Contents

1. INTRODUCTION ......................................................................................................... 3

1.1 Research Objectives ................................................................................................... 6

1.2 Research Aim ............................................................................................................. 6

1.3 Research Problem ...................................................................................................... 6

1.4 Research Question...................................................................................................... 6

1.5 Hypothesis .................................................................................................................. 6

1.6 Research Methodology .............................................................................................. 6

1.7 Limitations ................................................................................................................. 7

2. THEORITICAL FRAME OF THE RESEARCH .......................................................... 8

2.1 Microfinance Industry ................................................................................................ 8

2.2 Sri Lanka – Country Context ..................................................................................... 9

2.3 Microfinance Industry in Sri lanka .......................................................................... 10

2.4 Poverty Study in Sri Lanka ...................................................................................... 13

2.5 Impact of key factors on the efficiency of Microfinance Institutions ...................... 15

2.6 Role of Women in Microfinance ............................................................................. 15

2.7 Performance of Sri Lanka’s Microfinance Sector .................................................... 21

2.8 Performance of Micro Finance in Sri Lanka ............................................................ 26

3. References: ................................................................................................................... 31
 1. INTRODUCTION

Microfinance has been considered an effective tool for governments of developing

countries to get positive results for poverty alleviation. International organizations and
donors are working together to promote microfinancing instruments and bring innovation in a
respective field. Under the term of microfinance, it simply needs to understand the extensive
availability of financial services such as credit, loans, financial transactions, deposits, and
micro-enterprise insurances. The idea of giving loans to the poor to sustain their micro-
enterprises is common in the market but ongoing arguments are to discuss innovative
methods of loan facilities for a poor. (G Tilakaratna, U Wickramasinghe, 2005)

Small start-up businesses are demotivated and eventually excluded from the process of
getting credits from formal financial institutions due to their requirements of documentations
i.e. Asset declaration and agreement/deeds documents to use as security.

Over a period of time, different institutions have been established in many countries to
provide microfinance. The purpose of these institutes is to generate opportunities for poor
households by delivering them short & long term loans and arrangement of securities against
their credits. Many lending model groups have been created and tested in different countries
to evaluate the efficiency of microfinance i.e. Grameen Solidarity Group Model
(experimented in Bangladesh) and Self Help Group (SHG) model (popular in India). Poor
houses have received significant amounts of financial services from these microfinancing
Institutions (MFIs), Data shows their clientele has significantly increased, in 1997 MFIs have
10 million registered clients, in 2010 it had reached to over 200 million.

One important question is how to determine the efficiency of these IMFs and
improvement brought by them in living standards of poor families. Impact studies’ results
have been reviewed to address this issue by several studies. These studies have shown results
to determine the demand side of microfinance, but no systemic study has been done to
evaluate in a decrease in poverty from the supply-side because of these MFIs. That is, what
factors determine the success and failure of these institutions? How these institutes reach out
to poor? What are their financial models for financial sustainability? So far two papers have
been written to address these issues, but they evaluated specific topics related to financial and
social performances of MFIs.

Siri Lanka Financial institutional industry has been divided into two sectors one is an
organized sector and the other one is the unorganized sector. A diverse range of financial
institutions i.e. commercial banks and financial banks come under the umbrella of the
organized sector. However, the unorganized sector includes small financial institutions for
example Corporate based banking, the majority of small loan lenders and pawn brokers.
Regulation body of an organized financial service sector is Central Bank of Sri Lanka
(CBSL) which issues licenses to these institutes (Licensed commercial banks, licensed
specialized banks, registered finance companies and, specialized leasing companies). All
banking-related services’ license has only been issued to commercial banks. They are the
ones who could only ensure the provision of liquidity and being accountable for payment
services. Based on it all other financial entities carry out their financial activities.

According to the 2010 record, there were twenty-two commercial banks out of which
two institutes regulated by state, privately owned institutions were nine and eleven foreign
banks operating with 1,933 branches countrywide. (CBS, 2010) Additionally, banking
services have also been provided by a small financial institution in Sri Lanka. Certain
financial services are accounted for by these financial institutions i.e. microfinance,
insurance, and stockbroker services. The promotion of cooperative rural banks (CRBs) was
able to develop an extensive network countrywide. By the end of 2010 period, 235 CRBs are
being operated by multipurpose corporative societies (MPCS) which includes 1933 branches.

Cooperative Societies Act No. 5 of 19721 has permitted CRBs to accept members’
deposits and does provision of loans. In the rural sector, financial services are being
monitored by Samuradhi banking societies which operate under Samurdhi Authority of Sri
Lanka. However, CBSL does not regulate these small financial institutions but these
institutions played an important role to promote microfinance in rural areas in the form of
development of microcredit demand and small businesses.

Numerous constraints/barriers are affection the financial industry of Sri Lanka, such
are broadly defined as demand-side constraints, supply-side Constraints, and regulatory
constraints. Demand-side constraint encompassed financial literacy and education of these
microfinance instruments. i.e. understanding financial inclusion strategy, complex financial
trade-offs, knowledge of financial products and services and limitations of over-borrowing.
Supply-side constraints occur due to conventional banking practices for example
maintenance of minimum balance, documentation and withdrawal charges. Lack of safe and
inconvenient payment systems and high cost of conventional service delivery mechanism
also considered major constrain at supply end. Regulatory constraints are occurred due to the
absence of single regulatory authority and uniform standards are ignored by the supervisory
body. Other factors are the absence of regulatory infrastructure of microfinance, absence of
credit bureaus and inadequate client protection.

