Supporting Growth and

Competitiveness of SMEs in Sri Lanka
3 Areas to Consider

Anushka Wijesinha
Chief Economist
Ceylon Chamber of Commerce

Pathfinder - Konrad Stiftung Workshop | Colombo | 23 May 2017
Context: what we already know…
• SMEs are Key to
Inclusive Growth
• Wide geographical
spread within a
country and wide
sectoral coverage

• 93% are micro (< 5
• 4% are small (<10
• 3% are medium
(<100 employees)
Context: what we already know…

• SMEs face numerous challenges to growth and
• Finance
• Taxation
• Technology
• Business development services
• Managerial capacity
• Markets and information

• The focus today is mainly on Finance, Taxation, Technology
1. Access to
Exploring the evidence
• World Bank Enterprise Surveys: Among 610 firms
surveyed, access to finance was the 2nd-most cited
‘business environment constraint’ (30% of firms)

• IFC micro-study: ‘significant proportion’ (40%) of firms
interviewed mentioned that insufficient access to finance
had been a main obstacle either when starting or
expanding their business

• IPS-NCCSL Survey: 50% of respondents considered access
to finance as their ‘most significant constraint’; 91%
considered it as one of the ‘top five constraints’ on their
‘Top constraint’ to business: Access
to finance vs. other factors

Source: Wijesinha and Perera (2015), ‘Banking on SME Growth’
Exploring the evidence

• Inability of financing development/expansion plans
was the most significant reason for inadequate access to
finance (working capital is less problematic)

69% 31%
more difficult to more difficult
access finance for to access
development/ working capital
expansion finance
Exploring the evidence

• The majority of respondents (60%) noted that formal
channels were their main source of financing of which
government banks were the preferred option (37%).

• 40% acknowledged that informal sources were part of
their financing options, with the majority coming from
friends/relatives and local moneylenders

• Of those currently using informal sources, 75% declared
that they would prefer using formal financing sources
Where do SMEs go to for finance?
Current Sources of Finance for SMEs Reporting A2F as Most Significant Constraint

Source: Wijesinha and Perera (2015), ‘Banking on SME Growth’
Further evidence
• IPS survey on manufacturing SMEs in Western Province

• Only 44% of enterprises sought access to finance in the last
financial year, the majority (79%) sought it from commercial

• Of those that did not seek finance from formal credit channels,
the second most-cited reason (19%) for it was that ‘application
procedures were too complex’ (the first being that the enterprise
had sufficient capital).

• Other reasons included ‘need for formal registration’ (15%),
‘interest rates not favourable’ (4.6%), ‘collateral requirements were
too high’ (1.3%), ‘did not think it would be approved’ (2.6%), and
‘size of loan and maturity were insufficient’ (2%)
Further evidence
• IPS Survey on women entrepreneurs in the SME sector

• Support received from financial institutions to start and grow their businesses was
not satisfactory

• According to male and female survey respondents from five districts (Moneragala,
Batticaloa, Anuradhapura, Kurunegala and Matale) nearly 60% percent disagreed or
strongly disagreed with the statement that ‘support received from financial
institutions were good’

• Only 20% indicated satisfaction about the services received from financial

• Of the 44% of women-owned SMEs that had applied for a loan in the previous
year, development banks were the main source of funding

• Of recent women-owned start-ups, only 34% had obtained finance via banks loans
or local finance companies. 66% had raised capital from informal sources like
friends, relatives, and neighbours, also through gold pawning
Entrepreneur Perceptions on Support Received from Financial
Institutions to Help Grow the Business

Source: IPS (2014)
New Conceptual Framework: Twin-Pillar Approach
Wijesinha and Perera (2015)

Access to Finance

Availability Bankability
Twin-Pillar Approach

• Private sector credit availability,
particularly SMEs
• Spread of financial system and
efficiency in intermediation
Availability • Special SME funding lines
• Influenced by overall monetary
policy, liquidity levels in the
market, level of government
borrowing and credit availability
to the private sector
Twin-Pillar Approach

• Financial literacy
• Ability of firms to produce
bankable business proposals
Bankability • Providing solid financial
statements & prove effective
financial management
• Ability of banks to assess SME
• New instruments for SMEs
Availability vs. Bankability

