Sri Lanka banking perspectives 2018 Transforming horizons

May 2018 Oman banking perspectives 2018 35 Foreword Major developments in technology and regulation are likely to have a transformative effect on the current and future landscape of the banking sector in .

In Sri Lanka as well as globally great KPMG Sri Lanka, has undertaken an leaps are being taken in the analysis of the key financial technology space, be it block chain, indicators reported by the banking Fin Tech or digital transformation. sector for the past year, and Although, this makes transactions evaluated where we are in the roll- more efficient, the risk of cyber out of recently released legislation attacks has never been bigger than and regulations, mainly IFRS 9 it is now. Not only individual which affects all of us this year. companies but countries are at risk. This is the first Sri Lanka Banking As a result, there is a greater need for Perspectives we have produced. It vigilance and continued focus on complements our historic expertise enhancing existing regulations and in this sector, and highlights some of introducing new ones in response. the key financial trends, challenges and opportunities for the banking A fraud risk focused approach is industry in the country. necessary to mitigate the potential risk of fraud which may arise from As a team, we look forward to discuss previously benign channels. These these themes with you in the coming Ranjani Joseph efforts, together with existing weeks, and continue to update you as Partner | Head of Banking Services international and local initiatives to these evolve. T: + 94 11 5426 302 improve the stability of the global E: [email protected] financial system, require continued focus from both regulators and the Ranjani is an audit Partner and counts banking sector. This gets more over 20 years of experience, including complicated for those with extensive as lead partner for a number of operations across multiple multinational & local banks. She jurisdictions. recently served as the Audit Engagement Partner for the local The recent policy reforms affect Ranjani Joseph operations of three multinational the overall economy with a knock Partner and Head banks operating in Sri Lanka and also on effect on the banks, resulting in of Banking Services for the Audits of two of the largest muted growth forecasts in the near listed Banks in the Stock term while the outlook remains Exchange. positive in the mid to long term. She leads KPMG’s Banking services in Against this backdrop, banks are Sri Lanka and is also the Head of assessing how they can use new Markets for the Firm. She also and innovative technologies to represents KPMG Sri Lanka in the differentiate themselves from their KPMG Middle East South Asia (MESA) competitors. Financial Sector Network. Banks also find themselves having to invest to comply with ever more stringent and complex regulations and tax regimes. Contents

Foreword 3

Executive summary 5

Performance highlights 6

Cyber security 9

Regulation 13

Macro economic overview 17

Key banking indicators 22

About KPMG 31 Executive summary The Sri Lankan banking sector is in a healthy position, although more stringent regulations are being imposed in terms of risk and accounting. The increasing competition within the sector and from the non-banking financial institutions coupled with the tighter requirements on capital is expected to make banks more risk focused and innovative through technology. While the sector will improve its operational efficiency, mitigate risk, focus on sustainable earnings whilst enhancing customer experience, we expect the sector to consolidate to create larger and stronger banks. We have seen various regulations being imposed over the The Inland Revenue Act (IRA) effective from 1 April 2018 last year ensuring a stronger banking sector, particularly in has been one of the major reforms the Government of Sri capital requirements and provision treatments. The Basel Lanka has implemented recently. The main objective of III regulation has led to more stringent regulation in the new IRA is to simplify the tax system in order to capital, liquidity and leverage. The new and tighter create an investor friendly environment that would attract regulations that have come into force or are coming in, are more FDIs. The IRA is expected to reduce the indirect expected to have an impact on the core capital and taxes levied from the public from 80.0% to 60.0% whilst bottom line of all banks in the sector. The requirement for increasing the proportion of direct taxes within the next more high quality capital, which has a larger loss- three years. Changes in tax treatment on some absorbing capacity has led the banks to raise rights issues investment securities may have a positive impact on in the last year and the remaining are now considering deposit growth of the banks. equity infusions in the near future. The CBSL reversed the tight monetary policy stance it International Financial Reporting Standard (IFRS) 9 maintained since late 2015 by cutting the Standing came into effect for annual periods commencing 1 Lending Facility Rate by 25 bps in April 2018. With this January 2018. Most of the banks technically have been reversal the loan growth is expected to hover around able to meet the date of initial assessment, but we expect 15% in the coming year, given the low GDP growth much more refinement of processes to take place before expectation and prevailing low inflation levels. IFRS 9 will become business as usual. With the introduction of an expected credit loss model compared to The debt repayment, domestically and externally, along the current incurred loss model, going forward we expect with global developments is expected to refinance higher provisioning. This further has placed pressure on government debt at a higher cost which may put pressure the capital levels and ratios of the banks. on the interest rates starting late 2018. However, the net interest margins are expected to move in a narrower Six Domestic Systemically Important Banks hold over range with increased competition and less volatility in 70% of the total banking sector assets. The higher capital interest rates compared to the trends observed in the requirement and severe competition is expected to recent past. threaten the small banks’ performance over the medium term. Hence, we expect consolidation in the sector to The strong competition in the sector has led banks to be further strengthen the overall banking system. innovative with its products and migrate to the digital platform. Globally, a wave of new FinTech players have With increasing regulation, competition and the economic emerged with solutions covering most of the complex environment we expect the mid to large banks to move aspects of the banking value chain. Domestically, some into sustainable levels of loan growth and return on banks have identified the opportunity along with the equity. The economy is expected to attain its potential strength of their resources and scale and ventured into over the medium to long term with the implementation of the FinTech space. envisaged structural reforms, receipt of expected inflows of foreign investment, a conducive low inflation environment coupled with a competitive exchange rate. Sri Lanka banking perspectives 2018 5 Performance Total assets (LKR Bn)

