Sri Lanka's Gold Lending Boom Meets a 70% LTV Cap

The scale of the CBSL's response makes more sense against the wider credit picture. Total credit extended by the finance companies sector grew 52.4% year-on-year at the end of Q1 2026, more than double the 26.9% pace recorded in the same quarter of 2025.

Two products did most of that work. Vehicle-backed lending rose 52.8% year-on-year, while gold-backed lending ran ahead of it at 69.2%, making gold the single fastest-growing line on FC balance sheets.

That last line looks like unambiguous good news. A stage 3 loans ratio falling from 8.6% to 4.4% over twelve months suggests a healthier book.

Rapid loan growth mechanically dilutes a non-performing ratio, since new performing loans expand the denominator faster than old bad debt can be worked out. It is a pattern regulators have seen before in fast-growing gold-loan books, and it is one reason the CBSL chose to act on volume rather than wait for asset-quality data to turn.

Gold-backed lending did not grow this fast by accident. Under the capital rules that applied before May 2026, gold loans kept within a 70% LTV band carried a zero risk weight for both banks and finance companies, while vehicle financing carried a risk weight of at least 100%.

That gap made gold lending extraordinarily capital-efficient. A finance company could expand its loan book and its interest income without consuming scarce regulatory capital, a meaningful advantage for non-bank lenders still rebuilding balance sheets after Sri Lanka's economic crisis.

Vehicle import restrictions had also only recently eased, in early 2025, which pushed vehicle financing higher but simultaneously nudged more households toward gold loans as a faster, lower-friction source of credit. Rising gold prices through the period added a second tailwind, since every gram pledged as collateral could support a larger loan.

By the end of 2025, Fitch Ratings estimated gold-backed lending across finance companies and its rated banks had reached roughly LKR 1.5 trillion, about 11% of combined sector loans, up from 7% in 2022. Within finance companies specifically, gold loans had climbed to around a fifth of loan books, up from 17% three years earlier.

None of this happened in a vacuum. Sri Lanka's finance companies spent the years after the 2022 crisis working through elevated non-performing loans, thin capital buffers, and a shrunken appetite for riskier lending categories such as unsecured personal credit or SME finance.

Gold loans offered a way back to growth that felt lower-risk on paper. Collateral sat in the branch vault, tenors were short, and a borrower defaulting simply meant the lender could liquidate pledged gold rather than pursue a lengthy recovery process through the courts.

That combination of short duration, physical collateral, and favourable capital treatment made gold lending close to the perfect growth product for a sector still rebuilding investor confidence, right up until the volume itself became the risk the regulator wanted to contain.

The mechanics arrived through two instruments: Central Bank of Sri Lanka Act Directions No. 1 and No. 2 of 2026, issued by Governor Dr. P. Nandalal Weerasinghe under Section 105(1) of the CBSL Act, No. 16 of 2023.

The gold-lending direction sets a 70% ceiling on the loan-to-value ratio for credit facilities secured by gold collateral, applying to licensed commercial banks, licensed specialised banks and licensed finance companies alike. Crucially, the cap applies not only to new facilities but also to existing gold loans when they are renewed on or after 25 May 2026, closing an obvious workaround.

The vehicle-financing direction moved in the same window. The LTV ceiling on commercial vehicle financing dropped from 70% to 60%, while the ceiling on unregistered vehicles and those registered for under a year fell from 60% to 40%.

In its published rationale, the CBSL pointed to heightened geopolitical and geoeconomic uncertainty, volatility in gold prices, exchange rate swings, and a temporary surcharge on vehicle imports that was inflating vehicle prices, as the combined backdrop that made both markets more exposed to a sudden collateral repricing. Transitional treatment was carved out for letters of credit opened before the new direction where financing had not yet been drawn down, softening the immediate hit for vehicle importers already mid-transaction.

The LTV cap turned out to be the opening move, not the whole story. In mid-June, Fitch Ratings detailed a parallel overhaul of capital risk weights on gold-backed lending, set to take effect from 1 September 2026, that strips away much of the capital advantage gold loans previously enjoyed.

The practical effect is a jump in average risk density across gold-loan portfolios, to roughly 12% for Fitch-rated banks and about 26% for finance companies, up from 1% and 5% respectively.

Fitch's modelling, based on end-March 2026 exposures, puts the likely hit to common equity Tier 1 ratios at banks in a narrow 2 to 35 basis point range. Finance companies face a wider and heavier band: regulatory Tier 1 ratios could fall by 1 percentage point to a little over 5 percentage points, depending on how concentrated a lender's book already is in gold.

Exposure to gold-backed lending is not evenly spread across listed finance companies, and neither will the pain be. Fitch's issuer-level breakdown gives investors a rough map of where capital pressure concentrates.

