Sovereign is the ‘overarching constraint’ on banks’ ratings: report

Weak operating environment continues to pressure Sri Lankan Bank ratings and the Sovereign is the overarching constraint on the large banks’ ratings due to the banks’ high Sovereign exposure and Sri Lanka-centric operations, a new report by Fitch says.

“Heightened risks from the challenging operating environment stemming from the Sri Lanka sovereign’s (CCC) weak credit profile and the ongoing Covid-19 pandemic continue to pressure the ratings of large Sri Lankan banks, says the credit ratings agency in its report. “Large banks’ financial performance since the pandemic’s onset has been better than we expected, supported by relief and forbearance, although there are significant risks to the banks’ standalone credit profiles. We expect a recovery in real GDP in 2021 and 2022 relative to the contraction in 2020, which underpins our forecasts for better near-term performance of these banks. However, this is subject to a high degree of uncertainty, as it depends on the trajectory of the pandemic. Sri Lanka has experienced a surge in Covid-19 infections since April 2021 and the disruption to domestic economic activity may hinder the recovery in real GDP recorded in 1Q21,” Fitch says.”The sovereign is the overarching constraint on the large banks’ ratings due to the banks’ high sovereign exposure and Sri Lanka-centric operations. This has led to rating compression, with the national ratings of most large banks placed at ‘AA-(lka)’. The deteriorating operating environment has impacted, in particular, the large banks’ risk and financial profiles, although their franchises remain intact despite the pandemic. We see negative rating action as most likely to stem from a deterioration in the sovereign credit profile and the operating environment, with upside for the large banks’ ratings being limited,” Fitch says.Meanwhile, the report, “Large Sri Lankan Bank Peer Review – 2021″, available at www.fitchratings.com says,” The National Ratings of Sri Lanka’s large banks reflect unchanged relativities on the national rating scale. Most of the banks are rated at ‘AA-(lka)’, as current conditions do not permit their Viability Ratings or Local-Currency IDRs on the international scale to be higher than the sovereign’s Local-Currency IDR of ‘CCC’ and the banks’ OE score of ‘ccc’. This has led to rating compression.”