New gold-loan rules strengthen safeguards; limited rating impact seen: Fitch, as Sri Lanka’s banking and finance sectors prepare to comply with tighter capital requirements for gold-backed lending from September 1, 2026.
New gold-loan rules strengthen safeguards; limited rating impact seen: Fitch says
According to Fitch Ratings, the revised regulatory framework introduced by the Central Bank of Sri Lanka is expected to strengthen prudential safeguards and improve risk management across the financial system, while having a largely manageable impact on the capital positions of most rated banks and finance companies.
The new rules increase the risk weights applied to gold-backed loans, requiring lenders to hold more capital against these exposures. The move comes after a sharp rise in gold-backed lending in recent years, as vehicle import restrictions limited traditional lending opportunities and encouraged financial institutions to expand their gold loan portfolios.
Fitch noted that gold-backed lending became increasingly attractive due to its relatively low capital requirements under the previous framework. However, the revised regulations seek to address potential risks associated with the rapid growth of the segment.
Under the new framework, loans with loan-to-value (LTV) ratios below 70 percent will carry a 10 percent risk weight for both banks and finance companies, compared with a zero percent risk weight previously. Higher LTV categories will attract even greater capital charges, increasing the amount of regulatory capital institutions must maintain.
As a result, Fitch estimates that the average risk density of gold loan portfolios will rise significantly. For rated banks, risk density is expected to increase to approximately 12 percent from just 1 percent previously. For finance companies, the figure is projected to rise to 26 percent from around 5 percent.
Despite these changes, the impact on the banking sector is expected to remain relatively modest because gold-backed lending accounts for a comparatively small share of total lending portfolios. Fitch estimates that common equity Tier 1 capital ratios among rated banks could decline by between two basis points and 35 basis points based on end-March 2026 exposures.
Among the rated banks, People’s Bank is expected to experience the largest effect because gold loans represent around one-fifth of its gross loan portfolio. However, Fitch noted that the bank’s conservative LTV structure should help mitigate the impact on its capital position.
The effect on finance companies is likely to be more pronounced due to their greater reliance on gold-backed lending. Fitch estimates that Tier 1 capital ratios at the four rated finance companies could decline by between one percentage point and slightly more than five percentage points.
Asia Asset Finance is expected to face the greatest impact, with gold loans accounting for more than two-thirds of its total lending portfolio. Meanwhile, LB Finance and Mahindra Ideal Finance are projected to experience capital ratio declines of between one and two percentage points, while UB Finance could see a reduction of around one percentage point.
The rating agency also highlighted concerns regarding institutions that already have limited capital buffers. HNB Finance and Merchant Bank of Sri Lanka & Finance are expected to face additional pressure on their capital positions, while Mercantile Investments and Finance could see its regulatory capital buffers narrow further.
According to Fitch, HNB Finance’s total capital ratio may move closer to the minimum regulatory requirement, while Merchant Bank of Sri Lanka & Finance was already below the minimum Tier 1 and total capital requirements at the end of March 2026. In such cases, capital injections and continued earnings retention will be important to rebuild stronger capital cushions.
Nevertheless, Fitch does not expect lenders to significantly reduce their focus on gold-backed lending. The agency noted that even under the revised framework, gold loans remain less capital intensive than many alternative lending products, making them an attractive business segment for financial institutions.
Importantly, Fitch views the regulatory changes as credit positive. The higher capital requirements complement the Central Bank’s earlier decision in May 2026 to reduce maximum LTV limits in an effort to curb aggressive expansion in the gold loan market and enhance financial system stability.
The agency added that the eventual impact could be lower than currently estimated if lenders proactively reduce their exposure to gold-backed lending before the new rules come into effect.
However, Fitch cautioned that a significant decline in global gold prices remains the key risk for institutions with large concentrations in gold loans. Falling collateral values could weaken asset quality and place additional pressure on capital adequacy levels.
Despite these concerns, Fitch does not anticipate the new framework triggering rating actions for affected institutions, noting that most issuers either maintain adequate capital buffers or benefit from external support mechanisms that provide additional stability.