8 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY 8.1 Overview uring the year 2020, the stability of Sri Lanka’s financial system was preserved amidst challenging domestic and global market conditions posed by the COVID-19 pandemic. Despite the challenging economic environment resulting from the pandemic, and regional or countrywide lockdown periods Ddisrupting business activities to a larger extent, the banking sector exhibited moderate growth in terms of loans and advances, investments, and deposit base. However, deterioration in credit quality, sovereign rating downgrades and decreased foreign inflows due to the pandemic, exerted pressure on the banking sector operations. Having identified the importance of reviving adversely affected sectors in the economy, the Central Bank implemented several extraordinary regulatory measures to provide flexibility to Licensed Commercial Banks (LCBs) and Licensed Specialised Banks (LSBs) in supporting businesses and individuals affected by the pandemic. The Licensed Finance Companies (LFCs) and Specialised Leasing Companies (SLCs) sector recorded sluggish performance as reflected by the decline in asset base, loans and advances and deposits as well as increasing Non-Performing Loans (NPLs) and declining profitability during the year, mainly due to the COVID-19 pandemic related growth impediments and the lack of public confidence in some weak LFCs. The Central Bank initiated several regulatory actions along with the introduction of the Financial Sector Consolidation Master Plan to avoid further deterioration of the financial position of LFCs, maintain the stability of the sector and safeguard the interest of depositors. Other sectors in the financial system recorded a mixed performance. Meanwhile, the Central Bank ensured the availability of liquidity in the money market, particularly considering the need for supporting the financial system and facilitating economic activities during the COVID-19 pandemic period by introducing several monetary policy relaxation measures in 2020. Though the pressure on the exchange rate observed in March - April eased thereafter, with the imposition of restrictions on non- essential imports and selected outward remittances, improved workers’ remittances and the rebound of export earnings, the pressure re-emerged due to relatively low level of Foreign Exchange (FX) inflows together with the gradual relaxations of restrictions and FX repatriations. This situation was further aggravated by the consecutive sovereign rating downgrades by global rating agencies. However, owing to the modest FX interventions and several policy measures taken by the Central Bank, the exchange rate stood at around Rs. 185 by end 2020. The Colombo Stock Exchange (CSE) CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2020 recovered from the significant decline it witnessed with the spread of COVID-19 pandemic, to a record high in terms of overall price index. Domestic investors’ preference shifting towards equity investments in a low interest rate regime helped market recovery although foreign outflows continued. Meanwhile, the Central Bank continued to ensure uninterrupted payment and settlement services in the country amidst the COVID-19 pandemic. 8.2 Performance of the Banking and continued to expand at a notable pace Sector during 2020 compared to 2019. Additionally, to alleviate the impact of the pandemic, the Central Despite enduring challenges stemming from Bank implemented a number of extraordinary the COVID-19 pandemic, the banking sector regulatory measures to provide flexibility to licensed remained resilient mainly due to the capital and banks in supporting businesses and individuals liquidity buffers built over the past few years, affected by the pandemic. Table 8.1 Total Assets of the Financial System The banking sector dominated the financial 2019 (a) 2020 (b) sector accounting for 72.5 per cent of total Share Share assets as at end 2020. Despite the challenging Rs. bn Rs. bn (%) (%) economic environment resulting from the on-going Banking Sector 14,442.1 72.0 17,087.9 72.5 pandemic and regional or countrywide lock-down Central Bank 1,919.4 9.6 2,421.6 10.3 Licensed Commercial Banks (LCBs) 10,944.0 54.5 12,828.8 54.4 periods disrupting business activities to a greater Licensed Specialised Banks (LSBs) 1,578.7 7.9 1,837.5 7.8 extent, credit growth of the banking sector improved Other Deposit Taking Financial Institutions 1,553.2 7.7 1,637.6 6.9 Licensed Finance Companies (LFCs) 1,390.8 6.9 1,367.9 5.8 during 2020 compared to 2019. Deposits were Co-operative Rural Banks (c) 161.7 0.8 268.9 1.1 the dominant source of funding, while there was Thrift and Credit Co-operative Societies 0.8 0.0 0.8 0.0 a notable