Fitch Ratings has affirmed the credit ratings of several Sri Lankan banks, indicating a more stable outlook for the nation's banking sector. The agency's decision reflects the recent improvements in the country's economic and financial landscape.

Bank of Ceylon (BOC), one of Sri Lanka's leading banks, saw its Long-Term Local-Currency Issue Default Rating (IDR) affirmed at 'CCC-' and removed from Rating Watch Negative (RWN), with a Stable Outlook. Additionally, Fitch affirmed the National Long-Term Ratings of several other major banks, including People’s Bank, Commercial Bank of Ceylon PLC, Hatton National Bank PLC, Sampath Bank PLC, National Development Bank PLC, Seylan Bank PLC, DFCC Bank PLC, Nations Trust Bank PLC, Pan Asia Banking Corporation PLC, Union Bank of Colombo PLC, Amana Bank PLC, Sanasa Development Bank PLC, and Housing Development Finance Corporation Bank of Sri Lanka.

Fitch also affirmed Cargills Bank Limited’s (CBL) National Long-Term Rating at 'A(lka)' and removed it from RWN, but assigned a Negative Rating Outlook.

The removal of the Rating Watch Negative status for these banks' ratings reflects Fitch's view that near-term downside risks have substantially decreased, mainly due to the upgrade of Sri Lanka’s Long-Term Local-Currency IDR to 'CCC-' from 'RD' as reported on September 28, 2023.

The recent successful conclusion of the local-currency sovereign debt restructuring, along with the exclusion of banks' holdings of treasury securities from the domestic debt optimization program, has helped alleviate some of the pressure on banks' capital positions arising from weakening loan quality and rupee depreciation, as well as any immediate funding and liquidity stresses.

While the restructuring of Sri Lanka's foreign-currency debt, including the defaulted sovereign bonds that banks hold, is ongoing, Fitch believes that incremental risks to banks' capital are likely to be manageable, given their limited exposure to these bonds (3.6% of total assets at end-1H23) and high provision coverage.

However, access to foreign-currency wholesale funding remains challenging due to the sovereign's weak credit profile, though the stress on banks' foreign-currency liquidity has eased compared to the crisis period.

Fitch has assigned a Negative Outlook to CBL due to concerns about its increasing size relative to its ultimate parent, CT Holdings PLC (CTH). This size differential could potentially constrain CTH's ability to provide extraordinary support to CBL in times of need.

The removal of parental support considerations, stemming from CBL's growing size relative to CTH, could result in a downgrade of CBL’s rating to a level that reflects its standalone credit strength, which Fitch considers significantly weaker than the support-driven rating of 'A(lka)'.

Looking ahead, an improvement in Sri Lanka's operating environment, particularly after the successful completion of the restructuring of the remainder of the foreign-currency sovereign debt, could lead to positive rating actions. A sustained improvement in banks' key credit metrics relative to peers may also result in rating upgrades.

It's worth noting that BOC and PB each have a 1.78% equity stake in Fitch Ratings Lanka Ltd., and no shareholder other than Fitch, Inc. is involved in the day-to-day rating operations of, or credit reviews undertaken by, Fitch Ratings Lanka Ltd.

The removal of the Rating Watch Negative status also applies to the senior and subordinated debt ratings of these banks, where applicable.