10,292.6 highlights 5,941.567.0 70.7 Net profit (LKR Bn) 11.6%

138.9 74.6 13.2%

Total capital ratio

17.6%

15.2% 2.4%

Core capital ratio

14.9% 12.4% 10.0 11.2 2.5% Net Interest margin (NIM)(%)

3.5% 3.5%

Sri Lanka banking perspectives 2018 6 Credit to Deposit Ratio

82.2% 86.9% 4.7% Return Return on equity on assets

1.3% 1.4% 16.0% 17.6% 0.9% 1.6% 0.1%

Liquidity ratio

37.7% 31.3% 6.4%

Non-performing loan ratio

5.6% 3.12.5%%

Cost-to-income ratio

79.3% Key 76.3% Average 4 year CAGR// Total 5 year change

2013 Decline 3.0% 2017 Increase

Sri Lanka banking perspectives 2018 7 Sri Lanka banking perspectives 2018 8 Cyber security

Sri Lanka banking perspectives 2018 9 Cyber security: meeting the challenge With the rapid growth of Financial Services technology and the adoption of electronic channels, money is increasingly moving in a digital manner. But along with these advances we have seen a marked increase in cyber-security breaches and fraud. Precautions which banks can take are explained Priyanka Jayatilake

The pace of technology-enabled innovation has increased exponentially Cyber Security Strategy & Governance over the last decade, resulting in new business opportunities in the banking industry, such as digital branding (via mobile and internet channels), augmented reality (AR) and virtual Consumer identity Advanced Secure by Device reality (VR)-based banking channels, and access authentication design security blockchain-based transactions and management the internet of things (IOT)- based payments. Transactions are being processed faster, free, and in a user- friendly manner. These evolutions have fundamentally changed the way customers expect to Secure Privacy Regulatory interact with banks. They now demand transactions Privacy compliance a multi channel presence, improved client experience, secure transactions, Cyber Security Defense & Response and better control over privacy of their data to protect against fraud. These issues have made cybersecurity one of the top ten priorities in the board rooms, as any The financial services sector, being solutions for banks, we believe there are breach could undermine the trust that one of the most frequently targeted seven key capabilities that are strategic customers have in their banks, and sectors globally, has taken a particular to secure digital solutions for clients and therefore affect the future profitability interest in this subject. In the financial build greater trust in the organization: and sustainability of the organizations. sector in Sri Lanka we have noted that Cyber specifics banks have invested significantly on CBSL has always given great attention Cyber security strategy and cyber security. to cyber security: minimum guidelines governance and cyber security are set and needs to be maintained by IPGs are becoming more prevalent defense and response are the all banks and financial institutions and needs to be secure to provide traditional blocks of security. These regulated by CBSL. The present confidence to the users. translate into a number of specific Governor, Central Bank, has been areas, as follows: present at the Cyber Security Based on our global expertise of Summits in the last two years, from delivering cyber-security solutions Consumer Identity and Access the time he was appointed, to give and our experience of creating digital Management provides a single prominence to the subject. identity across multiple channels

Sri Lanka banking perspectives 2018 10 for users to access their accounts, a part in the organization’s digital manage their preferences, and strategy is essential in order to manage their credentials in a secure succeed and outpace competitors. manner. It also provides a mechanism Increasing regulatory pressure to gather data to understand from the US, the UK, Europe and customer needs and preferences. elsewhere require adjustments in technology configurations, and Changing technologies and increased security requirements are Priyanka Jayatilake security concerns have almost increasingly being enforced. New Partner, Head of Advisory rendered passwords obsolete. In T: +94 11 5426401 global regulatory pressures are order to meet both security and E: [email protected] likely to play a significant role in customer requirements, multiple, how financial services institutions advanced authentication options, interact and collect data of their Priyanka was the engagement and quality such as biometrics and push consumers. This needs to be aligned assurance partner for IT Infrastructure and notifications, will likely need to be and understood with the overall Security Review carried out in the year offered. Higher assurance credentials organizational digital strategy. 2005 for a leading international bank. can be leveraged to increase the Priyanka is also the National IT Security security assurance of a user for In our 2017 Global CEO Outlook survey Officer and Chief Knowledge Officer for higher risk transactions, such as it was clear that chief executives would KPMG Sri Lanka and Maldives. balance transfers and trades. be paying more attention to – and investing more in – cyber security in New technologies, such as cloud He has lead many engagements related the coming years. This will require and mobile, are driving customers to core banking applications reviews in finding staff with the appropriate wanting to access their accounts Sri Lanka skills; many CEOs report that human from any channel, at any time, capital is currently one of the biggest Priyanka has also lead an engagement from anywhere. This is resulting in challenges they face when it comes to on implementing Oracle E-Business significant changes in architecture. tackling this issue. These CEOs, Suite for a large listed commercial bank In order to adapt these changes, however, believe that such risks, if automating the back office functions of security ought to be designed into tackled adequately, can further prompt the bank including inventory, GL, the architecture and the innovation in products and services. accounts receivable, account payable and development lifecycle, across procurement different channels and We don’t think there are many board technologies. meetings or executive meetings in . Sri Lanka where the cyber threat The proliferation of different isn’t discussed. If companies aren’t devices poses new security risks. concerned, they probably should Understanding and adapting the be. security requirements of different devices and digital interfaces that the consumer connects with are essential to minimize account takeover and malware introduction. As digital financial transactions are becoming more common place, securing the mechanisms that enable each transaction is critical to successfully compete in the omni-channel and completely mobile environment. Direct Impact to Banks Banks handle a significant amount of personal information. Although “If companies aren’t regulations for handling this data vary from region to region, any personal information collected concerned, they should be managed in accordance with the local regulations and only used with the consent of the owner probably should be” of the information. Understanding how regulations, such as the EU General Data Protection Regulation (GDPR) and others, play

