GRI 2-22, 2-23

Dear stakeholders,

Navigating turbulent times

Sri Lanka faced an inauspicious start as it grappled with an acute balance of payments crisis that affected almost every aspect of life from early 2022 onwards. Access to international bond markets for Sri Lanka was effectively denied since mid 2020 due to the downgrades of the Country’s sovereign credit ratings by the international credit ratings agencies. In April 2020, Fitch Ratings, downgraded Sri Lanka’s sovereign rating to B-, followed by further, frequent downgrades to end up at a C rating by April 2022. Other international agencies effected similar downgrades. By December 2021, the country had depleted a significant portion of its foreign exchange reserves, leading to crippling shortages of fuel, gas, and other essential commodities in the first quarter of FY 2022/23. In May 2022, Sri Lanka defaulted on foreign debt obligations for the first time in its history.

To address the dire situation, policymakers understandably imposed drastic measures, which caused significant disruptions to both general and financial markets. The Sri Lankan Rupee (LKR) was allowed a free float from March 2022, resulting in a sharp depreciation. In April 2022, policy rates were raised by an unprecedented 700 basis points, nearly doubling the previous levels. Around May 2022, the Sri Lanka Rupee (LKR) hit a record low of around Rs. 377 against the US Dollar (USD), representing a 86.6% depreciation from the USD exchange rate before free float exchange of Rs. 202 to the USD. Additionally, strict import controls and higher taxes were implemented.

These measures had a direct and adverse impact on the operations of non-bank financial institutions (NBFIs) such as CDB, where vehicle financing makes up a major portion of their loan book. The NBFIs predominantly offer fixed-rate, long-term lease and hire purchase products, funded primarily by customer deposits and other borrowings. The spike in interest rates, resulting in increased funding costs could not be passed on to borrowers and had to be absorbed by the NBFIs.

Adapting to evolving conditions

Our management swiftly shifted into containment mode, implementing rigorous scrutiny of the loan portfolio, maintaining consistent contact and communication with borrowers, and customising payment terms to accommodate their altered circumstances. These proactive measures effectively mitigated, to some extent, the impact on asset quality brought about by the deteriorating credit conditions. It is appropriate to acknowledge the efforts of the Regulator in this regard. Anticipating potential balance sheet strain on the entire financial system due to the adverse credit environment that has prevailed since the COVID-19 pandemic, the Central Bank of Sri Lanka (CBSL) introduced measures to conserve and reinforce capital within the financial sector. Consequently, most financial institutions faced the current crisis with improved capitalisation levels. These measures included imposing restrictions on dividend payments by financial institutions, to bolster capital reserves. CDB also complied by reducing our dividend payout during the previous year.

During this challenging period, we adeptly manoeuvred through the turbulence, demonstrating resilience and maintaining our strategic framework without the need for a major overhaul.

During this challenging period, we adeptly manoeuvred through the turbulence, demonstrating resilience and maintaining our strategic framework without the need for a major overhaul. Furthermore, we proactively implemented a range of measures to address the evolving conditions. Notably, we strategically adapted our product offerings to better suit the highly volatile exchange and interest rate landscape. An example of this was our deliberate focus on Gold loans, which have shorter durations and more frequent re-pricing. This prudent decision helped in mitigating the adverse effects of extreme interest rate fluctuations, enabling us to navigate the uncertainties with greater stability.

Our business model has undergone a continuous and sustained transformation. Our crowd sourcing strategy continues to be developed and refined and is increasingly proving useful in allocating resources. Weaning ourselves away from being predominately a financier of vehicles is a long term initiative that is underway. In addition to being a responsible corporate citizen, we see sustainable alternatives and solutions as a growth area and intend seeking out and designing ways to finance same. These are still early days, but mobility solutions and renewable energy solutions for households are two tangible areas we have commenced working on.

Despite a temporary setback in loan portfolio growth over the last couple of years, we are optimistic about achieving our Quarter Trillion Asset Base (Q-Tab) target by 2030. The pandemic has accelerated customer adoption. The nature and scope of the vehicle financing market is undergoing structural change. Competitive intensity and also additional strictures on recovery measures that NBFIs could employ has reduced the risk reward payoff on some segments. Recognising these trends, CDBs strategic plan directed its attention towards developing new segments and new ways of delivering value and remaining relevant to both existing and potential customers.

Importantly, many of these developments would not have been possible without the corresponding investments in technology and automation. CDB implemented a Robotic Process Automation in 2020. This enabled our sales team to onboard customers and book business 24 x 7 bypassing the branch network. In 2022/23 we implemented an automated credit decision model bearing in mind that a credit decision should have speed and accuracy. Today, 75% of credit applications receive a credit decision in machine speed time. The results on the accuracy of the model have been very encouraging. These developments augur well for the modern economy and changing customer behaviours we see and also anticipate.

Managing interest rate challenges

CDB and other NBFIs confront a maturity mismatch. As discussed previously, a rising rate environment, impacts our spreads. The extreme volatility of interest rates was one of the difficult challenges we faced this year and our Managing Directors review discusses the impact in greater detail.

