Many newspapers are erroneously portraying the newly launched credit guarantee scheme (CGS) under the National Credit Guarantee Institution (NCGI) as a first-of-its-kind scheme. While the NCGI itself is a new institution set up to operationalise an ABD-funded CGS aimed at SMEs, CGS’s themselves are not a new phenomenon in Sri Lanka. Even the NCGI itself is not a brand-spanking new entity, it has existed since mid-2023. Its brief history is traced below:
- In April 2021, the Cabinet of Ministers gave its approval for the establishment of the NCGI.
- The NCGI was incorporated in February 2023 as a public limited company and an initial board of directors were appointed.
- The NCGI signed shareholder agreements with 12 participating financial institutions in July 2023.
Therefore, what appears to have been launched recently are the NCGI’s formal operations.
Regardless of the originality of the NCGI, Sri Lanka has a long history of credit guarantee schemes in various forms, dating back to the 1960s. The first CGS was launched in 1967 by the Central Bank of Sri Lanka (CBSL) to provide access to finance for farmers (paddy and other crops). The first CGS targeting MSMEs was launched by CBSL in 1978, guaranteed through a credit line from the World Bank’s International Development Association.
There have been many CGS’s even in the recent past. The most recent CGS was by the Central Bank of Sri Lanka in 2020 to support businesses affected by the Covid-19 pandemic. The Central Bank provided a 50-80% credit guarantee to banks for loans extended to business to meet their working capital requirements. This CGS was also coupled with an interest subsidy programme. In 2018, the USAID Development Credit Authority (DCA) launched a 7-year CGS targeting MSMEs is another recent example.
Sri Lanka’s restrictive financial landscape for SMEs has a long history. Research papers throughout the decades cite the same issues;
- SMEs are perceived as being high risk as they are small and therefore more vulnerable to shocks, they have high business closure rates and they operate in uncertain conditions
- Banks follow conservative lending practices that SME’s cannot keep up with:
- SMEs usually operate informally and do not keep meticulous accounting records and therefore cannot prove their fitness to borrow
- SMEs do not have any security or collateral to provide to off-set the risks to banks
- Banks and other financial institutions have a bias towards lending to larger businesses such as corporates and state-owned enterprises which crowds out lending for SMEs
- High administrative costs of small loans
As a result, lending is often very costly (high interest rates) or non-existent for SMEs, affecting their ability to survive, operate and grow.
What is a CGS?
A CGS is effectively a programme which aims to mitigate these barriers by providing a credit guarantee to lending institutions. It is form of insurance provided to the lender in case of non-payment by the borrower. A CGS helps reduce the risk of lending to SMEs, therefore expanding access to finance for SMEs. At least in theory. The guarantor is usually an institution which some heft and credibility among lending institutions, such as the Central Bank, the Asian Development Bank (ADB) or the World Bank.
The NCGI follows a model that is new to Sri Lanka. The NCGI is to serve as the apex institution for CGS’s, hopefully institutionalising and building the capacity of the financial sector to lend to SMEs.
The NCGI is a company with 90% of its shares owned by the government. The remaining 10% are owned by shareholding financial institutions (SFIs). There are 10 SFIs; 3 state-owned banks, 7 private sector banks and 3 private sector non-banking institutions. In March 2024, ADB approved a $100 million loan to Sri Lanka to support SMEs; $50 million of this will be used to infuse capital into the NCGI. SFI’s will contribute a further $5.3 million. This will form the financial base through which the NCGI offers credit guarantees to SMEs.
Have CGS’s been successful in enhancing SME access to finance?
The results of the various CGS programmes throughout the years have been mixed.
- In Sri Lanka’s first CGS for SMEs, it was found that despite the guarantee, banks still demanded collateral from borrowers, largely due to administrative issues between the bank and the guarantor. The World Bank’s audit report on this programme also reveals that the lack of decentralisation in lending and servicing SME loans and the lack of lending to non-traditional SMEs as major contributors to its poor performance.
- An evaluation of the several CGS’s run by the Regional Development Bank were deemed unsuccessful due to their short-term nature, inefficiencies in beneficiary selection and delays in processing claims.
Therefore, it is evident that administrative issues can impede the success of a CGS, despite its bold vision. The ADB has rightly identified the need for simpler and more flexible administrative procedures as a lesson it will implement via the NCGI. Addressing these will be critical to ensure the success of the NCGI.
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