Lanka banking system credit risk high, space for some expansion

* Fitch: Rapid Asia-Pacific  credit growth increases  banks’ risks

Loose monetary policy and rapid credit growth have increased the credit risks of banks in the Asia-Pacific region. While Sri Lanka’s banking system is grouped among the high risk category, Fitch Ratings says a relatively lower Credit-to-GDP ratio partially justified rapid credit growth as credit penetration increased and where the need for infrastructure investment was greater.

Rising banking system leverage in Asia-Pacific is increasing rating pressure for banks in the region, Fitch Ratings says. Strong credit growth across the region, particularly in China, is driving the region’s credit-to-GDP up towards its 1998-1999 peak.

"Credit growth in APAC has accelerated since 2007 due to underlying economic growth and loose global and regional monetary conditions, in particular China’s stimulus measures. The rapid balance-sheet expansion for the banks in some financial systems is likely to be unsustainable," Fitch said in a recent report.

"Rapid expansion often puts pressure on banks’ financial profiles. Relaxed underwriting standards, inadequate controls and speculative investments typically accompany strong credit and asset-price growth. This build-up of credit risks will constrain upward rating momentum and could even lead to downgrades for banks in the region, particularly ones with greater sensitivity to Chinese risk, where the build-up in credit has been greatest and which accounts for 37% of GDP in APAC.

"Credit growth in China remains relatively rapid and is likely to gather pace in support of generating higher GDP, with credit-to-GDP likely to exceed 200% in 2013. But funding and capital constraints in the banks could act as a brake on growth after the leadership transition. Our measure of broad credit adjusts the official total societal financing (TSF) metric to include shadow and offshore sources, as other channels for credit disbursement beyond on-balance-sheet lending have become increasingly important.

"Hong Kong banks are also vulnerable to higher risks due to their rapid expansion in China and the growing links between the two economies and their banking systems. The risks are partly offset by the high financial intermediation involving many foreign-owned banks.

But credit growth in Hong Kong remains strong and its credit-to-GDP is more than 20% above trend.

"Across the rest of APAC we expect the pace of credit growth to slow as the economy grows at a more moderate rate in 2013-2014. This should help unwind risks accumulated from the recent growth phase. However, loose global monetary conditions, including the likelihood of further easing by the Bank of Japan, pose a risk to this forecast. Asian central banks that leave monetary conditions too easy for too long, whether to promote growth or to avoid attracting capital inflows, could see overheating pressures build.

"APAC remains the region with the highest proportion of countries classified as ‘3’, high, in our macro-prudential indicator (MPI) scale, which we use to identify potential systemic stress. China, Hong Kong, Indonesia, Mongolia and Sri Lanka, all MPI 3, account for 43% of our 2012 GDP estimate for the region.

"Growth of real credit in Mongolia was particularly rapid in 2011 as was real exchange rate and equity market appreciation. Credit growth eased into 2012 but is still at a high-rate and the real policy interest rate remained negative. Indonesia and Sri Lanka had some of the fastest real credit growth among emerging markets in 2010 (15% and 18%, respectively) and 2011 (20% and 26%). Credit-to-GDP in these three countries is relatively low, which partially justifies more rapid credit growth as credit penetration increases and where the need for infrastructure investment is greater," Fitch said.

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