CSE Banking Sector 2026: Navigating Non-Performing Loans (NPLs) and ISB Restructuring

In early 2026, private sector credit from Sri Lankan commercial banks expanded at a measured pace. Outstanding private sector debt reached Rs. 10.3 trillion, up 26.3% year-on-year, even as new borrowings slowed sharply to Rs. 82.6 billion in January following external shocks. This mixed picture set the stage for listed banks to demonstrate resilience after the complex International Sovereign Bond (ISB) restructuring finalized in December 2024.

The restructuring of approximately $12.55 billion in ISBs brought relief to the sovereign through maturity extensions, nominal haircuts in certain options, and innovative macro-linked and governance-linked features. Domestic banks, as significant holders of government securities and some ISBs, absorbed accounting impacts but benefited from reduced sovereign risk. Among the top private players—Commercial Bank of Ceylon (COMB), Hatton National Bank (HNB), and Sampath Bank—differences in exposure and provisioning strategies shaped their post-restructuring balance sheets and ability to support lending recovery.

Asset quality improved across the sector as economic stabilization took hold, yet NPLs, or Stage 3 loans, continued to require careful management. The story unfolding in 2026 revolves around how these banks transitioned from crisis-era impairments to selective growth while carrying residual sovereign linkages.

The ISB Restructuring Landscape and Bank Exposures

Sri Lanka's ISB exchange, completed in late 2024, featured a local option for domestic holders including banks. This allowed exchanges into new dollar bonds with around 10% nominal haircuts for portions of exposure, alongside local currency instruments at market-related rates. International holders received macro-linked bonds (MLBs) with adjustments tied to GDP performance between 2025 and 2027, plus governance-linked coupon relief.

Domestic banks faced derecognition losses and provisioning adjustments on restructured holdings. Sector-wide, listed banks absorbed net impacts in the range of tens of billions of rupees in 2024-2025, though many reversed portions of prior impairments as stability returned. Government securities historically comprised a large share of bank assets, often around 40%, creating direct sovereign linkage even after the exchange.

COMB, with its large balance sheet, managed ISB-related exposures through conservative provisioning ahead of the deal. Reports indicated the bank had built substantial coverage, leading to potential reversals in subsequent periods as actual losses aligned with or fell below provisions. This approach buffered earnings volatility but required careful capital allocation.

HNB opted into the local framework and reported impacts from derecognition in its 2024-2025 filings. The bank maintained strong capital buffers throughout, with total capital adequacy ratios comfortably above regulatory minima. Its proactive risk management helped limit the drag from sovereign adjustments while supporting loan book expansion.

Sampath Bank similarly navigated the process, recording adjustments tied to its holdings. The bank's loan growth resumed in 2025, up around 10% in the prior year from contraction, reflecting a shift toward private sector lending as sovereign pressures eased. Yet the restructuring highlighted varying degrees of exposure across the trio, with balance sheet cleanliness becoming a key differentiator.

NPL Trends: From Peak Stress to Gradual Recovery

Non-performing loans peaked during the 2022-2023 crisis, pushing sector Stage 3 ratios into double digits before easing. By late 2024 and into 2025, ratios moderated as recoveries gained traction and banks applied prudent provisioning. Into 2026, private banks reported further improvements, though levels varied by institution and segment.

COMB saw its net Stage 3 ratio decline notably, reaching around 1.5-2.5% range in recent quarters from higher prior levels. The bank benefited from impairment reversals and focused lending in resilient segments, contributing to one of the stronger asset quality profiles among peers.

HNB stood out with particularly low impaired loan ratios. By September 2025, its net Stage 3 ratio had fallen to 1.36%, supported by Rs. 7.5 billion in impairment reversals over nine months. Coverage ratios remained robust at over 75%, reflecting disciplined recovery efforts and risk management that earned the bank recognition as Sri Lanka's strongest in 2025 assessments.

Sampath Bank posted reductions as well, with Stage 3 ratios moving toward 3-4% territory amid economic stabilization. The bank highlighted improved customer credit quality and proactive strategies from prior years, though its ratio stayed slightly elevated compared to the cleanest peers. Overall sector NPLs trended lower for large private banks, contrasting with higher levels at some state-owned institutions.

These trends mattered because NPL resolution directly influenced lending capacity. Banks with cleaner books could extend credit more confidently as private sector demand recovered unevenly, while those with lingering impairments remained selective to protect capital.

Comparative Balance Sheet Strength: Who Emerged Cleanest?

