A Bull in the ‘Credit’ Shop

Nigerian banks prefer to lend to Federal Government backed securities perceived as low risk, high yield investments but it is crowding out lending to small businesses with grave consequences for the economy, writes ISAAC ANYAOGU.

In the last three months ending March 2017, the Federal Government has borrowed N5.59 trillion from Nigerian banks. To situate this in the proper context, bank loans to the national government rose annually by 25 percent this year alone.

But within the same period, lending to the private sector by Nigerian banks fell by 3 percent. How does a government that want to grow the private sector compete with it for credit?

The contradiction is that while the government at every turn shouts itself hoarse on the need to grow small businesses, crowding out lending to small businesses which accounts for over 80 percent of economic activities in the country is counterproductive.

“The bulk of the resources in the economy is now being channelled to the purchase of government debt instruments at attractive rates of between 18 and 22 percent, rather than to businesses in the economy,” Muda Yusuf, director-general of the Lagos Chamber of Commerce and Industry (LCCI) recently told BusinesDay.

This system benefits commercial banks who mop up deposits from Nigerians at 4 percent and lend to government at 22 percent.

“This has also pushed up interest rates to the 30 percent threshold for private investors and will surely not help stimulate domestic investment, which is most critical to job creation,” said Yusuf.

The effect on small businesses is troubling. Pabina Yinkere, head of research at Vetiva Capital Management Limited, said in an interview that “the impact on the economy is first, it increases interest rates and leaves government crowding out the private sector. People see government as the safest borrower so they will prefer to give their money to government, while the private sector will be getting less money.”

Deep Economic Fissures
Africa’s largest economy’s credit to the private sector, as a percentage of Gross Domestic Product (GDP), is one of the lowest in the world, at 14.2 percent in comparison with the sub-Saharan Africa average of 45 percent and European average of 72 percent, according to a World Bank data.

The concept of finance-led growth assumes that credit to the private sector is the best measure of economic development. The higher the financing is to the private sector, the greater opportunity and space for the private sector to develop and grow, benefiting the economy.

But Nigeria is losing out on finance-led economic growth as commercial banks tempted by quick, high returns on sovereign bonds ramp up lending to the government. This is creating a debt trap as revenue plateaus on account of dip in crude oil prices.

This penchant for quick returns has become pervasive throughout the economy. Many small businesses in Nigeria play mostly in trading and service sectors, areas where they can generate quick returns. Whatever financing they get, therefore, is predicated on their ability to repay short-term loans.

“It is a broad reflection of what is wrong with the economy,” said Bunmi Lawson, MD/CEO of Accion Microfinance Bank, “hardly do you find investments in the manufacturing sector as it is tougher to get financing to the sector.”

Lawson further said that it is why government debt continues to grow, “because it is easier for banks to raise savings at 4 percent and give it to the government at 23%, so if you (the government) are forcing them to lend at 9%, why will they do that when you yourself, the lowest risk sector is getting at 23%.”

The attraction for banks is that government securities are usually considered low-risk investments because they are backed by the taxing power of the government.

But here’s the rub; Nigeria’s tax to GDP ratio of 6 % is among the lowest in the world indicating that banking on tax revenue by commercial banks to derisk lending to the public sector is not pragmatic.

All over the world, governments issue bonds to finance infrastructure projects or to raise funds for expenditure. But capital projects in Nigeria, have been too few and far between. Worse still, there are fears that the bulk of returns from government securities may be used to finance bloated, recurrent expenditure.

Nigeria plans to borrow N2.36 trillion to fund the fiscal deficit in the 2017 budget and has earmarked N1.841 trillion to service the debt. This translates to 24.74 per cent of the total budget and 36.3 per cent of revenue projections for the year.

The debts pile up because for now the returns are good. The yield on one-year Treasury bills of 18 percent is the highest in five years, while long term bonds, rake in 16 percent, the highest in since 2015.

