Fitch rating watch developments have placed HDFC and SMIB on a positive trajectory as Sri Lanka prepares for major state-led bank acquisitions. The shift signals potential strengthening of support structures once the proposed transfers are completed.
Fitch rating watch boosts confidence as Sri Lanka banks face major acquisition changes
Sri Lanka’s financial sector is seeing renewed momentum after Fitch Ratings placed the national ratings of Housing Development Finance Corporation Bank (HDFC) and State Mortgage & Investment Bank (SMIB) on Rating Watch Positive. The move follows the government’s announcement that all state-owned shares of the two banks will be transferred to Bank of Ceylon and People’s Bank under an extensive acquisition plan. The Fitch rating watch action marks a notable departure from earlier concerns, particularly as HDFC had previously held a Negative Outlook.
According to Fitch, the planned acquisitions create a high likelihood that both HDFC and SMIB will benefit from significantly stronger backing due to their integration with two of the country’s largest state banks. This anticipated support is expected to be reflected in future support-driven national ratings once the transactions are finalized. However, the agency cautioned that formal resolution of the Rating Watch Positive status may take longer than the typical six-month window because the acquisition modalities have not yet been disclosed.
The shift in rating sentiment represents a particularly important turnaround for HDFC, which only months ago faced a Negative Outlook due to regulatory restrictions that curtailed its deposit-mobilizing capacity and limited parts of its lending portfolio. These constraints weakened the bank’s ability to compete in the housing loan sector, where it traditionally relied heavily on Employees’ Provident Fund-backed borrowing. Reduced market share in both loans and deposits contributed to concerns about HDFC’s relative vulnerability compared with peers holding similar ratings.
SMIB, meanwhile, faces challenges of its own. As of mid-2025, the bank’s capital levels remain below the regulatory minimum of 7.5 billion rupees, with a shortfall estimated between 2 and 3 billion rupees. Fitch noted that although SMIB remains profitable, internal earnings retention is unlikely to allow the bank to meet its capital requirements within the near future. The acquisition by People’s Bank, therefore, could be a crucial turning point in stabilizing SMIB’s capital position while providing broader operational backing.
Fitch last reviewed SMIB’s rating in September 2025 without taking rating action, referencing its earlier analysis and sensitivities published in March of the same year. The new Fitch rating watch adjustment reflects the material change brought about by the government’s decision to approve state-share transfers, which alters the long-term risk landscape for both institutions.
Despite the positive outlook, Fitch emphasized that downward rating pressure remains possible if the acquisitions fail to proceed. Should the deals collapse, SMIB’s ratings would likely be affirmed at current levels, while HDFC could revert to a reinstated Negative Outlook if regulatory restrictions continue to limit its business model. Persistent deterioration in HDFC’s ability to compete in the housing-loan segment—particularly in areas reliant on EPF-backed loans—could further undermine its rating stability. Fitch also warned that any prolonged failure to restore HDFC’s capital to the regulatory minimum, or widening gaps between assets and liabilities due to funding challenges, could trigger a downgrade.
Conversely, the successful completion of the acquisitions could result in notable upgrades for both banks. Given the significantly stronger shareholder profiles of Bank of Ceylon and People’s Bank, Fitch believes the enhanced capacity for extraordinary support could be reflected in multiple-notch improvements. That said, the agency expects a clear gap to remain between the ratings of the acquirers and their newly acquired subsidiaries due to the limited strategic weight the smaller banks carry within their new parent groups.
The rating environment also includes additional nuances. SMIB holds a 1.78 percent equity stake in Fitch Ratings Lanka Ltd., though the agency clarified that no shareholder other than Fitch, Inc. influences the rating operations or credit assessments carried out by the local office. This ensures that the ratings remain independent despite cross-ownership ties within the market.
The broader context of these moves highlights Sri Lanka’s shifting financial landscape, as the government continues to consolidate state-owned institutions and restructure areas facing long-standing capital and regulatory challenges. The Fitch rating watch update underscores the transformative potential of the acquisitions, even as stakeholders await clearer timelines and procedural details.
For now, both HDFC and SMIB remain in a holding pattern, with expectations rising that the finalization of the transactions will bring enhanced stability and restored competitiveness. The Fitch rating watch signals cautious optimism within the sector, reflecting a belief that the banks’ futures may soon be anchored by larger and more resilient state-owned financial institutions.