1. Not just an issue of not having access to the banking
network or funding lines being available

2. Bankability is determined by both demand and supply-
side factors

• Demand-side: SMEs’ intrinsic weaknesses

• Supply-side: Limitations within the banking sector
Demand-side factors
• Lack of transparency and financial discipline
• Compliance with tax and other regulations
• Lack of sophistication in financial reporting (SLFRS has helped)
• Link between informality (and factors driving that) and access to finance
• Tax implications are a major driver of non compliance and poor financial
• Lack of solid financial information make it difficult for banks to assess credit

• Management Weakness
• One-man-show / no proper management structure / blurring of lines between
business and personal
• No specific skilled professionals in-house for financial reporting / bookkeeping
• No succession planning / leadership

• Competitiveness Factors
• The lack of access to markets, market information, and effective supply chains
• Technology underdevelopment, poor quality products/standards and labour issues
Demand-side factors

• Other issues

• Administrative delays and difficulties in obtaining
permits and licenses from government institutions -
banks unable to provide credit without proper

• Lack of proper insurance coverage for the SME segment
- high risk profile of SMEs make banks hesitant to lend
to SMEs that do not have proper insurance coverage
Supply-side factors
• Limited staff that is skilled in SME lending: requires a
different banking approach, expertise in handling SME
customers than normal corporate or retail customers,
specialised SME risk management techniques

• Lack of diverse and innovative banking products and
services: aimed at start-ups and small businesses; limited
range of SME-focused or SME-friendly financial products

• Specialised SME Centers: expensive to operate, not
always well-staffed by qualified business development and
advisory team
Recent trends in SME lending
• In line with Government
efforts to promote the SME
sector in recent years, the
banking sector of Sri Lanka
has diverted more attention
towards serving this

• 87% of SME lending came
from private banks, 13%
from state banks

• Industrial sector SMEs
relatively larger share of
SME loans; agri-based SMEs
have received the lowest.
What makes it hard to assess bank-level SME lending?

• Very little published data is available from individual banks as to
their SME lending portfolios

• A closer look at company Annual Reports along with key informant
interviews revealed some information for a few of the larger banks.

• NDB Bank: 10-15%; DFCC: over 50%; NTB: 22%; Sampath: 40%

• Cannot determine the lending to small enterprises vs. medium-

• No consistent classification of SME loans by banks when reporting
to CBSL (in meeting the mandated lending portfolios)
• Are funds concentrated amongst the more ‘medium’ end of the
Some solutions for Sri Lanka to consider
• SME Credit Guarantee Fund: Capitalised by banks and
CBSL, branch network, staffed by mix of finance
professionals but also business graduates, 70% loan coverage

• Small Business Credit Scoring: many examples of
specialised SME credit scoring and credit rating; can be a
best practice adopted by collective of banks rather than
imposed by CBSL

• Business Development Services: important link to
improving SMEs ability to develop bankable proposals,
improve accounting. (35-46% reported that lack of BDS was
a constraint in accessing formal finance)
Emerging issues & challenges

• Concessionary credit lines won't be as generous as before
- SL now a middle-income country

• Need specialised credit lines for technology upgrading,
technology development - needed now esp. with GSP+

• Malpractices by finance companies - aggressive lending

• Plans to exempt loans below Rs. 500,000 from CRIB
Emerging trends to watch

• Donors using new tools: ADB’s SME credit auction; GIZ
supporting NTB’s SME Academy

• Microfinance to SME while finance co’s getting in to micro

• Closer to customers: PoS devices by HNB Grameen;
Union Bank going on mobile, motorbike, cable TV

• Peer-to-Peer lending and FinTech: eZcash, mCash, Kashmi,
2. SMEs and
SMEs and Taxation: Firm-level Survey

• First time taxation and SMEs had been looked at

• Survey methodology: Harmonized questionnaire in
administered in 2014 across three districts in the Western
Province of Sri Lanka - Colombo, Kalutara and Gampha. A
total of 450 enterprises were surveyed.

