Sri Lanka’s banks have moved out of emergency mode. Policy rates are steady. Inflation is low. Liquidity is easier. The story is no longer “will the system hold,” but “who protects margins while lending sensibly.” This is the state of play as of October 2025, plus what borrowers and investors should watch next.
Rates and inflation: the noise has faded
The Central Bank’s standing corridor is 7.25% (SDFR) and 8.25% (SLFR). These are the anchors for deposit and lending prices. With this corridor unchanged in recent months, repricing shocks have cooled. Inflation is low as well: the CCPI release shows year-on-year inflation around the low single digits in September 2025, giving the Bank room to hold a steady line. Stable anchors reduce volatility in bank funding costs and help businesses plan cash flows without fearing weekly price swings.
Market gauges echo that stability. The AWPR/AWLR range has hovered near the 8% handle through October, with only small weekly moves as liquidity conditions ebb and flow. In plain terms, the big rate falls of 2024 have levelled off; what happens next will be driven more by bank competition for deposits and risk pricing than by policy surprises.
Asset quality: improving trend, not yet “good”
The 2025 Financial Stability Review frames the reality: impaired loans (IFRS 9 Stage 3) are trending down from crisis highs but are still elevated versus pre-2020. That means provisions remain a live line-item. Banks that recognised stress early in 2023–24 are now enjoying cleaner run-rates; late recognisers still carry a drag. Elevated Stage 3 also raises funding costs at the margin, because wholesale markets price risk off asset quality. Bottom line: asset quality is better, but not yet “comfortable.” Execution on recoveries and early-warning is still critical.
Funding cost is the battlefield
Margins come from the gap between asset yield and funding cost. Today the main battleground is deposits. Two forces pull in opposite directions:
- CASA rebuild. Every extra point of current and savings accounts lowers blended funding cost. Customers are slowly moving back to digital current/savings after the rate spike era. Banks with strong transaction franchises payroll, merchant collections, bill-pay have a structural edge.
- Deposit wars. Some banks keep fixed-deposit rates high to defend balances. Unless loan yields lift in step, this compresses NIM. With policy steady, the advantage shifts to banks that grow sticky, low-cost balances rather than “buying” deposits.
Asset yield: mix and repricing speed
On the asset side, the winners keep a mix that reprices quickly without loosening standards. Overdrafts, card receivables and short-tenor working capital reset faster than mortgages or long corporate loans. That speed helps preserve yield in a flat-to-nudging-up rate environment. The catch is underwriting discipline: chasing volume with thin pricing will show up later as provisions. Right now, banks price a steeper curve for weaker credits and shorter tenors, reflecting still-elevated Stage 3 and a cautious growth stance.
Fee income: a helpful cushion, not a cure
Fees smooth earnings when spreads narrow. Card issuing and acquiring add interchange/MDR; QR rails deepen small-ticket flows; trade finance and cash-management rebuild as supply chains normalise. Useful, but not a cure-all: if funding is expensive or credit costs rise, fee lines cannot fully offset margin squeeze. Banks still live and die by cheap funding + clean books.
What banks are actually doing
- Pushing transactions to grow CASA. Salary credits, collections APIs and QR acceptance build sticky balances and lower blended cost. This is the structural hedge against deposit wars.
- Keeping provision coverage high. With Stage 3 falling but elevated, coverage is the shock-absorber. Banks that built overlays are more resilient if growth in retail/SME turns late-cycle.
- Sticking to risk-based pricing. Coupons, fees and collateral haircuts align with PD/LGD. Price to probability, not to headlines.
- Digitising origination with guardrails. Scorecards, e-KYC, device binding and step-up authentication reduce cost-to-serve and fraud leakage.
- Managing duration. Avoiding long fixed-rate assets funded by short, flighty deposits limits mismatch risk.
What borrowers should do
- SMEs: bring clean statements, tax filings and bank feeds. Predictable cash flows drop the lender’s uncertainty premium and earn a tighter rate. Seek supply-chain finance or guarantees if collateral is thin.
- Corporates: centralise liquidity and give the bank full-relationship economics payroll, payments, FX in exchange for sharper spreads. A “deposits-only” approach won’t secure the best pricing.
- Households: choose between fixed vs variable based on budget tolerance. Fixed protects if rates back up; variable benefits if the cycle softens into 2026.
The IMF anchor still matters
Macro credibility shapes bank funding. The IMF fifth-review staff-level agreement on 9 Oct 2025 reinforces the stabilisation story and improves investor perception. Any slippage would raise sovereign risk, seep into funding costs and widen bid-ask spreads for banks raising wholesale money. Keep one eye on programme momentum through 2026.
Risks into 2026
- Inflation drift. If inflation lifts unexpectedly from current low levels, banks will fight harder for deposits, squeezing NIM until loan yields catch up.
- Late-cycle credit. Rapid growth in small-ticket digital credit can mask thin pricing and weak verification. That shows up in Stage 3 six to twelve months later.
- Policy uncertainty. A change in administered pricing or ad-hoc reliefs would distort spreads.
- External shocks. Trade or capital-flow shocks reprice wholesale lines and FX swaps quickly; banks with clean liquidity buffers ride them better.
Bottom line
Banking has moved from survival to spread management. With policy rates steady and inflation low, execution decides outcomes: build low-cost funding, protect asset quality, digitise with controls, and price to risk. That is how margins make it to the bottom line in 2026.
