Financial structure, rural credit and supportive institutional framework in Sri Lanka: An empirical analysis

This is a study on Sri Lanka's dualistic financial structure and changes in investment and financing arrangements in its informal (rural) sector. The paper uses both cross-section and time series data since mid-1950s to examine the supportive institutional aspects of financing (Stiglitz and Weiss 1981, and Stiglitz 1989). The first part of the paper provides a descriptive analysis of Sri Lanka's dualistic financial structure, urban bias in finance and the degree of monetisation of the rural sector. The second part of the paper is devoted to an analysis of savings, investment and loan arrangements in the informal sector using the latest cross-section data available. The third part of the paper provides an empirical analysis of rural credit scheme for rice (paddy) production in the informal sector in Sri Lanka. This part of the paper involves use of regression analysis on time-series data for the rural credit scheme for the period 1980-2001. The results of the regression analysis show that the level of credit extended is positively related to the number of rural banks branches and the level of repayments under the credit scheme. The analysis also shows that the level of credit repayments is positively influenced by crop insurance, farm grate price of paddy and the level of credit extended. This paper indicates that gradual but considerable progress has been made since the early 1980s in overcoming financial dualism and improving the level of informal sector financing in Sri Lanka. The main policy implication of the empirical analysis is that formal institutional arrangements such as rural credit scheme, rice marketing, rural banking access and crop insurance should be continually reinforced to improve the economic conditions in the informal sector.