• Asia Asset Finance PLC — gold loans make up more than two-thirds of its book, making it the most exposed rated finance company under the new framework.
• LB Finance PLC and Mahindra Ideal Finance PLC — roughly a third of loans are gold-backed, implying moderate capital pressure in the 1–2 percentage point range.
• UB Finance PLC — gold exposure below 20% of the book still translates into an estimated 1 percentage point Tier 1 impact.
• HNB Finance PLC and Merchant Bank of Sri Lanka & Finance PLC (MBSL) — both already carried strained capital positions; MBSL was reported below its minimum Tier 1 and total capital requirements at end-March 2026, before the new risk weights even apply.
• Mercantile Investments and Finance PLC — also expected to see regulatory buffers decline further.

For a firm like MBSL, the timing compounds an existing problem. A capital shortfall that predates the rule change leaves less room to absorb a further reduction once the September risk-weight change lands, raising the odds that fresh capital, rather than balance sheet rebalancing alone, becomes necessary.

The CBSL's own assessment of Q1 2026 described finance company liquidity and profitability as satisfactory, even as capital adequacy showed a slight moderation. That was the picture before either the LTV cap or the risk-weight change had bitten.

Across the wider financial system, liquidity buffers were already thinning. Rupee and all-currency liquidity coverage ratios for the banking sector fell to 267.9% and 234.7% respectively at end Q1 2026, down from 342.4% and 310.6% a year earlier, though both remained comfortably above the 100% regulatory floor.

Finance companies now face pressure from two directions at once. Loan origination slows as the 70% LTV ceiling caps how much can be lent per gram of gold pledged, while capital consumption per rupee of gold lending rises once the new risk weights take hold from September.

Fitch frames the net effect as credit-positive from a prudential standpoint, since it curbs an aggressive underwriting pattern, but explicitly flags that volume and earnings growth could slow, particularly for lenders most concentrated in gold. Some finance companies may choose to rebalance their portfolios ahead of the September deadline, provided gold prices hold steady, which would blunt the eventual capital hit before it fully arrives on the balance sheet.

Reported profitability at the FC sector level had not shown material deterioration through Q1, but earnings releases for the second and third quarters of 2026 will be the first real test of how much of that gold-lending growth was margin-accretive versus how much was simply volume for its own sake.

The Colombo Stock Exchange has already registered some of the broader unease. Foreign investors pulled a net US$103.4 million out of Sri Lankan equities in the first five months of 2026, and government securities yields climbed after the Central Bank raised policy interest rates in late May.

A rupee that stayed volatile through the period compounds the picture for gold-heavy lenders specifically, since currency swings feed directly into the local price of gold and therefore into how collateral is valued on any given day.

None of this points to a crisis at the sector level. Finance companies as a group still carry capital buffers above regulatory minimums, and the CBSL's own framing treats these steps as pre-emptive rather than remedial.

What it does mean is a narrower runway for the kind of growth investors had gotten used to. A sector that grew credit by more than 50% year-on-year is unlikely to repeat that pace once its two largest growth engines, gold and vehicles, are both operating under tighter ceilings.

The immediate effect on ordinary borrowers is straightforward. Someone pledging gold jewellery for emergency credit will now be able to borrow a smaller share of its appraised value, and that constraint applies even to loans being renewed rather than newly originated.

Gold loans have historically served as one of the more accessible forms of credit for low- and middle-income households in Sri Lanka, precisely because they required little documentation and moved quickly. A tighter cap does not remove that demand; it may simply push some of it toward informal lenders and pawnbrokers operating outside CBSL's regulatory perimeter, a trade-off regulators weigh but rarely eliminate entirely.

For investors in CSE-listed finance companies, the more useful signals will show up in quarterly disclosures rather than headlines. Loan book composition shifts away from gold and vehicle financing, movements in capital adequacy ratios at gold-heavy names, and any announcements of fresh capital raises are the concrete data points worth tracking through the rest of 2026.

Sequencing matters here. The LTV cap took effect in May, giving finance companies roughly three months before the heavier risk-weight change lands in September, a window regulators appear to have built in deliberately rather than by coincidence.

How individual lenders use that window will likely separate the names that absorb the new rules smoothly from those that need external capital support. Boards at gold-heavy issuers now face a choice between slowing originations to preserve capital ratios organically, or raising equity ahead of a deadline that is no longer a matter of speculation.

If finance companies manage to rebalance their portfolios before the September risk-weight change and gold prices stay firm, the capital pressure documented by Fitch could prove smaller in practice than the current estimates suggest. If global gold volatility resumes or portfolios stay as concentrated as they are today, the capital gaps at the most exposed non-bank lenders are more likely to widen than close heading into 2027.