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Country reportsApril 2 2006

Untapped potential

Nigerian banks are ignoring small businesses and, without a formal microlending industry, the prospects of this changing are bleak. Stuart Theobald reports.
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Most Nigerian banks lump small business lending in with their retail businesses. The logic works like this: small businesses in Nigeria are little more than the sum of the people involved, and that usually totals one person. The massive informal sector in the country – from street traders to small scale farmers – has very little formal regulation or structure. Banks see the business as the individual running it and, without a long employment history at a blue-chip corporate, as pretty much unbankable.

The informal sector does, however, have some access to finance apart from the banks because Nigeria has a system of informal financing. Community financing, in which community members contribute to a central fund that is lent to single members in rotation, is widespread. Community pressure keeps borrowers in line and also incentivises business knowledge sharing. However, informal lending like this is completely unregulated.

Sector development

It is difficult to measure the size of the informal sector but it is certainly a substantial part of Nigeria’s economy. The Central Bank of Nigeria estimated there to be eight million enterprises in 2003. The government has been working on developing the sector since the 1980s to tap into its potential for job creation.

Many states in Nigeria run small-scale credit schemes and technical assistance agencies and there is a substantial range of government initiatives aimed at developing small businesses, ranging from credit guarantee schemes to the government-owned Bank of Industry providing wholesale funding to the banks for small business lending.

In 1999, the government pressurised the banks into accepting a scheme in which 10% of banks’ profit before tax has to be set aside for equity finance of small businesses, dubbed the Small and Medium Enterprises Equity Investment Scheme (SMEEIS). Qualifying businesses were designated as those with an asset base of less than N500m ($3.6m) and usually between 10 and 300 staff. The banks could invest in such businesses directly or through separate fund managers – a number of jointly owned venture capital firms were set up to manage investments.

Slow progress

But take-up of the SMEEIS has been slow. By September last year, N31bn had been set aside for the scheme but only 200 investments had been made, worth a total of N10bn. One exit has been achieved on an internal rate of return of 50%, according to the venture capital association of Nigeria. Bankers blame the slow pace on a lack of venture capital and private equity experience.

Last year, the scheme was restructured to allow banks to inject subordinated debt as well as equity and the contribution was switched to 10% of profit after tax, reducing to 5% after five years. Investments can be up to N200m or 40% of the equity. Political pressure from the highest level is being applied to encourage the banks to put the cash to work.

Nevertheless, Nigeria urgently needs a formal microlending industry, something none of the banks have seriously considered. For one thing, it would be impossible under the current semi-formal cap on interest rates of 17% (although banks can load fees on top of that). The absence of a credit bureau or sound identification schemes are other major obstacles. In South Africa and Botswana, microlending has become a critical ingredient in the banking mix. With the right market infrastructure in place, the Nigerian government could give up forcing banks to lend and allow market forces to do it for them.

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