Union Bank of Colombo

ICRA Lanka has placed the ratings of Bank of Ceylon, People’s Bank, DFCC Bank PLC and Union Bank of Colombo PLC on Watch with Negative Implications

Rationale

The rating action takes into account the intensified risk in the banking sector, particularly the Licensed Commercial Banking (LCB) sector from the effects of the sharply weakened foreign reserve position of the country, and the deteriorating sovereign credit profile. As part of the debt restructuring process, the Central Bank of Sri Lanka (CBSL) on April 12, 2022 announced the suspension of servicing all foreign debts. However, the CBSL excluded the suspension of Sri Lanka Development Bonds (SLDB) from above given the large quantity of the same being held by the state-owned banks.

ICRA Lanka takes some comfort from the relatively low exposure on the International Sovereign Bonds (ISBs) by ICRA rated LCBs. However, ICRA Lanka does not drive much comfort from the same as the extremely weak foreign currency position of the country would exert pressure on all the dollar-denominated liabilities. In addition, ICRA Lanka takes cognizance of the higher impairment costs of these exposures that would affect the capital buffers of the banks.

Also, ICRA Lanka notes the weakening sovereign credit profile would affect the funding flexibility of the local LCB sector, as the banks are increasingly constrained in terms of foreign funding. The heightened counterparty risk would also affect the trade-related activities of the banks.

ICRA Lanka’s rating Watch with Negative Implications also factors in the core margin compression in CY2022 due to the sharp increase in systemic interest rates. In addition to this, ICRA Lanka envisages marked-to-market losses on the debt instruments (primarily treasury securities) held at fair value, due to this sharp rate increase. From ICRA Lanka rated LCBs, DFCC Bank PLC and Union Bank of Colombo has placed the majority of its treasury investments at fair value through other comprehensive income; and therefore, will have a larger impact on their capitalization profiles, while Bank of Ceylon and People’s Bank have recognized the bulk at amortized cost.

Finally, ICRA Lanka also expects the current challenging operating environment to exert pressure on the asset quality levels of the banking sector, despite the healthy recovery witnessed post-COVID. Overall GNPA levels of the LCB sector improved to 4.27% by Dec-21 from the peak levels of 5.27% in June-20. However, the same is expected to deteriorate over in Q2 and Q3 CY2022 as the current operating environment has affected several segments of the economy, including the SME sector.

 The current rating action does not cover MCB Bank (Sri Lanka Branch) and Habib Bank Limited (Sri Lanka Branch) as the ratings of the two entities are primarily driven by the strength of their parents.

Analytical approach:

For arriving at the ratings, ICRA has applied its rating methodologies as indicated below. Links to applicable criteria:   ICRA Lanka’s Credit Rating Methodology for Banks

Analysts
Sachini Costa
+94-774781595
sachini.costa@icralanka.com

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