SriLanka is a tiny island, located in southern tip of Indian sub
continent. Total land area is 65,610 square kilometers. Climate is
topical and four season does not exit Sri Lanka. The clouds and rains
rumble in more seriously at the two times of the year that come as
close as anything to being seasons – Monsoons. Two monsoon seasons
( South west and North east) can be seen in the country. The total
population is 18.5 Mn. and country can be classified as multi ethnic
country. Majority religions are Buddhism, Hinduism, Islam and
Catholic. Sri Lanka economy can be classified as an agricultural
economy but because of globalization and the innovation of the nature
of the economy is changing rapidly from agriculture to industries.
Most of the industries and agricultural enterprises are small and
has been an increase in the level of participation of the financial
institutions in credit savings to poor rural communities in
developing countries. This is mainly because of large-scale foreign
aid contributions by the donor agencies to promote micro credit
services. For instance, multilateral (IBRD,ADB,EC,UNDP,and IFAD)
funding agencies have committed a substantial amount of funds for
micro credit related activities.
Sri Lanka Commercial Banks, Development Banks and Regional
Development Banks are included in Financial institutions. Although
there is a role for Financial institutions, most of the microcredit
activities are under taken by non-formal banking sectors and non
government organizations (NGOs). This paper provide some empirical
evidence of a financial institutions which has allocated a
significant proportion of its portfolio for microcredit programme.
Microcredit refers to small scale borrowing and saving activities
conducted by individuals groups and small enterprises (generally self
employed poor) who would not normally be reached by the formal
business employ up to 5 people, often family-labor. Typically, they
have fixed workshop and capital investment but the character
is still small and most of the production is meant for local markets.
It is important to note that the number of employees is not the only
measure of the size of a micro credit enterprises. Other factors such
as output, sales and asset levels may be equally appropriate
indicators of the size of the firm's operation. Currently, most of
the loans to micro-entrepreneurs are provided primarily through the
government, foreign aid assisted
non-governmental agencies or informal money lenders. Financial
institutions must recover their cost of servicing loans by interest
charges and they must be confident borrower's intent ability to
repay. Financial institutions are also hampered by lack of formal
collateral. This means
the standard criteria used by the financial institutions are inappropriate for micro enterprise lending. To over-come this
problem Otero and Rhyne suggested three measures to be successful in
lending to micro-entrepreneurs.
Know the market
Keep administrative costs as low as possible
Ensure high portfolio quality.
in developing Small & medium enterprises (SMEs)
in Sri Lanka commenced in 1980 with the establishment of
National Development Bank (NDB) to provide medium to long term SME
project financing. During the 1980s most of lines of credit for the
SMEs were channeled through the NDB and its competitor the DFCC Bank.
In 1991 the World Bank rated Sri Lanka as number 1 amongst 31
countries for most successful operation of lines of credit for
SMEs. However the privatization of these institutions not only
changed their focus but also their portfolio mix. This means that
these institutions have moved considerably away from servicing
often use financial institutions as a channel to direct their own
programmes with the objective of achieving social welfare and micro
enterprise development. The Samurdhi Development Credit Scheme
developed by the Ministry of Rural Development in Sri Lanka has used
two state owned commercial banks ie: People's Bank, and Bank of
Ceylon, to distribute approximately Rs. 500 million (US $ 6 Million)
This scheme was intended to serve the rural community through village
level task forces called " Samurdhi Task Forces" which operated
as a social intermediary. The task force used its members called
to select recipients of the subsidized loans ranging from SL Rs.
2,500 to SL Rs. 10,000 ( approximately US $ 28 to US$ 110)
The Hatton National Bank (HNB) in Sri Lanka is one of the
leading commercial bank involved in lending to commercially viable
micro-enterprises. The HNB uses the concept of barefoot banker to set
up a number of village level schemes (Gami Pubuduwa or Village
Awakening) to distribute loans. The village level officers or village
awakening advisors function as intermediaries between the bank and
Loans up to SL Rs 15,000 (approximately US $ 165) can be
approved without formal collateral and this amount can increase to SL
Rs 25,000 if the applicant is guaranteed by two villagers. The role
of bank branches is kept at a minimum because most of the
transactions are carried out at village level. The interest rate on
loans ranges from 17 to 25 percent per annum. In some cases NGOs are
allowed to use the multiple deposits of its members in the bank to
raise funds for further development of micro-entrepreneurs. Despite
this evidence on the possibility of
financial institutions involvement in micro-credit, their
ability to serve the sector has been widely debated. However, any
attempt to get financial institutions into micro finance requires a careful assessment
of the issues faced by the financial institutions of the
developing countries. In addition to HNB there are six Regional
Development Banks also involving granting loans to rural poor. These
banks have been specially established for helping to the rural poor.
of the current donors are interested in funding microfinance
programme through financial institutions. Since most of foreign
funding is channeled through governments, the financial
institutions have to decide whether they should implement
lending programmes as commercial ventures or as required by the
government. Expanding market power and profitability are the main
objectives of the financial institutions. It is also important to
reorganize that there is significant gap in financial dept and
efficiency between low income and high income countries.
The domestic credit are generated from the savings of house
holds and institutions. The ratio of domestic credit provided by the
banking sector to GDP measures the growth of the banking system it
reflects the extent to which savings are financial. This ratio
indicates that banks in the low income countries have not performed
to level to close to the rest of the world. However the ratio does
not capture the activities of the informal financial sector and the
non-banking savings culture of the low income countries.
Lending to micro-entrepreneurs is not a new concept.
Financial institutions often consider lending to micro-entrepreneurs
or to a group of micro-entrepreneurs is either too risky or too
expensive. Lending to micro-enterprises means creating a portfolio
largely comprising small loans.
