TISL warns superficial amendments fail to meet SC determination in newly passed Microfinance Law

Transparency International Sri Lanka (TISL) yesterday expressed serious concern following the passage in Parliament on Wednesday of the Microfinance and Credit Regulatory Authority Bill. 

The law, which was anticipated to correct serious regulatory failures and protect vulnerable borrowers, falls significantly short of that objective, TISL claimed in a statement.

In response to the 2024 Bill Challenge filed by TISL and others, the Supreme Court (SC) determined that all entities conducting microfinance business must be subject to equal regulation. TISL’s analysis finds that the new law fails to address the said constitutional inconsistency and regulatory defects, leaving significant loopholes.

It said the enacted law removes specific language that previously allowed certain institutions to be exempt from regulation. However, the constitutional inconsistency identified by the SC of unequal regulation remains unaddressed. The new law relies on a definition of “microfinance business,” under which lending to low-income persons is considered microfinance only where the primary objective is “social empowerment.”

This loophole allows large banks, finance companies, and leasing institutions to extend identical small loans to vulnerable borrowers while avoiding classification as microfinance by claiming a commercial objective, thereby escaping the customer-protection and regulatory standards applicable to licenced microfinance institutions.

As a result, borrower protection will now depend on how a lender describes its purpose rather than the nature of the loan or the vulnerability of the borrower. This not only recreates the inequality the Supreme Court determined must be prevented but also reflects the deeper weaknesses in the drafting of this legislation.

Although the law refers to borrower protection, the safeguards remain largely broad and lack the mechanisms needed to make them effective. The law does not require income verification standards or debt-to-income thresholds, fails to provide a clear appeal mechanism against regulatory decisions, and restricts borrowers’ right to legal representation in certain proceedings.

The microfinance sector has been associated with serious abuses, including intimidation and coercive recovery practices, including sexual bribery and corruption targeting women borrowers. Yet the law fails to recognise such conduct as a regulatory breach, impose mandatory reporting obligations on licencees, or provide sanctions within the regulatory framework for such abuses. Without integrating these risks into compliance, supervision, and licencing mechanisms, the law’s stated objective of protecting borrowers remains incomplete.

TISL also noted weaknesses in the governance framework of the proposed Authority, including the absence of mandatory conflict-of-interest disclosures, inadequate transparency regarding grants and funding sources, and the concentration of discretionary powers without sufficient accountability safeguards. An effective regulator must itself be subject to strong transparency and integrity standards.

The passage of this law in its current form represents a serious failure to deliver on the Government’s stated commitments to serve and protect vulnerable communities. Microfinance borrowers are overwhelmingly drawn from economically vulnerable households, particularly women and low-income communities who rely on small loans to sustain their livelihoods. By passing legislation that is severely unfit for purpose, the Government risks leaving these communities exposed to exploitation and predatory lending practices the law was meant to prevent.

The concerns reflected in the legislation yet again highlight the shortcomings of the opaque and fragmented lawmaking process in Sri Lanka. The development of amendments to this law, and the drafting of all future legislation, must adopt a genuinely consultative approach – seeking and integrating public and expert input in a meaningful manner at the early stages of policy formulation and legislative drafting, rather than after the framework has already been finalised.