On the surface, economic activity in the countryside is growing. More people now have access to a smartphone and to the internet; many families own at least a motorbike and homes with brick walls, and rain proof roofing are common. However, these changes in the countryside also veil a failure: farm productivity isn’t keeping up with the rising fortunes of the rest of the economy. As a result, the countryside, where many are farmers, is falling behind.

Although it employs 23% of Sri Lanka’s working population, the agriculture sector’s share in the economy is shrinking. In 2020, it contributed around 8% of GDP. This isn’t a bad thing. A relatively small but efficient farming sector can produce a country’s food needs and supply export demand, as others have shown.

However, Sri Lanka’s rural villages face several challenges compared to low income earners living in the cities. The first is that low farm productivity limits earnings and growth opportunities, a second is the lack of opportunity in other economic sectors and a third is the small size of markets in the villages.

Entrepreneurs like W A Basnayake overcome several of these challenges to succeed. Together with his wife, Basnayake started a coconut oil destitution business in Sri Lanka’s North Central Province, but soon figured he had to scale as the demand in the surrounding villages was limited. A conversation with the village Sarvodaya society, a non-governmental network that supports village development, led to an introduction to Sarvodaya Development Finance (SDF), a registered finance company controlled by the movement.

“They processed the loan much faster than we expected. We also leased a vehicle and began distributing coconut oil to more villages,” Basnayake, who didn’t have a credit history before he obtained the SDF lease, says about the purchase of a small truck in 2019.

Basnayake and his wife are both young and determined to overcome the handicaps of entrepreneurship in rural areas. They obtained a second loan, this time to lease and equip a store near Anuradhapura town’s main bus stand for a wholesale coconut oil distribution business.

A distribution hub and a vehicle has enabled MS Coconut Oil, as the business is known, to supply customers across the Anuradhapura district, instead of just the surrounding villages.

Fifty years ago, many doubted Sri Lanka’s rural potential. In the decades since, rural economic growth has been lower than in the city, infrastructure is poor and the politics unremittingly wretched. When Dr A T Ariyaratne founded the Sarvodaya movement in 1958, villages lacked even the most basic needs like clean water, food, shelter, healthcare, and education.

Our midterm plan is to develop a business portal, a smart app of sorts, connecting producers in the village to the market and end users

The Sarvodaya movement without access to resources, a then young Dr Ariyaratne began by discussing with villagers what was needed and how it can be done. Since then Sarvodaya, (or Lanka Jathika Sarvodaya Shramadana Movement, its full name) has grown to become Sri Lanka’s largest social movement to support underserved villages and uplift grass root entrepreneurism. Sarvodaya encouraged villages to establish a council, a first step towards development.

During an era when government funding for infrastructure was limited, all around the country people in over 15,000 villages had organised themselves around a village council to improve the village infrastructure with voluntary labour.

Sarvodaya is Sri Lanka’s largest NGO and includes other units dedicated to different development projects. Sarvodaya, meaning ‘ awakening for all’, is based on Buddhist and Gandhian principles. Assistance deliberately begins with a change in the attitude of the villagers. Dr Ariyaratne emphasizes that Sarvodaya is about awakening both individuals and society.

In the decades since independence, Sri Lanka made huge gains in education, health, and bridging the gender divide. Primary school enrollment is nearly universal and more girls than boys enter state universities. Although Sri Lanka is still a lower-middle-income economy, many of its key health indicators, like infant mortality and life expectancy, are comparable to upper middle-income countries.

These improvements are largely due to public investment in healthcare, education, and physical infrastructure. However, the Sarvodaya movement’s contribution to the village economy overlaps and goes beyond what public finances are able to achieve. Successful Sarvodaya committees take village economies towards self-sustainability by starting a village bank, and offering credit in the community. Often, the beneficiaries of this microcredit are women, who tend to be the most creditworthy.

Beside the apparel industry, it’s the arrival of micro credit that put money in women’s pockets – from which it is more likely to be spent on health, education, and better food.

Economic development gradually altered credit needs even in the villages. Sarvodaya village societies were unable to provide credit to all villagers and small businesses requiring capital for expansion. In 1986, Sarvodaya Economic Enterprise Development Services (SEEDS) began as a micro credit division of Sarvodaya.

Today the original SEEDS microcredit venture has been incorporated as Sarvodaya Development Finance (SDF), a licensed finance company. As a member of the Sarvodaya movement, SDF is guided by the Sarvodaya philosophy and is the only finance company in Sri Lanka controlled by a charity. The Sarvodaya movement owns almost 80% of SDF’s equity. The rest are owned by investors from Sri Lanka and overseas.

