On average over the past five years Micro, Small and Medium Sized enterprises (MSMEs) account for 50% of industrial jobs and 84% of total employment in Nigeria and on average about 49% of GDP. Nonetheless, Nigerian banks have not offered much funding to MSMEs. Banks require a more supportive ecosystem to be able to manage the risks associated with assessing and managing MSME creditworthiness. In those cases where banks do lend to smaller enterprises, they most times prefer to lend to enterprises operating within the value-chains of their better-known larger corporate borrowers, such as smaller companies that deliver goods and services to ‘blue-chip’ borrowers, as this provides some assurance to banks regarding the MSME’s credit-worthiness.
Systemic gaps in the credit environment
First among the causes of the banks’ reluctance to lend to MSMEs is the relatively weak credit environment. Weaknesses relate to:
- insufficiencies in credit information sharing, particularly the quality, timeliness and coverage of information shared with credit bureaus, and the absence of coordinated information (a common database) shared among the bureaus;
- uncertain and unreliable loan foreclosure processes, which can result in creditors being subject to court challenge and lengthy delays; and
- the need to strengthen the institutional foundations for lending, such as the ongoing, efforts to establish the register for movable collateral. Nevertheless, The 2020 Doing Business Report shows relatively high ratings in access to credit for Nigeria, in part driven by high marks on the credit information depth subcomponent; it is dismal when it comes to coverage of adults perhaps a proxy for single proprietorships and thus very detrimental for securing access by micro-small firms.
Pervasive impact of macroeconomic uncertainty
Credit markets in Nigeria are particularly impacted by the so-called “sovereign-banking sector nexus”, a term used to describe the interconnectedness between the health of the balance sheet of the sovereign and the health of the balance sheet of the financial system, primarily the banking system. This is the result of a tendency to place more reliance on government borrowing when oil prices fall and economic growth faulters, thereby encouraging banks to purchase ‘risk-free’ government securities. Such crowding out works pro-cyclically and lessens the banking sector contribution to supporting economic recovery.
Factoring in the medium-term impact of CBN policy-responses to the CoVID-19 Shock
A third cause of the banks’ reluctance to engage in lending to MSMEs relates to impact of other policy responses implemented by the authorities. Cognizant of the fact that the fall in demand caused by COVID-19 and keen to increase MSME access to credit the CBN reduced its policy interest rates. As of May 28, 2020, the CBN reduced its benchmark monetary policy interest rate from 13.5% to 12.5% and further to 11.5% in September 2020 and held that till January 2021. With inflation gradually rising from 12.1% in January 2020, to close to 16.47% in January 2021, the CBN’s policy interest rates became negative in real terms. In March, 2020, the CBN also announced that it would: sanction bank loan forbearance; reduce interest rates on all applicable CBN intervention funds from 9 to 5%, while also applying a one year moratorium on these intervention facilities; and step up enforcement of its Loan to Deposit Ratio (LDR) policy.
As sanctioned by the CBN so far 22 banks out of 27 banks have undertaken loan restructuring impacting about 35,640 bank borrowers with a value of restructured loans amounting to N7.8 trillion which constitutes 42% of the total bank loans. Loan forbearance has been adopted by many countries as a response to the COVID-19 epidemic. Going forward to avoid a situation where forbearance results in the accumulation of nonperforming loans it will be important to apply increased vigilance both on the part of banks and the CBN in assessing the viability of the banks’ credit exposures.
In addition to easing the lending terms on its intervention funds the CBN has introduced new lending schemes (the household and SME facility (N50 billion), the healthcare facility (N100 billion) and the manufacturing and agricultural interventions (N1 trillion). Funding made available through the CBN’s manufacturing and agricultural interventions amounts to 25 % of the deposit money bank credit to these two sectors as of December 2020. To realize the potential of these interventions, the stance of monetary policy will need to be carefully monitored. Lending rates need to gradually adjust to rates that more adequately reflect the associated credit risk – this will be necessary to incentivize deposit money banks to lend to high-risk marginal MSME borrowers.
Setting the stage for recovery calls for adopting a more symmetric application of the CRR, as releasing liquidity back to banks could help banks to release and hence mobilize additional financing to support economic recovery of the real sector. This can be combined with consideration of the horizon for the forbearance policy in order to mitigate risks of moral hazard arising from reluctance to recognize impaired loans. According to recent CBN data private sector credit grew by 17.9% in the year ending June 2020, implying real growth of 5.5%.
However, this increase in private sector credit took place in a situation where the level of credit is well below the expected median for a country with the structural features of Nigeria and below the private credit to GDP ratios found in a range of peer countries. The combination of structural and sector specific factors call for an action plan to get banks back to the business of lending to MSMEs in order to put Nigeria on the path of sustainable recovery. Our perspectives around enabling sustainable financing for Nigerian MSMEs will follow in our subsequent blog … so please stay tuned!!