There are a number of challenges that plague the microfinancing landscape in Sri
Lanka. The most vital challenge faced by Sri Lanka financial industry is financial literacy, a
language barrier could create a big communication gap between financial authorities and
their clients. Financial literacy could only be promoted if financial education breaks the
language barrier among them. Lack of promotion of capacity building exercises among
children and youth hindrance in the creation of financially responsible citizens. Inadequate
resources result in the provision of lethargic infrastructure which could unable to provide
transparent and accurate information to clients.

Lack of capacity building for MFIs is also a big challenge for this industry, the scope
of services is limited and there is no regulatory body to monitor new innovative ways of
providing these microfinance instruments. Currently, it is observed that the majority of MFIs
are running with a single product approach instead of having a range of products. Such
development should do new market segmentation and design products keeping in view of
client needs. Limited funding resources have been a wrong viable approach adopted by MFIs
and resulted in financially unviable.

The focus of this research paper is to determine the factors which could evaluate the
efficiency of microfinance. We will determine & evaluate the indicators of financial and
social performances of these MFIs. The scope of this study will be focusing on micro-
financial industry of Sri Lanka.
 1.1 Research Objectives

 to determine the key factors impacting microfinancing

 to illustrate their relationship with each other
 to study how efficiency of microfinancing institues is determined

1.2Research Aim

To narrow down the research aim, it will mainly focus on the microfinancing industry
of Sri Lanka.
 To review relevant literature for microfinancing and its efficiency
 To determine the efficiency of micro-financing in Sri Lanka

1.3Research Problem

 A lot of literature is available on microfinancing, there is very little literature that

addresses efficiency of microfinancing, especially with reference to microfinancing in
Sri lanka. This study will aim to bridge that gap in literature.

1.4Research Question

1. What factors determine the efficiency of microfinancing institutes?

2. Which of the factors driving efficiency of microfinancing institutes relevant in case of
Sri Lanka?
3. Are the microfinancing institutes in Srilanka operating efficiently?

1.5Hypothesis

This research hypothesis statement will focus on the efficiency of MFIs;

H1: Do total assets employed and the operating costs impact the efficiency of financial
institutions?
H2: Does the engagement of women in microfinancing help to improve efficiency?

1.6Research Methodology

The research method comprises different techniques, schemes, and algorithms employed
to deduce meaningful results out of the research. Data is carefully collected, sampled and
experimented in methodology by employing careful theoretical procedures, experimental
studies, numerical schemes, and statistical approaches, etc. It is considered a systematic way
to get results regarding the solutions of the instant problems. `Research methodology is
defined as a procedural way-out opt by a researcher to describe, explain and predict
phenomena of his/her work. The major aim of it is to give a list of the work plan of research.

The methodology of this research mainly focuses on the quantitative analysis based on
secondary data. The main focus of this study is to retrieve data from officially published
reports. The problem statement will be analysed by the available literature and data
employment analysis (DEA) will be done for technical analysis. The relevant variables will
be selected through the review of the literature and data collected for those variables.
DEASolver software would be employed for the analysis of the data. Data sources will
broadly be discussed throughout this research paper, analysis method shows a considerable
whole section, aspect of data employment analysis (DEA) will set the base of output and
input selection, conceptual framework will be discussed and finally, results will be deduced
to derive a meaningful conclusion.

1.7Limitations

1. Research based on the major finance institution

2. Research based on setected years
 2. THEORITICAL FRAME OF THE RESEARCH

2.1Microfinance Industry

There is an enormous impact of microfinancing on rural development, especially in

emerging economies. Governments of different countries play a vital role in the building of
favourable conditions for poor households and they also use it as an important tool for the
social-economic revival of the poor. Formal financial services are not easily accessible to
every citizen in emerging and developing countries, a substantial amount of individual
especially women don’t have access to financial credit facilities. According to studies
worldwide near about 2 billion adults in 2014 don’t have their bank accounts and were
unable to access the financial services from commercial or non-commercial banks.

It really essential for poor households to have access to financial services, research
shows that it helps them to smoothly fulfill their daily consumption needs, opportunity of
establishing their own business and become part of the formal economy in the long run.

Micro financial services growth was picked a pace in the late 1970s, when poor in
developing countries get access to it. Figures show that clients had increased from 10 million
in 1997 to grow over 200 million in 2010.

We need to know the factors that help these institutions to fulfil their financial and
social goal which eventually help these MFIs to be part of the economy in the long run and
easily accessible to poor households. Financial sustainability is an important debate for an
MFI which is aiming for maximum outreach because still many MFIs are under financial
support of government bodies, NGOs, etc. Report results show that in 2010 roughly only 20
to 25 percent of MFIs are not using subsidies provided by different bodies to conduct their
activities.

