To achieve a higher income level, Sri Lanka’s monetary and fiscal policies implemented by the Central Bank should be handled by a centralised development and investment fund management system. This system should be regulated by a strong development bank as in many developing and developed countries, said Ariyarathna Herath, Professor in Economics and Head of the Department of Economics and Statistics at the University of Peradeniya.
Speaking to the Sunday Observer, he said a strong development bank should focus on development and investment projects, taking into consideration government development policy priorities and the needs of the society.
“A strong development bank creates a new class of entrepreneurs and help the weaker sections of society to be a part of the industrial culture,” he added.
Following are excerpts of the interview:
Q: Sri Lanka mainly has an SME-driven economy. What are the key factors that could financially support them?
A. Small and Medium scale Enterprises (SMEs) play a key role in an economy in enhancing the level of human development through the generation of employment, improvement of income distribution, poverty reduction and development of the rural economy among a myriad of other factors. Sri Lankan SMEs are mostly rural-based. At the same time, the need to improve the exports sector by promoting their integration to the exports value chain has been identified as mandatory. This is an excellent opportunity for the country to improve its exports figures and increase the overall income of the country.
SMEs form the backbone of the economy of Sri Lanka as it accounts for more than 75 percent of the total number of enterprises, provides 45 percent of the employment and contributes to 52 percent of the Gross Domestic Production (GDP). SME sector enterprises are those with asset values not exceeding Rs. 50 million per enterprise excluding land and buildings. This value is to be adjusted for inflation once in five years based on the implicit GDP deflator.
In 1983, the number employed in SMEs was 29 percent of the total employment of the industrial sector but improved to 45.7 percent in 2013/14 showing a significant increase. Employment in SMEs in 2014 was 633,933 which is 50 percent higher than the number of SMEs’ employment in 2004.
SMEs-related policies need to be focused on diversification of industrial activities, business linkages, equitable geographical distribution and value addition if a real contribution to GDP and employment is to be achieved. In this background, there are two key observations: 1. although it is argued that SMEs contribute to generate employment, accelerate economic growth and reduce poverty, income inequality, inflation and balance of payment, this argument has not been validated by serious research in Sri Lanka 2. As value addition and GDP is not at satisfactory level despite the incentives offered by the government, the question as to what more has to be done for the SME sector to generate a positive contribution to the agriculture and industrial development and economic growth in Sri Lanka.
Though the Sri Lankan banking sector is earning a considerable level of profits, many studies revealed that one area where Sri Lanka’s banks perform substantially below their regional peers is in lending to SMEs. Investing in SMEs is key to supporting financial inclusion and growth in the economy and, consequently, a driver of employment generation. With their high-quality loan portfolios but low profitability, banks in Sri Lanka should be able to gradually take more risks in the underserved SME segments without undermining financial stability.
Although SMEs have been recognised as an integral component of Sri Lanka’s economic and social fabric, they are faced with many constraints that impede their ability to grow. Even though the sector has received much attention from successive governments as well as international development agencies over recent decades, the sector is still faced with these challenges that need to be addressed in a comprehensive manner. Among them is the critical issue of the difficulty in accessing finance. The ability of SMEs to develop, grow, sustain and strengthen themselves is heavily determined by their capacity to access and manage finance.
Unfortunately, SMEs in Sri Lanka consistently cite the lack of access to finance as a serious bottleneck. 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 other’s’ priorities and constraints; lack of information on financing availabilities; and lack of mechanisms to mitigate risks.
Improving access to finance for SMEs is a case of improving ‘availability of finance’ on the one hand and improving ‘bankability’ on the other. ‘Availability’ refers to ensuring that funds are available for SMEs entrepreneurs to borrow - enhancing overall private sector credit, expanding lending volumes to SMEs, and providing more funding lines and special credit schemes for SMEs. These are often influenced by the 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.
‘Bankability’ is about improving banks’ approach to SME lending as well as improving SMEs’ ability to approach banks. To improve the climate for SMEs to borrow, the following questions need to be addressed: Are banks genuinely oriented towards the unique banking needs of SMEs?
Are there specialised branches dealing with SMEs? Are there mechanisms to bridge the information and risk asymmetry between SMEs and banks, such as credit guarantees and credit scoring? Are there schemes to improve SMEs’ financial management and ability to develop bankable business plans?
Our expectation is to become a higher income country. What are the key changes we should undergo for long-term and short-term gain?
To achieve a higher income level, the monetary and fiscal policies implemented by the Central Bank should be handled by a centralised development and investment fund management system. This system should regulate by a strong development bank as in many developing and developed countries. This strong development bank should focus on development and investment projects, taking into consideration government development policy priorities and needs of the society.
