Fitch Ratings has stated that Sri Lankan banks’ operating environment (OE) and overall credit profiles will be positively impacted by any improvement in the sovereign’s credit profile (Long-Term Foreign-Currency IDR: RD, Long-Term Local-Currency IDR: CCC-) following the completion of debt restructuring.
The agency emphasized the strong link between the financial health of the sovereign and the operating conditions of the country’s banks. Fitch believes that a sovereign credit profile improvement would be favorable for the National Ratings of Fitch-rated large Sri Lankan banks, based on their relative creditworthiness compared to other local issuers.
Sri Lanka’s banks currently hold an OE score of ‘ccc-’/stable, which is closely tied to the sovereign’s local-currency credit profile. This is due to their significant exposure to the domestic economy and government securities, which account for 33.4% of assets in local-currency treasury instruments and 3.4% in foreign currency instruments as of end-1H24. Additionally, their lending to the broader public sector exacerbates their exposure to the sovereign.
The exposure to the sovereign is typically higher among the large banks, with state-owned enterprise (SOE) exposure concentrated primarily in the two state-owned Domestic Systemically Important Banks (D-SIBs). Fitch anticipates that an improvement in Sri Lanka’s credit profile would reduce sovereign-related pressures on the banks, thus providing a credit-positive outlook for both financial and non-financial assessments.
According to Fitch’s National Scale Rating Criteria, an issuer’s national rating starts with an assessment of its credit quality on the international rating scale. This assessment may be updated following a sovereign rating change. In such cases, Fitch will adjust the national ratings of local issuers to reflect changes in relative rankings resulting from the sovereign’s rating revision.
Fitch last recalibrated its Sri Lankan national rating scale on January 12, 2023, to account for shifts in the relative creditworthiness of Sri Lankan issuers after the sovereign’s Long-Term Local-Currency IDR was downgraded to ‘CC’ from ‘CCC’.
Fitch further clarified that the ratings for locally incorporated banks, excluding Cargills Bank PLC (A(lka)/Negative), are based on their standalone credit profiles, with no expectation of extraordinary shareholder support. The ratings for the two state-owned D-SIBs, despite their strong linkages to the state, do not factor in support due to the sovereign’s constrained ability to offer extraordinary assistance. However, a sustained improvement in the sovereign’s financial flexibility could prompt a reevaluation of state support, the agency noted.
Sri Lanka is nearing completion of its foreign-currency debt restructuring. If successful, particularly in line with the proposed framework for local bondholders, the outcome would significantly ease challenges faced by banks, thereby improving their financial profiles.
Fitch also observed that pressures on both foreign- and local-currency funding and liquidity have eased substantially due to improved external sector flows and the banks’ efforts to maintain liquidity. The agency expects that banks will regain access to foreign-currency wholesale funding following the restoration of the sovereign’s creditworthiness.
Source: Fitch Ratings
