To Truly Overcome the SME Finance Challenge, Lets Look Beyond the ‘Quick Fix’ of Special Loan Schemes (‘Smart Future’ Article #5)

This is the 5th article in the ‘Smart Future’ column, originally published in the Daily Mirror Business of Wednesday 11th March.


With their wide geographical spread within a country as well as their wide sectoral coverage, SMEs are often an important source of inclusive economic growth and job creation. But Sri Lanka’s SMEs have not made great progress in recent years. Although in terms of the number of industrial establishments nearly 95% are small and medium-sized, these only contribute about one-fourth in value added and a third in employment. While it certainly isn’t the only factor, the ability of SMEs to access and manage finance does determine their ability to develop, grow, sustain and stay resilient in a competitive economy. Yet, despite rounds and rounds of special SME loan schemes over the past several years, SMEs still struggle with tapping bank finance. Half of all respondents in a recent survey by IPS and the National Chamber of Commerce reported access to finance as ‘the most significant constraint’ in growing their business. This echoes other studies (IFC Banking Survey, World Bank Enterprise Surveys, for example) that have reported similar results in the past.


What is unfortunate is that its been over twelve years since the path-breaking ‘SME White Paper’ (2002) clearly articulated what needs to be done to grow Sri Lanka’s SME sector, and pointed to several important areas in access to finance that need to be tackled. Yet, little real progress has been made. SMEs and banks continue to make the same complaints about each other. And neither donors nor successive governments have been very imaginative in their interventions to address them. They keep turning to what they believe is the ‘quick fix’ option – concessionary loan schemes.

‘Twin-Pillar’ Approach


In accessing finance, SMEs are faced with challenges on many fronts – lack of collateral by SMEs and unwillingness of banks to lend without it; financial sector ‘unfriendliness’ towards SMEs; mismatch in funding opportunities vs. SME needs; misunderstanding between banks and SMEs on each others priorities and constraints; lack of information on financing availabilities; and lack of mechanisms to mitigate risks. A unique contribution of a new paper that I co-authored (with Nipuni Perera) and has been published by IPS just last week is that it puts forward a new way of looking at the access to finance challenge. This ‘Twin-Pillar Approach to Access to Finance’ argues that improving access to finance for SMEs is a case of improving ‘availability’ on one hand and improving ‘bankability’ on the other. ‘Availability’ refers to ensuring that funds are available for SMEs to borrow – enhancing overall private sector credit, expanding lending volumes to SMEs, and providing more and more funding lines and special credit schemes for SMEs. There are often influenced by overall monetary policy of a country, liquidity levels in the market, level of borrowing by the state and credit availability to the private sector, and the number and nature of SME loan schemes with lower interest or concessionary terms. This first pillar is not the main focus of the paper. It largely focuses on the second pillar – ‘bankability’. This stems from the understanding that a flush of SME credit alone is not enough. ‘Bankability’ is about improving banks’ approach to SME lending as well as improving SMEs ability to approach banks. Things that improve the climate for SMEs to borrow and addresses the following questions are important – Are banks genuinely oriented towards the unique banking needs of SMEs? Are their specialised branches dealing with SMEs? Are their mechanisms to bridge the information and risk asymmetry between SMEs and banks, like credit guarantees and credit scoring? Are there schemes to improve SMEs financial management and ability to develop bankable business plans?


Thinking Beyond Special Loan Schemes


The findings of the paper suggests that the difficulties in access to credit for SMEs in Sri Lanka owe both to shortcomings within SMEs as well as shortcomings in the financial system. The former is driven by poor knowledge on financial management, poor financial literacy, lack of transparency in SME management, etc., while the latter is driven by a highly risk-averse banking system, lack of understanding on genuine SME-oriented banking practices, and insufficient mechanisms to improve information asymmetries in SME banking. So, the dynamics driving the problem arise from both the supply and demand sides and both dimensions must be addressed simultaneously. Even though the steps taken in recent times by both the Government and SME lenders are steps in the right direction it appears that much more needs to be done. Some of the key policy options put forward in the new research paper are the adoption of SME-friendly banking practices and re-orienting bank branches to serve SME clients better; introduction of SME credit scoring schemes and a Credit Guarantee Fund; and improving financial literacy and internal management of SMEs. The paper cautions against over-zealous policy intervention and argues that the focus of the government must be to put in place suitable incentives as well as regulatory frameworks that encourage greater SME lending.


Holistic Solutions


If given the right environment to thrive, the SME sector would not only create employment and promote industrial development, but also nurture entrepreneurial talent. But both the government and donors/development partners need to stop resorting to the easy policy tool of ad-hoc SME loan schemes, as a way to address the sector’s challenges. By tackling the SME access to finance problem in a holistic manner, much more progress can be made in improving the ability of SMEs to find the finance they need to start, run, and grow their businesses and make a stronger contribution to growth in the country. It’s time to look beyond the ‘quick fixes’, towards holistic longer-term solutions.



This is the 5th article in the ‘Smart Future’ column that advances ideas on economic reforms, innovation, and competitiveness. The paper titled ‘Banking on SME Growth: Concepts, Challenges, and Policy Options to Improve Access to Finance in Sri Lanka’ is available at the IPS and leading bookstores.



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