Financial Times

Bank loans too costly for small businesses – aid agency study
A new survey of Sri Lanka’s investment climate by the World Bank and Asian Development Bank has confirmed the complaint made by small businesses all along – that access to finance remains difficult and costly.

Private commercial banks rely heavily on collateral when giving loans, instead of considering the performance of businesses, which account for only a small fraction of rural investment finance, said the study called ‘Improving the rural and urban investment climate.’

“The cost of finance hampers urban and rural firms alike, with almost a third of urban firms and rural businesses citing it as a major constraint,” it said.
Rural entrepreneurs are also constrained by limited access to finance. Small urban manufacturing firms pay significantly higher average interest rates (18 percent) than larger ones (12 percent).

They also pay higher rates than rural enterprises (14.5 percent), which benefit from subsidies from some state financial institutions, especially Samurdhi banks and microfinance institutions.

The study adds that these subsidies, however, threaten the viability of these institutions.With support from international donors, commercial banks have also started to enter the market for small and medium-size enterprises, though their lending remains concentrated in Colombo. The study also noted that due to these distortions, interest rates in rural areas vary widely. Moreover, high and persistent budget deficits add to the cost of finance as government crowds out the private sector to meet its borrowing requirements.“Rural enterprises avail themselves of external finance but have extremely limited access to formal finance,” the study said. “They obtain most of their financing for new investments from internal sources (43 percent) and family and friends (35 percent).”

Public financial institutions, despite a widespread presence in rural areas, account for a far smaller share of rural investment finance, while private commercial banks provide a minimal share (2 percent), mostly to larger enterprises, the study has revealed.

“In the urban manufacturing sector, small firms have less access to bank finance than large ones, forcing them to rely more on internal financing, leasing, and informal and family sources. For firms with inadequate external finance, the consequence is limited opportunities for growth.”

Collateral plays a vital role in the availability of finance, the study said. “Results from the urban manufacturing survey show that greater productivity does not translate into easier access to bank loans. Apparently unable to discriminate on the basis of performance, banks instead rely heavily on the value of collateral when considering a loan application.”

The study said that collateral in the form of land is especially important for rural enterprises. “For many rural entrepreneurs, however, high levels of public landownership, unclear ownership records, and widespread restrictions on the use and transfer of land make it difficult to use land as collateral, limiting access to external finance.”

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