• Sampling frame: Database of registered SMEs with the
National Chamber of Commerce of Sri Lanka

• Complemented by series of KIIs and FGDs
SMEs and Taxation - What Our Survey Revealed
• SMEs unaware of, or cannot avail, concessionary tax rates
and tax concessions they are eligible for

• Many SMEs are below the tax-free threshold and
therefore are not in the corporate income tax net
• Only 38% were registered with IRD; 41% were tax payers

• Very few SMEs are VAT compliant - lack of awareness of
benefits + misguided perception of negatives

• Compliance is burdensome and costly; limited professional
tax advice; unfair treatment by tax officers; weaknesses in
dispute settlement processes
SMEs and Taxation - Tax Concessions

• 97% do not receive tax incentives or concessions

• Deeper analysis needed on which factor is biggest driver:
• minimum investment thresholds too high?
• lack of awareness and education?
• absence of tax advisors to guide SMEs on how to take
advantage of these?
• wilfully avoiding taking advantage, as it forces tax
SMEs and Taxation - VAT
• Preference to stay away from VAT; perception that VAT is
burdensome to their business.

• Non-VAT compliant SMEs may be able to circumvent the
payment of VAT on sales but are unable to reclaim VAT credits
on inputs, leading to higher costs.

• Non-VAT compliant SMEs lose out on the opportunity to do
business with VAT compliant firms as most VAT compliant
firms seek to trade with other VAT compliant firms (in order
to input VAT refunds).

• Majority of respondents (72%) were of the view that VAT
compliance leads to ‘increased raw material costs’
SMEs and Taxation - VAT Compliance

• A revealing finding was that on the frequency of visits by
VAT officials, 95% per cent of enterprises had never been

• Important implications for strengthening tax compliance
and expanding the tax net.

• While an SME may not be currently VAT-liable, by not
visiting for long periods tax officials miss out on finding
SMEs that become VAT liable as the business progresses
SMEs and Taxation - Perceptions on Tax

• 96%: prevailing number of taxes/the number of
instruments deployed is too high

• 96%: prevailing tax laws and tax structure was
cumbersome, procedures to fulfill compliance are too
complex, and hurting business growth
• ad-hoc changes in tax exemptions, concessions, and special
• difficult to interpret tax laws, and frequent changes.
• for e.g. April 1st tax changes not yet gazetted, no notice from
IRD on when.
SMEs and Taxation - Policy Implications
• Tax registration should come with business registration,
regardless of taxable threshold

• Reconsider the tax-free threshold (or consider the high
threshold as a de facto tax concession for SMEs)

• The low tax registration has implications for longer-term
tax compliance; while high threshold has implications for
current low tax-GDP ratio.
• Many sectors that have been growing (construction, whole and
retail trade, tourism) have high SME presence

• Enhance awareness of benefits of VAT compliance
3. SMEs and
SMEs and Technology - Issues
• These insights are based on observation + research for WB & GIZ
• No formal survey done yet - forthcoming

• Fragmented institutional space and breakdown of earlier
• NERD-C and IT does R&D
• IDB does tech transfer and extension
• DFCC does development financing

• Key tech transfer institutions like ITI, SLSI, NERD-C only based in
Colombo - no regional offices!

• Apart from University of Moratuwa and now University of Uva-
Wellassa, state universities do not have proper tech transfer offices,
industry-research collaboration, technology licensing offices, etc
SMEs and Technology - New Developments
• Some recent trends in angel, seed and VC funding - e.g. Blue
Ocean Ventures, MTI Idea2Fund
• But barriers: largely Western Province based; English-
speaking pitch and demo days.

• For start-ups - new incubators, accelerators, co-working
spaces have come up
• Again mostly in Western Province, and mainly digital
economy focussed
• Given economic structure in the Provinces, startups in
sectors like food processing need incubation

• Budget proposal to set up a VC ‘Fund of Funds’ with part
donor money (ADB) and part government money
Concluding Thoughts
• Finance: Overemphasised role of ‘availability’, underemphasised ‘bankability’
• Over reliance on rounds and rounds of concessionary loan schemes
refinanced by donors
• Need to focus now on strengthening SMEs’ intrinsic weaknesses that hurt
access to finance as well as improving banks’ SME lending competencies

• Taxation: Relatively under explored topic, but some issues becoming clear
• Tax compliance among SMEs is low for multiple reasons
• GoSL may need to consider revising tax-free threshold or at least make
registration compulsory
• VAT needs better messaging among SMEs
• Compliance procedures/costs are burdensome and need fixing

• Technology: Support to access technology (primarily tech transfer)
• In this, both access to an ecosystem and access financing need addressing
• Need to set up a ‘clearing house’ for SME technology access like Steinbeis