Banks play a critical role within the Sri Lankan financial system, as they are engaged in provision of liquidity to the entire economy, while transforming the risk characteristics of assets. Banks are also engaged in providing payment services, thereby facilitating all entities to carry out their financial transactions. On the other hand, banks can create vulnerabilities of systemic nature, partly due to a mismatch in maturity of assets and liabilities and their interconnectedness. Therefore, the soundness of banks is important, as it contributes towards maintaining confidence in the financial system, and any failure may have the potential to impact on activities of all other financial and non-financial entities, and finally the economy.

In terms of the asset base and the magnitude of services provided, the LCBs are the single most important category of financial institutions within the banking sector. At the end of 2014, the LCBs dominated the financial system with a market share of 49 per cent of the entire financial system's assets and 84 per cent of the banking sector's assets. Therefore, the health of Sri Lankan financial system depends to a large extent on the soundness of the LCBs.

The banking sector in Sri Lanka, which comprises LCBs and LSBs, dominates the financial system and accounted for 58 per cent of the total assets of the financial system as at the start of 2015. The banking sector consisted of 25 Licensed Commercial Banks (LCBs) and 7 Licensed Specialised Banks (LSBs) by end 2015. There were12 branches of foreign banks within the total number of LCBs. The banking sector continued its support to economic growth and development throughout the year by enhancing its banking services and expanding its network and accessibility throughout the island. Accordingly, 32 new banking outlets, including students savings units, were opened and 219 new Automated Teller Machines (ATMs) were installed in 79 locations during the year. By end 2015, there were 6,583 banking outlets and 3,558 ATMs spread throughout the island for efficient banking operations. During the year, DFCC Bank merged with DFCC Vardhana Bank to form DFCC Bank PLC, while MBSL Savings Bank Ltd., Merchant Bank of Sri Lanka PLC and MCSL Finance Services Ltd. amalgamated to form one Licensed Finance Company, namely, Merchant Bank of Sri Lanka & Finance PLC. Further, approval was granted to open a representative office of a Japanese bank in Sri Lanka, a foreign branch in Bengaluru, India and a banking subsidiary in the Republic of Maldives. Meanwhile, one LCB commenced operations of its representative offices in Myanmar. Even though a large number of licensed banks exist in the country, the stability of the financial system is primarily dependent on the performance and financial strength of the six largest LCBs, consisting of the two state banks and the four largest domestic private commercial banks. These six banks, which are generally, referred to as the Systemically Important Banks (SIBs), represented 75 per cent of the LCB sector assets, 63 per cent of the banking sector assets, and 36 per cent of the entire financial system’s assets.

The LSB sector represented 9 per cent and 16 per cent of the entire financial system's assets and banking sector's assets, respectively at the end of 2014. The systemic importance of the LSB sector is relatively low in comparison to the LCBs, both in terms of size and their impact on the financial system, as it does not play a major intermediary role in the payment cycle.

As the systemically most important sector in the domestic financial system, the banking sector continued to expand its asset base, risk management capabilities and also the risk absorption capacities in line with prudential regulations of the Central Bank during 2015. The asset base of the banking sector, which reached Rs. 8.1 trillion by end 2015, expanded by 15.9 per cent in 2015, although at a slower rate than the 17.3 per cent reported in 2014. The increase in assets was mainly attributed to the increase in loans and advances, which accounted for nearly 74.2 per cent of the increase in total assets. The increase in assets was mainly funded by a growth in deposits accounting for 66.9 per cent of the liability base. Meanwhile, borrowings during the year, which accounted for 21.8 per cent of the total liabilities of the banking sector, primarily consisted of foreign borrowings from foreign sources. The banking sector managed to maintain its liquidity and capital at comfortable levels during the year, while prudently managing its credit, market, interest rate and liquidity risks.

Banks play a critical role within the Sri Lankan financial system, as they are engaged in provision of liquidity to the entire economy, while transforming the risk characteristics of assets. Banks are also engaged in providing payment services, thereby facilitating all entities to carry out their financial transactions. On the other hand, banks can create vulnerabilities of systemic nature, partly due to a mismatch in maturity of assets and liabilities and their inter connectedness. Therefore, the soundness of banks is important, as it contributes towards maintaining confidence in the financial system, and any failure may have the potential to impact on activities of all other financial and non-financial entities, and finally the economy.

In terms of the asset base and the magnitude of services provided, the LCBs are the single most important category of financial institutions within the banking sector. At the end of 2014, the LCBs dominated the financial system with a market share of 49 per cent of the entire financial system's assets and 84 per cent of the banking sector's assets. Therefore, the health of Sri Lankan financial system depends to a large extent on the soundness of the LCBs.

The table II below provides data on certain macro-prudential indicators relating to LCBs and LSBs. The Central Bank as the regulator of the LCBs and LSBs, compiles aggregate macro-prudential indicators on the banking system, as part of its framework to assess financial system stability.