EconomyNext – Sri Lanka’s finance leasing companies, which turned to gold-loans due to restrictions on car imports, may face credit risk if gold prices fall, Fitch Ratings said.
Sri Lanka banned vehicle imports in 2020 after rate cuts implemented with liquidity injections to target ‘potential output’ led to a foreign exchange shortage.
Rates were cut to promote growth, although the old law made no provision for monetary stimulus and provided only stability. But critics have said that under Section 6(4) of the new central bank law, printing money for development (targeting potential output) has been legalized.
“Sri Lankan FLCs have grown their exposure to gold-backed loans rapidly over the past several years amid declining demand for their core vehicle-financing business,” the ratings agency said.
“Gold-backed loan balances more than quadrupled between the financial year ending March 2019 (FYE19) and FYE23, increasing its share in the sector’s gross credit to 18% from 4% at the end of FY19. “
If gold prices fall, NPLs may increase.
“This was evident in 2012 and 2013 when the sharp decline in gold prices led to increases in non-performing loans (NPLs) and credit costs at many Sri Lankan banks and non-bank financial institutions,” Fitch said.
“Extended loan tenure will make lenders more sensitive to continued price improvements.”
No risk weighting is required for loans with value ratio of less than 70 per cent of gold asset.
The NPL ratio from gold-backed loans remained “significantly low” as gold was easily auctioned and borrowers also passed the maturity period by paying only interest.
“However, the ratio has come under pressure amid the challenging operating environment and weak repayment capabilities of borrowers,” Fitch said.
Among Sri Lankan FLCs rated by Fitch on standalone strength, the 90+ days past due ratio on gold loans increased to 5.3 per cent in the first quarter of the current financial year from 1.9 per cent at the end of 2022.
“This is consistent with rising auction volumes, indicating rising defaults in this segment,” Fitch said.
Rising gold-backed debt raises risks for Sri Lankan finance companies
Fitch Ratings-Colombo/Hong Kong-20 November 2023: Growing gold-backed lending among Sri Lanka’s finance and leasing companies (FLC) sector is exposing financiers to higher collateral value risk and making them vulnerable to any adverse movement in gold prices. Made more sensitive to fluctuations, it is said. Fitch Ratings.
Sri Lankan FLCs have grown gold-backed loans rapidly over the past several years amid declining demand for their core vehicle-financing business.
Gold-backed loan balances more than quadrupled between the financial year ending March 2019 (FYE19) and FYE23, taking its share in the sector’s gross credit to 18% from 4% at the end of FY2019. We believe several factors have fueled this trend, including increased demand for short-term financing from borrowers, relatively high product yields, and the liquid nature of gold collateral that allows lenders to offer default facilities through regular auctions. Allows recovery. FLC has cut its exposure to gold-backed debt in 1QFY24, but we consider this to be temporary, as this is partly triggered by the decline in local gold prices in 1QFY24 following the global price decline, which The appreciation of the Sri Lankan rupee has increased during the period.
Excessive concentration in gold-backed loans may leave some FLCs at great risk of devaluation, especially if collateral haircuts are inadequate to protect them from any sudden and sharp price declines. This became evident in 2012 and 2013 when a sharp decline in gold prices led to an increase in non-performing loans (NPLs) and credit costs in many Sri Lankan banks and non-bank financial institutions. Extended loan tenure will expose lenders to continued price improvements. The increasing competition among FLCs has led to an increase in the average loan-to-value (LTV) ratio. They are currently between 70% and 80%, but if gold prices fall or borrowers start defaulting, the interest earned could increase. Unlike markets such as India, gold-backed loans in Sri Lanka are not subject to any regulatory LTV limits.
The current regulatory capital framework also tempts FLCs to build larger gold loan portfolios more quickly than they otherwise would. This may lead lenders to underestimate their risk levels and reserve insufficient capital to absorb potential shocks. For example, gold loans with LTV ratio up to 70% have no risk weighting, and only incremental exposures above the 70% limit are risk-weighted at 100%. This is in contrast to India, for example, where gold loans carry a standard 100% risk weight. The risk-weighted share of gold loans increased from 8% in FY23 to 13% due to fall in local prices in 1QFY24, but we expect this to mostly reverse in the subsequent months following recovery in gold prices.
Like other markets, Sri Lankan FLCs do not take into account the repayment capacity of borrowers when underwriting gold-backed loans, focusing only on the collateral value. Hence collateral risk mitigation becomes more important to protect against losses. However, valuation of gold collateral is at the discretion of the lenders and is subject to their own calculation methods. The accuracy of the collateral accepted may also vary. This is in contrast to markets like India, where regulators set methods for collateral valuation. The NPL ratio of gold-backed loans of Sri Lankan FLCs is well below that of conventional loan products, mainly due to the ability of lenders to recover overdues through frequent gold auctions and the borrowers getting a facility at maturity by paying only interest. Has the ability to roll over. ,
However, the ratio has come under pressure amid the challenging operating environment and weak repayment capabilities of borrowers. Among Sri Lankan FLCs rated by Fitch on standalone strength, the 90+ days past due ratio on gold loans increased from 1.9% at end-FY22 to 5.3% at 1QFY24. This is in line with increasing auction volumes, indicating increasing defaults in this segment.