By: Staff Writer

November 12, Colombo (LNW): As Sri Lanka approaches the December 15 deadline for the temporary suspension of debt recovery under the Parate law, the government, Central Bank, and commercial banks are considering the impact of this move on small and medium enterprises (SMEs).

A recent meeting at the Presidential Secretariat discussed the challenges faced by SMEs in repaying loans, exploring potential actions to support these businesses before the suspension ends.

SMEs, which form the backbone of Sri Lanka’s economy, contributing 75-80% of total employment, are heavily reliant on loans from commercial banks.

However, the COVID-19 pandemic and subsequent economic crises have placed many of these businesses in a precarious financial situation, with difficulties in meeting their debt obligations.

In response, the Central Bank introduced loan moratoriums and restructuring options to ease the burden on SMEs. Despite these measures, many businesses continue to face significant financial strain.

At the recent meeting, officials from the Ministry of Finance, Central Bank, and the Sri Lanka Banks Association discussed ways to assist SMEs. They decided to compile a comprehensive report on SME loans, which will inform future relief efforts.

With outstanding loans to SMEs estimated at LKR 1.5 to 2 trillion (USD 4 to 6 billion), these loans form a major part of the banking sector’s exposure. The suspension of Parate execution, which allows banks to recover loans through foreclosure, has raised concerns about its long-term consequences for the financial system.

The Parate law serves as a safeguard for banks, allowing them to recover funds in cases of default. Without this legal tool, banks face a higher risk of non-repayment, potentially leading them to increase interest rates across the board.

This could make borrowing more expensive for SMEs, further contracting the economy during a period of financial instability. Additionally, the suspension of Parate execution may create moral hazard, encouraging borrowers to default on their loans, knowing that the banks have fewer legal options for recovery.

This situation also undermines businesses that continue to make loan payments despite financial hardship. These responsible borrowers may feel disincentivized, as they see no benefit in fulfilling their obligations when others may be able to default without consequence.

The risk of defaults may also have a negative impact on the banking sector, which is already grappling with rising Non-Performing Loan (NPL) ratios and exposure to sovereign debt restructuring.

The government has announced a bank recapitalization plan of LKR 450 billion in the 2024 budget to stabilize the banking sector. However, the suspension of Parate execution could undermine this effort by eroding depositor confidence. With the ability to recover loans compromised, depositors may become reluctant to place their funds in banks, further exacerbating the financial challenges.

The situation also complicates Sri Lanka’s relationship with international bodies such as the International Monetary Fund (IMF). The IMF had initially recommended a thorough assessment of the banking sector’s stability, and the suspension of Parate execution without consultation with banks may send the wrong signals during ongoing reviews.

Ultimately, the suspension of Parate law poses significant risks to both SMEs and the broader financial system. While it aims to provide short-term relief, it could have unintended long-term consequences, including higher borrowing costs, reduced loan recovery, and weakened depositor confidence.