Sri Lanka’s banking and finance sector seems to be the worst hit from the 2016 fiscal budget with an estimated total impact of a whopping Rs. 7 billion as a result of the proposed increase in taxes, analysts at Bartleet Religare Securities (BRS) said today. Sri Lanka’s Budget 2016 presented to Parliament on Friday had proposed to increase corporate taxes from 28% to 30%, increase Value Added Tax (VAT) on financial services from 12.0% to 12.5% and raise Nation Building Tax by an additional 2%.

“Our estimations suggest an incremental impact of approximately LKR 7bn from the proposed change in taxes for the banking sector. Our calculation is based on published statistics for the Banking industry for nine months 2015 released by the Central Bank of Sri Lanka,” BRS said in a Budget Review released today.

According to the breakdown of impact for the banking Industry for Financial Year 2015, the 2% increase in corporate tax would cost the sector an estimated Rs. 3 billion, the 0.50% increase in VAT would cost Rs. 1 billion while the proposed 2% increase in Nation Building Tax would have an impact of Rs. 3 billion.

Analysts said that their estimations indicate a Return on Equity hit of 110 basis points (1.1%) for the industry for Financial Year 2015.

Meanwhile, the budget also proposed banks should cease engaging in leasing business from 01 June 2016.

“We believe this proposal would be a serious challenge not only to banks, but to the consumer as well. Leasing; motor leasing in particular is preferred way to drive loan book growth, due to (1) attractive yields (2) asset backed (3) active second hand market (4) good asset quality as domestic banks refrain providing facilities to the subprime market. We believe almost all banks would see a serious volume impact from this policy decision, as the sector’s median exposure to leasing stood at 8% by end September 2015. NTB, in particular would need a change in strategic direction, as the bank’s loan book concentration to leasing is as high as 24%,” analysts said commenting on the proposals.

They noted that finance companies would be the clear winners/beneficiaries of this proposal growing in both volumes and margins although from a consumer’s point of view, this will restrict access to low leasing advance rates, as banks generally quote low rates due to their access to low cost funds.

The budget has also directed to establish an Export Import Bank (EXIM Bank) to facilitate international trade business. Towards this exercise, the Government plans to inject an initial capital of Rs 25bn, subscribed jointly by the government and the industry expected to be operational from 01 April 2015 and listed in the Colombo Stock Exchange.

“We welcome this much needed proposal as means of focused attention to improve international trade in the Country. While SL is a late entrant to EXIM banking space, the neighboring India established an EXIM bank 23 years ago and is now the apex body in India for coordinating working of institutions engaged in financing exports and finance.

In our view, the proposed EXIM bank might cannibalize the loan growth of the LCB loan book growth into the trade sector in the short run. However in the long run, we expect them to enjoy a higher ROE by deploying funds to focused areas like MSME (Micro and Small and Medium Enterprises),” analysts said.

Meanwhile, the Budget has also proposed banks to expand their existing branch network by 15% by opening branches in under-banked areas in the country and stipulated that these branches will have to employ at least 6 employees per branch.

“We believe this proposal forces banks for sub optimal growth, as most of the banks have currently paced down expansion activities that started in 2009 post war period and currently are consolidating their position in the industry,” the review noted.

Among other proposals related to the banking sector include the restrictions on cash withdrawals (cash withdrawals above Rs. 1 million will be taxed at 2% withdrawals above Rs.10 million will be taxed at 3%), introduction of new exposure limits on bank lending, encouraging industry consolidation, welcoming overseas expansion, establishment of a Colombo International Financial Centre (CIFC), introduction of a minimum dividend payout for listed entities of 15% of the distributable profits, establishment of Financial Institution Restructuring Agency and the imposition of a cap on interest rates offered by finance companies.