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.
