As an integral part of the country’s financial system, Licensed Finance Companies (LFCs) and registered leasing companies play a vital role in the development of the national economy. Collectively known as the Non-Bank Financial (NBFI) sector, they offer a gamut of financial solutions to cater to individuals, proprietors, partnerships, corporates or business conglomerates.
Most NBFIs have also invested in developing an extensive islandwide presence that allows them to reach all sectors, social backgrounds and economic levels. Their ability to serve a wider cross-section of the market makes the NBFI sector a key contributor towards the development of the SME and Micro
enterprise segment in Sri Lanka. Leveraging on the expertise gained by serving the local SME and Micro segment, a few NBFIs have even ventured outside Sri Lanka to set up operations overseas.
Regulatory supervision, governance and compliance
Dealing with the SME/Micro segment has resulted in NBFIs being subject to increasing regulatory
controls in the past few years.
As the words ‘Licensed Finance Companies’ denote LFCs are licensed and regulated by the Central Bank of Sri Lanka (CBSL).
LFCs conduct their business in conformity with the provisions of the Finance Business Act No. 42 of 2011, Finance Leasing Act No. 56 of 2000, Directions, Rules and Guidelines issued the said Acts, Consumer Credit Act No. 29 of 1982, Financial Transactions Reporting Act No. 6 of 2006 and Prevention of Money Laundering Act No. 5 of 2006, under the direct supervision of CBSL and other applicable statutes. Through these statutes and regulations CBSL regulates the finance business and the finance leasing business to ensure the orderly function of the financial system.
In addition, LFCs are required to abide by the Corporate Governance Directions issued by the CBSL. This helps to create an environment of trust, transparency and accountability, which is required to foster long-term investment, financial stability and enhance the business integrity of LFCs.
Another Direction noteworthy of mention is the Financial Customer Protection Framework outlined in Finance Business Act Direction No. 01 of 2018 and the detailed guidelines thereon. This direction
provides the platform for customers of LFCs to assert their rights and to ensure that their rights are
The key objective of the said direction is to safeguard the interests of the customers and build trust in order to strengthen customer confidence in the sector. Since being introduced in 2018, the Financial Customer Protection Framework has become an integral part of the corporate governance culture and strategic decision making of the boards of LFCs.
To ensure compliance with the applicable laws and regulations, LFCs have established a very strong and robust compliance function, which is subject to regular reporting and monitoring by the CBSL.
Despite the stringent business and regulatory environment governing the NBFIs, it is unfortunate that there is still a segment of the general public who have a negative perception towards the sector. Such unfounded perceptions appear to have arisen primarily due to the lack of awareness regarding the
pricing mechanism and the foreclosure process followed by the NBFI sector. The purpose of this article is to provide some much needed clarity on these topics.
The pricing mechanism adopted by the NBFI sector
It is no secret that compared to the banking sector, the pricing structure of the NBFI sector for similar products is relatively higher. There are several fundamental reasons for this. Firstly, it is important to understand that the NBFI caters mainly to the SME and Micro segment of the market. Based on their profiles, SME and Micro segment customers fall into the high-risk category.
The typical SME/Micro customer who is often overlooked by the banking system due to their lack of
credentials and financial sophistication, is then motivated to approach the NBFI sector with the
expectation that their credit applications will be processed expeditiously even without necessary
documentary proof or credentials.
This puts NBFIs in a tough spot. On the one hand NBFIs are expected to be more flexible in their decision making process in order to secure their customer, while on the other hand they need to comply with
established risk appetite limits in order to safeguard the business.
Amidst this backdrop, the only rational way for NBFI’s to strike a balance is by building in a higher risk premium into their pricing structure. And with SME/Micro customers also likely to be more vulnerable to economic shocks, especially given their position at the lower end of the pyramid, NBFIs are compelled to factor-in additional risk premiums into their pricing structure.
Meanwhile being in the high-risk category, the cost of managing SME / Micro customers is also
comparatively higher. From the additional background checks to site visits and managerial oversight to encourage customers to adopt proper financial control and discipline, NBFIs incur significantly higher operational costs per customer, which leaves these companies with no option but to build cost buffers into their pricing structure.
Another key element that drives up the NBFIs pricing structure is their high cost of funding. Unlike Banks, which have access to low cost funds through their Current and Savings Accounts (CASA) base, NBFIs are funded largely by public deposits and often have to pay higher rates in order to attract
deposits away from the banking system.
On average more than 50% of the total interest costs of NBFIs go towards servicing deposits. Lowering these cost elements is an extremely difficult task since NBFIs do not have access to free funds such as current accounts.
Despite these challenges however, some NBFIs have adopted dynamic pricing strategies in line with their business model and risk appetite, enabling them to offer very competitive rates, often on par with the banks. In this manner, the NBFI sector has remained firm in its commitment to nurture the
SME/Micro segment – the ‘infants’ of the economy, to the level of bankable customers, thereby
contributing towards improving the country’s overall credit culture over time.
Regulated foreclosure process
In the interest of protecting the rights of both lessees and lessors, NBFIs follow a highly regulated
foreclosure process for the repossession of assets. They cannot deviate from the repossession guidelines set out under the Finance Leasing Act No. 56 of 2000.
The Finance Leasing Act was enacted in the year 2000 to provide for the regulation and monitoring of
finance leasing businesses, to specify the rights and duties of Lessors and Lessees and suppliers of
equipment and for matters connected therewith or incidental thereto. It is mandatory that all NBFIs strictly adhere to the provisions of the Finance Leasing Act when engaging in the business of leasing.
Accordingly, a repossession notice can be issued only if the instalments are in arrears more than the limit of substantial failure. However as directed by the Act, repossession is sought only as the last resort for the recovery of outstanding instalments. Repossession orders are issued only after sending
reminders, notices and notices of termination to lessees and guarantors according to the Act, within the stipulated timelines.
During the period leading up to the issue of a repossession order, NBFIs are expected to make every
endeavour to collect the instalments in arrears, by visiting the customer, through telephone calls etc.
The Act further states that if the Lessee is genuinely in a difficulty due to an unforeseen event, they are always welcome to visit the respective NBFI and make a formal request for deferment of recovery
action. At this point NBFIs are required to look into every avenue to offer relief to the customer including granting of concessions/deferment, whenever they are warranted.
Meanwhile if the leased property is repossessed, it is disposed of quickly in order to recover the outstanding according to the auction procedure that is laid down in the Act. Once the vehicle is repossessed, the final notice is sent to the Lessee giving a further 14 days for settlement.
A newspaper advertisement is published in all three languages advertising the sale. At the same time, another letter is sent to the lessee allowing a further seven days for settlement of the outstanding.
Finally, when the time period lapses, the repossessed vehicle is sold through tender process or at a
public auction. Prior to the public auctions another paper advertisement is published which is the end point of the auction procedure.
It is hoped that this article provides some reasonable clarity regarding the framework within which NBFIs operate, while also helping to alleviate some of the persistent misconceptions that have plagued the sector.
Going forward, it is imperative that NBFIs continue to serve the target market in utmost good faith. It is equally important that all players collaborate with the regulatory authorities to uphold the integrity of the NBFI sector at all times.
(The writer is an Executive Director of LB Finance with 30 years of experience in the Finance industry and a Council Member of The Finance Houses Association of Sri Lanka.)