CSE Banking Sector Breakdown 2026: Navigating NPLs and ISB Restructuring

The Post-Restructuring Landscape Takes Shape

On the trading floor of the Colombo Stock Exchange in early 2026, banking counters reflected a sector in transition. After the completion of Sri Lanka's complex International Sovereign Bond (ISB) restructuring in late 2024, the three largest private banks — Commercial Bank of Ceylon (COMB), Hatton National Bank (HNB), and Sampath Bank — posted improved earnings for 2025, yet faced lingering questions over asset quality and sovereign exposures.

Private sector credit growth accelerated in 2025, with system-wide loans expanding notably as economic stabilization took hold following the IMF-supported program. Yet non-performing loans (NPLs), while declining from crisis peaks, remained a drag. The sector's heavy historical holdings in government securities, including ISBs, had forced significant provisioning in prior years, with reversals boosting 2024-2025 profits but masking underlying differences in balance sheet cleanliness.

Investors scanning filings and analyst notes sought clarity: how exposed were these banks to the sovereign debt overhaul, and which institution entered 2026 with the strongest foundation for sustained lending?

ISB Restructuring: Uneven Pain and Relief Across the Trio

The ISB restructuring, finalized with high participation in December 2024, involved exchanging roughly USD 12.5-14 billion in bonds for new instruments featuring maturity extensions, haircuts in certain scenarios, and a local currency option for domestic holders. Local banks, part of a consortium holding around 12% of ISBs, participated notably. COMB, HNB, and Sampath each held meaningful positions, prompting pre-restructuring provisions of up to 50% or more on these exposures.

COMB recognized substantial derecognition impacts and impairment reversals tied to the deal in its 2024-2025 results. The bank reported strong loan growth in 2025, with gross loans surpassing LKR 2 trillion, yet adjusted figures highlighted the one-off nature of restructuring-related gains. Its diversified portfolio and large customer deposit base helped absorb volatility.

HNB, noted in market commentary for relatively higher sovereign bond exposure among peers, took a 52% provision on ISBs prior to the exchange. The local option — involving a mix of new USD bonds with a haircut and LKR bonds — allowed a reversal that supported 2025 profits of around LKR 45 billion for the bank (group PAT near LKR 50 billion). Asset quality metrics improved, with net Stage 3 ratios declining toward 1.1-1.9% range by late 2025.

Sampath Bank followed a similar path, reversing impairment charges of approximately LKR 15.8 billion linked to ISBs after opting into the local bonds component. Its 2025 performance showed record profitability on an adjusted basis, with loans crossing LKR 1 trillion and total group assets exceeding LKR 2 trillion. The bank's CET1 and total capital ratios stayed comfortably above regulatory thresholds even after D-SIB buffers.

Across the board, the restructuring provided breathing room by reducing near-term FX debt service pressures on the sovereign, indirectly benefiting bank holdings. However, the scale of prior provisioning and the specifics of each bank's participation created divergence in how cleanly their securities portfolios emerged.

Non-Performing Loans: The Persistent Shadow

While sovereign restructuring dominated headlines, NPLs told a more granular story of sectoral stress. System-wide Stage 3 ratios had eased from double-digit levels during the 2022-2023 crisis but hovered in the low single digits to mid-teens depending on classification and coverage in 2025 reports. Private banks focused on retail, SME, and corporate lending felt the effects unevenly.

COMB maintained disciplined risk management, reporting net impaired loans (Stage 3) ratios around 1.5-1.8% in 2025 filings, supported by strong provision coverage exceeding 70%. Its large branch network and focus on diversified lending, including SMEs, aided recovery in certain segments as private credit picked up.

HNB showcased resilient asset quality, with net Stage 3 ratios improving to approximately 1.09-1.88% by end-2025, backed by coverage ratios climbing toward 74%. The bank's diversified income streams, including insurance and fee-based businesses, provided a buffer against loan-side pressures. Operating expenses rose with expansion, yet cost discipline helped sustain margins amid a softening rate environment.

Sampath demonstrated solid progress too, with loan growth of 27% in 2025 pushing its book past LKR 1.2 trillion. Impairment charges normalized after the ISB reversals, and the bank emphasized SME and business revival units to manage recoveries. Its liquidity metrics remained robust, with liquidity coverage ratios well above 200%.

