BANKING SECTOR
Compiled by Tamara Rebeira
PATH TO RENEWED STABILITY
Nandika Buddhipala highlights the role of banks in maintaining stability
Q: What are the major financial challenges facing businesses in Sri Lanka?
A: A key issue is the lack of finance for certain sectors including SMEs. According to the Ministry of Finance, approximately Rs. 700 billion was disbursed to such businesses by the banking sector last year – up from 619 billion rupees in 2022.
However, due to the changed business cycle and 92 percent increase in the cost of living, the real impact of these disbursements may be less significant.
Financial literacy remains a major challenge, affecting both SMEs and larger corporates. This influences issues such as leverage, business expansion and cash flow management, which are crucial for all organisations.
Interestingly, a report found that basic financial literacy is notably high among engineers, indicating that strong financial literacy isn’t solely tied to one’s profession or formal education.
Beyond finance, challenges include market accessibility, productivity, competitiveness and regulatory issues. Key financial concerns involve the availability of funds and lack of collateral for some businesses.
Q: And what opportunities do you see for growth?
A: Despite some progress, we haven’t returned to pre-crisis economic levels. This is due to the severe economic contraction and currency depreciation. Minimal reforms during such cycles can spur improvements and while recent reforms have had limited success, a partial recovery is evident.
Growth has been observed over the last three quarters with Purchasing Managers’ Index readings for manufacturing and services improving to 56 and 63 respectively, and construction rebounding to 54.5.
SME disbursements have allocated 30-40 percent to industries, and tourism and other sectors are recovering. Local manufacturing is also gaining traction due to reduced imports.
While some industries are recovering, poverty has surged from five to 10 percent in 2019 to 25-30 percent, affecting many who can no longer afford basics.
Resilience is evident, yet labour force participation remains low particularly among women. The IMF reports that this exacerbates economic challenges.
Recent data indicates that economic deterioration has halted with opportunities emerging in manufacturing, services and export oriented sectors. For sustainable growth, focussing on competitiveness, productivity and integration into global value chains is crucial.
Q: How do you view the economic outlook for Sri Lanka over the next few years?
A: The economy is showing signs of recovery with the IMF predicting growth of between two and three percent while economists suggest three to 3.5 percent.
I believe that three percent growth is plausible, translating into real growth of around three percent – and nominal growth potentially reaching between nine and 10 percent due to expected inflation.
Returning to previous economic levels in US Dollar terms may take a few years. Even without major reforms, growth is possible though structural reforms identified by IMF diagnostics are crucial. Political changes are unlikely to derail these reforms, as all parties recognise the need for continued reform to avoid stagnation.
A major concern is our economic structure – over 70 percent of our economy comprises non-tradable sectors, which impedes export growth. Our past growth was driven by construction and consumption, which are heavily reliant on imports. Moving forward, we need to avoid this model especially since future commercial funding will be conditional.
For substantial growth, integrating into global value chains and enhancing export oriented industries are essential. Attracting international investments will require stable governance and an investor conducive environment; and a skilled labour force would be more important than even effective labour regulations.
While our literacy rates are high, we need to improve manufacturing skills rapidly.
Long-term stability and consistent policies are crucial to attracting large investments. Despite past liquidity issues and defaults, gradual growth is feasible with structural changes.
Without these, only subdued incremental progress is possible.
Q: How should banks navigate concerns related to financial stability?
A: As the economy stabilises, banks must focus on capital adequacy and liquidity. Most banks have a liquid asset ratio of 30-40 percent – which is well above the 20 percent requirement – indicating strong liquidity.
According to the IMF, banking assets comprise 80 percent of GDP with superannuation and savings adding another 12 percent given that Sri Lanka’s savings rate (33%) is high.
However, banks are heavily involved in government funding through Treasury bills and bonds. With limited credit growth, savings are redirected into these securities. While SMEs are improving, increasing lending is crucial for economic growth.
India’s market capitalisation exceeded 100 percent of its GDP while Sri Lanka’s is only 15 percent, highlighting the limited role of our capital markets. Banks are essential to converting savings into investments due to the lack of other financial intermediaries.
But increased lending doesn’t guarantee economic growth. Historical data indicates that consumption driven by imports can create problems, as evidenced by past trade deficits of between eight and 10 percent of GDP, mitigated by tourism and remittances.
Research also suggests that high household indebtedness in risky areas such as property can lead to economic collapse.
The key issue is whether bank lending can drive sustainable economic growth in the medium to long term. Given the lack of alternative financial intermediaries, banks are crucial in the prevailing economic landscape.
