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ECONOMYNEXT – Sri Lanka’s bank may need a 1.4 trillion rupee capital injection after bad loans from a currency crisis and debt -restructure hit their balance sheets, according to an analysis by the International Monetary Fund.

Sri Lanka is in the midst of the worst currency crisis in the history of the island’s intermediate regime central bank which ended in sovereign default, higher than required interest rates due to the lack of a cut-off date for domestic debt restructure and impoverishment of the population leading to crumbling demand.

A debt analysis by the IMF has identified a 6 percent of 2022 GDP (1.4 trillion rupees) requirement for losses from re-structuring public sector debt and for bad loans from the private sector after the currency crisis.

“The estimate is sensitive to the design of the restructuring,” the analysis noted.

Under the program Sri Lanka’s central bank has hired consultants to study five large banks by April 2023. The two largest state banks and three largest private banks account for 70 percent of banking assets.

“The diagnostic exercise will assess the impact on banks’ capital from asset quality deterioration, FX depreciation, and the sovereign default,” according to the IMF program document.

“The asset quality review will be completed by August 2023 for four more banks (three private and one public) accounting for a further 20 percent of domestically owned banking assets.”

The five assessed banks will be required to submit time-bound plans for capital restoration and
closure of their FX net open positions by June 2023.

NOPs of most banks are now plus after private credit collapsed and there is an overall balance of payments surplus, according to market participants.

“The CBSL will, by July 2023, develop a roadmap for financial sector restructuring and recapitalization, to address capital and FX liquidity shortfalls identified through the diagnostic exercise, and intervene in banks assessed to be non-viable,” the program said,

“This roadmap will include binding deadlines for compliance with capital requirements including buffers to be restored.”

The Ministry of Finance (MoF) “will determine the size, timing, instruments, and terms and conditions for potential government recapitalization of viable banks which are unable find capital from private sources.

“A similar process for capital restoration planning will be completed for the remaining four banks,” the program said.

“The CBSL will develop a roadmap by November 2023 and the MOF will determine the detailed
recapitalization plan by January 2024. The authorities will consult with IMF staff on the design
and implementation of these steps.”

A capital injection will not be recorded as an expense in the budget for determining the primary deficit. (Colombo/Mar21/2023)

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