The NPL challenge stemmed from pandemic-era and crisis-induced stress in tourism, construction, and SMEs. Banks that had built higher buffers or maintained conservative lending standards during the downturn found themselves better positioned as economic activity resumed in 2025-2026.

Comparative Sovereign Exposures and Balance Sheet Health

Pre-crisis, Sri Lankan commercial banks held significant government securities — often around 40% of assets in a mix of T-bills, T-bonds, and ISBs. The domestic debt optimization (DDO) and ISB deals altered this landscape, with redenomination of certain FX local law instruments into LKR bonds creating net open positions that required careful management.

Among the three, HNB carried noted higher exposure to sovereign bonds, which influenced provisioning levels and reversal impacts. COMB's larger overall balance sheet (assets nearing LKR 3.3 trillion by end-2025) and strong CASA deposits (industry-leading in prior periods) provided scale advantages and funding stability. Sampath, while smaller, focused on operational efficiency and achieved high ROE on adjusted earnings.

Capital adequacy stayed above minima for all three, with D-SIB requirements adding buffers for the larger players. Liquidity positions were comfortable system-wide, aided by deposit growth and moderated credit demand in earlier recovery phases. The cleanest balance sheet emerged from the bank that combined lower relative sovereign concentration risk post-restructuring, superior provision coverage, and disciplined NPL management — metrics pointing toward COMB's scale and diversification, though HNB and Sampath demonstrated competitive resilience in asset quality trends.

Differences arose from portfolio composition: banks with heavier pre-restructuring ISB holdings faced larger mark-to-market and impairment swings, but the local option mitigated some FX risks for domestic holders.

Credit Growth and Sectoral Recovery in 2026

By early 2026, private sector credit gained momentum as interest rates stabilized and business confidence improved. Banks reported loan expansions of 25-36% in 2025, driven by term loans and domestic currency lending. Tourism, remittances, and select export segments supported repayment capacity.

Yet challenges persisted. Elevated global energy prices and external vulnerabilities could pressure reserves and the currency, indirectly affecting borrower serviceability. Banks with robust retail and SME franchises stood to benefit most from broad-based recovery, while those with concentrated corporate exposures monitored specific sectors closely.

Fee income and digital channels provided upside, with card transactions and non-interest revenue growing for players investing in technology. Margins faced compression in a lower-rate cycle, making operational efficiency and cost-to-income ratios critical differentiators.

Regulatory and Macro Backdrop Shaping the Outlook

The Central Bank of Sri Lanka maintained vigilance, with policies supporting consolidation where needed and macroprudential tools to guard against future buildup of imbalances. The IMF program emphasized fiscal discipline, which reduced sovereign financing needs and eased pressure on bank holdings of government paper.

Rating agencies upgraded Sri Lanka's sovereign to CCC+ levels post-restructuring, reflecting improved debt sustainability metrics, though external risks remained. For banks, this translated into better sentiment but no immediate return to pre-crisis ease in foreign funding access.

Investors watched capital buffers closely, especially as D-SIB classifications imposed additional requirements. Banks that preserved strong Tier 1 ratios through the turmoil gained flexibility for growth without immediate dilution risks.

Who Holds the Edge Entering 2026?

Among COMB, HNB, and Sampath, balance sheet cleanliness in 2026 reflected a blend of pre-crisis positioning, provisioning prudence, and post-restructuring adjustments. COMB's scale, deposit franchise, and consistent loan growth positioned it as a market leader with diversified resilience. HNB's higher sovereign exposure was offset by strong asset quality recovery and diversified earnings. Sampath stood out for efficiency and rapid loan book expansion while maintaining solid capital and liquidity.

No single bank escaped the sovereign nexus entirely — the sector's deep interconnection with government debt remains a structural feature. Yet the one demonstrating the most measured exposure management, highest provision coverage on impaired assets, and least reliance on one-off restructuring gains appeared best equipped for normalized operations.

Market data and filings through 2025 suggested COMB edged ahead in overall robustness due to its size and funding stability, though all three outperformed system averages in key recovery metrics.

The Condition That Could Shift the Narrative

The current read on Sri Lanka's banking sector holds as long as fiscal consolidation continues and private credit demand sustains without fresh external shocks. A key condition that would invalidate this assessment is a sharp reversal in macroeconomic stability — such as renewed sovereign stress from external payment pressures or a surge in NPLs triggered by sector-specific downturns — forcing renewed heavy provisioning and eroding the hard-won improvements in asset quality and capital positions.