Microfinance in Lanka

The microfinance movement in Sri Lanka dates as far back as 1906 with the establishment of Thrift and Credit Co-operative Societies (TCCSs) under the Co-operative Societies Ordinance introduced by the British colonial administration. These were the first credit co-operatives to be established in Sri Lanka.

The network of TCCSs was weak and in decline by the late 1970s and there were plans to wind up many societies. It was that this time that a revival of the movement was initiated by the charismatic P A Kiriwandeniya with the TCCSs being re-organized under a new name: SANASA.

The SANASA TCCSs are member owned societies, grouped together as a Federation but coming under the purview of the Co-operative Development Department. Parallel to the SANASA TCCSs are the MPCSs and their financial service arms, the Co-operative Rural Banks (CRBs). The MPCSs and CRBs also fall under the purview of the Co-operative Development Department.

Act of Parliament

Commencing in 1985 the Government established 17 Regional Rural Development Banks (RRDBs) through an Act of Parliament.

These institutions were given the task of reaching remote rural areas and smallholders who lacked access to financial services from commercial banks. The RRDBs covered all districts of Sri Lanka with the exception of the North and East.

A significant restructuring and recapitalization took place in 1998-1999 and the RRDBs were consolidated into six Regional Development Banks (RDBs) with more autonomous management, a broader ownership base and board members appointed by shareholders.

The intension was to create more professionalism of operations and improve viability and sustainability. In July 2010, the six RDBs were merged into a single bank, Regional Development Bank, under a new Act of Parliament. It is expected that the merger will result in reduced costs and improved operating efficiency.

As a large nationwide entity, the new bank is also expected to be more successful in securing credit lines from international funding agencies for the development of regional infrastructure and small and medium enterprises.

It is noteworthy that the statue under which the new bank is established specifically mentions “granting financial assistance to Micro Finance Institutions” as one of the objectives of the Bank.

The late 1980s and 1990s saw the entry of several local and international NGOs into microfinance business. Many of these NGO-MFIs originally combined microfinance activities with other social and community development activities. However, in the recent past there has been an emerging trend of separation of the microfinance and non-microfinance activities of some of these institutions.

Government’s role

The Government is also a key player in the delivery of microfinance services. Various Government initiatives in the microfinance sector have been implemented from time to time. These are addressed in more detail in the section titled “Government Policy”. According to the “Mahinda Chintana”, the ten year development framework which covered the first term of the present Government, around 65 percent of microcredit in Sri Lanka is provided through the Government.

Donors’ contribution

Following the tsunami which struck Sri Lanka in 2004, there was an influx of foreign aid to the country, of which a substantial amount was channelled to the microfinance sector. While many donors worked through established microfinance institutions, some funded the establishment of multi-sectoral livelihood programs which included microfinance components.

These were largely unsustainable in the long-term and had some detrimental effects on the sector in the short-term through their mix of grants and subsidized loans and the resulting damage done to the established credit culture. Regional microfinance institutions such as BRAC of Bangladesh also entered the sector after the tsunami and rapidly scaled up to become a significant player among NGO-MFIs.

BRAC’s operations in Sri Lanka had an outreach of 100,000 microfinance clients by the end of 2009, less than five years after its entry into the sector.

Competition in the banking sector has encouraged financial deepening as formal financial institutions seek to reach lower income clients. An emerging trend is the entry of commercial banks, registered finance companies and other large corporate entities into the microfinance business.

The Gami Pubuduwa loan portfolio stands at Rs 2.0 billion reaching 15,000 micro entreprenurs across the country. Another recent entrant from the formal financial sector is LOLC Micro Credit (LOMC), a partnership between the local LOLC Group and FMO of the Netherlands.

Since its entry into the microfinance business in 2003, LOMC has grown to reach a loan portfolio of Rs 3.2 billion serving a client base of close to 23,000 through a network of service centres located in post offices and fuel stations.

Supervisory mechanism

The absence of a cohesive regulatory and supervisory system for the microfinance sector has in recent years become a barrier to the growth of the sector. This applies especially to the NGO-MFIs which in the past received substantial donor support for their operations. With the withdrawal of many donors from the Sri Lankan microfinance sector, funding became a key issue, especially for NGO-MFIs, which are currently not authorized to accept public deposits and further restricted from obtaining off-shore debt and equity funding under prevailing exchange control restrictions.

Accessing domestic funding is also somewhat of an issue as local banks and other funding agencies are still reluctant to lend to or invest in the microfinance sector due to the perception of high risk. In these circumstances, both the Government and the microfinance practitioners have come to recognize the need for an appropriate regulatory and supervisory mechanism for the sector. A draft law to govern the operations of microfinance providers has been released to the sector and is discussed below.

Regulating the microfinance sector

It would be incorrect to state that the microfinance sector is presently completely unregulated. A number of providers of microfinance, especially those which are owned by or linked to the state, are regulated and supervised by different entities e.g. the SBSs are regulated by the Samurdhi Authority of Sri Lanka; the CRBs are regulated by the Co-operative Development Department; the newly formed Regional Development Bank and Sanasa Development Bank, as licensed specialized banks, fall under the purview of CBSL.

Furthermore, there are a large number of NGO-MFIs which are entirely unsupervised and whose microfinance activities are not governed by specific regulations.

There is no definition of “low income persons” or “micro enterprises” provided in the Act but these will be separately defined by Gazette notification.

Monetary principles

A difference from the previous Act is that co-operative societies will now come under the purview of the Act. Licensed commercial banks and registered finance companies remain exempt. Other exemptions which are noteworthy (and remain the same as in the previous draft) are the network of SBSs.

However, the Act mentions that the Monetary Board of CBSL “may set principles or standards to the regulators of microfinance business” including the Samurdhi Authority of Sri Lanka, to “ensure that microfinance business is carried on in a transparent, professional and prudent manner...” Thus, although the SBSs will not be required to obtain a license or be registered by the MRSA, it seems that there is an attempt to ensure a uniform regulatory and supervisory mechanism which encompasses all providers of microfinance.

It would seem that access to offshore debt and equity funding is restricted under the Act although the relevant clause is not clear. The Act excludes licensed/registered MFIs from “business in foreign exchange transactions.”

It is not entirely clear whether this would include foreign currency borrowings or whether the current practice of obtaining approval of the Exchange Control authorities for foreign debt funding on a case-by-case basis would still be possible.

A departure from the previous draft Act is the licensed/registered MFIs are not mentioned as being exempt from the provisions of the Money Lending Ordinance which effectively prohibits MFIs from obtaining offshore equity investment into such business. This will be a blow to a number of large, well performing MFIs which will be unable to access offshore equity capital from the many Microfinance Investment Funds which are interested in investing in Sri Lankan MFIs.

It is likely that the sector will seek further clarification from the authorities on this point.At the time of writing it is not known how long it will be before the Microfinance Act becomes law and the MRSA is established.

(Microfinance Industry Report Sri Lanka 2010)