Bank consolidation can help revive SME sector

In Sri Lanka, SMEs comprise more than 75% of enterprises, provide 45% of employment, and form the backbone of the economy by contributing 52% to GDP.

It is no secret that the SME sector was devastated by the COVID pandemic measures, the unprecedented economic crisis and the high interest rates that were used like a sledgehammer in April 2022 by the Central Bank. The result was the closure of several SMEs and a historic contraction of the economy by 7.8%.

The anticipated flow of benefits from the ongoing debt restructuring has yet to have a positive impact on SMEs. Currently SMEs are facing severe working capital and cash flow challenges. With bank interest rates at between 20 to 25% on permanent overdrafts and 35 to 38% on temporary overdrafts coupled with corporate tax of 30% make it virtually impossible for SMEs to resuscitate their businesses.

In a situation which requires financial institutions to be more flexible towards SMEs, indiscriminate parate executions by financial institutions seizing collateral assets of SMEs such as business buildings, properties and vehicles for loans obtained have pushed many SMEs to a point of no return.

At a time when banking sector assistance becomes vital to create a conducive environment for the resurgence of the SME sector little if nothing seems to be happening. A strong and stable financial sector is imperative for economic growth. In the light of the foregoing, financial institutions have clarified their position, maintaining that they are not in a position to offer any material relief to borrowers due to declining profitability.

A comparison of the commercial banking sector of Sri Lanka with that of India clearly demonstrates an overbanked situation in Sri Lanka today. There are 33 commercial banks in India for an estimated population of 1,400 million whilst there are 13 commercial banks in Sri Lanka for an estimated population of merely 23.3 million. Further, geographically India is 50 times larger than Sri Lanka.

The recent calls by the governor to banks to lower interest rates and the appeals by SMEs to be more flexible when granting working capital loans to SMEs affected by the economic crisis and in carrying out parate executions have not received the desired response from the banking sector.

In such a scenario, bank consolidation that will bring into existence large banks capable of offering much lower interest rates to SMEs, with a higher capacity to take risk in the current situation would be one solution.

How will bank consolidation help lower interest rates whilst safeguarding the stability of the financial sector?

Lower cost of funds lower interest rates

•  Larger banks with better credit ratings can access lower cost funds that can be used to provide low cost finance to SMEs.
•  Larger banks can on lend these funds with a lower margin due to the cost-to-income ratios of larger banks being lower than smaller banks (i.e. passing on scale benefits).
•  Larger banks can mobilise equity funds through Sri Lankan and international (e.g. Indian) securities markets thereby reducing their cost of funds which should translate to lower interest rates to SMEs.
•  Large banks have higher Current Account Savings Account (CASA) ratios compared to smaller banks. Since current account balances come at zero cost and savings account balances come at very low cost, the governor could justify a direction to bring down interest rates to banks with high CASA ratios.
•  Larger and more stable banks with good capital adequacy ratios can attract increased levels of public deposits at lower cost. This too will contribute towards lowering the cost of funds in these banks and enable lending at lower rates without affecting the profitability of the banks.
•  Economies of scale will enable banks to have lower cost-to- income ratios that would safeguard profitability despite reduced net interest income.

Branch rationalisation and financial inclusion

•  Larger and fewer banks will enable the rationalisation of branch networks and create branch networks that reach out to all parts of Sri Lanka thereby enabling a bigger portion of our population to enter the formal financial sector. SMEs in the rural areas will benefit to a great extent through such initiatives.
•  Well distributed branch networks will give access to all segments of our population to participate in using financial products such as current accounts, savings accounts and fixed deposits thereby improving Sri Lanka’s saving rate. The funds so mobilised can in turn be channelled to SMEs to fund working capital. 

Larger balance sheets higher risk tolerance

•  Larger Banks would be in a better position to be more accommodating towards SMEs that are reported to the Credit Information Bureau (CRIB) as a result of the post 2021 economic crisis and be more receptive to continue providing working capital to assist SMEs to resuscitate and in some instances recommence business.
•  Larger banks are capable of deferring parate execution due to their ability to carry a higher quantum of non-performing loans on their balance sheet due to the size of their Balance Sheet.

With strong reasoning to pursue strategies to revive the Sri Lankan SME sector at this point in time and the benefits that the SME sector will have as a result of bank consolidation, it is time for the Central Bank to announce a consolidation plan.

 

(The writer is the Sri Lanka United National Businesses Alliance Chairperson.)