Sri Lanka: Enhancing Small and Medium-sized Enterprises Project (formerly Small and Medium-sized Enterprises Credit Guarantee Institution Project)

Finance / Banking systems and nonbank financial institutions - Small and medium enterprise finance and leasing

1. SMEs are critical for Sri Lanka's economic growth. They are responsible for 52% of the country's gross domestic product. SMEs are arguably even more important for poverty reduction as they provide 45% of employment._Despite their importance and despite the presence of key market infrastructure such as secured lending legislation, a credit information bureau, and a property registry, SMEs struggle to access financing. A 2011 World Bank survey found that 30% of Sri Lankan firms, the fourth highest among the 29 developing member countries included, cite access to finance as a major constraint._A key explanation is that Sri Lankan banks are hesitant to lend to SMEs because they rely on collateral-based lending. Yet, many SMEs cannot provide such collateral.

2. To address such market failures, the government has introduced various SME credit guarantee schemes over the years. However, none has flourished. Market participants cite slow claims processing, limited guarantee coverage, and high premiums. Recognizing the need for a comprehensive solution, the government proposed developing SME credit guarantees in the 2016 Budget Speech and requested ADB's assistance. ADB originated a capacity development technical assistance (TA) to assess market demand, research international best practices, and prepare a business plan._The steering committee established under ADB's 2016 Small and Medium-Sized Enterprises Line of Credit Project (SME LoC) reviewed this work and endorsed the draft final report in September 2016 to Sri Lanka''s Cabinet._The Cabinet Committee on Economic Management, chaired by the Prime Minister, endorsed ADB''s proposal in October 2016, and the finance minister highlighted the plans to establish the institution in the 2017 budget speech._

3. The proposed approach draws heavily from lessons learned from previous domestic SME credit guarantee schemes and international best practices. The new guarantee institution should be well-funded, efficiently managed, financially sustainable, removed from political influence, operated with the highest level of corporate governance, and subject to central bank regulation and supervision._The institution's initial gearing should be conservative to ensure profitability and a strong credit rating. The proposed approach is also aligned with World Bank principles for public credit guarantee schemes for SMEs.

4. The proposed ADB loan and TA are aligned with one of the two pillars of ADB's country partnership strategy for Sri Lanka 2018-2020 catalyzing private investment and enhancing the effectiveness of public investment. Moreover, ADB has three ongoing projects - a $50 million SME LoC and two TA projects on improving Sri Lankan SME's access to finance._A credit guarantee institution is a natural extension of this work.

Contribution of businesses to employment generation, export diversification and productivity growth increased

SMEs' access to finance enhanced

Financial institutions' capacity for lending to underserved SMEs increased

Regulatory and institutional framework for financially sustainable SME credit guarantee operations established

Enabling environment for SME finance developed