Sri Lanka banking perspectives 2018 11 Sri Lanka banking perspectives 2018 12 Regulation

Sri Lanka banking perspectives 2018 13 IFRS9:refininginitial implementation Given the gravity of the impact of IFRS 9, implementation efforts are likely to continue as banks work on refining the infrastructure- supporting areas to ensure all aspects of the standard are applied with smooth transition. Ranjani Joseph comments on the important aspects here.

Most banks around the world in meeting the increased capital decline in the quality, it is required would have completed the ratios under BASEL III, which is due by the standard that the bank makes implementation projects involved to come into full effect from January a provision for the lifetime of the with the International Financial 1, 2019. CA Sri Lanka has issued facility. While the ‘Expected Loss Reporting Standards 9 – Financial guidance providing the option to Model’ under IFRS 9, is considered Instruments (IFRS 9) over the last issue quarterly statements adjusted inherently subjective, it reduces the few months. The conceptual to reflect the IFRS 9 impact from 1Q possibility to delay provisions or transition from incurred loss to 2018 onwards. However the entities make inadequate provisions on expected credit losses is almost are required to apply IFRS 9 in the possible bad loans. completed. Adoption of IFRS 9 preparation of financial statements In order to promote reliability and has affected banks globally and for the annual periods beginning on comparability, CBSL is in the has completely transformed how after 01st January 2018. process of issuing guidelines to be they approach and view the loan In general the initial impact of IFRS 9 followed in the development of IFRS impairment process. is estimated to be roughly 40-50% 9 expected credit loss models, The standard has brought about increase in impairment provisions including the definition of default, significant changes in several and an approx. 10% increase in forward looking information, areas such as financial reporting, recurring impairment charges. To mapping of internal and external risk management, capital avoid a breach of these minimum ratings definitions, significant management, regulatory capital levels by banks, the Central increase in credit risk, low credit risk reporting, data sourcing and Bank of Sri Lanka (CBSL) has exemption and upgrading of collection, governance framework requested banks to provide them accounts. and IT systems. The standard has, with a reliable approximation of the While most banks have been able to in many ways, integrated the effect on their capital augmentation meet the date of initial Risk, Finance and IT functions of plans. assessment/implementation, we banks. In contrast to the “Incurred Loss assume that it may take longer The IFRS 9 on financial Model” under the former IAS 39, before IFRS 9 is fully implemented. instruments, replaced the where a bank assesses the need for Existing IT systems need to be previous version of IAS 39 from provision, when a facility significantly modified to account for January 1, 2018. The application demonstrates signs of difficulty, the the changes requested by IFRS 9 in of the standard is predicted to “Expected Loss Model” under IFRS the most cost-effective and scalable increase the impairment 9 assumes a probable loss on the way possible while data sources and provisions reported by the banks very first day the loan is granted. models need to be further to a great extent and this is likely This will result in booking provision enhanced. to affect profits and capital as during the first year of the facility. well. Consequentially, some of Furthermore, when the facility the banks might face challenges presents a serious