After its establishment in 2010, SDF formalised Sarvodays’s ability to channel private sector investments into low and mid-income groups and often to communities deemed ‘non- bankable’ by formal financial institutions, at scale. Sarvodaya’s village societies continue to also grant loans at village level.

For Sarvodaya, micro credit has been a tool for village regeneration and local activism. It’s also a third way between state provision of public services and full-on privatisation. The government is resource constrained and private capital is weary of low returns in rural investments.

Channa de Silva, a former securities regulator who chairs the SDF board, highlights the contrast with the financial sector. “From the beginning, our formula was to give back to the villages what we collect from them,” he says.

Sri Lanka’s banks, even the state-owned ones, raise a significant portion of their deposits at low cost from rural and economically disadvantaged areas and grant the most loans in Colombo to large businesses and the government. Banks fund up to 90% of their business through customer deposits. Shareholders only fund around 10%.

We serve a market segment not serviced by others. We’ve made competition irrelevant because none understand this market segment like we do

“So, empowering the village is the critical factor even now. Sarvodaya expects no great financial return, because they’re driven by a passion to serve these communities,” de Silva adds.

SDF operates 51 branches and service centers in the island, many of them outside the Western Province. Through partnerships with Sarvodaya Shramadana Societies (SSS) at the village level, SDF is capable of channeling development funds deep into the grass roots. Around 4% of SDF’s loans have been granted to village societies for on-lending, 9% are micro personal loans and a further 4% are micro business loans. Village societies also own 22% of SDF stock. SDF serves around 175,000 customers, a level it has been maintaining for three decades.

SDF Chief Executive Nilantha Jayanetti explains the mission-focus by highlighting that 80% of Sarvodaya Development Finance’s over Rs8 billion portfolio, is lent outside the Western province. “We have always been different from other finance companies. Our mission is to provide access to finance in the villages.”

To measure success at SDF, balance sheet size alone will not do. SDF accounts for around 1% of Sri Lanka’s financial sector assets, however almost its entire portfolio is lent to businesses other financial institutions don’t reach.

“We serve a market segment not serviced by others. We’ve made competition irrelevant because none understand this market segment like we do. So, our customers are loyal to us,” explains Jayanetti, who is based at SDF’s headquarters in Colombo. Many of SDF’s customers are farmers or those who depend on the farming supply chain. As a result, their income is seasonal. SDF has designed products to suit their cash flows.

Of its Rs8 billion loan portfolio, over a billion are leases funding tractors. None of its tractor loans are in the non-performing category. “We are promoting income generating assets,” Jayanetti says, explaining that only 16% of its loans are related to consumption.

SDF’s portfolio doesn’t reflect Sri Lanka’s economy. For instance, it has almost no exposure to sectors like tourism. Its lending supports small to medium-sized rural businesses. Many are related to the agriculture supply chain.

Jayanetti, has led a spurt of growth at SDF since being appointed Chief Executive in late 2018. The loan book has grown 50% in the three years to 2021 led by growth in its leases (see Chart 1) which now accounts for 39% of the loan book. During the four years to 2021, the loan book has doubled. In 2021 SDF’s achievement was validated with a Global Banking and Finance Review award as the fastest growing development finance company in Sri Lanka.

Growth in the agro-oriented lease portfolio illustrates SDF’s transformation from a microlender to a funder of small and medium-sized businesses looking to scale. In 2021, micro business and personal loans were 14% of lending (see Chart 2).

“Small and medium businesses are the engine of growth in the country. So, we want to make sure SMEs have access to finance first and empower them with the investment capital or working capital they need to grow,” Jayanetti says.

Jayanetti is keen to differentiate SDF from the predatory lenders in rural areas. “We are a development finance institution, not a microlender, because we practice inclusive financing. Many of our customers are members of Sarvodaya societies, or recommended to us by the social network,” Jayanetti explains. Although it is a registered finance company, and shareholder returns are an important measure of success, SDF is a social enterprise. Channa de Silva says SDF’s lending rates are 30-40% lower than those of other finance companies. However, offering low rates is not without challenges.

Unlike banks, SDF grooms entrepreneurs, with a keen eye on the advancement of the community in the long term. Banks on the other hand will prefer big ticket loans, which are lower cost to administer, and lower risk too.

De Silva is passionate about the potential impact entrepreneurship has on the rural economy. “For a small country, the disparity of knowledge, the know-how, and access to capital and markets is tremendous in Sri Lanka,” he contends.

However, over 21% of SDF’s customer loans are funded from bank borrowings. Customer deposits are the largest source of funding for SDF flowed by shareholder funds. De Silva says finance companies cannot continue to view banks as a source of long-term funding.