It is not considered a sustainable business model of an MFI to depend on subsidy for a

long period of time. A review study’s results will help the policymakers to define the
determinants of the performance and efficiency of MFIs that how micro-financial institutions
do poverty alleviation in a financially sustainable way. The research on MFI efficiency is still
in its early stages.
 In the early 1990s, the number of papers had been published to address this pressing
matter but there is a controversy among these papers and no evident result was concluded and
measurement of MFIs performance is still considering a research gap to be fulfilled by
researchers.

2.2Sri Lanka – Country Context

Sri Lank is an island state located off the south – eastern direction of India, it’s a small
country compared to other Asian countries with a surface area of around 65,000 sq km. The
latest census figure shows that the Sri Lanka population was estimated at around 21.7 million
people in 2018. The main sectors of the economy of the country are summarized in figure 2.

Figure 1 Major Economic Activiites in Srilanka

It is a land of multi-religious and multi-ethnic society. The majority of the population of

Sir Lanka are Sinhalse by ethnicity and religion-wise Buddhist, with the large presence of
Tamil, Muslim and Christian community. For the past 25 years, a dispute has been going on
between Sri Lanka Government and Tamil separatists, the Liberation Tigers. It has critically
disrupted the country's economic, social and well-fare activities. The country’s topography is
irregular and divided. It has a coastal belt which is less than 100m above the sea level and
along it, rolling plains of changing width leading to the foothills of the central hill. It has an
equatorial and tropical climate. The country’s climate is divided into two zones (wet-zone in
the south west & a dry zone covers the reminder part) due to uneven rainfall.
 Economy wise, the country is among the faster growing economies of the south Asian
region. The GDP of the country has grown considerably over the years while inflation and
unemployment has been in check. Adjusting for Purchasing Power Parity, the country has the
highest per capita GDP among the countries in the region. Some of the main macroeconomic
indicators and their trends over time have been summarized below.

Figure 2 Main Macro Econmomic Indicators for Sri Lanka

2.3Microfinance Industry in Sri lanka

MFIs have been practicing different models in Sri Lanka. Historically, In 1990s most
popular term is in use was Village Revolving Funds and community-based organizations
were operational in the form of credit Co-operatives, Village Societies. In the early century,
credit co-operatives were only introduced for those salaried employees who come under the
middle-class category than in the 1980’s, it was introduced to rural masses. In 1986, SEEDS
and the majority of NGOs adopted the village society model. Limitations of these models
made new organizations like Lakyaya, Ceylinco Grameen and BMI to employ methods of
client lending directly. (Atapattu, 2009). These models have been discussed in detail below:

Village Banking

Another name of Village Banking is Community Banking in which semi-formal or

formal institutes are made which treats the whole community as one unit and also disperse
microfinance in community. NGOs and other organizations put their great effort in the
establishment of these institutions, who also conduct training sessions of community
members to handle the various matters of finances of the community bank.(Atapattu, 2009)
Village banks firstly start with the creation of savings accounts than eventually provides
emergency loans and finally, it leads to larger loans. They operate the bank accordingly to
their own needs, they appoint their own officers, dedicate their own bylaws, authorized to
distribute loans to individuals, do recovery of payments and collect savings. A moral
collateral (a promise made by a group to back each individual) has been used as a guarantee
of payback for these loans instead of papers of property or goods.

Garmeen Type Group Collateral Lending

These are grassroots level institutes especially focus on poor people. Origin of
Garmeen banks is from Bangladesh, it is the initiative of Prof. Mohammad Yunus. This
establishment is consisting of a Field Manager and a number of bank workers and it covers
normally 15 to 22 villages. To understand the environmental settings of these villages, field
managers and workers pay a number of visits to these villages. Their main purpose is to
identify their clientele and let them know about the purpose and function of the bank.
Potential borrowers are identified and make groups of five of them. Initially, at the first level,
only two of them are given the opportunity to apply for and receive, a loan. They observe the
group for at least a month to check that if group members are following the specified rules of
the bank. If all instalments have been paid by the first two borrowers within fifty weeks than
the rest of the group members are given the opportunity to receive a loan from the bank. Such
a practice of restrictions put a group pressure on each group individual to keep their records
clear. Such responsible behaviour from a group effort considered as collateral for a bank to
give loans to them.
 Numerous Sri Lankans’ agencies tried to follow the approach of Grameen but Ceyline
Gareem Credit Co.Ltd is the only one who keenly adopted and followed the Grameen model.
Now they operate in Sri Lanka with a new name “Grameen Credit Company”

Group acts as a focal point for an individual borrowing

This approach is adapted from ASA model where a group of 25 to 30 members

becomes a point of contact for individual-level borrowing. Group is only formed to bring
efficiency in loan collection and ensure provision of other services, they don’t consider as a
form of collateral. These groups do minimum savings and the majority of time two members
volunteer to provide a guarantee. Weekly or monthly group meetings are held at specific
times and venues where new applications are submitted and all loan collections are done by
the credit officer of the MFIs.(Silva, 2012)
Lak Jaya and Berendina Microfinance institutions follow ASA model with some changes
accordingly. Lak Jaya implements this ASA model to get weekly recovery results with
women.
The model implemented by BRAC Sri Lanka is similar to the Bangladesh BRAC
model. In this model, only women are allowed to take a loan and give them a form of small
groups. The payment method is made once in a week which is another difference of this
model from other Sri Lanka models. They work in close geographical area and door to door
surveys are being done with 4 sq meter to find out potential clientele.

