Bad loans in Sri Lanka's banking system spiked after low interest rates up to 2011 set off a credit bubble, which ended in a balance of payments crisis, while plunging gold prices triggered default on gold-backed loans, delivering a double whammy.
Mark Young, Head of Asia Pacific Financial Institutions at Fitch Ratings said bad loans are peaking, especially from gold backed loans (pawning) and credit will gradually start to grow.
"The portfolios (of gold-backed loans) have shrunk and the risk is much more manageable," Young said.
"So I would that as other parts of lending begin to expand, that would become less of an issue."
Reported capital was overstated compared to other countries, due to zero risk allocation for gold loans.
"Clearly it should not have been risk weighted zero," Young said. "Yet it remains risk weighted zero.
"If you do not have to allocate capital against it then the commercial dynamics are skewed in the wrong direction."
But capital buffers in Sri Lanka's bank were sound though under pressure.