Credit squeeze on property bubble to save financial sector

by Amal Jayasinghe

COLOMBO:The Central Bank is likely to restrict the amount of money financial institutions could lend to real estate developers amid fears that a property bubble was about to burst and undermine the entire financial sector.

Finance Minister Mangala Samaraweera and Central Bank Governor Indrajit Coomaraswamy outlined the need to deploy what they called macro-prudential tools to control lending to construction and real estate.

Authorities had expressed fears that the decline of Sri Lanka’s billion-dollar luxury condominium market could hit commercial banks which had lent heavily to the sector which recorded artificially inflated growth in recent years.

"To strengthen our financial system, we intend to undertake several measures," Samaraweera and Coomaraswamy said in a joint letter to the International Monetary Fund.

The letter written in June, but released to the media by the IMF on Friday, identified the property sector as a key priority for the government.

It said the government will "deploy, as needed, macro-prudential tools such as a sector-specific limit on the loan-to-value ratio including in the construction and real estate sectors."

The authorities had earlier resorted to limiting credit to finance cars, three wheelers and motorcycles in a bid to slow imports and reduce pressure on the country’s balance of payments.

The real estate sector, in particular the luxury apartment development, has attracted investors expecting high returns. Central Bank feared that money lent to small and medium enterprises may have also ended up in real estate fuelling the problem.

The IMF is monitoring Sri Lanka’s economy since the government entered into a 1.5 billion dollar bail out last year. The latest letter was sent to secure the release of the third tranche of the loan spread over three years.

The letter to the IMF was sent a month after Coomaraswamy told the Foreign Correspondents’ Association in Colombo that punters could end up in tears if they invested heavily in luxury condominiums expecting high returns.

"What has been happening is that this (apartment/real estate) sector has given a much higher rate of return than anything else," he said. "When that happens, in whatever sector, usually too much money gets in and then you end up in tears."

-Shaky Banks-

The government said the country’s overall banking sector appeared to be healthy, but robust credit growth has increased risks.

"While financial soundness indicators remain adequate for the banking system as a whole, the capital adequacy ratio (CAR) has been declining as the broad-based and still robust credit growth has increased risk weighted assets."

-State enterprises-

The IMF was told that the government was reforming state owned enterprises (SOE) had a "outstanding obligations" of 1,360 billion (9,000 million dollars) by the end of 2015.

The liabilities of the Ceylon Petroleum Corporation, the Ceylon Electricity Board, Sri Lankan Airlines and the Sri Lanka Port Authority amounted to 1,200 billion rupees (8,000 million dollars).

"Although some SOEs are profitable and performing well, collectively they represent a risk to public finances (either directly or through the state banks which fund the largest SOEs).

"A comprehensive strategy for SOE reform and a more rules-based approach to financial management is being developed."

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