Fitch Ratings has assessed that the Central Bank of Sri Lanka’s recent adjustments to the capital treatment of gold-backed loans will have a largely manageable effect on the capital ratios of rated banks and financial institutions, while also enhancing their risk profiles. The anticipated impact is expected to be more significant for finance companies than for banks, given that gold-backed loans make up a larger portion of their lending portfolios and their underwriting practices have been notably more aggressive.
Both banks and finance companies will implement consistent risk weightings according to the new regulations. Loans with a loan-to-value (LTV) ratio under 70% will now be assigned a risk weight of 10% for both sectors, an increase from zero. For loans falling within the 70%-100% LTV range, banks will impose a 40% risk weight, up from the previous 20%, while finance companies will uniformly apply a 40% risk weight across the entire exposure instead of just the portion exceeding a 70% LTV. Loans exceeding a 100% LTV will continue to carry a 100% risk weight for both categories. Consequently, this adjustment raises the average risk density in gold-backed lending portfolios to approximately 12% for Fitch-rated banks and 26% for finance companies, up from 1% and 5%, respectively.
Fitch anticipates that the effect on banks’ capital ratios will be minimal due to their relatively lower exposure to gold loans. The projected impact on their common equity Tier 1 ratios is estimated to range from 2 basis points to 35 basis points, based on data from the end of March 2026. People’s Bank (Sri Lanka) (AA-(lka)/Stable) stands out with the highest exposure, where gold loans account for about 20% of its total loans, compared to under 10% for other banks. Nevertheless, the impact on its capital appears limited due to the bank’s cautious LTV profile.
The implications for four Fitch-rated finance companies are expected to be more significant, though still manageable given their existing capital buffers above the regulatory minimum. It is estimated that their regulatory Tier 1 capital ratios may drop between 1 percentage point and slightly more than 5 percentage points. Asia Asset Finance PLC (A+(lka)/Stable) is projected to be the most affected, with gold-backed loans representing over two-thirds of its lending portfolio. Gold loans make up a third of the total loans at LB Finance PLC (A-(lka)/Stable) and Mahindra Ideal Finance PLC (AA-(lka)/Stable), which suggests moderate capital strain of about 1 to 2 percentage points. UB Finance PLC (BB(lka)/Negative) may also experience an impact of around 1 percentage point, despite gold loans constituting less than 20% of its total portfolio. Other rated entities are likely to encounter more limited effects, ranging from 5 to 80 basis points.
For HNB Finance PLC (HNBF, A(lka)/Stable) and Merchant Bank of Sri Lanka & Finance PLC (MBSL, A(lka)/Stable), these regulatory changes will further stress their already challenged capital positions, while Mercantile Investments and Finance PLC’s (BBB-(lka)/Stable) capital buffers are expected to decline as well. HNBF’s total capital ratio may approach the regulatory minimum, and MBSL was already below the required levels for Tier 1 and overall capital at the end of March 2026. To re-establish adequate buffers above regulatory requirements, capital injections at HNBF and MBSL, along with ongoing capital accumulation, will be essential.
Following the restrictions on vehicle imports, lenders had rapidly increased their gold-backed lending due to the low risk weights associated with these loans. Although the revised framework is viewed as credit-positive from a prudential standpoint and aligns with the lower LTV caps introduced in May 2026 to control aggressive growth, lenders are likely to continue favoring gold loans, which require less capital compared to other lending products.
The overall impact on banks and finance companies may turn out to be less severe than projected if lenders adjust their portfolios ahead of the implementation date of September 1, 2026, assuming that gold prices remain stable. The brief duration of gold loans also supports this outlook. However, for lenders with high concentrations in gold loans, a significant drop in gold prices poses the primary risk, as it could elevate LTVs, weaken collateral value, and exert additional capital pressure.
Financial Chronicle Biz English | Sri Lanka Business News.