It should also include the enhancement of regional growth, reduction of poverty, creation of income generating activities and employment opportunities, provision of skills development and training, facilitation of formal financial services, strengthening economic activities in the lagging regions and enhancement of production of essential food items including organic food to ensure food security and food safety in the country. Enhanced resource utilisation and minimising of inefficiencies of loans can be ensured with a centralised development bank.
It should be a strong development and investment bank including small, medium and large loan facilities, current account transactions, foreign transactions, ability to deal with international organisations such as ADB, World Bank, and investments in foreign countries and so on.
Generally, development banks are specialised financial institutions. They provide medium and long-term finance to the industrial and agricultural sector. They carry out term lending, investment in securities and other activities. They even promote saving and investment habits.
Q: What are the weaknesses you see in the system that need to be addressed to help investors?
A. The fact that targeted gains could not be achieved. For instance, acceptable level of the SME sector and larger industries development could not be achieved, financial stability in the economy as a whole couldn’t be achieved, monetary policy didn’t increase investment in the private sector as expected by reducing interest rates. Creation of employment and export promotions did not happened in the economy.
Also, as a developing economy, Sri Lanka couldn’t produce dynamic, risk bearing and innovative entrepreneurs to drag the economy to development targets and full employment level.
The development type banks in Sri Lanka are not strong enough to provide the required and timely financial assistance and credit plus services to entrepreneurs. For instance, the Regional Development Bank (RDB) mainly targeted rural and regional development. The RDB was established as a statutory body under the Pradheshiya Sanwardana Bank Act No.41 of 2008. The 100 percent state-owned bank was set up with the objective of improving the living standards of the rural masses by providing them accessible and affordable credit facilities that in turn would contribute to strengthen the rural economy.
The bank is keen on empowering its customers in the micro, small and medium scale industries, women as well as the agriculture, livestock and fisheries industries who would in turn contribute towards the country’s economic development. The bank has also taken steps to inculcate the savings habit amongst the rural people providing higher returns on savings and fixed deposits, and encouraging schoolchildren and minors to save. Today, the bank is having 268 service points and given employment to over 3,000 staff members. Other development banks also only focus on limited sectors according to their mandates.
On the other hand, Government commercial banks have the power and mandate to provide all the financial facilities to their customers. However, the development of the economy is still at a questionable stage (lower middle-income stage). The development role of these major state-owned commercial banks is questionable on many levels as well. The following can be highlighted: 1. misuse of the Central Bank’s policy interest rates. For example, the lending under the lower interest rate going profit making individual/personal loans (to buy a house, a land, or invest in another entity and so on) rather than investment or development project loans. During the pandemic policies couldn’t achieve the expected economic boom. One of the major reasons is the short-term profit seeking operational behavior of existing commercial banks. 2. State commercial banks carefully select less risky personal loans and more risky project loans go to existing development banks. Because of the reputation as a strong commercial bank they can manage it easily. 3. Arbitrarily neglecting the development role of the economy. 4. Political interference resulting in bad investments (investments on government bonds). Therefore, knowingly or unknowingly, they deviate from the development objectives of the country.
Q: What are the vital elements of a development bank?
A. The objectives of development banks are as follows: increasing capital formation that can contribute towards the growth of economic development, ensure that the investors and entrepreneurs are induced by careful allocation of material and human resources, development activities are undertaken, ensuring that industrial units are promoted to fill the gaps in the industry structure, healthy projects should have enough financial, technical and credit plus services such as business development services (financial advisory services )and marketing assistances to make projects work. It should promote and encourage public and private capital.
A development bank inspires provincial development. They give money to beginning organisations in reverse zones. Similarly, they help organisations venturing in less-developed regions. The setting up of more industrial units will generate direct and indirect employment, make available goods and services in the country and help in increasing the standard of living. A strong bank provides requisite financial, managerial, technical help for setting up new units. Development banks help to resuscitate (fix) wiped out units. It encourages modernisation, rebuilding, and broadening of wiped out units by giving credit and different administrations.
It should be a strong development and investment bank including small, medium and large loan facilities, current account transactions, foreign transactions, ability to deal with international organisations such as ADB, World Bank, and investments in foreign countries. It should also be a specialised bank separate from the general rules and regulations applying the existing sate commercial banks imposed by the Central Bank.
Q: Currently, we have the RDB, DFCC, CDB and SDB as development banks. How should they improve?
A. They should be amalgamated to establish a strong sate-owned single development bank to support all kind of development and investment projects including foreign transactions. This bank should focus government policy priorities and financial stability of the economy. The development bank helps in the growth of capital markets. They invest in equity shares and debentures and mutual funds of several companies listed in Sri Lanka.
A strong development bank creates a new class of entrepreneurs and help the weaker sections of society to be a part of industrial culture. With a view for a long-term benefit to social development, the bank has new capital schemes which provide financial assistance to the innovative dynamic entrepreneurs. They help in covering the expense and manpower resources for undertaking the exercise of starting a new unit.