In the Maldives, the bank-sovereign nexus has become an increasingly critical and a topic that needs urgent dialogue, predominantly due to rising government debt, excessive banking sector exposure to sovereign risks, and external debt repayment pressures. In addition, it has been the first time IMF used the phrase “heightened systemic risks from bank-sovereign nexus”[1]; which is an indication that the matter should not be taken lightly; if left unaddressed, this situation could result in severe economic consequences, including financial instability, liquidity crises, and prolonged economic downturns.
Before embarking on a technical, and a financial discourse, it is important to understand the term Bank-Sovereign Nexus and the effect it has on an economy.
The bank-sovereign nexus refers to the interdependent relationship between a country’s banking sector and its government finances. In many economies, banks hold a significant amounts of government securities, while governments often rely on domestic banks for financing. This mutual dependence can often lead to systemic financial risks, particularly in nations with high public debt and fiscal vulnerabilities. However, if public debts are managed accordingly, the bank-sovereign nexus may not necessarily be a threat to economies.
The Maldivian financial system is heavily reliant on its banking sector, with banks controlling approximately 77% of the financial system’s total assets. A key characteristic of this banking structure is the overwhelming dominance of state-owned banks, which hold nearly three-fourths of the sector’s assets. Due to the government’s significant borrowing needs and Bank of Maldives holding a majority stake of the government, unfortunately it can be said that the burden will go to the Bank of Maldives; accumulating a large holding of these sovereign debts, exposing them to potential fiscal risks.
According to the International Monetary Fund (IMF), the Maldives’ public debt has exceeded 116% of its Gross Domestic Product (GDP) as of 2024, a sharp rise from previous years. The growing debt burden limits the government’s ability to manage economic shocks without resorting to further borrowings. Given that domestic banks exposure to sovereign debts is more than 30 percent of total assets (which according to IMF is alarming), any fiscal instability will directly affect their balance sheets. If the government faces difficulties in repaying its obligations, banks may suffer financial losses, leading to a dangerous cycle where sovereign distress fuels banking instability and vice versa.
The World Bank and IMF have highlighted additional concerns regarding the Maldives’ fiscal position. The country’s reliance on tourism, which generates around 28% of GDP, makes it particularly vulnerable to external shocks. Events such as global pandemics, geopolitical instability, or climate-related disasters can significantly reduce government revenues, increasing pressure on the banking sector. Moreover, the Maldives Monetary Authority (MMA) has been forced to ration foreign exchange, resulting in the growth of a parallel market that further complicates the financial landscape.
Several indicators suggest that the bank-sovereign nexus in the Maldives has reached a shaky stage; where IMF claims that “banking sector exposure to sovereign debt continues to rise above 30 percent of total assets, well above peer countries in the region”. Firstly, the high level of public debt reduces the government’s ability to respond to economic downturns without additional borrowing from domestic banks. This growing dependence not only constrains fiscal policy but also increases systemic risks for the banking sector.
Secondly, the stability of the banking sector itself is in jeopardy due to its large exposure to government-issued securities. Many banks have allocated a significant portion of their assets to sovereign debt, creating a direct link between government fiscal health and banking stability. According to IMF[2] some banks have reached over 400% of Sovereign Exposure as of their registered Capital, while all other banks have pretty much reached 100%. If the government encounters financial distress, banks holding these securities could face major capital losses, reducing their ability to extend credit to the private sector and worsening economic conditions.
Another pressing concern is the Maldives’ rising external debt repayment obligations, particularly to major lenders such as India and China. With repayment pressures set to intensify beyond 2026, the government may struggle to meet its foreign debt commitments. If external debt obligations become unmanageable, domestic banks that are heavily invested in government securities could see a decline in asset values, triggering a broader financial crisis.
Meanwhile on the 29th of August 2024, Fitch[3] had downgraded Maldives credit rating from CCC+ to CC. Although this rating does not have an immediate threat, it is alarming and should not be taken lightly. This can potentially face significant challenges for banks seeking external finance. Foreign lenders may find it riskier; or it may come with a higher borrowing cost than it is now.
