Structural shift in assets dampens banking sector profitability: report

The assets of the Sri Lankan banking sector underwent a significant structural change in 2013— similar to a trend emerged in 2009— which negatively affected the profitability of the sector, a special report on the banking sector by the research arm of a local equities brokerage noted.

According to Asia Securities Research, the total assets of the banking sector, which grew at 16.6 percent year-on-year (YoY), have outpaced an 8.8 percent YoY credit growth in 2013.

“This can be attributed to the shift in allocation of banking sector loanable funds from private lending towards instrumental government borrowing in the form of treasury securities (considered as investments in banking terminology) similar to what took place in 2009.

The reverse trend i.e., expansion of loans and advances at a higher rate than total assets, is seen during the following two years (2010 – 2011) when private sector activity grew at breakneck speeds,” the report noted.

The change in the structure of banking assets is indicated by the 70.7 percent YoY drop in the volume of loans disbursed in 2013 and the simultaneous increase in volume of invest- ments into government securities by as much as 72.6 percent YoY during the year.

In return, this trend negatively affects the profitability of the banks as their asset composition gets concentrated within a lower yielding asset class such as government securities.

However, the report showed that in the absence of this trend, the banking sector may face cash flow concerns during periods where private investments moderate.

“Hence, although it has brought about a drop in profits of the sector in general, the process of rising public debt during periods where private credit growth declines has assisted the banking sector as a whole to remain profitable in the face of growth in NPLs coupled with the drop in loans and advances.”

Sri Lanka’s banking sector non-performing loans (NPLs) rose to 64 percent in 2013 from 18 percent in 2012. According to Asia Securities Research, over 75 percent of the NPLs during the year were triggered by the Rs.56.4 billion worth of NPLs of pawning advances.

“The collapse of gold prices during the year directly contributed to this development.”

The report further noted that the private sector in general and banks in particular benefit from this development rather than being crowded out by the government as it is widely perceived.

“This is so given that government borrowing in times of moderation of private investments yields a secure source of return for the surplus funds of the private sector, which the latter is unable to acquire or riskier to acquire through other means such as direct investments.

On the other hand, it provides the banking sector with space to ‘invest’ its surplus funds profitably without having to expose itself to risks involved in private lending and hence, enabling them to pay interest on deposits when private investments and consumption are not sufficiently absorbing the loanable funds of the banking system,” the report stated.