Are Licensed Finance Companies the missing link in Sri Lanka’s financial inclusion quest?

Financial inclusion is essential for continuous and sustainable economic development, according to IFC. This is no exception for Sri Lanka despite showing strong numbers in bank penetration. 

According to the World Bank Group’s (WBG) Global Findex for 2017, nearly 74% of the population in Sri Lanka have accounts at a financial institution, higher than the regional average in South Asia of 70% (36%, excluding India). Sri Lanka also enjoys high levels of bank branch penetration, with bank branch density of 16.5 per 100,000 adults as of December 2018 (CBSL). 

Sri Lanka therefore has a high penetration rate but achieving the zenith – stronger financial inclusion – is fraught with constraints. Though 83% of all Lankan adults have bank accounts and over 80% of adult women have savings accounts, financial inclusion is not satisfactory in Sri Lanka.  Realising this, Sri Lanka began work to improve financial inclusion. 

Work on financial inclusion

The Central Bank’s work on Sri Lanka’s first National Financial Inclusion Strategy (NFIS) was expected to be implemented in early 2020 with other relevant authorities. The bank receives technical assistance from the International Finance Corporation (IFC). 

The NFIS was conducted to “increase financial accessibility for micro, small and medium-sized enterprises (MSMEs), done under four policy pillars; digital finance and payments, MSME finance, consumer protection and financial literacy and capacity building,” according to the former Governor Indrajit Coomaraswamy (October 2019).

According to Coomaraswamy over 75% of businesses in Sri Lanka (over one million) are MSMEs, providing employment for 45% of the labour force (3.2 million persons) and generating 52% of Gross Domestic Product, and thus are vital for the country’s economic growth. 

However, most MSMEs suffer from a lack of access to the formal financial ecosystem. High interest rates, the need for collateral and lack of formal documentation are the most frequently cited constraints for MSMEs to access finance in Sri Lanka, and so many are forced to deal with informal financial institutions which charge even higher interest rates. MSMEs need rationalised structures for financial inclusiveness. 

Interestingly, though ‘banks’ have been mentioned as having ‘some programs which provide refinance and credit guarantee schemes and interest subsidies for MSMEs’, one of the most powerful mechanisms that can access MSMEs for their financial inclusion are not mentioned at all-the Non-Banking Financial Sector (NBFI), and specifically the Licensed Finance Companies (LFCs) within the NBFIs.

Licensed Finance Companies (LFCs)

If Financial Inclusion (FI) is defined as creating first time lenders and borrowers – including MSMEs-into mainstream finance, NBFI is a key financial inclusion driver in Sri Lanka. In Sri Lanka NBFI sector bridges the formal and informal financing sectors by linking 60% of workforce to secure financing – the formal financing sector. The result is that NBFI rescues the struggling MSMEs from the most informal mechanisms such as loan-sharks and money lenders. 

NBFIs, especially the LFCs, take the risk of becoming the intuitional link for these MSMEs. As I recently described in a public forum on financial inclusion, the predominant role of NBFI, especially LFCs, is that it is a potent mechanism to reach lower income, Bottom of the Pyramid (BoP) market. 

Around 50% of BoP funding takes place through NBFIs, creating a massive stake in employment. Sri Lankan microfinancing market is totally (100%) financed by the NBFIs. They provide services to more than three million depositors in Sri Lanka with a total deposit base of Rs. 750 b. 

In addition, 55% of the CRIB reports are accessed by NBFI sector which bears testimony to the high impact of NBFIs despite having only 10% of the loan portfolio of the banking and finance industry. Also 90% of three-wheeler market, 70% of private bus passenger transport, 75% tractors and agricultural equipment, and 70% of small transport vehicles such as light trucks are NBFI funded.

NBFIs fund the BoP market

Though NBFIs are only around 8-10% of entire financial sector, 55% of CRIB reports are obtained by NBFIs. With a deposit base totalling Rs. 760 billion, the NBFI sector is therefore critical for the economy; 70% of its loan portfolio is funded by public deposits.

What is important in these numbers is that the MSMEs, the backbone of Lankan economy, predominantly depend on NBFI to meet their funding needs. Even though the commercial banking sector’s assets are eight times larger than NBFIs, NBFIs – unlike the formal banking sector – reach the very bottom of the pyramid that is out of reach for the banks. Such an access to BoP – a larger section of society – helps budding entrepreneurs to grow – a key step forward in developing the economy. 

If this portrayal does not convince anyone of the importance of LFC in Sri Lanka’s financial inclusion quest, then perhaps nothing else will. That is since no other regulated institutional financing mechanism in the country has the immediacy to the bottom of the pyramid that LFCs have. Any national financial inclusion effort that misses this point should be seriously reconsidered. 

History of the FHA

The FHA is the successor of the Ceylon Hire Purchase & Finance Association, founded in 1958. The association was formed to discuss the emerging problems in an unregulated industry at that time. The Association was successively renamed as the Finance Houses Association of Sri Lanka (FHA) in 1986. In the course of its history of over 62 years, the FHA has grown in form and stature to discharge a broad range of activities, expanding its original objectives. 

(The writer is the Immediate Past Chairman of the FHA with 25 years of experience in the finance industry.)