas for Licensed Specialized Banks (LSBs) the same was 706.

At present they account for 89% of total banking sector assets; thus the systemic importance of the segment is high in the overall industry.

The two largest LCBs are the Bank of Ceylon, and Peoples Bank (state-owned entities) holding a market share of 23.5% and 20.5%, respectively, in terms of the net loan book.

The government intends to divest a 20% stake in these two banks to private investors, which is expected to improve operational efficiency in these entities.

Amongst privately owned banks the three largest are Commercial Bank PLC, Hatton National Bank, and Sampath Bank holding market shares of 13.6%, 10.7% and 9.0%, respectively, in terms of the loan book.

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