Financial Literacy and Debt-Trap of Micro, Small, and Medium Enterprises in the Northern Province of Sri Lanka.

Abstract

The financial vulnerability of Micro Small and Medium scale Enterprises (MSMEs) in Sri Lanka threatens their survival and the livelihoods they support within communities. Thus, this study investigates the influence of financial literacy on the debt-trap of MSMEs, with a particular focus on the mediating role of financial decision-making. Based on the data collected from a structured survey, with a sample of 400 MSMEs operating in manufacturing and industry, trading, and service sectors in the five districts of Northern Province and analyzed using both SPSS and SmartPLS, the study explores a conceptual model in which financial literacy is conceptualized as a multidimensional construct consists of financial knowledge, financial attitudes, and financial behavior. According to research, these MSME entrepreneurs have a financial literacy percentage ranging from 25% to 32%, below the average rate in Sri Lanka (57.9% in 2021). The structural equation modelling results reveal that financial literacy significantly and negatively impacts the likelihood of MSMEs falling into a debt trap (β = -0.549, p < 0.01). Furthermore, financial literacy significantly enhances financial decision making (β = 0.872), which in turn also negatively influences the debt-trap (β = -0.415). The mediation analysis confirms that financial decision-making partially mediates the relationship between financial literacy and the debt-trap (β = -0.362), indicating that better financial literacy directly and indirectly reduces debt vulnerability. The study findings provide constructive awareness for policymakers and financial institutions in Sri Lanka to design targeted financial literacy programs that cater to the specific needs of MSME owners.