ADB urges government to revisit proposal to set up credit guarantee institution for SMEs

• Policy decision was taken in 2016 to set up credit guarantee institution 
• for SMEs
• US$ 50mn ADB loan was committed for the project, which still remains at proposed status
• IFC says SMEs remain crowded out from the banking sector by larger corporates
• According to IFC estimates, SL has highest share of SMEs either fully or partially credit constrained

Asian Development Bank (ADB) urged the government to revisit the policy decision taken in 2016 to setup a small and medium-sized enterprises (SMEs) credit guarantee institution in order to enable access to credit for the country’s credit-constrained SMEs.

“Establishing a credit guarantee institution for small and medium-sized enterprises would encourage entrepreneurs and private sector participation,” ADB stated in its Asian Development Outlook (ADO) report released in this week.

Responding to a request by the government in 2016, ADB initiated a capacity development technical assistance (TA) committee to support and proposed a project to assist the move to setup a SME credit guarantee institution, a new non-bank financial institution that would support SMEs to access commercial loans, with a US$ 50 million loan. However, the project to-date remains in proposed status.

As banks and other financial institutions consider SMEs to be of high credit risks and lending continues to be largely based on collateral rather than cash-flows, SMEs remain crowded out from the banking sector by larger corporates.
The World Bank (WB) and its private-sector funding arm, International Finance Corporation (IFC) have also echoed a similar sentiment on the need for such an institution given the significant role played by SMEs in the economy as SMEs account for 52 percent of the country’s gross domestic product while employing 45 percent of the country’s workforce.

“A credit enhancement fund for SMEs through a partial credit guarantee agency could help address banks’ reluctance to engage in cashflow-based lending. Apart from increasing the flow of credit to SMEs, this would build banks’ capacity for cashflow- based credit appraisals and over time induce more cashflow-based lending without the need for guarantees,” IFC pointed out in a report released last year.

According to IFC estimates, Sri Lanka has the highest share of SMEs that are either fully or partially 
credit constrained.

“These unmet financing needs are particularly acute among SMEs where 50 percent of MSMEs have reported that their working capital came from their own resources. The finance needs of the agriculture sector are also large, with IFC estimating the credit gap to the sector at US$2 billion in agriculture financing; 2.45 percent of Sri Lanka’s GDP,” it said. 

Despite having a per capita income of 2.5 times higher than that of India, IFC noted that Sri Lanka’s credit to GDP ratio which was at 50 percent, is slightly lower than India’s while it’s a mere fraction of the credit-to-GDP ratio of aspirational peers.

As a solution to credit constraints, successive governments had come up with various SME credit guarantee schemes over the years.However, ADB pointed out that nearly all of them failed to flourish, mainly due to slow claims processing, limited guarantee coverage, and high premiums.

ADB also outlined the need for robust capital markets to mobilise long-term financing of risk capital for entrepreneurs.

Therefore, it urged the government to continue with capital market developments as a policy priority over the medium and long term.