Financial system remained resilient during the first quarter (Q1) of 2026 amidst challenging global and domestic conditions arising from heightening tension in the Middle East and global uncertainties. Despite global uncertainties and external sector pressures, domestic macrofinancial conditions remained broadly supportive during Q1 of 2026. Credit growth accelerated further during the period, with total credit extended by Licensed Banks (LBs) and Finance Companies (FCs) growing during the period, supported mainly by strong private sector lending. Thus, credit exposures increasingly shifted towards the private sector, while exposures to the Government and public corporations moderated marginally. The sovereign-bank nexus continued to reflect established interlinkages between the sovereign and the banking sector.
Financial intermediation improved further during the quarter, with the banking sector credit-to-deposit ratio surpassing 70% for the first time in the last three years, indicating continued recovery in lending. However, credit-to-GDP gap widened further into the positive territory, underscoring the potential build-up of systemic risk within the financial sector. Going forward, heighted global challenges including elevated energy prices, commodity price volatility, along with exchange rate volatility, adverse weather conditions and rising inflation may exert pressures on macrofinancial conditions. Hence, sustained fiscal consolidation, stronger external buffers, and vigilant monitoring of emerging macrofinancial risks remain critical to safeguard financial system stability.
Credit growth of the banking sector continued to accelerate during Q1 of 2026, while liquidity and capital buffers showed slight moderations, accompanied by a marginal deceleration in profitability. Credit granted by the banking sector grew by 24.4% year-on-year (y-o-y) at end Q1 of 2026 compared to a growth of 7.9% y-o-y reported at end Q1 of 2025. Stage 3 loans ratio of the sector declined to 9.4% at end Q1 of 2026 compared to 12.7% at end Q1 of 2025, supported by the credit expansion and a slight drop in stage 3 loans. Further, the impairment coverage ratio for stage 3 loans increased to 59.5% at end Q1 of 2026 compared to 54.1% at end Q1 of 2025. The increased credit growth was further reflected through the decline in liquidity buffers, as Rupee and all currency liquidity coverage ratios declined to 267.9% and 234.7%, respectively, at end Q1 of 2026 from 342.4% and 310.6%, respectively, at end Q1 of 2025. Nevertheless, these liquidity buffers remained well above the minimum regulatory requirement of 100%. Meanwhile, profit after tax of the sector recorded a slight decline of 7.1% y-o-y in Q1 of 2026, mainly due to increased operating expenses. Reflecting the declined profits, return on equity (ROE) and return on assets (ROA) of the banking sector declined to 14.8% and 2.2%, respectively, at end Q1 of 2026, compared to 18.7% and 2.6%, respectively, reported at end Q1 of 2025. Moreover, the total capital adequacy ratio (CAR) declined to 18.3% at end Q1 of 2026 compared with 19.4% a year earlier, primarily reflecting the elevated risk weighted assets mainly driven by credit expansion. However, capital buffers remained well above the minimum regulatory requirements. In addition, the recent depreciation of the Sri Lanka rupee, together with increased secondary market yields, could further moderate the sector’s capital buffers through the revaluation impact on assets. Moreover, the potential exposure to scams and cyber-related incidents remains a concern, requiring close monitoring and greater vigilance in digital transactions.
The FCs sector continued its significant credit growth momentum during Q1 of 2026, while liquidity and profitability maintained at satisfactory levels, amidst a slight moderation in capital adequacy. Credit granted by the FCs sector surged by 52.4% y-o-y at end Q1 of 2026 compared to a growth of 26.9% y-o-y reported at end Q1 of 2025, mainly driven by vehicle and gold-backed lending. Accordingly, vehicle backed lending increased by 52.8% y-o-y, while gold-backed lending demonstrated a robust y-o-y growth of 69.2% at end Q1 of 2026. However, the increase in vehicle prices, driven by higher import duties and the depreciation of the exchange rate, together with tightened monetary policy and macroprudential measures, could moderate the future credit growth momentum of the FCs sector. Stage 3 loans ratio of the sector declined to 4.4% at end Q1 of 2026 from 8.6% recorded at end Q1 of 2025, supported by a considerable decline in stage 3 loans alongside the rapid credit expansion. Despite this decline in stage 3 loans, the impairment coverage ratio for stage 3 loans of the sector decreased to 45.1% at end Q1 of 2026 compared to 47.4% at end Q1 of 2025. Moreover, liquidity level of the FCs sector remained well above the minimum regulatory requirements with an increase in total liquid assets by 9.7% y-o-y at end Q1 of 2026. Meanwhile, the sector’s profit after tax recorded a considerable increase of 28.8% y-o-y during the financial year 2025/26. Further, ROE of the FCs sector increased to 17.2% at end Q1 of 2026 compared to 15.2% at end Q1 of 2025, while ROA declined to 6.2% from 6.6% during the same period. In addition, the sector’s total CAR moderated to 18.4% at end Q1 of 2026 from 20.9% at end Q1 of 2025, consequent to the substantial credit expansion during the period.
During the first five months of 2026, domestic financial markets experienced some pressure amid heightened tension in the Middle East and rising external sector vulnerabilities, along with speculative activities of market participants. The Colombo Stock Exchange (CSE) exhibited increased volatility and weaker markets sentiment, with the All Share Price Index (ASPI) declining marginally by 1.4%, while the S&P SL20 Index remained mostly unchanged with a modest gain of 0.03% as of end May 2026. Market conditions were characterised by elevated volatility, uneven liquidity conditions, and continued foreign investor withdrawals, largely reflecting increased sensitivity to global risk sentiment, rising domestic inflation expectations, and external shocks. Net foreign outflows from the share market reached USD 103.4 mn, compounding the cumulative divestments recorded in 2025 and 2024. Meanwhile, the government securities market experienced an upward pressure on yields, particularly from March 2026 onwards. Yields increased further following the increase in policy interest rate in late May 2026. Secondary market activity in government securities moderated somewhat during the period, while foreign inflows remained volatile due to evolving global uncertainties. In the domestic foreign exchange market, the Sri Lanka rupee continued to record volatility reflecting increased external sector pressures. In the domestic money market, surplus liquidity continued to persist with the Central Bank absorbing excess liquidity through open market operations.
Considering the recent significant expansion in collateral-based lending and asset-price volatilities stemming from geopolitical uncertainties and exchange rate fluctuations in the domestic forex market, the Central Bank of Sri Lanka (CBSL) introduced several measures to ensure the stability of the financial system. Accordingly, with effect from 25 May 2026, a maximum Loan to Value (LTV) ratio of 70% has been introduced for credit facilities secured by gold , while the existing maximum LTV limits applicable on credit facilities granted in respect of motor vehicles have been tightened by 10 percentage points.
