Sri Lankan Banks Under Fire Over Outdated Lending Practices as Regulators Push for Modern Risk-Based Approach

Sri Lankan banks are facing sharp criticism for their continued reliance on traditional collateral-based lending practices, with financial regulators now calling for an urgent transition towards more sophisticated, risk-based lending models.

The Problem With Collateral-First Banking

For decades, Sri Lankan financial institutions have defaulted to requiring physical collateral — such as land, property, or vehicles — as the primary condition for granting loans. Critics argue this approach is outdated and exclusionary, effectively locking out large segments of the population, particularly small and medium-sized enterprises (SMEs), young entrepreneurs, and low-income borrowers who lack significant tangible assets.

The heavy dependence on collateral has long been identified as a structural barrier to financial inclusion in Sri Lanka, stifling economic growth and entrepreneurship at a time when the country is striving to rebuild its economy following a devastating financial crisis.

Regulators Call for a Fundamental Shift

Financial regulators have now stepped up pressure on banks to move away from this archaic framework and adopt risk-based lending models, which assess a borrower's creditworthiness based on a broader range of factors — including cash flow analysis, business viability, credit history, and repayment capacity — rather than simply the value of assets pledged as security.

Risk-based lending is widely regarded as international best practice and is already standard procedure among financial institutions in more developed economies. Regulators believe its adoption in Sri Lanka would open up access to credit for a far wider cross-section of society and stimulate productive economic activity.

Impact on SMEs and the Broader Economy

Small and medium enterprises, which form the backbone of Sri Lanka's economy, have been among the hardest hit by the existing lending culture. Many viable businesses with strong revenue streams and growth potential have repeatedly been turned away by banks simply because their owners could not provide sufficient collateral.

• SMEs account for a significant share of employment and GDP in Sri Lanka
• Lack of access to credit remains one of the top challenges cited by small business owners
• Risk-based models could unlock financing for entrepreneurs who currently operate in the informal sector

Banks Urged to Modernise Their Frameworks

Regulators have made clear that the status quo is no longer acceptable. Banks are being urged to invest in the necessary infrastructure, data systems, and staff training required to implement credible risk assessment frameworks. This includes developing internal credit scoring models and improving the use of financial data to make more informed, fair, and transparent lending decisions.

The push for risk-based lending reflects a broader global movement toward inclusive finance, where access to credit is determined by a borrower's actual ability to repay rather than the assets they happen to own.

As Sri Lanka continues its path toward economic recovery and stabilisation, the modernisation of the country's lending landscape is increasingly being viewed not merely as a regulatory requirement, but as an economic imperative that could determine the pace and inclusivity of the nation's growth in the years ahead.