Sri Lanka banking perspectives 2018 14 Adequate infrastructure and Profitability has been found to be The role of the business teams is systems must be provided for affected at present and may likely to be more onerous with the data. An example would involve continue to be so, in the future as incentive structures tied to an the recording of collateral well. Increased impairment appropriate risk- adjusted profitability information, costs and details of provisions will result in a fall in metric, such as return on risk- recoveries used in Loss Given profitability. The implementation of weighted assets, return on risk- Default (LGD) calculation. Basel III, alongside IFRS 9, will result adjusted capital or economic value Constant monitoring is required in a higher cost of capital for banks added. for the models that have already as the capital adequacy ratio rises to been implemented to ensure a 14% by 2019 with a supplementary smooth transition now, while capital conservation buffer. maintaining efficiency in the Furthermore, the requirements for future. All these changes, will the Liquidity Coverage Ratio (LCR) require a significant investment in and Net Stable Funding Ratio (NSFR) terms of resources and time from will cause a rise in the cost of the bank’s perspective. liquidity. This is likely to affect Ranjani Joseph profitability and capital. This will Partner | Head of Banking Services Reinforcing sound governance affect product pricing, deal T: + 94 11 5426 302 origination, maturity and the E: [email protected] The inter-dependency between amortization of products offered. the IT, Finance and Risk functions Ranjani is an audit Partner and calls for a revised governance Credit management counts over 20 years of policy. Such a policy will require a experience, including as lead sound structure comprising the Credit management practices will Partner for a number of board of directors, steering also be affected in the future as Multinational & local Banks. She committee, working group banks may have to estimate forward- most recently served as the Audit committee and technical working looking expected loss over the life of Engagement Partner for the local group committee. The Basel the financial facility and continuously operations of three multinational Committee for Banking check for ongoing credit-quality banks operating in Sri Lanka and Supervision (BCBS) and Global deterioration. Costs and recoveries also for the Audits of two of the Public Policy Committee (GPPC) will have to be captured and largest listed Banks in the Colombo and other such bodies under the monitored frequently. As the credit Stock Exchange. Central Bank of Sri Lanka, have all benchmarks have become higher, She leads KPMG’s Banking services recommended minimum more relevant costs and recoveries in Sri Lanka and is also the Head of standards of governance to will need to be captured and Markets. She also represents support the proper regularly monitored. KPMG Sri Lanka in the KPMG implementation of IFRS 9. The Banks may also need to review and Middle East South Asia (MESA) implementation of these adjust performance indicators, Financial Sector Network. governance measures will need incentives and compensation careful deliberation and time. schemes to reflect for the associated Ranjani’s responsibilities include: changes in IFRS 9. The Collections leading clients through emerging It is expected to bring changes to and Recoveries teams will need to accounting challenges, specifically the way banks conduct business. commence their work earlier, IFRS 9, advising on various IFRS 9 is likely to result in some considering the 30 days past due accounting transactions, and of the business lines and the (DPD) threshold for a considerable guiding senior stakeholders on products becoming less feasible increase in credit risk (SICR). Shocks accounting matters. than others. Provisions under on the economy will call for vigorous Her focus is on the integration of IFRS 9 are point-in- time, hence monitoring and transferring of the risk and financial data to achieve are closely linked to the economic borrowers from stage 1 to stage 2. business outcomes while meeting cycle. It is likely that banks will Such monitoring will lead to an compliance requirements. reconsider lending to those increase in collection and recovery sectors that are susceptible to costs. changes in the economic cycle. Similarly, loans with a longer time The relationship manager has a period and bullet payments are pivotal role in an IFRS 9 scenario. also likely to come under She or he has a role in structuring increased pressure following the and pricing the product for the effect of expected credit loss obligor, collecting the installments (ECL). This will require the and being the first point of contact to Portfolio strategy to be amended obtain credit information from the to avoid the increased volatility. customer.

Sri Lanka banking perspectives 2018 15 Sri Lanka banking perspectives 2018 16 Macro economic overview

Sri Lanka banking perspectives 2018 17 Sri Lanka’s economy expanded 3.1% in 2017

National accounts Sri Lanka’s economy expanded at a lacklustre 3.1% in Real GDP and Real GDP growth rate 2017 in real terms compared to 4.5% in 2016. The adverse LKR Bn weather conditions that prevailed during the year 9,500 6% contributed mainly to the slower growth. 5.0% 5.0% 4.5% 5% In 2017, agriculture, services and industry sectors 9,000 3.4% contributed their share to the GDP at 6.9%, 26.8% and 3.1% 4% 56.8% respectively. 8,500 3% Agricultural activities reported a negative growth of 0.8% 8,000 2% in 2017 compared to a negative growth of 3.8% recorded in 2016. The contraction in agricultural activities was due 7,500 1% to the continued impact of adverse weather conditions that 7,000 0% prevailed during the period. 2013 2014 2015 2016 2017 Industrial activities recorded a growth of 3.9% in 2017 Real GDP Real GDP Growth Rate compared to 5.8% recorded in 2016. Under the sub- (GDP at constant 2010 prices) (Base year 2010) activities construction activities grew 3.1%, manufacturing grew 3.9% whilst mining and quarrying grew 5.9%. Source: Department of Census and Statistics Services activities with the highest contribution to the overall GDP grew at 3.2% in 2017 compared to 4.7% in Colombo Consumer Price Index (CCPI) 2016. 10% The CBSL expects the Sri Lankan economy to have grown at 3.7% in 1Q2018. 8%

ADB expects Sri Lanka’s economy to expand at 4.2% in 6% 2018 and 4.8% in 2019, whilst World Bank expects Sri Lanka’s GDP to rebound in 2018 and continue around 4% 4.5% in the medium term. 2%

Inflation as measured by CCPI 0% The annual average inflation as measured according to CCPI (Colombo Consumer price Index – Base 2013) increased to 6.6% as of end 2017. However since January CCPI Headline CCPI Core 2018 the inflation is on a downward trend falling to 3.8% in April 2018 from a 5.8% recorded in January. Source: Department of Census and Statistics Trade deficit widened in 2017 as a higher fuel bill weighed on imports

The trade deficit expanded to 11.0% of GDP in 2017 Exports vs. Imports (LKR Bn) compared to 10.9% of GDP in 2016 due to increased 4,000 import of fuel, rice and gold. 3,199 2,794 Adverse weather related conditions slumped domestic 3,000 2,535 2,572 2,323 rice production creating the need for higher rice imports 2,000 1,732 during 2017, while fuel imports increased to replace the 1,344 1,453 1,431 1,501 loss in hydro power generation. 513 616 1,000 In the first two months of 2018, the trade deficit 261 290 expanded to LKR 325.9Bn (USD 2.1Bn) compared to LKR - 252.3Bn (USD 1.7Bn) a year before as expenditure on 2013 2014 2015 2016 2017 2017 2018 Jan- Jan- imports offset the increase in export earnings. Feb Feb

Exports Imports Source: CBSL

Sri Lanka banking perspectives 2018 18 Trade deficit (LKR Bn) Fuel imports as a percentage of total imports 2017 2018 2013 2014 2015 2016 2017 Jan-FebJan-Feb 24% 24% 19% 16% 17% 14% (252) (326) 13%

