Banking system sound, high profits – CBSL Review

The 2007 Financial System Stability Review from the Central Bank of Sri Lanka (CBSL) concludes that the financial system, supported by sustained economic growth remained resilient and stable amidst challenging macroeconomic and financial market developments.

The review stated that financial institutions remain sound and stable, sustained by strong financial positions and improved risk management systems within an enhanced regulatory and supervisory framework. The high profitability, increased capital levels and enhanced prudential measure have strengthened the resilience of these institutions and enabled them to withstand shocks, it said.

However, the Review also said there are downside risks and therefore, risk mitigation should be continued to prevent and pre-empt the occurrence of events that would have an adverse impact on the stability of the financial system.

As development in international financial markets in the recent past have clearly demonstrated, weaknesses in some areas can have negative effects rippling over much broader segments of the economy.

The CBSL further stated that global financial market conditions have deteriorated and external risks have increased.

'The recent turbulence in international financial markets set off by difficulties in the US sub-prime mortgage market has reduced the risk appetites of investors and affected the cost and availability of credit in these markets.' Furthermore, the widening of credit spreads between low and high risk assets and tightened liquidity conditions could affect the terms on which developing countries obtain funds from international financial markets.

The mobilization of medium term funds at competitive rates from international markets will reduce pressure on the domestic market and free up funds for private sector investment. “The ($500 million) bond proceeds will enhance liquidity in the system which would require mopping-up operations by the Central Bank.

It is also imperative that the government uses the bond proceeds for infrastructure related financial requirements to retain foreign investor confidence,” the report said.

The CBSL said a major downside risk is the continuing higher oil and food commodity prices in international markets. The recent increases in petroleum prices and the prices of a number of imported food commodities such as wheat, sugar, milk powder, rice and edible oils have fuelled inflationary pressures and exchange rate volatility with implications for the balance of payments and foreign reserves.

As the prices of these imported comm odities are expected to remain high in the near term, these macroeconomic risks will persists, the review concluded. Further, given the high international price of oil, there is a clear need to conserve energy use in Sri Lanka. Unlike in many other countries, Sri Lanka has not effectively raised public awareness of the need to conserve energy.
The rising debt servicing obligations could exert an upward pressure on interest rates. The high proportion of public debt is of a relatively short-term maturity resulting in a large concentration of debt repayments in the next two years. The higher debt servicing obligations are likely to cause as upward pressure on interest rates in the future. Therefore, the CBSL states it is important to implement a debt management strategy to extend the maturity profile of public debt and reduce potential risks. (NG)