CBSL warns of rising credit risks despite financial system stability

Sri Lanka’s financial system remained stable during the first half of 2026, supported by economic recovery, improved fiscal performance and adequate capital and liquidity buffers, although rising household borrowing and external uncertainties pose emerging risks, the Central Bank of Sri Lanka (CBSL) said.

In its Financial Stability Review 2026, released yesterday, the Central Bank highlighted rapid growth in vehicle financing and gold-backed lending, rising household indebtedness and increasing property prices as potential sources of financial vulnerabilities.

The report noted that intensifying geopolitical tensions, elevated energy prices, global inflationary pressures and tighter international financial conditions could affect Sri Lanka through trade, tourism earnings, workers’ remittances, capital flows and exchange rate movements.

In response to the growing risks, the Central Bank increased its overnight policy interest rate in May 2026 and introduced macroprudential measures, including loan-to-value limits on vehicle financing and gold-backed lending, to contain excessive borrowing and promote prudent lending practices. Banking sector credit expanded significantly, with year-on-year growth reaching 23.6% in the second quarter of 2026, compared with 11.4% a year earlier.

Although banks maintained capital and liquidity buffers above regulatory requirements, the increase in loans showing early signs of credit deterioration warrants continued monitoring.

Finance companies also recorded strong credit expansion, with lending growing 45% year-on-year in the second quarter, driven largely by vehicle financing and gold-backed loans.

The Central Bank cautioned that rising Stage 2 loans indicated increasing credit risks in the sector.

Meanwhile, domestic financial markets remained broadly stable, although equity market performance moderated, government securities yields increased and foreign investor participation remained subdued.

The report also highlighted growing cyber and operational risks arising from the expansion of digital financial services, alongside climate-related vulnerabilities and potential exposure to external economic shocks.

The Central Bank said the financial stability outlook remained broadly positive, provided the economic recovery continued, fiscal consolidation progressed and prudent policies were maintained.

It stressed the importance of preserving capital and liquidity buffers, strengthening risk management and ensuring credit expansion remained consistent with underlying economic conditions

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