(979) (1,082)(1,141) (1,294) (1,466) 2013 2014 2015 2016 2017 2017 2018 Jan-Feb Jan-Feb

Source: CBSL Source: CBSL Gross official reserves improved to USD 9.9Bn by April 2018 from USD 8.0Bn as at end 2017

Gross official reserves (USD Mn) Sri Lanka’s gross official reserves reached USD 9.9Bn in April 2018 from USD 8.0Bn as at end 2017 aided by issuance of international sovereign bonds and foreign 12,000 exchange purchases by CBSL. The 8-year syndicated loan the government accepted recently from China 10,000 Development Bank will further strengthen the reserve position. 8,000 The strong importer dollar demand coupled with the USD strengthening in global markets caused the LKR to 6,000 depreciate against the USD during the year. Furthermore, during the last 18 months CBSL has been following a flexible market oriented exchange rate policy. 4,000 LKR depreciation against USD 2,000 9.9%

4.0% - 2.8% 2.0% 3.1% 0.2%

2013 2014 2015 2016 2017 2018 YTD Source: CBSL Source: CBSL, KPMG analysis New Inland Revenue Act (IRA) to aid fiscal consolidation

Governments fiscal operations (LKR Bn) Government revenue as a percentage of GDP declined to 13.8% in 2017 from 14.2% in 2016 due to a reduction in 2,500 non-tax revenue (dividends transfers by State Owned Business Enterprises) during the year. 2,000

Expenditure and net lending reduced to 19.4% of GDP in 1,500 2017 compared to 19.6% of GDP in 2016 reflecting a reduction in recurrent expenditure (subdued growth in 1,000 salaries and wages, and current transfer payments). 500

- 2013 2014 2015 2016 2017 Revenue and grants Expenditure and Net lending Source: Ministry of Finance

Sri Lanka banking perspectives 2018 19 The fiscal deficit as a percentage of GDP increased to 5.5% in 2017 compared to 5.4% in 2016 as a result of Fiscal deficit (LKR Bn) - higher interest payments and disaster relief measures coupled with the fall in non tax revenue in 2017. (200) Sri Lanka's new Inland Revenue Act (IRA) took effect from (400) 1 April 2018 with the main objective of simplifying the tax system in order to create an investor friendly environment (600) that would attract more FDIs. (800) The IRA is expected to reduce the indirect taxes levied from the public from 80% to 60% and increase the direct (1,000) taxes from 20% to 40% within the next three years. 2013 2014 2015 2016 2017

Source: Ministry of Finance The policy rate changes slowed credit growth

Credit extended to private sector (LKR Bn) The CBSL reversed the trend of tightening monetary policy 6,000 30% in April 2018 by reducing 25bps off the Standing Lending Facility Rate (SLFR). This was after considering the 5,000 favorable developments in inflation and inflation outlook. 25% The CBSL maintained a tight monetary policy stance since 4,000 early 2016 in order to curtail adverse inflationary pressure 3,000 20% through excessive monetary and credit expansion.

2,000 The policy rates were increased by 25bps in March 2017 in 15% addition to the 100bps increase in policy rates in 2016 1,000 (Both SLFR and SDFR increased by 50bps each in February 2016 and in July 2016) and 150bps increase in Statutory - 10% Reserve Ratio in January 2016. Further, macro prudential measures like the imposition of Loan to value (LTV) ratios Jul-17 Jul-16 Jan-18 Jan-17 Jan-16 Mar-18 Mar-17 Mar-16 Nov-17 Sep-17 Nov-16 Sep-16 May-17 May-16 on lease of motor vehicles contributed to a tighter monetary policy. Credit extended to private sector YoY Growth

Source: CBSL

Movement in key interest rates

13% 12% 11% 10% 9% 8% 7% 6% 5%

SLFR SDFR AWPR AWDR 364 day T-bill

Source: CBSL

Sri Lanka banking perspectives 2018 20 Sri Lanka banking perspectives 2018 21 Key Banking Indicators

Sri Lanka banking perspectives 2018 22 Sector at a glance

Companies in the banking sector- 31 December 2017 Licensed commercial banks Total asset Total asset bas e (LKR Bn) bas e (LKR Bn) State banks Foreign banks 1.* 1,952 14.The Hongkong & Shanghai Corporation Ltd 435 2.People’s Bank* 1,467 15. Bank 162 Local banks 16.MCB Bank Ltd 29 3.Commercial Bank of Ceylon PLC* 1,143 17.ICICI Bank Ltd 26 4. PLC* 955 18. 8 5. PLC* 795 19. AG N/A 6. PLC 408 20. N/A 7.National Development Bank PLC 383 21. N/A 8.DFCC Bank PLC 333 22. Ltd N/A 9. PLC 267 23. N/A 10.Pan Asia Banking Corporation PLC 139 24. N/A 11. PLC 119 25.Habib Bank Ltd N/A 12. PLC 64 26.Bank of China (Banking operations are yet to 13. Bank Ltd 33 commence) Licensed specialized banks Total asset Total asset bas e (LKR Bn) bas e (LKR Bn) State banks Private banks 1.National Savings Bank* 1,012 5.State Mortgage & Investment Bank 42 2.Pradeshiya Sanw ardhana Bank 171 6.Sri Lanka Savings Bank Ltd N/A 3. PLC 82 7.Lankaputhra Development Bank Ltd N/A 4.Housing Development Finance Corporation Bank 50 of Sri Lanka

