Fitch report soon on Lankan finance companies

Fitch Ratings is preparing a special report on Sri Lanka's Registered Finance Companies (RFC) sector and is due to release it shortly.

Although small in terms of size (accounting for 3% of financial system assets at end-December 2006) and low in systemic importance, RFCs have a relatively long operating history in Sri Lanka, and continue to provide a notable contribution to the economy, especially in the area of vehicle financing. By March 2007 (FYE07), there were 31 RFCs operating in Sri Lanka; the two largest companies accounted for approximately 50% of the industry at FYE07 with the remainder being scattered amongst the other much smaller entities.

“A number of finance companies came under severe financial distress in the 1980s, and state intervention in the form of re-financing facilities extended to 12 failed companies in the period 1987-1994 amounted to Rs 2.3 billion (0.4% of GDP at end-1994). Against this backdrop, the Finance Companies Act No. 78 of 1988 was enacted where all RFCs came under the regulatory domain of the Central Bank of Sri Lanka (CBSL) and are monitored on a regular basis, based on their adherence to the prudential directions as specified by the latter,” Fitch said.

Steady growth at a compounded annual growth rate of 25.3% was recorded in the period 2002-2006. This growth was primarily driven by the provision of vehicle finance, largely to borrowers who fall outside the risk appetite of commercial banks. Vehicle finance accounted for 70% of the sector's loan portfolio at FYE06; the rising demand for vehicles together with the high cost of purchase due to rising taxes drove the need for long-term financing. This, together with the somewhat specialised nature of acquiring and servicing this type of clientele, ensured that RFCs (together with specialised leasing companies) developed a defendable niche in this segment versus the commercial banks.

“Fitch notes that risk management practices in the sector are relative weak and vary widely across the industry, compared to the banking sector.

However, RFCs have begun to address this issue primarily via improvements in its management information systems, credit appraisal techniques and streamlined recovery procedures. Consequently, their asset quality improved with the gross non performing loans/gross loans ratio declining to 11.6% at FYE06 from 15.0% at FYE05,” the statement added.

The majority of the RFCs are family-owned and have a long operating history. However, in the last five years, institutional lending from the banking sector to the industry has gathered pace and accounted for 19% of the funding mix at FYE06.