Fitch Ratings raises RED FLAG over Sri Lankan Banks’ Exposure to Sovereign Risk

Fitch Ratings raises RED FLAG over Sri Lankan Banks’ Exposure to Sovereign Risk

Fitch Ratings raises RED FLAG over Sri Lankan Banks’ Exposure to Sovereign Risk

Written by Staff Writer

01 Jul, 2021 | 12:10 pm

COLOMBO (News 1st); Fitch Ratings believes Sri Lanka’s largest banks are the most susceptible to heightened sovereign risk due to their greater exposure to foreign-currency-denominated government securities and, in some cases, weak capital positions.

This exposure for Fitchrated banks stood at around 6.4% of total assets and 78% of total equity at end-2020. For every 10% reduction in the value of foreign-currency-denominated government securities, we calculate that the large banks’ common equity Tier 1 (CET1) ratios would have dropped by 18-219bp as at end-2020.

Some smaller banks may appear to be relatively unscathed by such exposure, but they would not be immune to any spillover effects of sovereign stress.

Overall, Fitch-rated Sri Lankan banks had about one-third of their combined assets exposed to the central government as at end2020, increasing the risk of heightened sovereign stress causing significant deterioration in their financial condition.

Fitch expects bank ratings to remain constrained by, and closely linked to, its assessment of the Sri Lanka sovereign, which has a ‘CCC’ Long-Term Local-Currency Issuer Default Rating (IDR), due to the strong correlation between the sovereign and bank credit profiles.

This stems from the banks’ significant direct exposure to the sovereign, largely via their government-security holdings as well as to the wider domestic economy and local financial markets through their Sri Lanka-centric operations.

Under Fitch Rating’s Bank Rating Criteria, a bank can only be rated above the sovereign if we assess that it has the capacity to continue to service its obligations in the event of a sovereign default, and there would likely be no imposition of restrictions on the banks’ ability to service their obligations by the sovereign in the event of a sovereign default.

As such, Fitch do not rate any Sri Lankan banks above the sovereign’s Local-Currency IDR and have a ‘ccc’/negative score on the banks’ operating environment.

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