Small- and Medium-sized Enterprises (SMEs) have been significantly affected by the economic turmoil in Sri Lanka, placing many business owners in untenable positions and leading to the downfall of numerous enterprises.
Amidst this crisis, access to finance remains a formidable challenge for SMEs. Numerous barriers hinder SMEs from securing loans from formal financial institutions in Sri Lanka, as they are often perceived as high-risk borrowers.
Consequently, SMEs frequently struggle to obtain loans and other financial credit services. This has driven an increasing number of business owners to rely heavily on informal financial sources and microfinance options where regulatory compliance can prove problematic. At a stage where Sri Lanka stands to gain significantly from developing a production-based economy, fostering the growth of SMEs is a crucial factor.
Exacerbated since Easter attacks
Speaking to The Sunday Morning, Colombo Chamber of Commerce (CCC) President Saranga Wijeyarathne stated that the issues relating to SMEs had emerged following the Easter attacks, as from that point onwards, the SME sector had been on the receiving end of economic difficulties.
When asked about the initiatives taken to solve the barriers facing SMEs when securing loans from formal financial institutions, he stated that during the pandemic, securing a loan moratorium became the top priority. Wijeyarathne stated that they had successfully advocated for it and that it had been accommodated by the Government to a certain extent.
However, he also stated that it had been challenging to speak up on the problems faced by this sector in the recent past, due to the inability of certain business owners to manage the repayment of loans and given the situation in the country regarding access to finance, with the cost of finance being quite high.
Furthermore, he stated that despite creating significant pressure, most institutions financing this sector were private financial institutions that had their own limitations and that the Government was faced with the challenge of debt restructuring.
As a chamber and a prominent pressure group, they have the potential to present a strong case to establish development banks and other dedicated banks focusing solely on this sector. Additionally, with Sri Lanka heading towards a Presidential Election, they can encourage candidates to prioritise the implementation of initiatives driven towards the growth of SMEs.
“Our challenge is to get confirmation from all the leading election candidates that they will give the maximum to this sector, which has been waiting for so long to get some assistance.”
Addressing the potential microfinance regulatory issues that the SME sector has to face, Wijeyarathne suggested following methods similar to those adopted by countries like Bangladesh, which have been successful in managing microfinance. He further emphasised the need for the two State banks to head an initiative or to establish a Government-controlled institution as mending the regulatory framework may not impact private institutions.
SMEs in Sri Lanka
SMEs play a significant role in shaping the Sri Lankan economy. The SME sector consists of a variety of micro, small, and medium industries and enterprises which employ less than 300 employees each and have an annual turnover not exceeding Rs. 750 million.
The sector encompasses more than 75% of the total number of enterprises in Sri Lanka, providing 45% of the employment and contributing to 52% of the Gross Domestic Product (GDP). Composed of a wide range of sectors such as agriculture, manufacturing, services, and information technology, it essentially is the backbone of the Sri Lankan economy.
Another significant challenge in the SME sector in Sri Lanka is the lack of access to technology. Wijeyarathne highlighted the necessity of digitising the sector. Taking India as a case study, he discussed the need to adapt a systematic programme to implement initiatives in this regard and the need for a mindset change that embraces digital technology.
“Somebody has to look into what India has done and why it was very successful there. If somebody does this and gives a recommendation on implementation and mindset change, it might work.”
Digitalisation to the fore
Addressing the prospect of digitalisation, Joint Apparel Association Forum (JAAF) Secretary General Yohan Lawrence acknowledged the importance of digitalisation in the SME sector, However, he highlighted that the requirement was more relevant to State sector institutes such as the Customs Department, where connectivity played a significant role: “There are certain programmes that exist to help the companies. The bigger role for digitalisation is in the State sector.”
National Construction Association of Sri Lanka (NCASL) Chairman Susantha Liyanaarachchi also emphasised the need for a national digitalisation policy: “It should be done with the collaboration of the entrepreneur and the Government. The President can establish a performance committee for it, or even establish one from our end. We can propose it.”
When asked about barriers facing the SME sector, Lawrence noted the difficulties faced as a third party with regard to the direct involvement in implementing initiatives, with the securing of loans being dependent on the individual financial company. However, he pointed out their potential in influencing financial institutions and in presenting positions regarding markets.
