A developing segment: Microfinance institutions receive more regulation and options to expand their services for underserved households

 

Although Sri Lanka has numerous banks, a large part of the population – particularly outside the major urban areas – has looked to other types of financial intermediaries to meet its needs, or has remained outside of the financial system altogether. In addition, years of conflict denied large numbers of citizens contact with normal banking practices, particularly in the north and north-west regions – the areas most badly affected by the violence and from where large populations of internally displaced people were forced to migrate. Many of these individuals lacked an ID card, let alone proof of credit worthiness or bankable assets.

In many areas, non-banking financial institutions (NBFIs) – such as licensed finance companies (LFCs) and specialised leasing companies (SLCs) – have now come to fill the gap, as have government banks and a wide range of microfinance (MF) institutions.

A Wide Base

Sri Lanka had around 2.6m low-income households in 2013 earning $2.97-$8.44 per capita, per day. This is the main target market for MF providers, although the middle-income tier – roughly 1.1m households that earn $8.44-$23.00 per capita, per day – may use both MF and traditional banking options, according to research by the University of Michigan. The country’s MF segment, therefore, has an enormous potential customer base.

A range of private companies now offer MF services, as does the government. While exact figures on accounts and assets are difficult to come by given the unmonitored nature of much of the work, the Lanka MF Practitioners’ Association, a professional body representing nearly 80 MF outfits in the field, recently surveyed 37 of its member companies. Results found that they served some 702,900 active borrowers and 104,400 depositors with a combined deposit value of LKR923.6m ($6.3m).

Diveneguma

These numbers do not include Diveneguma. This scheme, running since 1995, is the government’s single largest poverty-reduction programme and includes welfare and livelihood initiatives, as well as an MF system. The MF arm consists of a network of community-based banks, originally established to funnel cash payments and transfers from the welfare part of the scheme to the programme beneficiaries.

However, the Diveneguma banks do much more nowadays, such as promoting savings habits among low-income families and providing them access to loan facilities. Small groups and village-level societies form the customer base of Diveneguma banks, which currently number 40,000 institutions. Customers apply for loans and make deposits with around 330 community-based banking societies, looked after at the national level by the Diveneguma Board of Management. MICROFINANCE ACT: There are a large number of other MF institutions in the field. These outfits are being brought under a new Microfinance Act that came into effect in July 2016 – although licensed commercial banks (LCBs), licensed specialised banks (LSBs) and NBFIs are not covered by this legislation, nor are the Diveneguma banking societies. Under the act, the affected institutions, which range from small family-based outfits to the financial dispensaries of non-governmental organisations, are being brought under the direct authority of the Monetary Board of the Central Bank of Sri Lanka (CBSL), which has also established the Department of Supervision of MF Institutions to specialise in this work.

The major change for MF institutions is that if they become licensed under the act (a move that remains Government microfinance banks promote savings habits among low-income families and provide them access to loan facilities optional) they will be able to accept savings, while those that are not licensed cannot. This represents a significant step forward for these other MF bodies which, if licensed, will be able to mobilise deposits to boost their businesses. Being licensed also requires them to follow the CBSL regulations, lending confidence to the segment and thus potentially opening the door for MF institutions to attract external funds. Naturally, this is also good for the low-income families that utilise the MF institutions, as they will be able to benefit from savings accounts and may then move to monetise their assets accordingly. In rural Sri Lanka this would be a great benefit, as households may hold gold and jewellery as their principle assets, with all the concomitant risks.

The act should also open the door for MF institutions to join the Credit Information Bureau, a key finance sector institution. This integration will decrease systemic risk, identify multiple borrowing and allow for more affective screening of loan applicants both inside and outside the MF segment.

While the act has been broadly welcomed, one concern is that as MF institutions become more regulated they will further crowd the sector at a time when it is trying to consolidate (see overview). With some 15-20 MF institutions likely to apply for licenses, according to local financial media, this could make for an ever-more competitive market at the low-income tier of the economy.

Stiffening Competition

These MF institutions will also be in a better position to compete with the NBFIs in particular, many of which have been involved in MF initiatives themselves over the years. Currently, there are some 46 LFCs and seven SLCs in business nationwide, and these institutions had combined assets of LKR1.1trn ($7.6bn) in the second quarter of 2016. This figure represented around 13% of the total assets of the conventional banking sector. The market leader in this segment is People’s Leasing and Finance, the SLC and LFC arm of the state-owned People’s Bank.

NBFIs typically accept deposits, issue vehicle, equipment and personal loans, and offer microcredit and business loans – often to small and medium-sized enterprises. The NBFIs are usually family-based outfits, characterised by very close relationships between local branches and customers, with loans often granted on the basis of this local knowledge and personal client assessment.

Nbfi Regulation

The NBFIs are also not as strictly regulated as banks, with greater flexibility in their governance structures and operations. However, the CBSL imposes a cap on the interest rates they are able to give on deposits – a rule that has recently disadvantaged them in competing for deposits with the banks, which are able to give much higher rates. In November 2016 the government bowed to pressure from the NBFIs and raised the interest rate cap on deposits to the outfits from 12.5% to 13.5%, enabling them to compete more directly with the kind of rates being offered by LCBs.

Regulatory flexibility is also changing, as NBFIs undergo a shift towards greater supervision and transparency, with these moves likely to see the number of institutions in the field shrink, as well as the industry grow more robust. This shift began in 2011 with the Finance Business Act which, among other measures, required finance companies to list. This boosted transparency and began to shift NBFIs away from their traditional family business structures, opening them up to other owners.

Now, as part of the government’s overall efforts to move the financial sector towards meeting more stringent international capital criteria, moves are currently under way to boost the minimum capital requirements of these institutions.

Sector Shifts

Some of the smaller outfits will likely find these changes tough, especially in an environment of rising interest rates and fiscal tightening, and some of these more minor players may either exit the market or merge in the year ahead. This will create stronger surviving NBFIs, which may also be able to compete in a range of services with the conventional banks, potentially leaving more space for MF institutions to fill the roles being vacated by increasingly bank-like NBFIs.

The increasingly stringent regulatory framework should also encourage customer confidence in the NBFI network. This confidence took something of a hit in 2008-09, when three NBFIs collapsed due to fraud and mismanagement. The CBSL announced in late 2016 that it would repay the customers of these outfits for their losses, but going forward a stronger NBFI sector, combined with a more regulated MF industry, should ensure that such mistakes are not made again. This means not only broader coverage from the country’s financial services, but also decreased risk, along with more successful investment in Sri Lanka’s lower-income households, helping them pull themselves up the financial ladder.