Sri Lanka finance companies under regulatory pressure: Fitch
View(s):Sri Lanka’s finance and leasing sector will face added pressure for consolidation as deadlines for the implementation of tougher capitalisation requirements approach in 2021, says Fitch Ratings.
“We view further consolidation of the sector as positive for financial sector stability in Sri Lanka, but the process could be impeded by a challenging operating environment,” the rating agency said in a media release on Monday.
Gross loan growth for Sri Lanka’s finance and leasing companies (FLCs) has slowed sharply in a sluggish economy, coming in at only 0.5 per cent year-on-year (yoy) at end-September 2019 against 12.9 per cent on average between end-2015 and end-2018.
The capacity of some of smaller FLCs to withstand asset-quality pressures stemming from this more challenging environment has been weak, owing in part to thin capital buffers.
Figures from the Central Bank (CB) indicate that FLCs accounted for 7.6 per cent of total financial system assets at end-2018, so developments in the sector are significant for the overall stability of the financial sector.
The top 10 FLCs accounted for 69 per cent of the sector assets at end-September 2019, with 33 smaller FLCs representing the remaining 31 per cent.
Fitch said the CB has sought to reduce risks by raising capital thresholds to encourage consolidation. FLCs are required to meet an enhanced Rs. 2.5 billion absolute capital requirement by January 1, 2021, up from Rs. 2 billion at present.
“We believe the CB is unlikely to delay the deadlines for raising capital thresholds. It has already taken action against several FLCs that failed to meet capital requirements. In 2019, the regulator cancelled licences held by TKS Finance and issued a notice of cancellation for the licence held by The Finance Company and Sinhaputhra Finance,” it said
FLCs may face difficulty improving their profitability, as Fitch expects economic growth to remain subdued. This could impede efforts to meet enhanced regulatory capital requirements by generating capital internally or by raising capital externally.
“We believe this risk will be higher for smaller standalone finance companies. Those FLCs that have raised external capital recently, as part of efforts to meet the higher capitalisation standards, have benefited mainly from support from their major shareholders. The tough operating environment may also impede consolidation, as asset-quality issues and limited near-term growth prospects for the sector could make M and A less attractive. We estimate that Fitch-rated FLCs would require additional equity capital of around Rs. 5.5 billion to meet the absolute regulatory capital thresholds by next January. We believe that generating this internally through profits may be difficult and therefore might require additional external capital raising. Capitalisation factors are likely to remain a prominent rating sensitivity for most of our rated standalone FLCs,” Fitch said.