LNP – Sri Lanka’s Government Debt Plan Tempers Funding Risk for NBFIs

Sri Lanka’s proposed government debt restructuring plan should reduce funding and liquidity risk for non-bank financial institutions (NBFIs), says Fitch Ratings. The plan avoids direct impact on the local-currency government debt holdings of NBFIs and commercial banks, easing uncertainty over the entities’ capital, funding and liquidity profiles. Nonetheless, the proposal is only one aspect of the sovereign’s debt sustainability plan, and the weak economic environment continues to pose downside risk to the sector.

The government debt holdings of Sri Lankan NBFIs mainly comprise local-currency treasury securities to meet regulatory liquid-asset requirements and for investment returns. Finance and leasing companies (FLCs) have boosted government debt securities holdings amid a weak economic outlook, lacklustre lending opportunities and a preference for stronger liquidity buffers at a time of extreme market uncertainty.

Such holdings are not excessive, at around 8% of sector assets at end-March 2023 (end-March 2020: 5%), but any direct impact from a government restructuring plan would have added to asset quality and earnings pressure arising from Sri Lanka’s difficult economic backdrop. These securities also comprise a larger proportion of banking-sector assets, and any losses arising from a restructuring could have further constrained banks’ capacity and willingness to provide funding to the NBFI sector. Foreign-currency denominated Sri Lanka Development Bonds will be subject to restructuring, but Fitch-rated NBFIs have no exposure to these instruments.

We also do not expect the latest proposal to prompt a loss of depositor confidence in the banking system that would raise contagion risk for NBFIs’ deposits and bank funding lines. For more analysis on the implications for the banking sector, see Sri Lanka’s Domestic Debt Plan a Significant Step for Resolving Bank Uncertainty