Sri Lanka net interest margin is expected to decline as economic conditions improve and market competition intensifies. The Central Bank says the unusually high profitability enjoyed by banks will normalize with more transparency and regulatory reforms.
Sri Lanka net interest margin expected to ease as competition rises and economic recovery gains pace
The Central Bank of Sri Lanka (CBSL) anticipates a notable reduction in the net interest margin of commercial banks as financial conditions stabilize and the industry shifts into a more competitive phase of economic recovery. Governor Dr. Nandalal Weerasinghe highlighted that the margin, currently above 4 percent, will gradually decline toward historical norms around 3.5 percent, easing the cost of intermediation in the system.
The comments came during the launch of the Financial Stability Review 2025, where the CBSL addressed the improving health of the banking industry. Banks have experienced stronger profitability in recent quarters despite reductions in policy rates. Data shows that the sector reported a profit after tax of Rs. 187.5 billion from January to June this year, marking an impressive 67.8 percent surge compared to Rs. 111.8 billion during the same period in 2024.
Dr. Weerasinghe explained that the elevated profits reflect both recovering activity and the reversal of provisions previously made for debt restructuring during the economic crisis. Although profitability remains relatively strong, he noted that the pace of improvement has already begun to slow, signaling a more balanced trajectory in the months ahead.
During the crisis period, the Sri Lanka net interest margin narrowed significantly as banks raised provisions and faced asset quality deterioration linked to stressed borrowers. Lending volumes decreased, and caution prevailed across the financial system. With the broader recovery now underway, both lending and deposit rates are adjusting downward, but the margin has temporarily expanded by approximately 0.5 percentage points as banks rebuild financial strength.
The Governor emphasized that this wider spread is neither sustainable nor desirable over the long term. Policymakers prefer to see margins ease alongside economic recovery, ensuring that credit growth does not become overly expensive for consumers and businesses. Encouraging greater transparency and accountability within the banking sector forms a key part of this plan.
Regulations enforced by the Financial Consumer Relations Department are pushing banks to enhance disclosures and operate with higher levels of clarity for clients. Authorities expect that standardization and improved customer awareness will stimulate healthy competition among commercial lenders, ultimately contributing to a smooth reduction in the net interest spread.
A range of other factors has also influenced the current levels. Higher taxes on financial institutions and the lingering presence of non-performing loans continue to exert pressure on the margin, prompting banks to maintain elevated pricing for risk management reasons. The Central Bank has acknowledged that these legacy issues remain relevant in the short term, even as asset quality gradually recovers.
However, optimism over the long-term outlook remains strong. The CBSL forecasts that as economic growth accelerates and credit conditions improve, the profitability of banks will align more closely with normal operating conditions observed prior to the crisis. Lower intermediation costs would support a more dynamic business environment, promoting borrowing for investment, household consumption, and broader economic transformation.
Transparency-driven reforms represent a key pillar of confidence building, especially at a time when the public is highly sensitive to the performance of financial institutions. Sustained communication and strengthened governance frameworks are seen as essential to preserving trust.
Dr. Weerasinghe reiterated that the transition would not unfold overnight. The system is going through a period of recalibration in which margins stay slightly higher than preferred levels while recovery proceeds. He encouraged a patient outlook while still reaffirming the Central Bank’s commitment to guiding interest structures toward efficiency.
“Relatively higher earnings reflect relief from some of the crisis-era burdens,” he noted. “What matters now is enabling a competitive environment that channels profitability into growth rather than excess pricing.”
The banking industry remains a key engine in the country’s rehabilitation efforts, and its stability has provided resilience during a demanding period. A gradual easing of the Sri Lanka net interest margin would help unlock further expansion, encouraging economic participants to re-engage with borrowing and investment at an affordable cost.
As momentum in economic activity continues to improve and the financial sector adjusts more closely to current fundamentals, the Central Bank expects the path ahead to reflect more typical market behavior, marking one more step toward a stronger and healthier financial landscape.