Sri Lanka’s banks rejected fewer loan applications overall during the second quarter of 2026, but the headline improvement conceals a sharper divide between borrowers. While corporate and State-Owned Enterprise applicants benefited from lower rejection rates, retail and small and medium enterprise (SME) borrowers faced greater scrutiny.
The Central Bank’s latest Credit Supply Survey shows that loan application rejection rates across the banking sector declined compared with the first quarter. The reduction was driven mainly by lower rejection rates among corporate and SOE applicants, which the Central Bank associated with improved macroeconomic conditions and better-quality loan proposals.
But the experience was different for households and smaller businesses. Rejection rates increased in both retail and SME lending. The Central Bank said stricter credit assessment and risk-management criteria contributed to the increase, suggesting that banks are not treating the improving economic environment as a reason to relax lending standards across the board.
That distinction matters because SMEs and retail borrowers are closely connected to domestic consumption, employment and day-to-day economic activity. Higher rejection rates could restrict access to financing even as the broader economy shows signs of recovery.
The survey indicates that demand for loans increased across all four major borrower groups during the second quarter, although the pace moderated from the first quarter. Working capital requirements, demand for short-term loans and renewed investment activity were the main drivers.
For SMEs, tighter screening comes at a time when financing demand is rising. Banks expect loan demand from the sector to increase further in the third quarter, supported by higher working capital requirements and anticipated improvements in macroeconomic conditions. The tension is clear: borrowers may need more credit precisely when banks are becoming more selective about whom they finance.
The quality of existing loans adds another layer to the story. Overall non-performing loans (NPLs) declined in the second quarter, largely because of improvements in retail lending. Yet corporate, SME and SOE sectors recorded increases in NPLs.
The Central Bank attributed the deterioration partly to weakened repayment capacity caused by exchange-rate depreciation, cost pressures and external shocks linked to the Middle East crisis. Some loans also migrated into Stage III, indicating a higher level of credit impairment.
Banks expect NPLs to fall across all sectors in the third quarter, helped by improving economic conditions, stronger borrower cash flows, recovery efforts and restructuring. If those expectations materialise, lenders may gain greater room to expand credit.
For now, however, the survey points to a banking sector balancing two competing priorities: supporting an economic recovery through increased lending while protecting balance sheets from renewed credit deterioration. The falling overall rejection rate may suggest easier access to finance, but the sectoral breakdown tells a more complicated story. Corporate and SOE borrowers appear to be benefiting from improved confidence, while retail and SME applicants face a tougher test before banks open the credit door.
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