Sri Lanka: Banks start the countdown to consolidation


Elliot Wilson
Published on:

Thanks to new capital and accounting rules, higher costs and increased competition, the island’s cosy banking sector is heading for a long overdue shake-up.


For a frontier economy of $87 billion, with moderate growth and just 21 million people, Sri Lanka has far too many banks.

Customers have a choice of 25 commercial lenders, seven specialists and 47 non-banks. 

The bigger players include state-owned Bank of Ceylon (BoC) and People’s Bank, as well as private-sector lenders Sampath Bank and Hatton National Bank (HNB). Then there are the banks that began life as development outfits before switching to commercial lending (National Development Bank), Islamic finance specialists (Amana Bank) and lenders run by big conglomerates (Cargills Bank).

This over-banked market is ripe for a shake-up. New regulatory and accounting requirements, tougher competition and disruptive technology will force Sri Lanka’s banks to find cost savings and tap local markets for fresh capital. Smaller or struggling lenders that cannot – or will not – do so may well find themselves swept away, analysts warn, by a wave of much-needed consolidation.

Ratios up

In June 2017, the Central Bank of Sri Lanka said that all licensed lenders would have to meet new minimum capital standards, in line with Basel III guidelines, while any systemically important lender with more than SLRs500 billion ($3.2 billion) in assets must raise its capital adequacy ratio to 14% from 10% by January 1, 2019. 

Six lenders currently meet that threshold, notably BoC and People’s Bank, the two largest domestic lenders by assets, and Commercial Bank of Ceylon (CommBank). 

All other licensed lenders would need to increase their ratios to 12.5% from 10%.

Some have been stocking up ahead of the storm. Sampath Bank completed the country’s first Basel III-compliant debenture in December 2017, raising SLRs6 billion; it plans to raise another SLRs7.5 billion worth of tier-two capital this year.

Nimesha Jayakody, banking analyst at Colombo-based Frontier Research, warns that even bigger lenders will have to fight tooth and nail to raise all the money they need.

“We are a small market, and all the banks will be essentially fighting over the same investors,” she says. “Some of them will strike out.” 

Meanwhile a new levy, likely to come into force at some point after April 2018, will impose a 0.2% tax on every financial transaction, costing the sector up to SLRs150 billion a year.

The other main challenge is one that banks face everywhere. New IFRS9 standards set out by the International Accounting Standards Board require banks to set aside provisions for future losses, not just losses already reported.


Banks will be forced to “look more carefully at the loans they are disbursing, and to decide from the outset whether they need to provision against them,” says Jayakody. “First-time provisions could be up to 20% higher, so that could be a challenge.”

The new standards were originally slated to be enforced from January 1, but “that was delayed”, she adds, “because most banks were not ready to comply.”

The new accounting rules are expected to push up non-performing loans and raise risk costs across the entire sector, research firm Exotix warned in a note published in March, adding that certain lenders would be hit harder than others. 

Exotix lowered its rating on National Development Bank to sell from hold, pointing to the bank’s rising cost of risk and its low coverage ratio. 

The London-based research house says it expects rising NPLs and the new IFRS9 rules to “increase the cost of risk at all” of the lenders it rates: CommBank, Sampath Bank, HNB and NDB.

Industry insiders say the outcome of all of this change will be a wave of mergers – something that has been predicted for a long time but has so far failed to materialize.

“It’s consolidation all the way,” says a senior executive at a leading private lender. “The central bank is tacitly encouraging it by raising capital requirements. It’s what they want.” 

The most likely targets include smaller, well-run institutions such as Pan Asia Bank and Amana Bank, says one industry insider.

Other problems stand out too, each presenting its own headache to lenders large and small. Net interest margins and returns are falling across the sector, with Exotix tipping average industry return on equity to fall to 14.3% in 2019, from 17.1% in 2017.

Digital disruption has also finally arrived on the island. Local telco Dialog Axiata paid just over SLRs1 billion for an 80% stake in Colombo Trust Finance, a non-bank financial institution, in September 2017, and will use the acquisition to expand into digital financial services. 

It is one more thing for Sri Lanka’s embattled banks to worry about.