Sri Lanka’s financial system remained stable during the first half of 2026 despite global challenges, including geopolitical tensions, inflationary pressures, rising energy prices and tighter financial conditions, according to the Central Bank of Sri Lanka’s (CBSL) latest Financial Stability Review.
The report attributed the country’s financial stability to the continued economic recovery, improved fiscal performance, and adequate capital and liquidity buffers maintained by banks and finance companies. However, it warned that rising household debt, rapid credit expansion and increased reliance on collateral-backed lending were emerging vulnerabilities requiring close monitoring.
The Central Bank noted that Sri Lanka remained vulnerable to external shocks because of its dependence on trade, tourism, workers’ remittances, capital flows and external financing. Geopolitical tensions, particularly the conflict in the Middle East, rising commodity prices, climate-related risks and global economic uncertainty continued to pose challenges to the domestic economy.
Private sector credit growth accelerated during the review period, particularly in household lending, vehicle financing and gold-backed lending. This widened the credit gap and raised concerns about potential systemic risks. Rising real estate prices, volatile collateral values and inflationary pressures also contributed to emerging vulnerabilities.
In response, the Central Bank increased the overnight policy interest rate in May 2026 and introduced macroprudential measures, including tighter loan-to-value limits for vehicle financing and gold-backed lending, to curb excessive borrowing and promote responsible lending.
Financial markets remained broadly stable despite periods of volatility. Government securities yields increased across maturities amid changing market expectations and tighter monetary policy, while foreign investor participation remained subdued. The foreign exchange market also faced pressure during heightened tensions in the Middle East, contributing to the rupee’s depreciation against the US dollar. Conditions subsequently improved with continued inflows from tourism, exports and workers’ remittances.
The banking sector remained resilient, supported by stronger profitability and healthy capital and liquidity positions. Credit growth reached 23.6% year-on-year by the second quarter of 2026, driven by lending to consumption, trade, construction, financial services and overseas-related activities. Asset quality improved, with the gross Stage 3 loans ratio declining to 9.1% from 11.9% a year earlier. However, an increase in Stage 2 loans indicated potential credit risks amid rapid lending growth.
Finance companies recorded credit growth of 45% year-on-year, largely driven by vehicle financing and gold-backed lending. The report highlighted the impact of Cyclone Ditwah and the Middle East conflict on affected borrowers, stressing the need for continued monitoring of vulnerabilities in the sector.
The insurance industry remained adequately capitalised despite pressure on profitability. Claims related to Cyclone Ditwah increased reinsurance receivables and heightened liquidity and underwriting risks.
The review also highlighted the growing importance of digital financial services in improving efficiency and financial inclusion. However, expanding digital connectivity has increased exposure to cyber threats, operational disruptions and third-party risks, making cyber resilience increasingly important for financial stability.
Looking ahead, the Central Bank said the financial stability outlook remained broadly positive, provided the economic recovery continued, fiscal consolidation progressed and prudent policies were maintained. However, external uncertainties and domestic vulnerabilities, including excessive credit expansion, sectoral concentration and evolving cyber risks, could pose challenges.
The Central Bank stressed that preserving financial stability would require a balanced combination of prudent monetary, macroprudential and regulatory policies, supported by continued structural reforms.
It identified key priorities, including maintaining strong capital and liquidity buffers, strengthening the management of climate-related and cyber risks, improving crisis preparedness and ensuring that credit growth remained consistent with underlying economic activity and risk conditions.
These measures, the Central Bank said, would help limit systemic vulnerabilities, strengthen the financial system’s ability to withstand shocks and safeguard financial stability over the medium term.