Individual Borrowing

It is the simplest model to be adopted in which lending is given directly to a borrower.

It does not require to form a specific number of groups or put peer pressure for recovery of
these loan payments. Commercial and regional development banks both followed this model
to give loans in Sri Lanka. Groups are not involved to put pressure but individuals will be
asked for collateral or letters from guarantors. Since the 1960’s, both commercial and private
banks are giving loans based on this model and presently it is still the most popular mode of
loan model for commercial banks to lend money to people. The majority of loans issued by
regional development banks are based on the approach of this model. It is also increasingly in
practice of NGOs like SEEDS (MFI) to lend large loans or products specific loans, for
example, solar loans and business development loans of specific types.

Self Help Groups

In this model, credit is generated via group members’ savings, it usually a small group
of 10 to 20 women. In a few cases, agencies facilitate initial training and capital to the group
to encourage the activity. In Sri Lanka, the existence of this model is limited to specific areas
but popular among them. It trains the local people to become the supporting pillar of each
other and develops habits of saving among them.

Credit Unions/ Cooperatives

These are self-help financial institutions in which members of a particular group or

organization make an agreement to do saving than give loans to each other on a reasonable
rate of interest.

Rosca’s (Seettu)

Rosca stands for Rotating Saving Credit Association another name of it is ‘Seettu”. It is a
group of people who does cyclical contributions to generate a common fund and this lump
sum amount is given to one member in each cycle. For example, 12 members make a group
and decided to contribute Rs. 10 by each member at the end of each month. This collection of
Rs. 120 monthly will be given to each member once in 12 months cycle. This practice is
really popular in urban and rural areas of Sri Lanka. (Atapattu, 2009)

2.4Poverty Study in Sri Lanka

According to the 2009 estimate of the International Monetary Fund Sri Lanks’s GDP
per capita is $ 2041 (US dollars) which ranks it at 119th wealthiest country out of 180
countries. Its GDP per capital gives it a high rank than India - $1,033 (US dollars) and
Pakistan – 1,1077 (US dollars). It doesn’t mean the GDP of a country depicts the whole
picture of a country’s economy, it skips the fact that how this wealth is disturbed among
masses.
 Reports like Household Income and Expenditure Survey – 2006/2007 HIES (MFP Sri
Lanka, 2006) shows that Sri Lanka’s official poverty line is Rs. 3,087 a month and 15% of
Sri Lankans live below it. But the figure given by the world bank is at 23 %. Reports of HIES
2009/10 (DCS, 2009) shown that the country’s poverty level has declined from 15.2%
(2006/07) to 8.9 %. 41% of reduction has been indicated by HIES which is highest drop in
first three years and its is noted to be higher than the previous one which was 66% exactly
one third of drop from a 22.7% to 15.2% and it was reported over the 4 years and six months
period which was from 2002 to 2006/2007 survey.

Sri Lanka is a country where wealth is unequally dispersed, it is noted that 40 percent
of the country’s wealth is under the hold of only 10% of the country’s richest and only 1
percent of it is under the hold of 10% of poor.Gini index of wealth distribution has given
27th rank to Sri Lanka as the most unequal country which means wealth distribution is
insane, the majority of wealth in hold of few people. It is generally a percentage that shows
the proportion of the poor population to the total population.

According to HIES-2009/2010 (DCS, 2009) the official poverty line of Srilanka was
Rs. 3,028/- and it varies over the period of time because of variation in price level. For
example, in 2002 the official poverty line was Rs. 1,423/- which was eventually updated in
2006/2007.The poverty headcount ratio has been shown in Figure 1.1 by HIES Survey
Period. In 1990/91, the national poverty headcount was 26.1 percent which has increased to
28.8 percent in the period of 1995/1996. But statistics of 2006/2007 survey periods show a
15.2 percent declined which indicates that 42 percent decline has been observed in poverty
from the period of 1990/91 till 2006/07 survey. The poverty reduction percentage indicates
the same decline for the period of 2006/07 till the 2009/10 survey period. If comparison
made province wise than it is clearly evident that the rate of poverty has declined in all
provinces (1990/91 to 2006/07).
 Figure 3 Poverty Headcount Ratio (DCS, 2009)

2.5Impact of key factors on the efficiency of Microfinance Institutions

Literature investigating performance is a specific and growing branch that is mainly

focused on factors that determine the efficiency of MFI operations. Studies of literature
belonging to this branch analyze how organizations use their resources to convert them into a
value creation like goods and/or services, which is the main crust captured behind the
organizational efficiency. A generalized idea has been discussed in the literature regarding
these non – profit organizations.

Financial Efficiency of MFI has been measured in literature in various ways. The
majority of researches used traditional ways by calculating financial ratios for example return
on assets (ROA) and return on equity (ROE). In some literature they measured financial
efficiency by measuring riskiness on a portfolio of loans or measured via calculation of
income through interest and fee (loan portfolio). Some indicators are used which are more
related to microfinance. Such indicates are operational self-sufficiency and financial self-
sufficiency. Operational self-sufficiency tells the ability of MFIs to pay their expenses & cost
with revenues, it actually illustrates that MFI has the potential to do break even with its
existing operations. On the other hand, the financial self-sufficiency indicator measures the
extent to which operations of MFI could perform without availing subsidies like grants and
soft loans.

