Sri Lanka’s banks would be reluctant to absorb their finance and leasing companies (FLC) due to the significant difference between their risk profiles and underwriting practices which could lead to elevated challenges in achieving effective management, According to Fitch Ratings.
The government’s budget speech, presented on 17 November 2020, reiterated the importance of consolidation in the FLC sector, which has been on the cards since 2014 when the Central Bank (CB) announced its ‘Master Plan for the Consolidation of the Financial Sector’. It led to several banks acquiring FLC subsidiaries in 2014 and 2015, including the acquisition of HNB Finance (then Prime Grameen Micro Finance Limited) by Hatton National Bank and Serendib Finance (then Indra Finance Limited) by Commercial Bank of Ceylon.
“We believe banks will be reluctant to absorb their FLCs due to the significant difference between their risk profiles and underwriting practices, leading to elevated challenges in achieving effective management. FLCs typically cater to sub-prime customers, which banks have very little appetite for. However, if the proposed mergers are enforced, we expect the risk appetite of the amalgamated bank to be lower than the simple aggregated risk appetite of the parent and the FLC subsidiary, as the FLC business is unlikely to be a core business line for the parent,” it stated.
The proposal affects five Fitch-rated banks with FLC subsidiaries – Hatton National Bank PLC (AA+(lka)/Negative), which owns HNB Finance Limited (AA-(lka)/Negative), Commercial Bank of Ceylon PLC (AA+(lka)/Negative), which owns Serendib Finance Limited (AA-(lka)/Negative), Sampath Bank PLC (AA-(lka)/Stable), which owns Siyapatha Finance PLC (A(lka)/Stable), Bank of Ceylon (AA+(lka)/Negative), which owns Merchant Bank of Sri Lanka & Finance PLC, and People’s Bank (Sri Lanka) (AA+(lka)/Negative), which owns People’s Leasing & Finance PLC (A+(lka)/Stable). These subsidiaries’ assets account for 0.5%-7.7% of their group assets (median: 3%) and 0.5%-26% of profit before tax (median: 5%).
Fitch said that the consolidation in the Sri Lankan FLC sector is positive for its long-term stability, but will not necessarily ease its near-term challenges. The sector continues to struggle with a lack of access to capital, muted income generation, and very weak asset quality despite the regulatory moratoriums for stressed loans
The Rating Agency noted that the extent of the impact of absorbed FLCs on banks’ business models and their consolidated risk and financial metrics, particularly asset quality and profitability, would be important for the banks’ ratings in the medium term.