Fitch Ratings reports that Sri Lanka’s state banks continue to have weaker capital adequacy ratios compared to key private banks, despite improved profitability. This is largely due to a mandatory special reserve that state banks must maintain for foreign-currency debt restructured in 2024.

Bank of Ceylon and People’s Bank have allocated 72% of their 2024 profits to this special reserve, affecting capital ratios. These reserves are not included in capital adequacy calculations, creating vulnerability in the event of increased risk.

Private banks such as Commercial Bank and HNB have allocated a much smaller portion of profits to reserves, due to their lower exposure to restructured sovereign debt.

Fitch warns that if higher risk weights were applied to these exposures, the core capital ratios of state banks could drop below 10%, underlining their sensitivity to sovereign-related risks.

Despite these challenges, profitability improved across the sector in 2024 due to debt restructuring outcomes and provision reversals. However, Fitch maintains that the state banks’ risk profiles are still heavily linked to the country’s fiscal position.