Large SL banks most exposed to sovereign risk: Fitch says

Sri Lanka's largest banks are the most susceptible to heightened sovereign risk due to their higher exposure to foreign- currency denominated government securities and, in some cases, weaker capital positions, said Fitch Ratings in a new report this week.

Domestic banks have significant direct exposure to the sovereign, largely via government-security holdings, as well as to the wider domestic economy and local financial markets through their Sri Lankacentric operations.

Overall, Fitch- rated Sri Lankan banks had about one third of their combined assets exposed to the central government as at end- 2020, increasing the risk of sovereign stress causing major deterioration in their financial condition.

Foreign currency government securities held by Fitch- rated Sri Lankan banks accounted for around 6.4 percent of assets and 78 percent of equity at end-2020.

“We estimate that for every 10 percent value reduction in foreign- currency denominated government securities, the large banks' common equity Tier 1 ratios would have declined 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 on the financial system and domestic economy. We expect bank ratings to remain constrained by, and closely linked to, our assessment of the sovereign, due to the strong correlation between the sovereign and bank credit profiles,” the report said.

As such, Fitch said it doesn’ t rate any Sri Lankan bank above the sovereign's ' CCC' LocalCurrency Issuer Default Rating and the 'CCC'/negative score on the banks' operating environment.

Domestic banks have significant direct exposure to the sovereign, largely via government-security holdings