By the Frontpage Journal Business Desk
While 2024 marked a turnaround year for Sri Lanka’s domestic liquidity landscape, the uneven distribution of that liquidity across institutions has exposed a deeper structural flaw in the financial system. Drawing from the Annual Economic Review 2024 published by the Central Bank of Sri Lanka, the data reveals not just a story of monetary surplus but also one of rising disparity, a challenge that, if left unaddressed, could hinder the competitiveness and resilience of the country’s banking sector.
The Central Bank’s monetary interventions were significant. It injected liquidity into the system through net foreign exchange purchases amounting to approximately Rs. 858 billion.
This was supplemented by net foreign loan inflows from bilateral partners and foreign currency swaps with Licensed Commercial Banks (LCBs). These actions collectively shifted the money market from a liquidity deficit of Rs. 70 billion in 2023 to a surplus of Rs. 168 billion by the end of 2024.
But as the report highlights, the benefits of this liquidity shift were not evenly shared. A handful of foreign banks held a disproportionate share of the surplus. Domestic banks, especially smaller ones or those with weaker credit profiles, struggled to access these funds due to transaction exposure limits and risk aversion in the interbank market. This resulted in limited interbank market activity, particularly in the first half of 2024.
The implications are significant. At a time when the financial sector is expected to support economic recovery and credit expansion, asymmetric liquidity distribution acts as a bottleneck. Institutions with surplus liquidity find themselves constrained by regulatory or counterparty limits, while those in deficit remain overly reliant on Central Bank facilities, weakening the autonomy of market mechanisms.
In this environment, competitiveness suffers. Banks unable to access cheap surplus liquidity face higher funding costs, reducing their capacity to lend or invest in expansion. They are less agile in responding to market signals, less attractive to depositors, and more vulnerable to liquidity shocks. In contrast, institutions sitting on excess funds have limited incentive to lend in a market where counterparties are deemed risky or constrained. This concentration of liquidity also amplifies systemic risk, if the few surplus holders face disruptions, the entire
system becomes more vulnerable.
The Central Bank sought to address some of these imbalances through active Open Market Operations (OMOs), injecting liquidity where needed to smooth distributional inefficiencies. These interventions were critical in bridging short-term mismatches and maintaining orderly market conditions. However, as market activity gradually improved, helped by a sovereign credit rating upgrade later in the year, the Central Bank began to step back, scaling down its OMOs and discontinuing overnight reverse repo operations by early December 2024.
Still, the structural issues persist. As noted in the Central Bank’s report, interbank activity remains suboptimal. The lack of trust, credit limits, and insufficient mechanisms for risk-sharing between institutions point to a broader need for regulatory and institutional reforms.
Addressing these challenges requires a multi-pronged approach. First, risk-based capital and exposure frameworks should be reviewed to allow greater flexibility in interbank lending while preserving financial stability. Second, strengthening market infrastructure, such as collateralized interbank platforms, enhanced transparency in credit profiling, and modern payment settlement systems, can facilitate trust and smoother liquidity flows. Finally, sustained fiscal discipline and macroeconomic stability are necessary to reduce perceived
sovereign and institutional risk, thereby expanding the scope for liquidity circulation across the sector.
Sri Lanka’s liquidity surplus in 2024 is not an endpoint, it is an opportunity. An opportunity to shift from a Central Bank-dependent ecosystem toward a more dynamic, interdependent financial system capable of allocating resources efficiently and competitively. As the country moves into 2025, the real test will not be the presence of liquidity, but its productive and equitable utilization across institutions.
In the words of the Central Bank’s own report, the liquidity shift was a “notable” development, but whether it translates into a stronger, more competitive banking sector will depend on the next set of reforms and the willingness of stakeholders to address structural imbalances head-on.
Source: Central Bank of Sri Lanka, Annual Economic Review 2024
