COVID-19 impact could significantly deepen Sri Lanka’s inclusion challenges

While Sri Lanka’s financial inclusion challenges are likely to deepen further post-pandemic, neither the formal nor the informal financial sector of the country appears to be in a position to address the issue 

By Rukula

Sri Lanka was facing many challenges with regard to inclusion, particularly financial inclusion, even prior to the COVID-19 pandemic in 2020. 

As a business with strong links to the country’s informal economy, over the years Rukula has developed a deep understanding of the pulse of the informal economy, given its fundamental importance to our business. This understanding, as well as a multitude of macroeconomic data points, indicates that COVID-19 is likely to significantly deepen Sri Lanka’s inclusion challenges, including in financial inclusion. 

Trends from Rukula’s own operations

Typically, Rukula’s offering of credit sales has attracted certain types of customers – such as trishaw drivers for instance, who have above-average incomes but who are unable to meet the rigorous documentation requirements of banks and finance companies. However, post-pandemic, Rukula has seen the emergence of a new type of customer for the company’s offering. 

Those with formal income sources and a higher income level, the typical Rukula customer (especially relatively senior/experienced workers from sectors such as hospitality and tourism) started approaching the company to seek credit, as the adverse impact of the pandemic on their livelihoods and incomes have made it difficult for them to balance their finances.

Many of Rukula’s existing customers also experienced sharp erosion of their incomes, due to inability to work because of lockdowns or reduced demand for goods and services as a result of COVID-19. 

The first development (the emergence of a new profile of customers) indicates that the pandemic has likely further restricted access to the formal financial system to those who were previously able to access it. The second (reduction of incomes of those in the informal economy) indicates that those in the informal economy are more cut off from the formal financial system now than ever before. Both these factors imply that Sri Lanka’s financial inclusion challenges will be more severe post-pandemic.

Support from macroeconomic data

The above data is supported by macroeconomic data.

Generally, Sri Lankan banks are extremely risk averse and do not lend to borrowers unless they are deemed to have a very low risk profile. According to the World Bank, around 70% of Sri Lanka’s workforce is informally employed and thus would not be eligible for credit from banks, as they would be unable to fulfil the documentation criteria. 

Given also their relatively high marginal costs, banks often find it unprofitable to process payments of say a few hundred rupees and hence have little incentive to serve small-scale customers. After seeing a spike in non-performing loans (NPLs) towards the mid part of last year, banks are likely to be more risk averse than ever, making it likely impossible for borrowers who don’t have strong risk profiles on paper to borrow from them. 

But as Rukula’s experience has validated, the perception of higher risk associated with this segment of customers is often due to the poorly designed credit evaluation process of the formal financial sector. However, given the need to adhere to various regulations, there is also limited room for innovation in this front for formal financial establishments.

Borrowers who are unable to borrow from banks first turn to finance or microfinance companies, both of whom charge higher interest. Unfortunately, these organisations have been severely compromised by the pandemic with NPLs of Non-Bank Financial Institutions (NBFIs) hitting a very high level of around 13% by the end of 2020. This implies that approximately one in eight loans are categorised as non-performing. In addition, even microfinance institutions largely provide loans for business purposes rather than for consumption, however critical such borrowings might be for the customer. 

With these developments virtually closing the doors of the formal financial sector to many borrowers, in desperation many reach out to informal money lenders and various unregulated online lenders who charge exorbitant interest rates while resorting to unscrupulous practices to collect dues. 

Even before the pandemic the activities of informal money lenders were widespread. A local study done as far back in 2005 found that 32% (approximately one third) of households surveyed had borrowed from informal sources, of which one fifth or 20% had come from informal money lenders. It has been recorded that interest rates charged by informal money lenders can be as high as 300% annually. 

Challenges stemming from lack of financial inclusion

It is important to be mindful that lack of financial inclusion, particularly ability to access lending on affordable terms, contributes towards other forms of inequality.

Since people are unable to access borrowings, they are unable to acquire critical assets – leading to lack of inclusion in aspects such as digital inclusion for instance.

A recent study found that of Sri Lankan small and medium businesses (SMBs) who don’t use computers/laptops, the primary reason for one-fifth or 20% not using such devices was the lack of affordability. However, if they had the ability to purchase the devices on affordable credit terms, perhaps at least some such SMBs would make use of such opportunities. The same survey found that only a meagre 34% (approximately one third) of local SMBs had laptops or desktop computers. 

Rukula’s own experience too demonstrates how lack of financial inclusion is creating disparities in other aspects. Following the initial outbreak of the pandemic in Sri Lanka, it was found that smartphone sales purchased on credit from Rukula’s network of small-scale merchants in the Eastern Province had increased sharply. This was motivated by the need for children to access online classes. With their parents being unable to afford computers or tabs, they purchased smartphones instead. 

It should be noted in this regard that basic smartphones do not have sufficient features to use apps such as Zoom, which are used commonly for online education. Hence, smartphones with higher specifications have to be used instead and these obviously tend to be higher in price as well.

With prices of devices such as smartphones rising noticeably post-pandemic, combined with decrease in disposable incomes of people due to both sharp rise in food prices and decline in incomes, challenges in areas such as digital inclusion is likely to deepen further. 

Need for innovative solutions

While Sri Lanka’s financial inclusion challenges are likely to deepen further post-pandemic, neither the formal nor the informal financial sector of the country appears to be in a position to address the issue. However, the inability to address the issue is likely to create inclusion challenges in other areas – for instance, in terms of digital inclusion. 

In this situation, there is a pressing need for innovative models of financial inclusion, which have low transaction costs and thereby can provide credit on affordable terms to the poor on commercial terms, without making them ‘donor/subsidy dependent’. 

(Rukula is a for-profit social impact fintech. To engage with Rukula or to obtain any additional information on any content mentioned in this write-up please contact the Social Inclusion Department of Rukula. Queries can be directed to Hashim Nazahim ([email protected]) and/or Saminda Uswatta ([email protected]).)