How the economic crisis has reset People’s Bank short-term objectives

Economic crises invariably impact banks by pushing up bad loans and constraining liquidity. Sri Lanka’s second largest bank by assets, People’s Bank’s Chief Executive Ranjith Kodituwakku discusses the bank’s approach to the challenge.

For several years, People’s Bank has been one of Sri Lanka’s most profitable banks – across both State and Private – which has helped it maintain benchmark levels of solvency from a regulatory capital perspective. This has, and is likely to continue to help the bank relatively better navigate through these challenging circumstances as Sri Lanka’s deeply distressed macro-economic environment continues to erode the quality of loan books across the industry.

In an interview People’s Bank’s Chief Executive Ranjith Kodituwakku highlighted the bank’s balance sheet growth as a secondary priority in a contracting economic context, whilst safeguarding its depositors and efforts to further strengthen the Institution’s risk management framework takes front seat. Kodituwakku suggests the bank may absorb some of the losses arising from its lending at lower interest rates in the more shorter-term. He reasonably expects that ongoing and expected reforms will likely shape the country’s path to stabilisation and, aided therefrom, it will slowly help interest rates reduce on a systematic basis during 2023.

Sri Lanka is facing a challenging economic period and it’s affected many industries and people. How have the current economic conditions impacted banking?

It has, on many fronts. As the backbone of any economy, the banking industry is a victim in the first instance of any macro level distress.

By way of example, from a macroeconomic standpoint, with the country’s GDP set to contract by close to 10.0% this year, this has given rise to a shortfall in liquidity across the entire industry and caused sizable pressure on customer repayments and asset quality. The downgrading of the sovereign rating by both Fitch and S&P from its pre-COVID levels to what is now a default status has meant that the industry’s new access to foreign sources of funding is now nearly non-existent. In addition, with the rupee devaluing by close to 80.0% and, as a primary result thereto, inflation peaking at near 70.0% levels has meant sizable cost pressures from an institution standpoint, and exacerbated pressure on asset quality amongst others. Further, in view of addressing high inflation, the Central Bank increased policy rates by 700 basis points in April this year, which has seen interest rates on government securities over-shooting to near 30.0% levels, which were previously unseen. This has caused substantial earnings pressure as deposits of banks have got repriced at a faster pace relative to their loan books.

Needless to say, pressure is all-around. In my four decades of experience, this is the first.

Banks are sensitive to changes in interest rates because their customers are. It also determines the demand for credit. How is People’s Bank navigating the current interest rate environment?

It is very challenging. The key is however to strike the right balance. On one hand, deposit liabilities, which are close to 80.0% of total industry funding, get repriced faster. Needless to say, the higher rates are naturally attractive for depositors. This has resulted in many converting their savings to more significantly higher yielding fixed deposits.

On the other hand, if the assets are repriced at the same pace, it will make it difficult for borrowers to service their debt. So, taking a balanced approach here is key; particularly in the case of our retail and SME customers. One important aspect to keep in mind is that much of the fixed deposits are at tenors of one year or less and thus, should interest rates come down in the short term, these deposits will get similarly repriced downward.

Is the higher cost of your deposit base, when your loan book isn’t following suit, the most concerning short-term challenge you face?

It is important to manage the pressure on net interest margins and strike the right balance between transferring such burden to the customer whilst managing customer delinquencies. However, the strategy adopted here will differ from bank to bank. Whilst some may choose to transfer their entire incremental cost of funding to their customers, certain others, such as us, may opt to absorb a portion of such losses and transfer only to the extent they can manage. With many of our retail customers being fixed-income earners, with inflation soaring, their ability to service their debt is already under pressure. So, naturally this repricing needs to be managed delicately. The same applies across our SME customers. On our corporate customers, to our benefit, much is on floating rates of interest.

As Chief Executive, how do you balance the short-term and long-term needs of People’s Bank?

Foremost, I don’t reasonably expect such high interest rates to persist in the longer term. As a country, this is unsustainable. The question is how we manage our business until interest rates reduce.

In the shorter term, profitability is not our focus but stability, solvency, risk management and more importantly safeguarding our customers is. Post an IMF engagement, we reasonably expect the risk premium to come off and interest rates to gradually reduce. In this context, it must be pointed out that the Ministry of Finance and the Central Bank of Sri Lanka have laid the necessary foundation requisite for an economic stabilization to take place. We look to the future with a degree of optimism.

