Fitch sees limited capital impact from new gold loan rules

Sri Lanka
By Editor_1

COLOMBO – Fitch Ratings said Sri Lanka’s revised capital requirements for gold-backed lending are expected to have a manageable impact on the capital positions of banks and finance companies, while strengthening the sector’s overall risk profile.

The rating agency said the Central Bank’s new directive, which increases risk weights applied to gold-backed loans, will affect finance companies more significantly than banks because such loans account for a larger share of their lending portfolios and have generally been underwritten more aggressively.

Under the revised framework, gold loans with loan-to-value (LTV) ratios below 70% will attract a 10% risk weight for both banks and finance companies, compared with a previous zero-risk weighting. Loans with LTV ratios between 70% and 100% will carry a 40% risk weight, while exposures above 100% LTV will continue to be risk-weighted at 100%.

Fitch estimates the changes will increase the average risk density of gold-loan portfolios to around 12% for rated banks and 26% for rated finance companies, up from 1% and 5%, respectively.

Despite the increase, Fitch expects only a modest effect on banks’ capital ratios due to their relatively low exposure to gold-backed lending. The agency estimates common equity Tier 1 capital ratios at rated banks could decline by between two and 35 basis points based on end-March 2026 data.

Among rated banks, People’s Bank had the largest exposure to gold-backed loans, which accounted for around 20% of its gross loan portfolio, compared with less than 10% for most peers. Fitch said the impact on the bank’s capital position should nevertheless remain limited due to its conservative LTV profile.

The impact is expected to be more pronounced for finance companies. Fitch estimates Tier 1 capital ratios at four rated finance companies could decline by between one and slightly more than five percentage points, although existing capital buffers should allow them to absorb the changes.

Asia Asset Finance PLC is likely to be the most affected, with gold-backed lending accounting for more than two-thirds of its loan book. Gold loans represent roughly one-third of lending portfolios at LB Finance PLC and Mahindra Ideal Finance PLC, resulting in an estimated capital impact of one to two percentage points.

Fitch also expects a capital impact of about one percentage point for UB Finance PLC despite gold loans accounting for less than 20% of its portfolio. Other rated institutions are expected to experience smaller reductions ranging from five to 80 basis points.

The agency warned that the new requirements would add further pressure on the capital positions of HNB Finance PLC and Merchant Bank of Sri Lanka & Finance PLC, both of which already face capital challenges. It also said regulatory capital buffers at Mercantile Investments and Finance PLC would decline under the revised framework.

According to Fitch, HNB Finance’s total capital ratio could move close to the regulatory minimum, while Merchant Bank of Sri Lanka & Finance was already below minimum Tier 1 and total capital requirements at the end of March 2026. The agency said capital injections and continued earnings retention would be important to rebuild adequate buffers at both institutions.

Fitch noted that lenders expanded gold-backed lending rapidly in recent years following restrictions on vehicle imports, as the product benefited from low risk weights and relatively low capital consumption.

The agency described the revised framework as credit-positive from a prudential perspective, particularly when combined with lower LTV caps introduced by the Central Bank in May 2026 to curb aggressive growth in the sector. However, it said lenders are still likely to favour gold-backed lending because it remains less capital-intensive than many other lending products.

Fitch added that the ultimate impact may be lower than current estimates if lenders adjust their portfolios before the new rules take effect on September 1, 2026. The short-term nature of most gold loans could facilitate such adjustments.

The agency identified a sharp decline in gold prices as the principal risk facing institutions with high concentrations of gold-backed loans, warning that falling prices could increase LTV ratios, weaken collateral coverage and place additional pressure on capital adequacy.

Despite the changes, Fitch said it does not expect the revised directive to result in rating actions, noting that the most affected institutions either benefit from external support or maintain sufficient capital buffers to absorb the impact.

-ENCL

Editor_1
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