A finance company raising funding from a bank will have a double digit spread. Within this spread, the finance company must absorb the cost of operations, taxation, and shareholder returns. De Silva argues that finance companies, including SDF must reexamine their capital structure to be competitive over the long term.

Despite this challenge, SDF continues to approach customers with a holistic view, like a social enterprise.

The label social enterprise is fuzzy, accommodating old-fashioned cooperative societies to big businesses with a conscience. Social enterprises come in a variety of legal forms, and their social credentials vary.

In the last financial year, when operations were impacted by the coronavirus pandemic, SDF reported its largest ever profit of Rs183 million with ROE at 10.9%. Its net interest margin at 11.4% was a record low. The average for the four years preceding 2021 was 13.5%. Lower net interest margins and high profitability is only possible when a company is efficiently run.

Sarvodaya ownership and the values this relationship imparted made SDF a social enterprise from the beginning. However, in the decade since founding, SDF has undergone several changes. In the early years, SDF benefited from professionalisation, of applying business skills to achieve social ends.

When they are supercharged, social enterprises can begin to address major problems not just through efficiency but through innovation. With scale and momentum behind it SDF is now emerging as that transformative force.

“Our midterm plan is to develop a business portal, a smart app of sorts, connecting producers in the village to the market and end users, it’s kind of like the Uber Eats for village entrepreneurs,” de Silva explains. “We have been keen to serve and empower these people because we believe that there’s so much potential in the village. We owe it to them,” he says about the need for innovative solutions to overcome stubborn challenges.

“Sarvodaya and its societies will also endorse the origins of the products as being from the villages they claim to be from, and we will work with the village entrepreneur and the village transport system for delivery,” de Silva suggests. What is now referred to as the ‘Smart Village App’ will eventually connect village entrepreneurs to global supply chains.

In villages across the country there are 5,400 active Sarvodaya societies and already, SDF is creating trading hubs with some of them. SDF’s Chief Executive Jayanetti says societies that already have a device have become a hub for village transactions. Villages who don’t have access to online banking pay bills and carry out basic transactions though the Sarvodaya society. On a day following the lifting of a lockdown to slow the spread of the coronavirus, Sarvodaya societies recorded 37,000 transactions on a single day.

Jayanetti is excited about the potential. “A society can become a ‘Super Center’ of sorts. Soon we plan to establish distributorships for commodities like gas with the societies so that they become a hub for economic activity”.

More than most, Jayanetti understands how the village economy is being transformed being the son of a rice farmer from the Eastern province of Ampara. Jayanetti attended a preschool run by Sarvodaya in his village and frequented a playground that was also built by the movement.

Besides the familiarity with rural Sri Lanka, Jayanetti also brought with him to SDF a hard charging culture.

Jayanetti suggests the agriculture yield, although low, isn’t the major challenge farmers face. For them and other village entrepreneurs, market access, technical knowhow on improving their products, and supply chains are far more important.

Weighs in de Silva: “The problem is how to sustain the expenditure for capacity development of these villages. You have to train them on product development, marketing and stuff like that.

Credit alone won’t do. Earlier, funding for this came through grants, but that’s not happening anymore. Due to that, we are challenged.”

SDF’s solution for this is its profitability and dividends to Sarvodaya, coupled with SDF’s own activism on rural entrepreneurship, will bridge this divide. For optimal growth, SDF also needs to meet several objectives. A central piece is its ambition to double its balance sheet size and loan book in four years.

Aggressive growth and lower reliance on borrowing from banks to fund that will have SDF tapping public markets. The Central Bank, which regulates finance companies, requires them to be listed on the stock exchange by end 2021.

Discussing the benefits of a listing, de Silva says more than half the challenges to scaling SDF will be eliminated by being a public company. He says international funding lines will open up and international equity investors will be comfortable when the exit path is clear. It will also give the right messages on governance and transparency as soon as SDF is listed, he says.

“We can then grow the book substantially, increase loan ticket sizes and attract international credit lines. So our notion is clear, we want to make SDF a benchmark development finance institution which is globally recognized.”

“With everything we do we are heading in that direction. From the people we hire to how we structure the loan portfolio, we do everything with that in mind,” de Silva says.

Over 80% of SDF’s portfolio is lent outside the Western province. It is also a diversified portfolio. Diversification and resilience made it possible for SDF to navigate the coronavirus-related impacts.

SDF’s clients too appreciate the organisation’s capability beyond being a mere lender. W A Basnayake, the young coconut oil distributor from Anuradhapura, says the guidance SDF provided during the pandemic ‘helped overcome many challenges. “This has given us the confidence to aim for bigger things in the future,” he says.