Evaluating the cleanest balance sheet in 2026 requires looking beyond headline NPLs to capital adequacy, provisioning coverage, sovereign residual exposure, and liquidity. All three banks maintained ratios well above Basel III minima, but nuances appeared in execution.

COMB demonstrated scale and stability, with solid loan growth and reversals helping offset restructuring hits. Its larger government securities portfolio exposed it to mark-to-market effects, yet conservative pre-provisioning positioned it for recovery. Asset quality ranked among the better in the system, supporting consistent profitability.

HNB frequently appeared at the forefront of strength metrics. Low Stage 3 ratios, high coverage, strong capital (total CAR around 20%+), and liquidity buffers well exceeding requirements painted a picture of resilience. The bank's emphasis on transaction banking, digital channels, and diversified advances growth further reinforced its position. Recognition as the strongest bank underscored this operational and financial discipline.

Sampath Bank showed solid progress with asset expansion surpassing Rs. 2 trillion milestones and profit growth. Its NPL improvements and capital rebuilding allowed renewed lending, though slightly higher impaired ratios relative to HNB or COMB suggested a marginally higher risk profile in the comparison. The bank excelled in non-fund based income and selective corporate exposure.

Across the group, private banks generally held less direct ISB exposure than state peers post-restructuring, limiting downside. Sovereign-linked assets shifted toward restructured instruments classified often as Stage 2 with lower risk weights in some cases. This dynamic favored institutions with tighter risk frameworks and proactive provisioning.

HNB edged ahead in many observer assessments for overall cleanliness due to superior asset quality metrics and buffers, though COMB offered scale advantages and Sampath delivered agile growth. No single bank escaped sovereign linkages entirely, but differences in management translated to varying degrees of post-crisis flexibility.

Credit Growth Dynamics and Sector Implications

Private sector lending resumed in 2025 but faced headwinds into 2026. January new borrowings hit multi-month lows amid seasonal and external factors, yet the overall stock continued expanding. Banks shifted from defensive postures to measured expansion, prioritizing quality over volume in high-risk segments.

COMB leveraged its branch network and corporate relationships for advances growth while maintaining tight credit standards. HNB reported record advances in periods, driven by vehicle imports recovery and broader economic activity, with net loans increasing substantially. Sampath highlighted turnaround in its loan book, expanding after prior contraction.

This selective approach reflected lessons from the crisis: over-reliance on sovereign paper or lax underwriting amplified vulnerabilities. Post-ISB restructuring, banks recalibrated portfolios toward private credit, but NPL vigilance persisted in tourism, SMEs, and import-dependent areas.

Profitability rebounded across the trio through net interest income recovery as rates normalized, fee income from transaction volumes, and impairment reversals. Cost-to-income ratios improved for disciplined operators, though margin compression from lower rates posed ongoing challenges.

Regulatory and Macro Backdrop Shaping 2026 Outlook

The Central Bank of Sri Lanka monitored financial stability closely, with improvements in bank profiles noted after ISB completion. Fitch and other agencies adjusted outlooks positively as sovereign ratings moved off restricted default. Capital adequacy remained a focus, particularly for institutions with foreign currency exposures or special reserves.

Broader macro stabilization under the IMF program supported the sector, though risks from external shocks, fiscal execution, and GDP performance triggers in MLBs lingered. Banks with stronger buffers stood better positioned to absorb volatility from macro-linked adjustments or renewed NPL formation.

Consolidation discussions for smaller entities continued, but the top private banks focused on organic growth and digital efficiency. Liquidity coverage ratios stayed elevated, providing cushions against potential outflows.

Key Conditions Ahead for Sustained Recovery

As 2026 progresses, the banking sector's trajectory hinges on continued NPL resolution and prudent credit extension. Institutions that maintained cleaner balance sheets through the restructuring phase gained advantages in capital deployment and market confidence.

HNB's combination of low impaired loans, robust coverage, and operational strength positioned it favorably in comparative terms. COMB offered scale with solid quality, while Sampath demonstrated recovery momentum. Differences in sovereign exposure management and provisioning proved decisive in determining post-crisis positioning.

The sector as a whole benefited from the ISB outcome, yet challenges persist in fully decoupling from sovereign dynamics and sustaining private sector momentum. A key condition that would alter the current read involves any reversal in economic stabilization or fresh shocks that could elevate NPL formation beyond current improving trends, testing the resilience built over recent quarters.