Sri Lanka’s domestic debt plan a significant step for resolving bank uncertainty

Fitch Ratings states that the Sri Lankan government's proposal for treating domestic debt is significant in resolving uncertainties for the local banking sector. 

 

 

The proposal excludes banks' holdings of Sri Lankan rupee-denominated treasury securities, easing pressure on their capital positions. However, complications may arise from the impact on holdings of Sri Lanka Development Bonds (SLDBs) and international sovereign bonds (ISBs). 

 

 

These represent a smaller share of banks' assets compared to treasury securities. Provisioning measures should help mitigate the impact on bank capital, but worsening impaired loans and funding stress remain concerns. 

 

 

Restructuring local-currency obligations is not expected to trigger a loss of confidence in depositors. Still, funding stress is a negative sensitivity for bank ratings. Fitch-rated Sri Lankan banks' ratings remain on Rating Watch Negative due to near-term downside risks from capital and funding stress. 

 

 

The final impact on banks' capital and the government's debt treatment terms will determine the resolution of these ratings. While the government's domestic debt treatment proposals address some uncertainties, risks persist, mainly if there is no support from external creditors, potentially leading to further debt restructuring and instability in the banking sector.