In literature, the social mission of MFIs depicts social performance indicator, it could
be missions like gain access to information of those poor individuals household and small
companies who have limited resources and in seek of more financial resources. Social
performance usually gaged by two factors which show the outreach of an MFI, its breadth
and depth. Breath of outreach of an MFI defines its number of actual clientele which means
how much clients served by an MFI. However, the depth of outreach tells us about the
client’s portfolio (type or profile) served by the MFI. Majority of researches used the two
most popular measures of depth of outreach are as following.

One is ratio based which shows active female borrowers out of the total number of
active borrowers. The second is calculated by the loan’s average size divided by the GDP per
capita of the country. The perception behind the first ratio is female borrowers generally fall
in the poorest category of poverty, usually, they are unable to receive a loan from a formal
banks.
Other measurements for social performance are the number of clients for loans, the
number of accounts for loan and saving, the average loan size, figures of established
branches and share of female borrowers. These measurements are critically evaluated in the
literature.
The majority of research’s focus is on cost efficiency for the measurement of MFIs. It is
often hard to collect data to use in more sophisticated methods of measuring social
performance, especially if a cross – country comparison needs to be made for performance
measurement that's why many researchers used simple measurements for it.
Dissanayake (2012) did research on eleven Sri Lankan MFIs from the period of 2005
till 2011 and studied their ROI to figure out the determinants of profitability. He tried to
investigate the relationship between MFI’s Internal or specific factors and ROE. He did a
regression analysis of the data collected from MIX market database. His study shows that
there is a negative statistical relationship between ROE and debt to equity ratio & operating
expense ratios. However, a statistically positive and significant relationship has been
calculated between ROE and write-off ratio and operating expense ratio. One of the
determinants of ROE is not statistically significant which is the personnel productivity ratio.
Majority MFI have a high debt to equity ratio (High gearing) from financial sources (Long
Term) to conduct their operations. Additionally, to reduce the risk they lend to more clients.
Mel, McKenzie, & Woodruff (2007) investigated that outreach of the poor reduced because
of leverage which leads to an increase in cost of capital resultant into high cost of borrowing.
It eventually influences default rates which affects MFIs’ growth.
A recent study has shown that high gearing MFIs had a high proportion of costs
which had an average 36 % of limited growth to service loans.Another negative effect was
that the total cost had 15 % of high bad debt expense. There main source of funding was
provided by banks and other credit institutions in the form of debt capital via loans. Injected
capital was on average consisted of 68% of banks borrowings account while on average 32%
of the pool of capital came from savings accounts combined with equity and shareholders
contribution. Theoretically, ROE (return on equity ) is affected by financial leverage and it
could be positive or negative based on used debt finance for productivity and
profitability.Following conditions could help to materialized it, for example, timely usage of
debt, minimum interest rate, and low cost, effective usage of these plus positive leverage and
unlimited debt financing.
A perfect condition of financial leverage is when return of equity increases because
leverage effects the stock volatility and increases the risk level which eventually leads
towards higher returns. However, a decrease in the return of equity could be happened, if a
company’s finance is overly leveraged. Financial over-leverage is a condition in which at a
lower rate of interest a huge debt by borrowing incurred and used of high resources in high-
risk investment. If expected returns overshadowed by the risk of the investment than the
value of equity of the company decreases because it has given an impression to stockholders
that debt to asset rate is too risky.

Mukama, Volschenk, & Fish (2005) research illustrated factors like clients’
educational level, insufficient funds to provide loans to clients, limited compensations for
staff and limited resources for skills development could affect the efficiency of MFIs.Other
studies have pointed out that liquidity problems for some MFIs were due to their
mismanagement of funds to meet their cash-related needs. (Harker, 2006) study showed that
educational and health-related services greatly benefit individuals, poor household and small
firms. His recommendation was that IMFs practicing such services increase the living
standard of the borrower but also increase the rate of repayment over period. The population
of borrowers with better education and health facilities is more capable to earn money and
eventually greater chance of repaying loans which leads to the growth of these IMFs.
Education level management gives a better view and understanding of marketing conditions
and it should be the utmost importance of IMFs. Because it could lead to profitability,
financial sustainable environment, loan book quality could be enhanced, more saving
accounts and firms the trust level and growth of shareholder. Repayment of loans greatly
affected by factors like household size, rate of interest, the purpose of issuing credit, age,
gender, demographics and a number of times field works pay visit to societies. Such factors
could define the efficiency of IMFs.

As per Financial literacy theory, people with more financial literacy usually have great
chance of prevailing two thinking style, it is called Dual-process theories (intuition and
cognition). According to it a major source of financial decisions could be lead by intuition
and processes of cognition. Such a decision-making process could create a better chance of
repayment, better debt management, economic welfare and reduction in poverty which all
lead to more efficient MFIs.

