Reforming leasing

Saturday, 29 August 2020 00:00 -     - {{hitsCtrl.values.hits}}

Sri Lanka is preparing to take steps to resolve a good chunk of the longstanding issues of the leasing industry, which will require both short- and long-term efforts, with the latter including amending the Finance Leasing Act to close existing loopholes.

Abolishing illegal leasing companies, ending confiscation of vehicles, regulating penal rates, and differentiating between hire purchases and leases were among the recommendations listed out by the committee appointed by the Central Bank to report on the unfair practices of the sector. 

The recommendations of the report are noteworthy and identified loopholes such as defining the term ‘notice’ and ‘substantial failure’. It also called for widespread consumer protection in the financial sector so there is stronger bargaining power between clients and companies, which is an extremely important point given the relatively low levels of financial literacy held by many members who seek out unregistered or small-time leasing operators or micro finance companies. 

Sri Lanka has a large informal economy, which encompasses a large part of the population. Despite the wide network of licensed banking and non-bank institutions operating in the country, those who exist in the informal or semi-formal economy frequently prefer to deal with smaller unregulated companies. This is for a variety of reasons, including better access and lower interest rates. Those who use these sources are at times people who are excluded from the formal finance systems. This is certainly true of microfinance companies that have been guilty of unethical and fraudulent practices for a long time. 

Unfortunately these questionable grey areas overlap with larger financial, economic and regulatory weaknesses. For example, most formal institutions are very strict about giving loans, but in Sri Lanka savings rates are typically low and many people struggle with liquidity and collateral issues. Formal or licensed organisations therefore prefer to avoid lending to such people as they are seen as high risk. The well-entrenched companies already have a solid base of clients they seldom stray from. 

Poorer customers have effectively no demand. Other groups in this category may not have access due to discrimination, lack of information, shortcomings in contract enforcement, information environment, shortcomings in product features that may make a product inappropriate for some customer groups, or price barriers due to market imperfections. If high prices exclude large parts of the population, this may be a symptom of underdeveloped physical or institutional infrastructures, regulatory barriers or lack of competition. 

Financial exclusion deserves policy action when it is driven by barriers that restrict access for individuals for whom the marginal benefit of using a given financial service would otherwise be greater than the marginal cost of providing that service. 

The global financial crisis has highlighted that extending access at the expense of reduced screening and monitoring standards can have severely negative implications both for consumers and for financial stability. Therefore, in the case of credit, it is generally preferable to promote financial inclusion through interventions that increase supply by removing market imperfections. Examples are new lending technologies that reduce transaction costs, or improved borrower identification that can mitigate (even if not fully eradicate) problems of asymmetric information and accountability. 

Given Sri Lanka’s longstanding macroeconomic issues, policy measures need to be holistic, incremental, innovative and sustainable.