Credit Boom in Sri Lanka: Growth Signal or Brewing Trouble?
Article Reference
- Source:
EconomyNext – “Sri Lanka private credit continues blistering
expansion in July with Rs201bn”
- Date
Accessed:12th September 2025
Summary of the News
Private credit in Sri Lanka increased to levels not seen in
recent times. Credit to households and enterprises grew by LKR 1,485
billion in the 12 months period, from just LKR 493 billion
in the prior year. This is an annual growth rate of 19.6%.
The rate this year is even more startling: lenders and banks
dispensed loans of LKR 901.6 billion in the first seven months alone,
nearly doubling the LKR 341 billion for the same time frame in 2024.
Others caution that the resulting rapid boom can put a
strain on inflation, foreign reserves, and financial stability, but others
greet the boom as proof of recovery.
Reading the Situation
Strong lending expansion appears to be a positive sign at
first sight. While borrowing on the part of consumers might drive consumption,
credit to enterprises could encourage investment. This intensity can be
perceived as momentum in an economy that is still recovering confidence
following the default in 2022.
A more conservative worry is provoked by the boom's scale
and velocity, however: Are Sri Lanka's central bank and financial system
equipped to handle the risks that go with it?
What Theory Tells Us
There are few theories which help us to determine the direction of the interest rate of a nation.
•Liquidity Preference Theory (LPT):
Interest rates tend to increase when demand for money increases significantly,
such as during credit booms, unless the supply of money is constant. In fact,
short-term rates can drop right away if CBSL creates room by increasing the
supply of money, but inflation pressure will increase.
•Loanable Funds Theory (LFT):
Rising borrowing reflects high demand for loanable funds. Without proportionate
growth in savings, the imbalance pushes interest rates up. This is the
situation in Sri Lanka, whose domestic savings remain low.
•Banking Perspective: Finance
companies and banks are at the centre of this boom. Though lending is to blame
for growth, without well-screened loans, excessive amounts of new credit pose
risks to asset quality. How rapidly irresponsible lending may result in
non-performing loans has already been established through earlier crises.
Central Bank and Policy Angle
The credit boom has a two-sided face for the Central Bank
of Sri Lanka (CBSL). On one hand, it encourages healing and growth. On the
other hand, if further rupee liquidity fuels import demand, it might deplete
foreign reserves and push up inflation.
To have control of this, CBSL could consider:
• Raising policy rates or changing the Overnight
Policy Rate (OPR) to contain unsound credit.
• Using macroprudential tools like sectoral lending
limits or housing loan-to-value restrictions.
• Consolidation of banking and NBFI regulation to prevent a new wave of bad loans resulting from credit growth.
Why This Matters for Debt Sustainability
The burden of restructuring the government debt is already
being carried in Sri Lanka. Irresponsible credit growth may make the IMF
program more difficult by:
• Rising inflationary pressures, which increase borrowing
costs.
• Banks are increasingly exposed, especially if the global
environment constricts.
• If credit growth seems unfettered, monetary policy
credibility will be undermined.
Private credit is therefore not so much a question of
domestic banking; rather, it is extremely linked to the nation's larger
trajectory toward fiscal and financial health.
A Real-World Illustration of Classroom Theory
This illustration shows how role models in the classroom
become the talk of the town. Interest rate determination theories are not
abstract; they describe how a credit boom can increase rates, stress reserves,
and test the balance between stability and growth.
All three operations of loanable funds, income, and
liquidity effects are experiences for students in the current Sri Lankan
economy.
Closing Thought
Credit growth is needed for recovery in an economy. But the
risks can accumulate just as quickly if growth becomes a surge. Sri Lanka's
July figures reveal both momentum and vulnerability. Policymakers must now
balance between promoting recovery and preventing overheating.
Today's boom can turn into tomorrow's bust if not managed.
The credit market is screaming caution, although the yield curve may be saying
it softly.
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