According to OCDE, (2005) definition of financial literacy is a state of clear

understanding of financial products for customers and investors in order to make sound
decisions to minimize their risk level and maximize the results of opportunities for better
financial well- being.

Mel et al. (2007) studied and evaluated the grant programs offered to males and
females by the micro-finance institutions after three devastation tsunami’s impact in Sri
Lanka. According to study results, the return on investment was over 9% in the case of
enterprises owned by males but received zero percent for female-owned enterprises.
Studies have shown women’s empowerment could be affected by the ownership of
microfinance loans. Results of the research were positive and showed the significant effect of
women’s ownership of a loan and study its effect on the project control index and composite
index is used to measure her empowerment.
Globally women have been seemed under keen focus to be given microfinance services by
MFIs. On average women are around 74% of the world’s poor population which is 19.3
million.
 2.6Role of Women in Microfinance

Founder of Grameen Banks, Mr. Muhammad Yunus addressed at the Australian

Business Chambers Forum in Melbourne that any earned credit by women straight spend on
the well being of children. They always think about the future. They are concern about such
thought that losing money will lead to distrust. But men are overconfident and now their
priorities are to enjoy money.

It is stated on the Grameen website that Grameen discovered that women are more
reliable in paying back. Scholars of researches had admitted this microfinance principle that
poor women with financial access from MFIs lead to better development of households and
families.Financial efficiency of microfinance could be improved if they target the women for
financial services.Women's clients' accounts are mostly less associated with, write off loans,
risky portfolios and credit loss for IMFs. Dual goals could be achieved by giving
microfinancing services to women, number one that women are more trustworthy in paying
back loans thus bring efficiency for MFIs and second reason is that lending to women could
have long term effects on poverty alleviation as their utmost preference is their children and
family.

Hofstetter (2008) studied the customary law related to the participation of women in
microfinance. Study found that customers and law are problematic for microfinance
enterprises but programs of this microfinance could bring alteration in customs and laws
including the empowerment of women. Further research has identified that emerging
countries' law affects the most to women getting access to financial capital.
Stevenson & St-Onge (2005) research was focused on credit creation for Tanzanian
Women and showed the constraints of institutional and cultural to get access to credit and
deduced this conclusion via field experiment conducted in Sri Lanka.

Women are given less opportunity in terms of credit as compared to men. Rate of
return is much lower for microfinance capital given to women than men but it does not
represent the actual picture of women’s ability, entrepreneurial skills or risk aversion.
However, women's privileges are limited to access financial capital but they seemed to be
considered much safer loan payers.
 Bernstein & Seibel (2011) explained the microfinance and loan payments and
explained that women are considered more trustworthy in terms of usage of credit for well
being of their families. This is a specially relevant finding in context of Sri Lanka, as the
number of non performing loans are on the rise, specially in case of MFIs. The trend is
depicted in the graph below.

Figure 4 Non Performing Loan Trend in Sri Lanka

Women play a vital role in economic development and particularly poor household
development mainly dependent on them. Important discussion needs to be done on women
and gender development differences in microfinance. Some researches came up with a
game-theoretical model of activity choices. Its findings showed that female empowerment
has been nurtured by microfinance organizations. Women's adoption of high productivity
activities is being conditioned by access to credit in the informal economy. Such
developments decrease the cost of male-controlled activities because of their less
involvement in the informal economy.Another study focused on informal practices of women
by exploring the complexity and diversity based on survey data held in Senegal, argued that
measures could be complemented throught microfinance services that are there to minimize
the effects of systemic cause of inequality.
 Grameen Bank initially make portofolio of men as clients but eventually they start
focusing on women clients more than men because of women's repayment history as compare
to men clients. Empirical investigation showed that 81 percent of Bangladeshi women have
paid their loans timely as compare to 75 percent of men. One study reported that reported that
groups with a higher percentage of repayment are of women and identified that 95% of
women repaid their loans compare to men who were 75% out of the sample size.
A well-reputed MFI in Indonesia BRI claimed that their focus level on women clients on
repayment had never intense but still they are receiving repayment in a timely manner.
Women's investment strategies are much conservative and cautious hence, their repayment
record is quite impressive.
Women could easily come under the pressure of their peers and involvement of
recovery managers. Women are more sensitive to verbal hostility by recovery workers
because of their reputation and honor matters to them. Women are usually more interested to
work closely to their home place that’s why they are much more easier to monitor and track
by the MFIs’ managers.They showed that men have ample areas from where they could
manage to get credit, it could be formal or informal channels but for women it is hard to find
means for financial support that’s why they are more carful in repaying the credit amount to
protect their trust level for future loans.
Literature discussed this matter in detailed through empirical studies and theoretical studies
that women are much more ideal options for MFIs to do credit financing. As women’ record
has been observed more positive in repaying the loan, it means the rate of return is much
higher in female loans which leads to efficiency of MFIs.

