The issue of constrained access to finance for SMEs continues to plague our small business sector, and it is often blamed on the narrow approach to SME lending by banks. The lack of cashflow-based lending, the heavy focus on high collateral requirements, inability to assess risk in SMEs, are the usual suspects. These are all very valid, and probably the most crucial factors. However, in recent conversations with bankers and financial sector leaders I’ve realised that there are at least two other factors we need to consider, which often don’t get highlighted. One is the high operational expenses of Sri Lankan banks (cost to income ratio). On this, I don’t have enough information and it’s something I would be taking a closer look at. There is some limited analysis in this paper by two University of Colombo academics, but it limitedly looks at the factors influencing the efficiency of Sri Lankan banks and does not actually quantify the efficiency levels.
The second is the concentration of banking in the state banking sector and the role that might play in constraining credit to SMEs. The eight state banks in Sri Lanka account for close to half of the assets of the total banking sector. And the larger share of lending by these banks tends to be to state-owned enterprises (SOEs) . The largest commercial bank, Bank of Ceylon, lent a staggering 38% of its total portfolio to SOEs in 2013 and the second largest bank, People’s Bank, lent 28% of its total portfolio to SOEs. And many of these are loss-making entities, as this latest study by Advocata Institute has shown. No doubt this would crowd out the available funds for lending to enterprises. We must shift lending by these state banks from SOEs to SMEs.