The escalating bank-sovereign nexus presents multiple dangers to the Maldivian banking sector. One of the most immediate risks is capital erosion. If the government finances deteriorate and sovereign debt loses value, banks that hold large amounts of these securities will experience a decline in capital reserves. The IMF has warned[4] that in some Maldivian banks, sovereign debt exposure already exceeds 400% of their capital, making them particularly vulnerable to fiscal shocks.
Liquidity constraints also pose a significant risk. Given the country’s foreign exchange shortages, banks may find it increasingly difficult to meet foreign currency obligations. This could lead to credit restrictions, limiting the ability of businesses to invest and grow. Additionally, the concentration of credit in a few key industries, particularly tourism and construction, makes the banking sector highly susceptible to sector-specific downturns. If tourism revenues decline due to external shocks, non-performing loans in the sector could rise sharply, further weakening the financial system.
If the current trajectory of the bank-sovereign nexus in the Maldives is not corrected, the country could risks experiencing a financial crisis similar to those seen in other nations with similar economic structures. A notable example is Greece during the European debt crisis. Greek banks held a significant share of domestic government debt, and when the government defaulted on its obligations, the banking sector suffered catastrophic losses. This led to capital flight, liquidity shortages, and an eventual need for international bailouts. The crisis resulted in prolonged economic stagnation and severe austerity measures, which further weakened the banking sector.
Sri Lanka provides another relevant case study. In 2022, Sri Lanka faced a sovereign debt crisis due to unsustainable borrowing and declining foreign reserves. As the government defaulted on its external debt, the banking sector experienced liquidity shortages, causing severe disruptions in credit markets. The crisis triggered widespread social unrest, leading to political instability and an economic downturn that took years to stabilize.
For the Maldives, these examples highlight the dangers of unchecked government borrowing and excessive reliance on domestic banks for financing. If the bank-sovereign nexus continues to worsen, the country could face a similar trajectory, characterized by banking sector instability, credit freezes, and an eventual loss of investor confidence.
To mitigate the risks associated with the bank-sovereign nexus, the Maldives must implement a series of reforms to strengthen fiscal sustainability and reduce banking sector vulnerabilities.
One key step is diversifying bank assets to ensure that banks do not become overly dependent on government securities. Encouraging banks to allocate more resources toward productive private sector lending will help reduce sovereign exposure while stimulating economic growth. Additionally, enhancing fiscal discipline is essential. The government should implement policies aimed at reducing budget deficits and managing debt levels more effectively to decrease reliance on domestic banks for financing.
Strengthening regulatory frameworks is also necessary. The Maldives Monetary Authority must enforce stricter capital requirements and improve risk assessment measures for banks with high sovereign exposure. By ensuring that banks maintain sufficient capital buffers, the financial sector can better withstand potential fiscal shocks.
Exploring alternative financing mechanisms, such as public-private partnerships and external investments, can help reduce the government’s borrowing needs. The Maldives could also consider innovative solutions such as debt-for-nature or debt-for-climate swaps, where debt obligations are restructured in exchange for commitments to environmental conservation. This approach has been successfully implemented in other small island economies and could provide a sustainable pathway to reducing debt burdens.
Finally, enhancing financial transparency will play a crucial role in restoring investor confidence. Clear reporting on government debt obligations, banking sector risks, and foreign exchange reserves will enable better decision-making and improve the country’s creditworthiness.
The bank-sovereign nexus in the Maldives has reached a critical stage, with rising public debt, excessive banking sector exposure to sovereign risks, and growing external repayment obligations threatening financial stability. If left unaddressed, the country risks experiencing a banking crisis like those seen in Greece or in Sri Lanka, with long-term economic and social consequences. However, by implementing prudent fiscal policies, strengthening regulatory oversight, and diversifying banking sector assets, the Maldives can enhance financial resilience and mitigate systemic risks. Addressing these issues proactively is essential to ensuring sustainable economic growth and long-term financial stability.
[1] https://www.imf.org/en/News/Articles/2025/02/18/pr25037-maldives-imf-staff-completes-2025-article-iv-mission-to-the-maldives
[2] Source: https://www.elibrary.imf.org/view/journals/002/2023/404/article-A001-en.xml
[3] Fitch Ratings: https://www.fitchratings.com/entity/maldives-88305904
[4] https://www.elibrary.imf.org/downloadpdf/view/journals/002/2024/106/article-A001-en.pdf