*Domestic Systematically Important Banks (D-SIBs) – Banks with asset bases higher than LKR 500Bn

Introduction Composition of total assets of the banking sector (December 2017) The banking sector consisted of 25 Licensed Commercial SCB Others (21 banks) Banks (LCBs), including 12 branches of foreign banks, and 2% 9% 7 Licensed Specialized Banks (LSBs) by end of 2017. NTB BOC 3% 19% The total asset base of the banking sector was recorded at DFCC LKR 10.3Tn by end 2017 compared to LKR 9.0Tn in 2016. 3%

With the establishment of Bank of China in Sri Lanka, the NDB number of banks in the banking sector increased to 26 as 4% th SEYB of 16 March 2018. 4% The report further analyses banks that currently account PSB (according to latest available financial information) for total 14% HSBC assets of more than LKR 250 Bn. 4%

SAMP 8%

COMB HNB 11% 9% NSB 10%

Sources: Company reports, CSE

Sri Lanka banking perspectives 2018 23 Growth in loans and advances (Gross)

40% Total gross loans and advances of the banking sector increased by 30% 16.1% in 2017 to LKR 6.4Tn 20% compared to LKR 5.5Tn in 2016. 10% Credit growth moderated during the 0% latter part of 2017 owing to the tightening of monetary policy. (10%)

2013 2014 2015 2016 2017 * DFCC – Results after amalgamation of DFCC Bank Sources: Company reports, CSE, KPMG analysis Composition& DFCC Vardhana Bank of gross loans & advances (as at 31 March 2018) 100% As at 2017 consumption and other sector accounted for 20.7% of loans 80% extended by the banking sector 60% followed by construction sector at 18.4%, trading sector at 14.5% and 40% manufacturing sector at 11.2% 20% During 2017 lending extended to 0% manufacturing sector increased by 21.9% (the largest growing sector) followed by trading sector at 19.8%, Term Loans Overdrafts Trade finance Housing loans construction sector at 19.5% and Lease receivable Credit cards Pawning Staff loans Personal loans Other consumption and other sector at Growth*as at 31 December in 2017 deposits of banksSources: Company under reports, CSE, KPMGreview analysis 15.8%. 50% 40% Total deposits of the banking sector increased by 17.5% in 2017 to LKR 30% 7.4Tn compared to LKR 6.3Tn in 20% 2016. 10% 0% (10%) (20%)

2013 2014 2015 2016 2017 *DFCC – Results after amalgamation of DFCC Bank & Sources: Company reports, CSE, KPMG analysis CompositionDFCC Vardhana Bank of deposits (as at 31 March 2018) 100% Due to the increase in interest rates 80% during 2017, the share of term 60% deposits increased to 63.6%. 40% The CASA Ratio decreased from 20% 37.1% in 2016 to 33.2% by the end 0% of 2017.

Demand Deposits Savings Deposits Fixed/ Time Deposits Other Deposits *as at 31 December 2017 Sources: Company reports, CSE, KPMG analysis

Sri Lanka banking perspectives 2018 24 Growth in Interest Earnings

Net Interest Income (LKR Bn) 80

60 Higher growth in interest expenses (39.1%) was witnessed compared 40 to the growth in the interest income 20 (28.3%). Thus caused a marginal decrease in NIM to 3.5% by the end - of 2017, from 3.6% during 2016. Tightening of monetary policy implementation in the previous 2013 2014 2015 2016 2017 years also led to a slight decrease in Sources: Company reports, CSE the NIM of the sector. Net interest margin (NIM)

8%

6%

4%

2%

0%

2013 2014 2015 2016 2017 Sources: Company reports, CSE Cost to income ratio

Most banks have concluded their 80% aggressive branch expansion which was observed post war. In particular 60% banks are concentrating more on 40% digital banking whilst consolidating its physical branch network which 20% has eased cost to income ratios.

0%

2013 2014 2015 2016 2017 Sources: Company reports, CSE

Sri Lanka banking perspectives 2018 25 Impairments Individual Impairment (LKR Bn) 5 1.0

- - (5)

(10) (1.0)

(15) (2.0) BOC PSB COMB HNB SAMP SEYB NDB DFCC NTB HSBC SCB 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 *No Individual impairment charge for NSB

Sources: Company reports, CSE Collective Impairment (LKR Bn) 1.0 5 0.5 - -

(5) (0.5) (1.0) (10) (1.5) (15) NDB DFCC NTB HSBC SCB BOC PSB NSB COMB HNB SAMP SEYB 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Sources: Company reports, CSE Sources: Company reports, CSE IFRS 9 (SLFRS 9) is effective for annual periods beginning On average the initial impact is estimated to be a 40% to from 1 January 2018. It is expected that with the 50% increase in collective impairment and an approximate implementation of IFRS 9, impairments of banks will 10% increase recurring impairment charges. increase in FY18 due to the introduction of Expected Credit Loss (ECL) model compared to the current Incurred loss model. Non performing loans and advances Gross NPL The gross NPL ratio of the banking 12% sector declined marginally to 2.5% 10% in 2017 compared to 2.6% in 2016 8% reflecting the improvement in credit 6% quality within the year. This was despite an increase in NPLs in 4% absolute terms by LKR 18.3Bn 2% during 2017. 0% NPL ratios are managed by the banks by precise diversification of the portfolio and avoiding over- Net NPL 2013 2014 2015 2016 2017 concentration on any one sector. 12% Most banks maintained NPL ratio 10% well below sector average apart from a few banks by the end of 8% 2017. 6% However, the slowdown in 4% economic growth coupled with the 2% recent adverse weather conditions 0% may cause pressure on the NPLs going forward.