Lack of formal collateral and the previous experience of non
payment by low income borrowers have led the financial institutions
and their staff to distrust the micro-entrepreneurs. Most bankers
have underestimated the capacity of micro – entrepreneurs to save
and have not examined the feasibility of an alternative lending
formula. Furthermore, less rigorous informal lending criteria have
made non-bank borrowing attractive to the micro-entrepreneurs in low
The Financial institutions in low
income countries have been subjected to regulation such as interest
rate caps and reserve requirements. These regulations not only reduce
the competition between banks but also prevent banks from servicing
micro- entrepreneurs with innovative lending/savings products.
Regulations has also prevented financial institutions from borrowing
from overseas. Further more most of the government supported lending
programmes have combined the objectives of social service and
enterprise development. Although this is theoretically possible, most
of these programmes have not provided the anticipated benefit as a
result of political intervention and corruption.
The last decade has seen a revolution in the banking system.
With the introduction of technology and privatization, banks have
moved from labor intensive institutions to labour saving or
technology intensive institutions. However, most financial
institutions in Sri Lanka are still labor intensive. Eventual
introduction of technology, privatization and possible bank mergers
will impose considerable threats on the labor input of the banks in
low income countries.
Lack of competition in the banking sectors in Sri Lanka is the
major reason for low involvement in micro enterprise lending. A
banking system's role is to intermediate between household savings
and investment. Competition among bank makes borrowing more
attractive. It also promotes the access of micro entrepreneurs to the
formal banking sector.
major service needs for micro-entrepreneurs are saving and credit for
liquidity and working capital. Supporting this group creates
considerable positive externalities. This is because it creates a
basic economic environment in which
households can economically survive through self employment
with a possibility of creating further employment or reducing
unemployment within family units.
Since micro-entrepreneurs reduce the problems of unemployment,
government and other international donors who are trying to promote
employment are particularly interested in them. Therefore
microfinance justifies intervention and support
experience on subsidized lending indicates that it has led to poor
repayment and high failure rates. At the same time the informal
lending sectors which lend at substantially high interest rates are
thriving in most of low income countries. For this reason some
practitioners have argued that subsidized lending for micro-
entrepreneurs is inappropriate because they can afford high interest
provision for loan losses seems to be understated. This may be due
lack of accurate data on previous loan losses. The impact of loan
losses can be significantly reduced by providing adequate insurance
to cover risks. However insurance products in micro-finance are yet
to be introduced. The lower rate of loan losses will certainly
encourage private investment but government assisted insurance
provision will bring more benefits than interest rates subsidies.
The financial system in the developing countries are highly
regulated through prudential requirements which do not promote entry
and competition. The Financial
institutions involved in micro finance require competitive wholesale
borrowing. Only a
wholesaler available in Sri Lanka ie: National Development Bank. The
potential benefits of financial institutions lending to
micro-enterprises can not be achieved without reforms to existing
prudential regulations and facilitating the functions of small
financial institutions. The reforms should be include abolition of
rigid banking supervision,
interest rate restrictions, reserve requirements capital adequacy
Government in low income countries also emphasize on the
concept of community banking which is a popular concept even within
high income countries. A community bank or an independent bank is a
commercial or saving whose operations are limited to its immediate
city or country area. Community banks have the capacity to
differentiate themselves by building on the strength of community
associations and leadership to serve the financial needs to those
communities. Governments in developing countries may be able to
obtain better economic benefits by divorcing enterprise development
programme from social welfare driven programmes so that political
influence on lending can be kept at minimum.
The basic problem of the banking sector of the less
developed countries is insufficient diversification. Increased
competition for profitable loan assets has resulted in growing
portfolio concentration in narrow range of lending. Banks are also
lenient on following government
mandated policies on lending than independent assessment of
credit risks of the borrowers. These problems are further exacerbated
by the weakness of supervisory framework.
The banking institutions in low income countries normally do
not pay attention to potential micro-entrepreneurial clients because
they do not fit into the traditional perception of what constitutes a
good client. The inability to provide clear collaterals. has led the
financial institutions to believe that funding micro-enterprises
should be a charity activity or a part of the governments welfare
schemes. This means banks do not use appropriate credit risk
assessment of micro –entrepreneurs.
One way to over come this problem is work with other
organizations (charity or thrift societies or community banks
suggested above) that already involved in successful enterprise
development programmes. By networking these groups to lending
programmes bank can not only reduce the cost of the loan
administration but also reduce the burden on supervisory staff. The
most appropriate way to promote banks in rural communities is by
promoting micro-savings of the micro-borrowers.
This paper has examined whether commercial banks in low income
countries are capable of delivering micro financial services. There
are strong incentives for financial institutions to be involved
micro-finance. A summary of the key points covered is given below.
In order to facilitate financial institutions' interest in
microfinance , government sponsored
income support programmes should be separated from the
Subsidized lending does not encourage microfinance and leads to
poor loan repayment and portfolio quality. Introduction of
insurance cover to micro-entrepreneurs provide grater benefits.
The insurance can also be a part of the portfolio of the banks
Government should acknowledge the social contributions of
developing micro-enterprises. Therefore government should provide
a suitable regulatory
environment to promote micro lending. This should include
competitive wholesale borrowing, introducing micro-insurance
systems, and minimizing the restrictions on entry by the small
banks serving micro-entrepreneurs.
Banks should change their visions. Micro-finance can be a
profitable item in banks' portfolios provided that they use cost
effective methods for the delivery of loan products. Considerable
gains in efficiencies are possible through incorporating NGOs in
micro enterprise development. In order to maintain an effective
supervisory framework, banks should use a system of bench marking.
Banks should combine micro lending with micro saving.
Annual Report - Central Bank of Sri Lanka 2000 & 2001
National Microfinance study of Sri Lanka.