Sri Lanka’s financial system is on the path to recovery, with expectations of improved asset quality and strengthened capital buffers, according to the Central Bank of Sri Lanka (CBSL) in its Financial Stability Review 2024. This positive outlook emerges as the economy stabilizes despite ongoing challenges stemming from previous macrofinancial imbalances, which are gradually being addressed through various policy measures, reforms, and adaptive behaviors.
The CBSL acknowledged the commendable efforts of the financial sector in managing the impacts of the economic crisis but emphasized the need for ongoing commitment to ensuring financial stability in the medium to long term. As economic conditions improve, demand for financial services is anticipated to rise, driven by stable prices and enhanced financial intermediation.
However, the bank warned that as credit expansion occurs in the private sector, financial institutions must vigilantly manage potential pressures on credit quality and capital adequacy, especially in light of high non-performing loan (NPL) ratios and limits on large exposures. Attracting deposits amid low-interest rates remains a significant challenge, while declining lending rates may impact net interest income and profitability. Additionally, the CBSL cautioned that the significant returns generated from sovereign exposure in government securities may diminish.
The report highlighted the importance of carefully navigating adjustments in the external and fiscal sectors, particularly regarding suppressed import demand and delays in meeting sovereign debt obligations, to maintain financial stability. The completion of external debt restructuring is expected to unlock additional external financial resources, albeit with prudence.
Despite these optimistic indicators, the CBSL noted that challenges would persist as the benefits gained from recovering macrofinancial conditions begin to fade. The future outlook hinges on sustained fiscal consolidation, balanced external demand, and stable prices to foster ongoing economic growth.
As the credit cycle expands, increased risk-taking may lead to vulnerabilities, underscoring the need for proactive risk management. The CBSL, acting as the macroprudential authority, alongside the Financial System Oversight Committee, will continue to monitor systemic risks and recommend necessary policy measures to ensure financial stability. The CBSL urged all stakeholders to remain committed to timely and well-sequenced reforms to secure sustained stability in the financial system.