2013 2014 2015 2016 2017 Sources: Company reports, CSE Sri Lanka banking perspectives 2018 26 Profit after tax (LKR Bn) Return on Assets (ROA)

30 10%

25 8% 20 6% 15 4% 10

5 2%

- 0%

2013 2014 2015 2016 2017 2013 2014 2015 2016 2017

Sources: Company reports, CSE Sources: Company reports, CSE

Net earnings of the Banking sector improved 19.2% YoY in Banking sector ROA increased by 6bps from 2016 to 2017 to LKR 138.9Bn compared to LKR 116.5Bn in 2016. 1.4% in 2017. Dividend payout ratio Return on Equity (ROE)

60% 50%

50% 40%

40% 30% 30% 20% 20% 10% 10% 0% 0% COMB HNB SAMP SEYB NDB DFCC NTB 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017

Sources: Company reports, CSE Sources: Company reports, CSE

Most banks pay dividends in the form of cash and scrip, Banking sector ROE increased by 28bps from 2016 to 17.6% with most banks favoring the latter due to tighter capital in 2017. Due to introduction of BASEL III, several banks raised requirements. rights issues which impacted their ROEs during 2017. Hence, we expect banks to record sustainable ROE’s around 15%.

Sri Lanka banking perspectives 2018 27 Liquidity

Statutory liquid asset ratio (domestic banking units) 100% The Statutory Liquid Asset Ratio (SLAR) of domestic 80% banking units (regulatory minimum of 20.0%) increased 60% to 31.3% as at end 2017 compared to 29.9% in 2016. 40%

20%

0%

2013 2014 2015 2016 2017 Credit to deposit ratio Sources: Company reports, CSE 150%

Most of the branches operate below 100% of credit to 100% deposit ratio. However, NDB and DFCC, which were earlier development banks are now converted to LCBS. 50% As a result their credit to deposit ratios have gradually decreased. 0%

2013 2014 2015 2016 2017 Sources: Company reports, CSE Capital adequacy ratio Tier 1 Capital adequacy ratio 25%

20% D-SIB Minimum requirement by Non D-SIBs - Minimum requirement by 1 Jan 2019 – 8.5% 1 Jan 2019 – 10.0% In view of Basel III capital adequacy requirements, the 15% CBSL issued a wave of regulations and directions with which banks must comply. 10% This required banks to increase their Capital adequacy 5% ratios on a staggered basis starting from 1 July 2017 with D-SIBs having to maintain higher ratios compared 0% to Non D-SIBs. By 1 January 2019 D-SIBs are required to increase their Tier 1 capital adequacy ratio and Total capital adequacy Sep-17 Dec-17 Mar-18 ratio to 10.0% and 14.0% respectively, whilst Non D- Shaded in blue – D-SIBs as at end 2017 Sources: Company reports, CSE SIBs are required to increase the same to 8.5% and Total capital adequacy ratio 12.5% respectively. 25% D-SIB - Minimum requirement by Non D-SIBs - Minimum Further, directions relating to Net Stable Funding Ratio 20% 1 Jan 2019 – 14.0% requirement by 1 Jan 2019 – 12.5% (NSFR) which relates to assets and off-balance sheet activities are expected to be issued by the CBSL in the 15% second half of 2018. 10%

5%

0%

Sep-17 Dec-17 Mar-18 Shaded in blue – D-SIBs as at end 2017 Sources: Company reports, CSE

Sri Lanka banking perspectives 2018 28 1Q2018 performance

Net interest income (LKR Bn) - 2 4 6 8 10 12 14 16

BOC 6.0% COMB 33.6% HNB 15.1% SAMP 31.0% SEYB 17.2% NDB 43.6% DFCC 29.5% NTB 44.9% Data labels indicate YoY growth Net Interest Income - 1Q2018 Net Interest Income - 1Q2017 Sources: Company reports, CSE

Non interest income (LKR Bn) - 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

BOC 0.8% COMB 7.1% HNB 28.1% SAMP 30.3% SEYB 23.0% NDB 43.9% DFCC (18.6%) NTB 29.5%

Data labels indicate YoY growth Non Interest Income - 1Q2018 Non Interest Income - 1Q2017 Sources: Company reports, CSE

Profit after tax (LKR Bn) - 1 2 3 4 5 6 7

BOC (18.8%) COMB 16.0% HNB 22.5% SAMP 41.4% SEYB 21.6% NDB 34.7% DFCC (15.3%) NTB 82.8%

Profit after tax - 1Q2018 Profit after tax- 1Q2017 Data labels indicate YoY growth

Sources: Company reports, CSE

*PSB,NSB,HSBC & SCB 31 March 2018 quarter results not available

Sri Lanka banking perspectives 2018 29 1Q2018 performance

Loans and advances (LKR Bn) - 200 400 600 800 1,000 1,200 1,400 BOC 2.1% COMB 5.7% HNB 5.4% SAMP 7.5% SEYB 3.2% NDB 3.1% DFCC 4.3% NTB 7.5%

Loans and advances as at end 1Q2018 Loans and advances as at end 4Q2017 Data labels indicate quarterly growth Sources: Company reports, CSE Deposit (LKR Bn) - 500 1,000 1,500 2,000