2.7Performance of Sri Lanka’s Microfinance Sector

A worldwide accepted instrument for poverty alleviated is considered Microfinance, it has

been part of Sir Lanka's economy for the past several decades. A wide geographical outreach
of these financial services has been observed in Sir Lanka but private operators (Non-
Government Organizations (NGO) and commercial banks) outreach is limited in rural areas
of Sir Lanka. Middle-income groups have able to increase their income and assets, have
helped them to increase consumption expenditures, and have appreciated them to develop the
habit of doing long term and short-term savings because of microfinance. Microfinance
almost helped every income group to smoothly fulfill their consumption level and it also
helped the women to raise their social status and positive progression in their economic
conditions. Overall object of the Government policy of SirLanka is to encourage the
establishment of the small and medium enterprises (SME) sector, It has been seen as a
driving force to bring impactful changes in economic growth, employment generation,
regional growth and poverty reduction. Statistical data shows that these enterprises are 75%
of Sir Lanka’s economy, 45% of employment generation and Gross domestic production
(GDP) has been contributed by 52%. (DDF, 2017)

In Sri Lanka, poverty alleviation has been reduced due to the employment of microfinance
tools in rural communities. It has shown an impressive contribution to the growth of the rural
sector. Over the last decade, Sri Lanka’s micro-financial Industry has shown an impressive
transformation and new instruments have been developed in form of saving associations,
rotating saving clubs, funeral or death benefit societies, credit associations, credit groups and
clubs at the rural and urban community level. Services provided by these microfinance
institutions (MFIs) include loans, savings accounts, insurance remittance, and non-financial
services to low-income people which were previously not facilitated and ignored to have
benefits from such services.

Such privileges of MFIs’ services are developed to facilitate the needs of individuals,
households, small domestic enterprises and increase income & competences of low-income
groups. Different micro financial institutions’ supervision are given to different authorities, a
large group of microfinance institutions do not come under any framework,
supervisory/regulatory authorities.

Regulatory framework is provided to microfinance institutions especially those who were

previously non-regulated, it is defined in Microfinance Act No 6 which is effective from 15th
July 2016. Mainly purpose of such Act is to bring improvement in financial services which
are provided to lower-income people and small & medium-size enterprises, increase financial
activities, maintain check & balance on the financial health of these IMFs, enhance their
funds’ source pools and promote a stable and safe financial system for their customers.
Central Bank of Sri Lanka (CBSL) greatly empowered due this Act, it has the authority to
issue licenses for applicant companies to pursue microfinance business, it gives guidelines to
Registrar of Voluntary Social Sector Services Organizations (RVSSOs) who acts as a
regulatory authority to do supervision of Microfinance Non-Government Organizations and
also set rules for Licensed Microfinance Companies (LMFCs).A total of eleven applications
for microfinance licenses have been submitted to CBSL in year 2017. During the year 2017,
MNGOs were issued a set of governing rules by the registrar of RVSSOs based on a set of
principles, standards, and guidelines issued by the monetary board of CBSL. No entity could
able to engage in microfinance business or use the term “Microfinance” until or unless it is a
licensed microfinance company or a registered MNGO.(DDF, 2017)
Government affiliated institutions have implemented many microfinance programs and their
progress in 2017 is shown in Table 1.1
 Table 1.1 : Progress of Major Microfinance Institutions – 2017
Microfinance Institute Branches Depositors Borrowers Total Deposits Total Investment Total Loan Portfolio
Divineguma Community bank 1,074 14,060,141 1,314,357 87,407 78,068 54,547
Cooperative Rural Bank 2,258 9,868,445 1,347,237 113,387 111,287 75,281
Agrarian Bank 551 697,977 630,806 680 2,319 1,452
Regional Development Bank 268 6,263,479 576,293 136,582 36,430 128,343
Lankaputhra Development Bank 8 64,530 8,899 375 5,361 3,965
Total 4,151 30,954,572 3,877,592 338,431 228,104 263,588
(DDF, 2017)

Figure 5 Banking Service Providers Density - Sri Lanka

Financial services inform of loans and deposit facilities are provided by these microfinance
institutions. By the end of 2017, major government microfinance institutions’ loan portfolio
was stood at Rs. 263 Billion, the major chunk of it is held by 49 percent in terms of monetary
figure Rs. 128 billion by Regional Development bank, Co-operative Rural Bank contributed
28 percent in terms of monetary figure Rs. 75 billion and 20 percent in terms of monetary
figure Rs. 54 billion by Divinegu,a Community based bank. It is recorded that by the end of
2017 the saving of poor households reached Rs. 338 billion and around Rs. 228 billion was
invested by these institutions in long- and short-term investments. In 2017, the Micro
financial sector availed Rs. 165 billion in form of loans given by the banking sector, out of
which Rs. 87 billion loans were disbursed to these institutes in form of small loans
(SMELoC, Jaya Isura, NCRCS and “Saubhagya” loan schemes by the Sampath Bank).
During 2017, loans disbursed by Regional and Development bank and People’s bank was Rs.
44 billion and 7 billion respectively.

Figure 6 Loan Distribution

 2.8 Performance of Micro Finance in Sri Lanka

Sri Lanka is a unique case among the emerging economies. Usually economies find it
hard to grow as unemployed people and cottage industries don’t have access to finances to
start new businesses or to expand already established business. In case of Sri Lanka
however, there are a diverse range of options available that people can use to get loans.
These include formal, semi formal and informal servie providers. Micro financing is quite
popular in the country. The table below shows the number of different MFi service
providers operating in different regions of the country.

