During any economic crisis, small businesses are the first and hardest hit. “SMEs need help and COVID-19 is an unprecedented challenge, so were the Easter attacks in 2019. However, there have been moratoriums announced thrice in under a year and this must not turn into a popular rent-seeking instrument,” cautions Nilantha Jayanetti, Chief Executive at Sarvodaya Development Finance. Economic growth was declining for two years even before the COVID-19 outbreak and lockdowns.
Combined profits of sub-prime lending institutions, or non-bank finance companies, fell 32% in 2019, a year wrecked by the devastating Easter bombings and uncertainty ahead of the presidential elections. Economicgrowth fell to 2.3% in 2019 compared to 3.3% in 2018 which was another year of economic uncertainty caused by a constitutional crisis. The sector’s gross non-performing loans ratio doubled to 10.6% as of end December 2019, a five year high as credit growth also declined.
“In my experience, most entrepreneurs are not focusing enough on building sustainable businesses,” Jayanetti says. When the economy booms, they spend earnings on expansion, real estate or upgrading lifestyles or moving up the social ladder. During a bust or unforeseen shock, they are desperate.
“We live in a world of volatility, uncertainty, complexity and ambiguity. Sri Lanka often has to deal with external and internal economic shocks and disruptive weather which are constants businesses need to deal with. Every business should understand this and be prepared. If not, you cannot manage a business,” Jayanetti says. “Unfortunately, most businesses are used to government handouts,” he said.
Sarvodaya Development Finance (SDF), one of the smallest sub-prime lenders in the country with assets in the range of Rs8 billion, however, reported an impressive performance for the financial year ending March 2020. While industry profits fell 32%, SDF’s earnings grew 147% from a year earlier to Rs102 million. Two years earlier the company reported an Rs34 million loss. The company engineered the turn around by investing in talent and training. Restructuring the firm did not mean layoffs but developing a culture that embraced dynamism and innovation. SDF deployed technology for process efficiencies and cost savings.
It strengthened risk management and recovery processes. Loss-making units were turned into profit centres. SDF is a unique company because its profits go to its parent, the Sarvodaya Movement, which redistributes the money through various social development and poverty alleviation programmes in the country.
Jayanetti concedes that small businesses have genuine grievances. Access to bank credit is a challenge for SMEs world over and often they must borrow at a premium. In Sri Lanka, the problem of access and the cost of borrowing is acute. Over the past 30 years, SMEs have paid 20% per annum on loans, which is half the rate across the Palk Strait.
Conservative lenders like banks are often unsatisfied with the lack of proper bookkeeping and robust governance structures at small businesses. Many small businesses are forced to borrow from unregulated lenders at 10% a month, leading an unsustainable hand to mouth existence. They cannot afford to build reserves for a rainy day. SMEs will need a paradigm shift in attitude to survive post-COVID-19.
Governance structures must improve and boards comprising family-members must make room for professionals from outside who can add value to decision making.
“These are some of the things we are trying to teach our customers,” Jayanetti says. Moratorium impact Over 50% of SDF’s borrowers opted for the moratorium ranging from two to six months, which has impacted the company’s monthly incomes.
“We are resilient because we’ve built reserves and have a business plan. We can honour our commitments to depositors, provide the moratoriums and support our customers beyond that, and pay all our staff their full salaries,” Jayanetti says. SDF is likely to report lower profits in the current financial year amidst lowcredit growth. Non-performing loans will likely increase, but to manageable levels after the moratoriums end in September.
“As finance companies, we must responsibly manage risks. It is for us to make the moratoriums work, reduce costs and make the business expansion happen,” Jayanetti says. SDF’s microfinance customers had not opted for the moratorium nor defaulted on their loans while a majority of SME customers who opted for the two-month moratorium are beginning to service their loans, he said.
“I believe the government’s efforts to revive the economy will bear fruit without overstressing the NBFI sector,” Jayanetti says. “We are unlikely to see negative GDP growth”. Businesses will have to be nimbler and more resilient to survive beyond September when the moratoriums end. They must quickly adopt sustainable business practices to succeed post-COVID-19. “I sometimes wonder how many entrepreneurs understand this,” Jayanetti says.