Sri Lanka needs to look beyond financial stability and inflation | Daily FT

“The global economy today has entered an era in which shocks are no longer exceptional. They have become recurring and, in many ways, define the future economic landscape,” he said, noting that Sri Lanka, as a small open economy, remained particularly vulnerable to geopolitical…

“The global economy today has entered an era in which shocks are no longer exceptional. They have become recurring and, in many ways, define the future economic landscape,” he said, noting that Sri Lanka, as a small open economy, remained particularly vulnerable to geopolitical fragmentation, supply chain disruptions, volatile commodity prices, climate events and changing global financial conditions.He said traditional indicators such as capital adequacy, liquidity and profitability remained important but were no longer sufficient to assess the true strength of financial institutions. “True resilience today extends beyond capital adequacy, profitability and liquidity. It reflects the ability of the financial system as a whole, including institutions, markets and infrastructure, to continue performing critical functions, absorb shocks, preserve confidence and adapt to structural changes in the risk environment,” Sirikumara said. Drawing lessons from recent crises, he said policymakers should no longer ask whether shocks would occur but whether financial systems possessed the capacity to absorb, adapt and recover while continuing to support economic activity. He warned that external shocks increasingly interacted with domestic vulnerabilities, amplifying risks through weaker governance, concentrated exposures and operational weaknesses. “The objective is not to eliminate uncertainty, but to ensure policymakers and financial institutions possess the information, tools and capacity to absorb shocks, preserve confidence and continue supporting sustainable economic growth,” he said. Sirikumara also highlighted the increasingly difficult policy trade-offs confronting central banks, particularly when inflationary shocks require tighter monetary policy while higher interest rates simultaneously increase borrowing costs and weigh on financial intermediation. Recent experience had demonstrated the importance of carefully balancing price stability and financial stability, he said, stressing that neither objective could be pursued in isolation. He said this reinforced the need for stronger coordination between monetary policy and financial stability frameworks, particularly as uncertainty increasingly reduced the effectiveness of backward-looking policy approaches. The Deputy Governor said Sri Lanka had responded to recent crises by significantly strengthening its institutional framework. He pointed to the Central Bank of Sri Lanka Act No. 16 of 2023, which enhanced the Bank’s independence, governance and accountability while formally recognising its financial stability mandate. He also cited the Banking (Special Provisions) Act, amendments to the Banking Act, the establishment of the Coordination Council for Fiscal, Monetary and Financial Stability Policies and the Financial System Oversight Committee as key reforms that have improved crisis preparedness and policy coordination. He said resilience required forward-looking supervision supported by stress testing, risk assessments, scenario analysis and stronger coordination across regulators rather than reliance on historical indicators alone. “Financial stability is a shared responsibility,” Sirikumara said, adding that strong institutions, effective coordination and robust preparedness mechanisms were essential to preserve confidence during periods of stress. The keynote address was followed by a panel discussion featuring University of Colombo Economics Professor Priyanga Dunusinghe, former CBSL Deputy Governor J.P.R. Karunaratne, HNB Managing Director/CEO Damith Pallewatte and Alliance Finance Company PLC Deputy Chairman/Managing Director Romani de Silva, and moderated by Daily FT Editor Nisthar Cassim. Prof. Dunusinghe said maintaining financial stability alone would not be sufficient if financial institutions remained excessively risk-averse. He said the financial sector must continue providing adequate funding to productive sectors of the economy, warning that excessive caution following the crisis risked slowing the recovery, particularly in rural and semi-urban areas. “We need to ensure the financial sector delivers the expected outcomes to the economy by providing the necessary financial resources to productive sectors,” he said, adding that inclusive finance should remain a priority alongside resilience. Karunaratne cautioned against relying solely on improving headline banking indicators, noting that rapid credit growth could temporarily improve non-performing loan ratios without necessarily reflecting underlying asset quality. He said operational risks, cyber vulnerabilities, market risks and the economic impact of recent Middle East tensions had yet to be fully reflected in financial sector data and warranted close monitoring. Pallewatte said banks now faced multiple overlapping risks rather than isolated shocks, identifying geopolitical developments, cyber security, climate change and talent shortages as the principal threats confronting the industry. Despite these challenges, he expressed confidence in the sector’s resilience, pointing to strong capital, liquidity and recovery planning developed following Sri Lanka’s recent economic crisis. “The banking sector has the capacity to manage this,” he said, describing the industry’s performance during the crisis as evidence of its resilience. De Silva said resilience should also be measured by how effectively the financial sector serves the real economy. He argued that greater coordination between policymakers, banks and the non-bank financial sector was needed to improve financial inclusion, noting that almost half of Sri Lanka’s economically active population still lacked access to formal finance despite the country’s extensive financial network. De Silva also called for greater collaboration to mobilise climate finance, strengthen agricultural value chains and expand access to productive credit, particularly through institutions serving under-banked communities.