Figure 7 MFI Service Providers in Each Region

Overall the MFIs in Sri lanka have been quite successful in achiving poverty
alleviation and ensure the supply of credit to small businesses and people living in poverty. It
has been estimated that a total of 2.6 million households have benefitted through these MFI.
It is because of these MFIs that the country has seen a growth in the middle income class of
the country. This has also allowed the country to maintain a reasonable GDP growth rate and
unemployment level (shown below) even though the country is going through difficult years
financially. The surge in government debt and obligations of the country have a major reason
behind the country’s economic worries.
 Figure 8 GDP Groth & Unemployment in Sri Lanka

These benefits of poverty alleviation and GDP growth have been achieved without the
contributionof the formal sector in micro financing. Due ot the lack of collateral and
guarantees, the formal sector financial institutions tend to shy away from micro credit in Sri
Lanka. The MFIs in Sri Lanka have been targeting the low income households in the country
which has provided them a very wide customer base.

Another major contribution of these microfinance institutions is that they have been
able to serve more customers in the past years than the formal sector insitutions. In this
regard the larger MFIs have played a major roe through serving an estimated 1.5 million
customers. On the other hand, the small MFIs catered to only 0.3 million customer, which is
around 25% of the contribution of the larger institutions. This was mainly due to the higher
reach and penetration of the larger MFIs as a result of which they are able to cater to more
customers. Additionally, the capital employed by the bigger MFIs is also a reason that they
are able to cater to a larger audience.
 The MFIs have been instrumental in Sri Lanka in uplift of the living standard of the
common man, specially the low income people. The MFIs have helped to transform the
communities across the Island. This has been done not only through employment generation
for these people but also through giving out small loans which have enable the loe income
households to hold house renovations and repair. Before the spread of MFIs, these
households didn’t have access to loans for housing purposes as the formal sector required
many different documentation for the purpose of loans and these households were not able to
fulfil all those requirements. The low turn around time of these MFIs and the short
processudral formalities meant that loans were readily available to these housholds which
were able to utilize them fully.

The MFIs have also played a significant part in the success of the MSME (Micro,
small and medium enterprise) sector. The MFIs have targeted these enterprises for their low
requirements of loans. On the other hand, the MSMEs found the MFI more aligned to their
needs as there are lesser formalities and documentation needed and also there is no middle
man. Additionally, the MFIs have proven to be successful in meeting the needs of this sector
because of their better understanding of each region of the country and the busineses and
communities which reside in those regions. This means that the products introduced by these
MFIs have been tailored to the needs to specialist businesses and the requirements of each
region which has had a far reaching impact on the growth of the economy.

The MFIs in Sri Lanka has also been able to achieve a higher level fo success because
of innovative products and market strategies. The marketing strategy of these institutions of
financial inclusion has meant that the penetration level of these MFIs has increased which
has resulted in better credit to GDP ratio. However, Sri Lanka still lags behind in this ratio as
compared to other South Asian Countries. The average ratio of private credit to GDP in
South Asia is 46%, whereas for Sri Lanka this ratio lingers around 35% mark. This shows
that there is still a lot of room for improment in this regard. To better achive their growth
targets and penetration level, the MFIs in. Sri Lanka have started better to differentiate their
products, providing more customization to the customers with respect to loan size and
duration. This has helped to rejuninate the growth of this sector and increase its impact on the
over all economic growth of the country.
 A rather far reaching impact of these MFIs is the way they have changed the
behavioural patterns of the people of the country, specially with respect to technology. MFIs
have introduced digital finance services to improve inclusion and access to their services. Sri
Lanka lagged behind the rest of the region in digital financial services in 2014 as is depicted
by the chart below.

Figure 9 Technology Useage in Financial Services

It is clear that just five years ago, Sri Lanka was non existant in digital financial
services. However, after the adoption of the digital servies by the MFIs, the landscape
changed. People of the country, specially of rural regions became more receptive towards
digital financial services, which led to a drastic increase in the services which were being
used by people. The severity of the change can be gauged from the fact that today, Sri Lanka
is almost at part with the region in use of digital financial services. This is a significant
achievement considering that the low income households of Sri Lanka are known to have a
behavioural trait of prefering useage of cash for their transactions.

Another behavioural change which has been induced by these MFIs is the low income
households of Sri Lanka have become saving orientated. The MFIs introduced savings
prodcuts in rural areas where the reach of formal sector is almost negligible. Studies have
shown that before the introduction of these products, the low income households were
consumption based with very little to no savings. However, the pintroduciotn of saving
products by the MFIs and their penetration in the market lead to a surge in savings in the low
income households. This has been critical in raising heir living standards as the savings have
reduced their dependence on outside credit.

Given the above mentioned points it is relevant here that the MFI have contributed not
only in economic development of the country but also in the social uplift of the country. The
MFIs have helped to transform the economy into a modern progressive economy which is
growing at a higher rate than most regional economies. They have also contributed towards
alliveation of poverty and improvement of the living standards of the people. This has been
achieved through innovative products which are tailored to the needs of the people of the
region. The MFIs have also succedd in the region because of the penetration level that they
have achieved.
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Appendix II: