Fitch Ratings has stated that Sri Lanka’s recent implementation of stricter macroprudential regulations regarding vehicle and gold-backed loans is likely to enhance the risk profiles of lenders, especially finance companies. The Central Bank of Sri Lanka has reduced the loan-to-value (LTV) limits, specifically targeting two financial products that have seen significant growth in recent years and constitute a major portion of the balance sheets of primarily finance companies. However, these tighter limits could impact the volume of loans and earnings growth for lenders that have substantial exposure to these categories.
On May 25, 2026, the LTV cap for motor vehicle financing was adjusted, dropping from 70% to 60% for cars registered for over one year, and from 60% to 40% for vehicles that are either unregistered or registered for less than one year. Additionally, the central bank has allowed transitional provisions for letters of credit that were established prior to this new regulation, where financing has not yet been finalized.
In terms of gold-backed lending, the LTV cap has been lowered from 80% to 70%, applicable to both new loans and those that are being rolled over. This adjustment is anticipated to help mitigate risk accumulation in the gold-backed lending sector, which has experienced rapid growth among banks and finance companies due to elevated collateral values, favorable capital treatment, and minimal provisioning requirements.
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Both forms of financing are susceptible to fluctuations in collateral value. The market for local vehicles is sensitive to changes in import duties and tax regulations, while gold prices can exhibit volatility. The new, lower LTV caps are expected to strengthen the resilience of lenders against any decline in collateral values, thereby reducing the potential losses in the event of borrower defaults.
Over the past three years, the volume of gold-backed lending at finance companies and Fitch-rated banks has surged, with a compound annual growth rate (CAGR) of nearly 30%. By the end of 2025, this segment accounted for approximately LKR 1.5 trillion, or 11% of the total loans in the sector, up from 7% in 2022. For finance companies, this share was about 20%, compared to 17% in 2022, while Fitch-rated banks held around 9%, an increase from 5%.
Among Fitch-rated banks, People’s Bank (Sri Lanka) (AA-(lka)/Stable) exhibited the highest exposure to gold-backed loans, with these loans constituting about 20% of its total lending portfolio. Most of its competitors remained under 10%. In the finance sector, Asia Asset Finance PLC (A+(lka)/Stable) had nearly two-thirds of its loans in gold-backed lending, while LB Finance PLC (A-(lka)/Stable) and Mahindra Ideal Finance PLC (AA-(lka)/Stable) reported figures just above one-third and two-thirds, respectively.
The resumption of motor vehicle imports in early 2025 led to a notable increase in vehicle financing, with both banks and finance companies experiencing growth rates exceeding 50% that year. Finance companies are particularly exposed, with vehicle financing making up about 65% of their total loans, whereas banks accounted for less than 5%. This swift expansion raises asset quality concerns, especially if economic downturns affect borrowers’ ability to repay loans.
Moreover, favorable capital treatment has fueled growth in gold-backed loans. Vehicle financing is subject to a risk-weight of at least 100%, while loans with LTVs up to 70% for gold are assigned a zero risk-weight for banks and finance companies. For LTVs above 70%, banks apply a risk-weight of 20% up to 100%, while finance companies impose a 100% risk-weight for all exposures exceeding 70%.
This results in an average risk density of less than 1% for Fitch-rated banks and around 5% for finance companies concerning gold-backed lending. While the new LTV caps may reduce the regulatory incentives for prioritizing gold-backed lending, the existing risk-weighting structure remains unchanged.
Nonetheless, the prudential measures introduced by the central bank are expected to primarily enhance the risk buffers of finance companies, as gold-backed lending and vehicle financing are essential offerings for them. The positive implications for banks’ risk profiles are anticipated to be more limited since these products are categorized under retail lending rather than being core components of their balance sheets.
Source: Financial Chronicle Biz English | Sri Lanka Business News.