BOC 5.0%

COMB 6.5%

HNB 2.7%

SAMP 2.9%

SEYB 1.2%

NDB 3.9%

DFCC 3.7%

NTB 8.9%

Deposits as at end 1Q2018 Deposits as at end 4Q2017 Data labels indicate quarterly growth

Sources: Company reports, CSE

*PSB,NSB,HSBC & SCB 31 March 2018 quarter results not available

Sri Lanka banking perspectives 2018 30 KPMG at a glance

Office People Established in, KPMG is expanded in, 1897 6 districts 18 1,150 197,263 Partners People Locally People globally The oldest Chartered Accountancy firm in KPMG value proposition, the country • Our Values Lifelong learning Is our global citizenship priority • Our Credentials Part of KPMG Celebrating, • Proven global network Methodology Dedicated to Learning & Development 120 years • Experienced Core Committed to developing a Service Team Global continuous learning culture Opportunities Professional Service Provider • Technical training, • Coaching, 3,000 people on • Mentoring, Global Mobility Audit Ta x Advisory • Industry secondments and assignments • Skill-building programs

Achievements Customers KPMG named “Best Deal KPMG named “The Best Top client base Advisory Firm in Sri Advisory Firm – Sri Lanka Hatton National Bank Lanka 2015” 2016” 1,500+ PLC Clients by Global by PLC Banking and International Sunshine Holdings PLC Finance Finance Brown & Company PLC Review Magazine Toyota Lanka KPMG Industry Base Cargills Ceylon PLC KPMG named “Tax Firm Lion Brewery Ceylon PLC of the Year - 2017” Most Respected 2017 - LMD Sri Lankan Airlines Limited by International Tax KPMG was ranked among Commercial Bank Review, Asia Tax the most respected in the Diesel & Motor Engineering Awards 2017 latest LMD rankings PLC KPMG named “Tax becoming John Keells PLC Disputes & Litigation first in the Ceylon Biscuits Limited Firm of the Year – 2017” financial Nestle Lanka PLC by International service Dilmah Tax Review, category Asia Tax Awards 2017

5 Sri Lanka banking perspectives 2018 31 KPMGserviceofferings

Audit Management Risk Deal Ta x Consulting Consulting Advisory

High quality, Our high capability Our risk consulting Our experienced A business’s approach independent financial teams offer deep practice combines investment to tax is increasingly statement audits are industry and technical the knowledge and professionals skilfully subject to public essential to maintaining knowledge, and expertise of over 50 assess how scrutiny and is now market-leading tools investor confidence. partners, directors opportunities to buy, a major reputation to deliver solutions sell, partner, fund or driver. From company and professionals. Our audit professionals across every business fix a company can add set-up to cross-border We help organizations are committed to the and industrial sector. and preserve value. and transfer pricing public interest.They transform risk and Our teams combine a solutions, we work seek to challenge Our consultants assist compliance efforts into global mind-set and with a wide range of assumptions and clients to make better competitive advantage local experience with national and multi- unlock valuable insights decisions that may by applying a risk lens deep sector national organizations based on a thorough reduce costs, enhance to corporate strategy. knowledge and to deliver effective understanding of organizational This improves risk superior analytic tools tax solutions. Our tax an organization’s effectiveness and intelligence and to support clients. professionals combine develop appropriate business and industry, decision making, From assisting to international experience technology strategies. and innovative audit protects financial and plan and implement with local knowledge methodologies and reputational assets, strategic change to to provide leading approaches. and enhances measurably increasing edge commercial tax Understanding the business value. portfolio value, we strategies tailored to financial performance of deliver tangible results. specific client needs. any business must be placed in the context of strategic priorities, risk appetites and competitive positioning. Our technology-enabled audit approach applies extensive data analytics to provide the necessary evidence confirming that critical controls and disclosures uphold the highest level of integrity. — Audits of financial — People & Change — Forensic — Valuations — Inbound & indirect statements — Customer & Analytics — Business Process — Debt Advisory taxes — Audit-related services — Financial Management Management — Transaction Solutions — Mergers, — Audit data & analytics acquisitions — Operations — Accounting Advisory — Mergers & and restructuring — Strategy & Economic Services Acquisitions — International tax Advisory — Internal Audit & Risk — Restructuring services — IT Advisory Compliance — Transfer pricing — Tax management consulting — Global mobility services — Automatic exchange of information

Sri Lanka banking perspectives 2018 32 Oman banking perspectives 2018 35 Contact us

Reyaz Mihular Suren Rajakarier Ranjani Joseph Managing Partner Partner, Head of Audit Partner, Audit & Banking Services T: +94 11 5426500 T: +94 11 5426301 T: +94 11 5426302 E: [email protected] E: [email protected] E: [email protected]

Priyanka Jayatilake Shamila Jayasekara Shiluka Goonewardene Partner, Head of Advisory Partner, Head of Tax & Regulatory Principal, Head of Deal Advisory T: +94 11 5426401 T: +94 11 5426503 T: +94 11 5426403 E: [email protected] E: [email protected] E: [email protected]

kpmg.com/lk kpmg.com/app

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

© 2018 KPMG, a Sri Lankan partnership and a member firm of the KPMG network of independent member firms affiliated with International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. Printed in Sri Lanka.

The KPMG name and logo are registered trademarks or trademarks of KPMG International.