I would like to dwell on the manner in which CDB managed these challenges. It serves as a litmus test for the effectiveness of our existing risk control measures, which have proven resilient. The strength and diversity of our funding sources were also put to the test and, reassuringly, showcased their resilience. At the start of the year, corporate borrowings from local institutions, which are highly susceptible to market rates and rapid shifts in volatile periods, constituted 26% of our funding. To manage such volatility, we consciously reduced our reliance on corporate borrowing from local institutions, pivoting instead to customer deposits. By 31 March 2023, we successfully reduced corporate borrowing from local institutions by 32%, comprising 17% of the overall funding. Customer deposits on the other hand increased by 20% and comprised 75% of funding. Accomplishing this feat in a liquidity-constrained environment is a testament to the capabilities of our team and the robustness of our deposit franchise.

Our performance

In terms of our financial performance, our profit before taxes declined by 53% YoY to LKR 2,494 Mn. as of 31 March 2023. This can be attributed to the steep 50% reduction in our spreads that was discussed previously. It should also be viewed in the context of the sharp economic contractions that Sri Lanka experienced, where its GDP shrank by 7.8% in 2022. In a highly inflationary environment (reported inflation touched 69% in September 2022), CDB contained expenses well. Overheads increased by only 15%. Asset quality was impacted and is a factor of the economic environment. Our NPL ratio (120 days past due) was 10.98% as at year end, a 4% increase. CDB leases are always against collateral and therefore we are confident of our ability to work through and resolve these NPLs. Our balance sheet remains highly liquid and we have consistently improved our capital levels in recent years and met all regulatory capital adequacy requirements satisfactorily. Please refer our Managing Directors review for a more detailed discussion on CDB’s financial performance. Notwithstanding the challenges faced, you would be pleased to know that the Company declared a Rs. 5 dividend for the financial year 2022/23.

Fostering financial inclusion

Our commitment to mobilising finances from urban areas to finance rural borrowers remains unwavering. We are deeply dedicated to promoting financial inclusion, with a strong focus on empowering women entrepreneurs and supporting the SME sector. The integration of advanced technology and the expansion of virtual channels have significantly bolstered our ability to reach out to these segments. As a result, access to financial services has improved, empowering these groups and fuelling their economic progress. This in turn has led to an enhancement in their lifestyles and increased participation in the economic mainstream.

Embedding sustainability across all operations

We have made significant efforts and investments to educate our employees about the importance of environmental sustainability, fostering green awareness, and encouraging employee volunteerism. Additionally, we actively manage our carbon footprint and continuously strive to optimise energy, water, and waste management. We actively support initiatives that have positive environmental impacts, preserve biodiversity, and collaborate with business partners to protect the environment. We participate in community projects to contribute to sustainability goals.

I earnestly encourage you to see Impact section of this Annual Report which details the exemplary projects CDB continues to undertake in this space.

Strengthening risk management

The challenging circumstances of the year presented a real-life test of our risk management, which demonstrated commendable performance. Our prudent strategies and diversified balance sheet positioning, combined with a range of funding sources, facilitated successful navigation through what could be considered the most severe conditions faced. Continuous improvement in risk management remains a priority. This year we commissioned a team of international experts for 18 months assignment to assess our risk management processes against best in class practices and make recommendations to further strengthen same.

Addressing domestic debt optimisation

With the government presenting its domestic debt optimisation (DDO) on the 28 June 2023 a prominent factor weighing on market sentiment and interest rates has been dispelled. As we write this report interest rates on government securities have plummeted by over 1,000 basis points from what it was prior to the presentation of the DDO plan. Assuming the plan is implemented largely as proposed, we anticipate a further easing of interest rates and a reduction in uncertainty. It will enable economic actors in various sectors to make more accurate assessments and contribute to widespread economic growth. Encouragingly, we were already witnessing a recovery in interest and demand for financing within our operating sectors, and we expect this trend to expand and strengthen. We anticipate a rebound in profitability this year driven by lower funding costs and an increase in demand. Although not immediate, we also foresee a gradual resumption of vehicle imports, which will serve as a significant source of growth in the future.

Acknowledgement

In the face of the challenges that lie ahead in the year 2023, we remain resolute in our commitment to pursue our purpose. I would like to express my sincere gratitude to our dedicated employees for their unwavering engagement and dedication during these unprecedented times. Their efforts have been instrumental in our collective success. I extend my deep appreciation to my esteemed colleagues on the Board for their invaluable counsel in steering the Company through difficult circumstances. I wish to commend Mr Mahesh Nanayakkara, our Managing Director and CEO, for his exceptional leadership, which has inspired our entire organisation. I also extend my thanks to the senior officials of the Central Bank of Sri Lanka for their valuable counsel, guidance, and support. Additionally, I express my appreciation to our auditors, KPMG, for their valuable services. To our customers, I offer my sincere appreciation for your loyalty and continued patronage. I would like to thank our shareholders for their unwavering confidence and steadfast support.

Alastair Corera
Chairman

28 June 2023
Colombo