Multiple issues
Liyanaarachchi shared his insights on multiple issues regarding the SME sector while emphasising the need to revitalise them due to the significant role the sector plays in the Sri Lankan economic landscape. He emphasised the critical difficulties faced by SME entrepreneurs due to the devastating impact of the economic crisis.
He has engaged in discussions to address the issues faced by this sector, including the urgent need for financial aid, noting that a loan programme of $ 1,000,000 had been approved to help these enterprises recover. Moreover, Liyanaarachchi claimed that in order to strengthen existing businesses, they had proposed allowing entrepreneurs to obtain personal guarantee loans of Rs. 200,000.
Another programme offers loans ranging from Rs. 5-150 million for establishing new enterprises or maintaining existing ones. These larger loans come with a longer grace period of one to two years and require property as collateral. The Government has reportedly approved both propositions, allocating funds to the Ministry of Industries and commercial banks, specifically for streamlining the process of strengthening Micro, Small, and Medium Enterprises (MSMEs).
Another suggestion made by Liyanaarachchi was that the Government should prioritise providing incentives to the SME sector by dismissing the Credit Information Bureau of Sri Lanka (CRIB). This proposal has reportedly been well received by the Government and a decision has been made to move forward with this approach. He considers this as a significant achievement of the efforts aimed at rebuilding the SMEs.
He pointed out the difficulties faced by MSMEs due to limited access to adequate support from banks. To address this, they had proposed a Government programme to waive off small business loans in the range of Rs. 25,000-50,000, highlighting that MSMEs only account for a fraction of the total loans compared to large corporations and multinationals. He further expressed concern about the lack of proper criteria for granting loans and offered their support in developing such strategies.
Banks’ risk-averse attitude
Speaking to The Sunday Morning, First Capital Chief Research and Strategy Officer Dimantha Mathew assessed that the most common reasons for banks to be less inclined towards financing SMEs came from a risk-averse attitude.
“There is an issue as to how much of a risk they’re willing to take. At present, the amount of risk they’re willing to take is quite low. “
He stated that the lack of collateral and the absence of proper financial records within some SMEs had contributed to this situation. Without well-maintained accounting practices, banks struggle to accurately assess the financial health of a business and its capacity to repay a loan.
Furthermore, he said that the current credit assessment system in Sri Lanka, the CRIB, presents a challenge: “We don’t have a proper credit score in the system. There’s no centralised way of assessing the clients. Either you’re in the CRIB or not there. There’s no middle ground.”
As a solution to improving the chances of loan approval, he recommended implementing a centralised credit scoring system specifically designed for SMEs as this would empower banks to make informed decisions based on a broader range of factors beyond just CRIB status. Additionally, he claimed that a development bank dedicated to supporting SMEs could provide a vital source of financing as well.
Speaking on Government policies that could encourage banks to increase lending to SMEs, he said: “The Government will have to get involved and implement a proper credit assessment mechanism.”
However, speaking to The Sunday Morning, a Chief Financial Officer of a leading Licensed Commercial Bank stated that losses from the SME sector were generally higher than from other business sectors.
“When you’re investing depositors’ money in different organisations, higher returns are needed to compensate for higher risks. For example, many SMEs have failed, as noted in media reports, due to various structural issues.”
Over the past 50-60 years, only a few successful business figures have emerged, with none following in their footsteps, the officer stated.
“SMEs face numerous issues that aren’t easily resolved. Statistics from 2019 to the present show how many have failed, not just due to financial costs but other factors as well. Financial intermediaries typically invest on behalf of stakeholders and aim to protect depositors’ money globally. This issue of serving SMEs through the commercial banking sector is a widespread problem, indicating inherent challenges,” he added.
Secured Transactions Registry
Meanwhile, speaking to The Sunday Morning, a high-level source from the Ministry of Finance stated that SMEs in Sri Lanka would benefit from the new Secured Transactions Registry (STR), which allows the use of moveable assets as collateral for loans. This initiative, supported by the International Finance Corporation (IFC) of the World Bank Group, aims to enhance financial stability and promote economic growth, according to the source.
The Secured Transactions Registry Act, developed with the IFC’s technical assistance, addresses legal and operational challenges in the current law. This effort is led by the CRIB in collaboration with the Central Bank of Sri Lanka and the Ministry of Finance.