Central Bank rejects Moody’s assertion on recent interest rate cuts

Sri Lanka's Central Bank (CB) on Monday rejected assertions by rating agency Moody’s Investors Service that the recent interest rate cut was ‘credit negative for banks”.

Responding to a September 26 Moody’s statement titled “Sri Lanka’s lending rate cut is credit negative for banks”, the CB said Moody’s has not taken into account the complete information set, and its comment is  therefore unfounded.

“… the CB is of the view that the imposition of caps on lending rates of licensed banks would, in fact, be credit positive, contrary to the view held by Moody’s Investors Service,” it said in a statement.

The statement said that the CB has taken a number of measures over the past 11 months to ease monetary policy and monetary conditions in view of decelerating growth of credit and monetary aggregates and subdued economic growth, amidst well anchored inflation expectations. 

Amongst these measures, the reduction in the Statutory Reserve Ratio (SRR) by 2.50 percentage points in two steps has enabled licensed commercial banks (LCBs) to invest additional funds amounting to around Rs. 150 billion in revenue generating activities. The reduction in SRR has also improved rupee liquidity in the domestic money market, while a further reduction in money market interest rates has been effected by reducing policy interest rates by 100 basis points in two steps in May and August 2019.

The imposition of caps on deposit interest rates of licensed banks in April 2019, which was subsequently removed in September 2019, was aimed at limiting unhealthy competition in deposit mobilisation amongst banks and assisting them to reduce lending interest rates.

This temporary cap imposed in consultation with banks helped reduce the Average Weighted New Deposit Rate (AWNDR) by 284 basis points within four months since end April 2019. However, in spite of continued deliberations with banks, most market lending interest rates have been downward rigid, unlike deposit interest rates as well as rates on short term funds and government securities, the statement said.

It is in this context that the CB imposed caps on lending rates of licensed banks on September 24. With the substantial decline in cost of funds, in terms of lower SRR, lower money market interest rates, lower policy interest rates and lower deposit interest rates, along with the allowance of sufficient time for banks to adjust lending rates downwards, the CB has sought to minimise any disruption to the smooth operation of the banking system as well as its profitability.

“The CB does not expect a material change in interest margins of the banking system arising from the imposition of caps on lending rates, holding other factors constant. The CB has also announced its intention to review this action by March 2020,” it said.