But shifting capital to the public sector in an economy such as Nigeria is a fine way to asphyxiate the economy. Every shade of experts and government functionary have said that funding is the greatest threat facing small businesses as lending to SMEs has progressively been shrinking. (See chart unwilling lenders)

A research work by Olutoye Adedayo (Afe Babalola University), Akinmulegun Ojo (Adekunle Ajasin University) and Olutoye Toluwalope (Babcock University) on identifying financing gaps in Nigerian banking sector identified three periods of SMES financing policies by the monetary authorities.

The first period was identified as that of mandatory credit allocation of 1992- 1996 which stipulates that every bank must give 20 percent of its total credits to SMEs, banks’ pre-consolidation era from 1997 to 2005 and banks’ post consolidation period from 2006 to date which liberalised lending to small businesses.

The study found that in the between 1992 and 1996 Nigerian granted an average of 28.6 % of its total credit to SMEs. During the banks’ pre-consolidation era from 1997 to 2005, it fell to 6.5% and further slumped to 0.29% during the post consolidation period of (2006-2013). According to data from the Central Bank, it fell further to less than 0.20% between 2014 and 2015.

China presents a good example of leveraging SMEs to grow the economy. The country’s economy ramped up growth following the launching of her economic reform in 1978 on the back of SMEs.

China grew its economy by 9.75% between 1979 and 2007 making it one of the fastest growing economies in the world riding the waves of SMEs. By 2005, 99.6% of enterprises in China were SMEs

These enterprises account for 59% of GDP, 60% of total sales, 48.2% of taxes, and about 75% of employment in urban areas. SMEs’ participation in international trade and outward investment is also very significant, representing 68.85% of the total national income indicating how SMEs can be a catalyst for economic growth.

But Nigerian banks have all kinds of motivation to deny funding to small businesses. “These include desire to make huge profit from the very short term investments since their funds come from very short term deposits, credit rationing as high interest rate favours large loans because of lower administrative costs, and perception of SMEs as specially risky and likely to default even when they attempt to show that they are credit worthy,” said the study cited earlier.

Small businesses rank very low when evaluated on the basis of credit worthiness. Key indicators such as character, capacity, collateral, condition and capital do not add up.

There are also gaps in information on businesses seeking capital and financial institutions providing the capital. In comparison to big public corporations, SMEs do not publish as much financial information regarding their operations and profit forecasts are sometimes overstated.

Some categories of small businesses have also not done enough to make their operations attractive for credit.

“Most of the micro businesses in Nigeria are informal; most of these people have not formalized their businesses. The businesses are not registered, and it does not have the component of micro insurance in it,” says Dikko Umaru Radda, director general of SMEDAN at a recent training event for staff of the agency Kaduna.

Radda said further, “Most of the businesses do not even have bank accounts and it is important because, for you to grow any business in Nigeria from micro to small to medium, you need to formalize this largely informal sector, it is only when you formalize that you can grow them.”

While the high credit risk involved in lending to SMEs by Nigerian banks is a valid reason to carefully consider granting credit to SMEs, but the banks too have failed to take advantage of mechanisms provided by Nigerian regulation to minimise credit risks.

De-risking Lending to SMEs

One effective risk mitigating factor for lending to operations of small businesses is the operations of Microfinance Banks (MFBs). These microcredit institutions have tools and expertise in micro loan operations.

Through the provision of collateral security in the form of land or any other valuable asset, business records, credit history and close supervision, MFIs help to check high rate of default.

Nigeria’s Central Bank in 2010 began series of reforms to position MFBs into profitable ventures. Their capital base was raised by 500% and licenses of 224 unsuitable operators were revoked. These actions have restored sanity to the sector with positive results. By 2016, MFBs have provided N214 billion worth of loans to SMEs which constitute 100% of their loan portfolio.

In July, Citibank granted N500m loan to Accion Microfinance Bank to fund the MFB’s loan portfolio and support the development of approximately 5,000 micro and small enterprises in the country.

“We hope that other financial institutions will emulate Citibank by providing loans to the Microfinance banks which will, in turn, ensure that we truly meet the credit needs of the average Nigerian entrepreneur,” said Bunmi Lawson, MD/CEO Accion MFB.

