In recent months, many Sri Lankans have started withdrawing their fixed deposits (FDs) from banks. The reason? New tax rules that make interest income taxable, especially for individuals with larger deposits.
But while this might seem like a smart move for individuals trying to avoid higher taxes, it could have serious consequences for the country’s banking system and economy.
Let’s unpack this.
📌 What’s Happening?
- Sri Lanka introduced or increased taxes on interest income, especially from fixed deposits and savings.
- Interest income is now taxed under the progressive personal income tax system, going up to 36% for high earners.
- Many depositors — especially pensioners, retirees, and high-net-worth individuals — are now pulling their money out of banks to avoid this tax hit.
💡 Why People Are Withdrawing FDs
Here’s what’s driving the trend:
- Avoid Tax: People don’t want to lose a big chunk of their interest to tax. For example, someone earning LKR 1 million in annual interest could lose over LKR 300,000 if taxed at the top rate.
- Seek Alternatives: Some are turning to informal lending, real estate, gold, or investing abroad — looking for tax-free or lower-tax options.
- Distrust & Frustration: There’s growing frustration that the middle class and retirees are being burdened, while some sectors escape scrutiny.
🏦 What Happens to Banks When Deposits Leave?
Banks rely heavily on customer deposits — especially fixed deposits — as a major source of funding. If people withdraw large sums, it can lead to several ripple effects:
1. Liquidity Issues
Banks need deposits to give out loans. If too much money is pulled out:
- Lending capacity drops
- Banks may struggle to meet short-term cash needs
- Liquidity stress can rise
2. Higher Interest Rates
To attract depositors back, banks might need to raise interest rates on FDs — increasing their cost of funds. This can:
- Push up loan interest rates
- Slow down borrowing and investment
- Make it harder for businesses and individuals to access affordable credit
3. Pressure on Small Banks
Smaller and regional banks may feel the biggest impact, as they often rely more on fixed deposits and have fewer alternative funding sources.
4. Shadow Banking Risks
As people move money to informal lenders or “under-the-mattress” savings:
- It creates unregulated financial activity
- Increases risk of scams or defaults
- Reduces money in the formal financial system
📉 Long-Term Economic Impact
- Reduced lending can hurt economic growth, especially in sectors like construction, agriculture, and small businesses.
- Less trust in the banking system can weaken financial stability.
- A shrinking deposit base forces banks to rely more on costlier or riskier funding sources (like borrowing from other banks or the central bank).
🧾 What Can Be Done?
For Policymakers:
- Reconsider tax thresholds for interest income — perhaps exempting smaller savers or retirees.
- Provide clear, fair, and consistent tax rules to avoid panic reactions.
- Encourage investment in government bonds or retirement-focused products with favorable tax treatment.
For Banks:
- Offer more flexible products — like tax-saving FDs or capital-guaranteed investment plans.
- Improve financial education to help customers understand safe alternatives.
- Innovate: explore partnerships for mutual funds, REITs, or government-backed instruments.
🧠 Final Thoughts
While tax compliance is important for national recovery, the sudden shift in how deposits are taxed has spooked many ordinary Sri Lankans. The banking system is feeling the pressure — and if the trend continues, we could see long-term effects on liquidity, interest rates, and trust in formal finance.
Balance is key.
Sri Lanka needs tax revenue — but it also needs a strong, stable banking sector and a financial system where people feel safe to save.