decline in foreign currency borrowings Specialised Financial Institutions 286.7 1.4 415.3 1.8 Specialised Leasing Companies (SLCs) 41.9 0.2 33.7 0.1 during 2020 due to decreased FX inflows as a result Licensed Microfinance Companies 5.8 0.0 6.8 0.0 Primary Dealers 77.5 0.4 87.2 0.4 of the pandemic and sovereign rating downgrades. Stock Brokers (c) 9.7 0.0 17.1 0.1 The banking sector profits improved compared Unit Trusts / Unit Trust Management Companies (c) 113.8 0.6 190.5 0.8 Market Intermediaries (d) 18.4 0.1 60.1 0.3 to the previous year due to notable increase in Venture Capital Companies 19.5 0.1 19.9 0.1 non-interest income as a result of movements in Contractual Savings Institutions 3,787.5 18.9 4,429.8 18.8 Insurance Companies 689.6 3.4 790.1 3.4 the interest rates and exchange rates, decrease in Employees’ Provident Fund 2,540.4 12.7 2,824.3 12.0 non-interest expenses and reduction of taxes. Employees’ Trust Fund 343.3 1.7 380.4 1.6 Approved Pension and Provident Funds (e) 149.1 0.7 364.9 1.5 Business Expansion: By end 2020, the Public Service Provident Fund 63.7 0.3 70.1 0.3 Total 20,068.2 100.0 23,570.6 100.0 banking sector comprised 30 banks, i.e., 24 (a) Revised Source: Central Bank of Sri Lanka LCBs including 11 branches of foreign banks, (b) Provisional Department of Co-operative (c) Due to unavailability of data for Q4 Development and 6 LSBs. Upon completion of the closure 2020, Q-o-Q growth for Q3 2020 was Department of Labour used to estimate the asset base for year Department of Pensions procedures which commenced in 2019, based 2020 Employees’ Trust Fund Board (d) Includes Investment Managers, Margin Insurance Regulatory Commission of Sri Lanka on decisions taken by their Head Offices, the Providers, Underwriters and Credit Rating SANASA Federation Agencies and due to unavailability of Securities and Exchange Commission banking licences issued to ICICI Bank Limited and data for Q4 2020, Q-o-Q growth for of Sri Lanka Q3 2020 was used to estimate the asset Unit Trust Association of Sri Lanka Axis Bank Limited to operate in Sri Lanka were base for year 2020 Venture Capital Companies (e) Due to unavailability of data, 2019 asset cancelled during the year 2020. The banking sector 8 base of Approved Pension and Provident Funds was taken as same as 2018. continued to support economic growth and promote 190 FINANCIAL SECTOR PERFORMANCE AND SYSTEM STABILITY Figure 8.1 Performance of the Financial Sector Banking Sector 9.7 14.6 Y-o-Y Growth in Y-o-Y Growth in GWP (%) Total Assets (%) 38.6 Prot Before Tax (Rs. bn) Banking sector exhibited satisfactory growth in terms of loans and advances, investments, and deposit base. Insurance Sector 11.9 40.0 21.6 Y-o-Y Growth in Y-o-Y Growth in Y-o-Y Growth in Loans and Advances (%) Investments (%) Deposits (%) The insurance sector reported a growth in 4.9 37.3 16.5 asset base and profits. Statutory Liquid Capital Adequacy Gross NPL Ratio (%) Asset Ratio - DBU (%) Ratio (%) Despite enduring challenges stemming from the COVID-19 pandemic, the banking sector remained resilient during 2020. The fund earned a total gross income of Rs. 285.6 billion in 2020, recording an increase of 10.1 per cent compared with the previous year. -5.7 15.7 19.4 11.2 150.7 Y-o-Y Growth in Capital Adequacy No of Member Y-o-Y Growth in Contributions Loans and Advances Ratio (%) Accounts (mn) Total Assets (%) (Rs. bn) (%) 13.9 1.7 109.7 10.6 9.0 Refunds (Rs. bn) Return on Interest Paid to Gross NPL Ratio Return on Investment (%) Member (%) Assets Balances (%) (%) The Central Bank initiated several regulatory actions LFCs and SLCs along with introducing Employees’ Sector the Consolidation Provident Fund Master Plan to revive the sector. 8 191 CENTRAL BANK OF SRI LANKA | ANNUAL REPORT 2020 Table 8.2 loans. Increase in credit was diversified across the Distribution of Banks, Bank Branches and Other Banking Outlets major sectors of the economy. In terms of products, End End re-scheduled loans (38.0 per cent), housing loans Category 2019 (a) 2020 (b) (18.0 per cent) and term loans (14.1 per cent) were Licensed Commercial Banks (LCBs) I. Total No. of LCBs 26 24 the main products which reported higher growth Domestic banks 13 13 rates during 2020. Meanwhile, the year-on-year Foreign banks 13 11 II. Total No. of LCB Banking Outlets 6,690 6,703 growth in investments exceeded that of credit Branches (c) 2,907 2,916 during the year, increasing from 12.2 per cent Domestic Banks 2,842 2,854 Foreign Banks 50 47 as at end 2019 to 40.0 per cent as at end 2020. Student Savings Units 3,783 3,787 The Held to Maturity (HTM) portfolio grew by 41.8 III.Automated Teller Machines 5,393 5,744 Licensed Specialised Banks (LSBs) per cent during 2020 due to Treasury Bonds and I.