Loans like this would enable the MFB to expand its financial services to a larger number of micro-entrepreneurs across the country. Some like Diamond Bank and Stanbic IBTC have good programmes to support MFBs.

In the insurance industry, the Credit Derivate Instruments (CDI) has created a mechanism by which banks and other credit-giving institutions are able to mitigate the risks associated with the loans granted customers.

“The premise for this idea is a belief that once the credit risk is removed, the lenders would be more willing to advance loans to businesses. Thus spurring increased economic activities and ultimately, economic growth,” said analysts at Perchstone & Graeys, a legal firm based in Lagos.

A CDI allows for the transfer of credit risk without the necessity of transferring the underlying asset, i.e. bank loan, says the law firm. The instrument most commonly used is the Credit Default Swap (CDS).

Under this arrangement, the lender and the insurance company enter into a contract whereby the lender pays a regular premium to the insurance company to provide cover against the default risk of the borrower. So that, where the borrower defaults, the insurance company would pay to the lender an agreed amount of money to compensate the lender for the default, says the law firm.

This concept seems to be getting attention from the right quarters. Last year, Waheed Olagunju, managing director, Bank of Industry (BoI), said ten insurance firms had already been shortlisted and agreed to collaborate on the new initiative.

Olagunju told journalists that the BOI wants to see how insurance companies can insure and protect the loans that the agency grants to SMEs, so they are able to repay premiums to insurance companies and secure their loans at the 2016 National insurance Conference, organised by the Insurance Industry Consultative Council (IICC).

By the terms of the arrangement, NAICOM would work with BOI to provide a framework to ensure that risks are shared effectively and efficiently, so that when there are claims, they’ll be able to honour their obligations with the BOI.

“So the more viable enterprises that we are able to promote and support, the more the customers the insurance companies would also have-so it will be a win-win situation because if the customer is doing well and is able to honour his or her obligation to the Bank of Industry, then that same person will also be able to honour his obligation to the insurance company,” said Olagunju,

Nigeria’s Bank of Industry (BoI) has dedicated funds for SMEs at single-digit interest rates but business owners often decry difficulty in accessing the fund. The difficulty usually stem from their inability to provide needed documentation including tax receipts, audited accounts and evidence of good corporate governance practices.

Scaling Down Debts

Experts say the best way to improve credit to SMEs is to allow market forces dictate interest rates at the same time growing the economy by diversifying it away from oil. Banks consider inflation rates, cost of capital and the cost of doing business to arrive at sustainable lending rates.

“There’s a need to come up with a strategic way to reduce interest rates for both the government and the private sector,” Bismarck Rewane, CEO of advisory firm, Financial Derivatives Company (FDC) told BusinessDay.

“It is difficult for businesses to make profit when interest rates are as high as 30 percent,” Rewane said. “You can’t fight an economic recession without allowing interest rates ease,” in order to enhance credit flow.

At some point, the Federal Government must realise that debts have a cost. After the CBN Monetary Policy Meeting (MPC) in May this year, the apex bank warned that the borrowing activities of the federal government, has outpaced target for the 2017 fiscal year.

Godwin Emefiele, CBN governor, said the Net Domestic Credit, (NDC) – the sum of net claims on the central government and on other sectors of the domestic economy – grew by 1.40 per cent in April, annualized to 4.21 per cent, which is significantly below the 17.93 per cent provisional growth benchmark for 2017.

However, net credit to government, grew by 24.08 per cent over end-December 2016, representing an annualized growth of 72 per cent, said the nation’s top banker.

“The Committee was concerned that credit to government continued to outpace the programmed target of 33.12 per cent for fiscal 2017, while credit to the private sector declined considerably far below the programmed target of 14.88 per cent,” reads a communiqué released at the meeting.

But at some point something has to give. “We cannot borrow anymore, we just have to generate enough to fund our budget” lamented Kemi Adeosun, finance minister, adding that the government needs to “mobilise revenue to fund the necessary budget increase” and this would be mostly drawn from tax.

It will also involve doing actually more about diversifying the economy away from oil rather than just talking about it.



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