Your shareholder is the government, and some of your biggest customers are state-owned enterprises. Is this significantly affecting your liquidity, even though your commercial relationships with them are profitable?

Contrary to popular belief, it must be said that not all state exposures are at market rates. Several are yet at concessionary rates of interest. Here, the goal for us as a State Bank is to do so as it benefits the society at large. Therefore, whilst financing some of them at lower rates of interest does not necessarily translate to higher profit, it helps us fulfil a key responsibility as a State Bank.

Currently, Sri Lanka appears to be pursuing an ambitious state-sector restructuring programme. A lot of assets in your balance sheet are state-sector loans to the government or state-owned enterprises. The reforms may shrink the public sector’s role in the economy. How will this affect your balance sheet?

Ultimately, the creation and enhancement of efficiency and productivity through restructuring and other means is net positive. For us as a Bank, the improved standalone profile naturally dictates higher and improved capacity to service their debts without any state support. Needless to say, this is a good thing. On a more longer-term basis, this will help the country, the Institution and, equally importantly, the State Banks. In this context, it is also worthy to point out that, only a few years ago People’s Bank’s exposure to the State Sector was as high as 54 percent of its total loans which is now, around 44 percent. So, we have meaningfully balanced our lending to both private and state-owned enterprises.

How will People’s Bank approach its future capital needs?

As done in the recent past, primarily through a combination of Basel III compliant Tier II and Additional Tier I debt issuances and through higher earnings retention. In addition, as the Bank’s ultimate beneficial owner, we are also bound to act on instructions from the Ministry of Finance as and when necessary.

With the prohibitively expensive rates that will decline in time, borrowing isn’t an enticing prospect. How do you aim to grow your assets and balance current circumstances when the cost of capital is so high?

With the economy set to recover only in the second half of next year, naturally our lending will be synchronized with such revival, with a focus more on critical areas such as Small and Medium Scale Enterprise and those export oriented. In general, the Banking industry is unlikely to witness pre crisis level of credit growth but one which is more measured and focused and where they see a right trade off between finer margins and lower probability of default.

There is a discussion that even locally issued debt needs some level of restructuring. What do you think will be the impact if this is done?

The industry has close to LKR 4.0 trillion invested in locally issued GoSL debt; much of which to meet a regulatory requirement. In this context, needless to say, the slightest hair cut will have bearing on the sector from a solvency perspective. A resilient banking industry is key to reviving the country’s economy. For this very delicate reason, I reasonably doubt that there will be any hair cut on domestic debt but rather a reprofiling or a term extension. After all, the last thing the country needs is the solution to its current problem giving rise to a bigger problem.

Regardless of rupee debt restructuring Sri Lankan banks may require recapitalization. How do you envision this taking place?

It will take place on a piecemeal basis and through a combination of Basel III compliant Tier II issuances, additional Tier I issuances and in certain cases through share issuances. Sector consolidation is also one aspect which cannot be ruled out. All the above said, one cannot rule out that this will take time and the regulator, in my view, is likely to allow reasonable time to do so. At present, the market is characterized by a liquidity shortfall and rising interest rates which on its own are challenging.

How do you anticipate all this will affect your customers?

At People’s Bank, we have taken a balanced approach when imposing any additional interest burden on our most vulnerable customer segments. At present, our priorities are to strengthen the Bank’s various aspects of business so as to protect our depositors and help our customers. In addition, we have several funding lines from multiple foreign agencies at concessionary rates of interest. We will also focus on making these funds available to our eligible customers.

The demand for new loans from SMEs and individual borrowers must be significantly lower than it was several years ago?

The current interest rates have made it difficult for businesses to borrow, but it is still necessary to help stabilize the market. Interest is only one factor and once economic stability sets in and rates go down, businesses can once again return to their usual rhythm.

When People’s Bank was established 61 years ago, there was no other bank like it, serving the rural masses of Sri Lanka. How will you reinvent yourself for the future while staying true to your founding principles?

People’s Bank was established to cater to the rural masses and today, we serve Sri Lankans throughout the country. We have remained true to our founding principles by growing as a bank that is affordable and accessible, serves the public and aids economic growth in line with the government’s objectives. Part of this was the reason behind enhancing our digital capability, providing customers with efficient service and an unparalleled experience.

We have faced many challenges in the past 61 years but have overcome them all. From humble beginnings, we are now a giant in the banking industry. Our resilience comes from the strength of our customers who have stood with us and I’m confident that they will remain with us moving forward. We will continue our growth, staying true to our core values as a bank that supports its customers and the economy