Sri Lanka’s Banking Sector Faces Pressure as Foreign Assets Decline

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CBSL names 20 institutions being investigated over prohibited schemes

 

The article on the Sri Lanka bank foreign assets in reverse gear (EconomyNext, September 16, 2025) was one of the recent articles to raise concerns about the foreign exchange (FX) position of Sri Lanka. The working report reveals that the net foreign assets (NFA) of the banking system which had reached its highest point of USD 3.3 billion in April 2025 have begun to decrease steadily. By July NFAs had declined to USD 2.90 billion.

This fall has cast doubt on the prognosis of the banking system and the capacity of the Central Bank of Sri Lanka (CBSL) to restore sufficient reserves. The article continues on to state that the CBSL and the commercial banks are both strained because of repayments, swaps and policy dilemmas.

 

What Do Net Foreign Assets (NFA) Mean?

Foreign Investment: Definition, How It Works, and Types

 

The difference between the foreign assets and the foreign liabilities of the banking system in a particular country is the Net Foreign Assets. When NFA is positive, it means that the banks and central bank possess greater foreign assets as compared to the foreign liabilities and therefore, the capability to defend the currency and fulfill the obligations that are external.

The fall of NFAs is an indicator of higher outflows of foreign currency than inflows which will lower the cushion that can be used to stabilize the domestic currency.

 

Development of the NFA Situation of Sri Lanka.

·       April 2022: NFAs were negative USD 6.4billion, with the central bank funding imports with borrowed reserves and settling debt with the same at artificially maintained low rates.

·       April 2025: NFAs had gone up to USD 3.3 billion partly attributed to rate increases and temporary inflows.

·       July 2025: NFAs dropped to USD 2.90 billion once more, with the central bank reducing the rates and the growth of private credit.

The circle demonstrates the direct influence of monetary policy decisions (rate cuts and increases) on the FX market and foreign reserves.

 

Associated with the FX Market Concepts.

1. Exchange Rate Regime

The Sri Lankan regime is based on a managed float regime. The central bank has been known to intervene regularly to stabilize the rupee, however, interventions financed by borrowed reserves cannot be sustained.


2. Spot Transactions

The CBSL usually purchases dollars in the interbank market to reserve the currency. It had made USD 142 million purchase in August 2025, such an acquisition is an example of a spot transaction. Nevertheless, NFAs deteriorate when the debt amounts are greater than the purchasing.

 

3. Interest Rate and FX Link

NFAs began to fall after the rate cut in June 2025. This is an interest rate parity: lower domestic interest rates decrease the demand of the investors on the assets of the rupee, and as the result, it is a capital outflow as well as a weak NFA.

 

4. There are dangers of Sterilized Intervention.

The CBSL has applied sterilized measures in the past; selling dollars but printing rupees to counteract liquidity. This is an action that increases the short-term credit expansion at the detriment of long-term FX stability.

Month

NFA (USD Billion)

Change (USD Billion)

April 2025

3.30

–

May 2025

3.15

-0.15

June 2025

2.96

-0.19

July 2025

2.90

-0.06

 

The banking sector in Sri Lanka is back to pressure of the foreign reserves. NFAs are declining as a result of interest rate cut, credit growth, and liabilities settlement, even though the central bank is making short-run purchases.

This scenario points to the precariousness of the domestic monetary policy and external stability. Sri Lanka will need to implement:

·       Deflationary policies which accumulate reserves do so in good faith,

·       Less dependence upon borrowed dollars, and

·       The Signals market was in harmony with the international principles.

Otherwise there is a likelihood that the nation will follow the same spirals of depreciation, inflation, and the external crisis.

 

References

·       Economy Two. (2025, September 16). Sri Lanka bank foreign assets in reverse gear. EconomyNext. https://economynext.com/sri-lanka-bank-foreign-assets-in-reverse-gear-240623/?utm_source=chatgpt.com#modal-one

·        GRATTON, P. (2024, November 2). Foreign Investment. Investopedia. https://www.investopedia.com/terms/f/foreign-investment.asp

·       Economic Indicators | Central Bank of Sri Lanka. (n.d.). Www.cbsl.gov.lk. https://www.cbsl.gov.lk/en/statistics/economic-indicators

·       IMF. (2019). Sri Lanka and the IMF. IMF. https://www.imf.org/en/Countries/LKA

·       CBSL names 20 institutions being investigated over prohibited schemes. (2025). Adaderana.lk. https://www.adaderana.lk/news.php?nid=104367

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