The soundness of the banking industry is improving as interest rates decline and economic conditions stabilize, though challenges remain with non-performing loans (NPLs) in certain domestic banks. According to a report from the Central Bank of Sri Lanka, financial soundness indicators such as credit quality, liquidity, and capital adequacy have strengthened during the first half of 2024, reflecting a gradual improvement in the resilience of financial institutions.
Interest rates have eased, with deposit rates falling ahead of lending rates, contributing to a better economic environment. However, the NPL ratio remains high, indicating ongoing challenges in the sector. While the overall NPL ratio fell to 12.8% by the second quarter of 2024, down from 13.5% a year earlier, certain domestic banks not classified as systemically important saw their NPL ratios rise from 12.9% to 13.4%.
Despite the 2.2% contraction in NPLs, the Central Bank noted that banks are setting aside more funds to cover the risk of loans not being repaid: the industry average coverage ratio for loans that have been overdue for more than 90 days increased to 51.1% by mid-2024, compared to 44.8% a year earlier. The Central Bank reported that banks have bolstered their business revival units to assist viable businesses facing financial difficulties, thereby preemptively securing the quality of their lending books.
The Central Bank says banks must be more vigilant after the state suspended the use of Parate Executions to recover mortgaged assets until December 2024. Parate Executions are a legal process allowing the sale of mortgaged properties without going through legal and formal court proceedings to recover bad loans. The banking regulator warned that the suspension could create a moral hazard (a lack of incentive) among borrowers to service their debts, leading to further defaults in the future.