Bullion Bullion

Volume 25 Number 3 Article 3

9-2001

Financial small-scale business under the new CBN directive and Financial small-scale business under the new CBN directive and

its likely impact on industrial growth of the Nigerian economy. its likely impact on industrial growth of the Nigerian economy.

O. J. Nnanna

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Recommended Citation Recommended Citation Nnanna, O. J. (2001). Financing small-scale business under the new CBN directive and its likely impact on industrial growth of the Nigerian economy. CBN Bullion, 25(3), 7-11.

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JULY/SEPTEMBER,2OOl.Volume25No.3

*Dr. O. J. Nnanna is the acting Director of Research, CBN. The Paper was presented at a Banking Conference in Lagos,June 2001 . The contributions of Mr C. M. Anyanwu, Asst. Director and other colleagues are aclcnowledged.

INTRODUCTION

JJ conomy of scale is a theorYf{ which is oreciicated on the

-l.L /notion that "big is better"while "small is bad." Thus, theview that large firms were the cor-nerstone of the modern economyprevailed for the better part of the20th century (ADCG, 2000).Small enterprises were seen asoutmoded and synonimous withtechnological and economicbackwardness, although almostall businesses were small beforethey became "big." Of recent,however, this view has changedand the important role of smallscale enterprises in industrial andeconomic development has beenrecognised.

Evidence around the world in-dicate that small scale enterprisesprovide an effective means ofstimulating indigenous entrepre-neurship, enhancing greater em-ployment opportunities per unit ofcapital invested and aiding thedevelopment of local technologY(Sule. 1986: World Bank 1995).Through their wide dispersal, theyprovide an effective means ofmitigating rural-urban migrationand resource utilization. Further-more, by producing intermediateproducts for use in large scaleenterprises, small scale enter-prises contribute to the strength-ening of industrial linkages.

Typically, small enterprisesare known to adapt with greaterease under difficult and changingcircumstances because their lowcapital intensity allow productlines and inputs to be chanced atrelatively low cost. Also, they en-joy a competitive advantage overlarge enterprises in servicing dis-persed local markets and produc-tion of various goods with low

FINANCING SMALL SCALE BUSINESSES UNDER THE

CBN DIREGTIVE AND ITS LIKELY IMPACT ON INDUST

GROWTH OF THE NIGERIAN ECONOMYBY

O. J. NNANNA, Ph.D*

scale economies for niche mar-kets, as well as serving as veri-table means of mobilisation andutilization of domestic savings.These explain the increased in-terest which developing countrieshave shown in the promotion ofsmall and medium enterprises(SMEs) since the 1970s.Programmes of assist-ance, es-pecially, in the areas of finance,extension and advisory services,training and provision of infra-structure have been designed bythe Nigerian governments for thedevelopment of SMEs to enhancethe attainment of these develop-ment objectives. Despite govern-ments' interests and support forthe sector in the recent past, lackof adequate financing andinfrastructural constraints contin-ued to hamper the develop-mentof the sector.

The significance of finance inthe drive for economic growth isfairly well established and gener-ally accepted. For instance, thetake-off and efficient performanceof any industrial enterprise, be itsmall or large, will require the pro-vision of funds for its capita-lisation, working capital and reha-bilitation needs, as well as for thecreation of new investments. Apartfrom the entrepreneur, funds arerequired to bring together theother factors of production - land,labour and capital -before pro-duction can take place. Provisionof funds to the industrial sector,particularly, for the SMEs has,therefore, been of prime interestto policy-makers in both the pub-lic and private sectors. Succes-sive governments in Nigeria have,since the last three decades,shown great interest in me financ-ing of SMEs, by establishing

NEWRIAL

Dr. O. J. NNANNAspecialised banks and othercredit agencies/schemes to pro-vide customised funding to thesub-sector. Most of these institu-tional arrangements have, how-ever, performed below expecta-tions over the years owing to op-erational bottlenecks. The failureof most of the schemes and theneed for a sustainable source offinancing small scale industries(SSls), therefore, necessitatedthe recent Central Bank of Nige-ria (CBN) inspired Bankers' Com-mittee initiative which is aimed atcommitting the banking industryto the provision of finance andother ancillary support to the sub-sector.

This paper, therefore, at-tempts to articulate the prospectsof the current drive to ensure ef-ficient and sustainable credit de-livery system to the SSls. The restof the paper is divided into threebroad sections. The first sectionreviews and appraises past fi-nancing prog-rammes / schemes,highlighting the major constraintson their performance. The currentinitiative of the Bankers' Commit-tee is discussed in section two,focussing on its likely impact andunderscoring the needed comple-

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mentary policy measures. Sectionthree summa-rises and concludesthe paper.

1 . REVIEWAND APPRAiSAL OFSMEs FINANCING PRo-GRAMMES/SCHEMES

1.1 A Brief Review and Ap--./ praisal

ln order to encourage thegrowth of small and medium scaleenterprises, successive adminis-trations have over the years em-ployed: monetary, fiscal and in-dustrial policy measures at themacro level and financing ar-rangements at the micro level, toassist the development of SMEsin Nigeria. These include interalia:

i. providing local financethrough its agencies - FederallVlinistry of lndustry, Central Bankof Nigeria (CBN). Nigerian lndus-trial Development Bank (NIDB),Nigerian Bank for Commerce andlndustry (NBCI). Nigeria Export-lmport Bank (NEXIM), etc

ii facilitating and guaranteeingexternal finance through theWorld Bank, African DevelopmentBank and other international in-stitutions willing and capable ofassisting SMEs:

iii setting up of the National Eco-nomic Reconstruction Fund(NERFUND) which was a sourceof medium to long term local andforeign loans for SMEs. The out-come of sonle of these fundingarrangements in support of SMEsin Nigeria are reviewed and ap-praised below:

(i) Small Scale lndustriesCredit Scheme (SSTCS)The Federal Government

through the Federal Ministry of ln-dustry setup, in 1971, a Small ln-d ustries Development Programmeto provide technical and financialsupport for SMEs. This led to theestablishment of the Small lndus-tries Credit Committee (SICC) toadminister the Small lndustriesCredit Fund (SICF) throughout thecountry. The SICF was formally

launched as the Small Scale ln-dustries Credit Scheme (SStCS) inthe Third National DevelopmentPlan, 1975-1980. The schemewhich operated as a matchinggrant arrangement between theFederal and State Governmentswas designed to make creditavailable, in liberal terms, toSMEs and was managed by theStates' [Vlinistries of lndustry,Trade and Cooperatives throughthe Loan [Vlanagement Commit-tees (LMCs). The scheme hadmaturing periods ranging from 4to 10 years, including a morato-rium of 2lo 4 years, and the for-eign exchange risk was borne bythe Federal Government. Thescheme was largely unsuccessfulbecause of the dearth of execu-tive capacity to appraise, super-vise and monitor projects. As aresult, many unviable projectswere funded, resulting in massiveloan repayment default. Conse-quently, the scheme which wasexpected to be revolving becameprogressively starved of fundsand had to be stopped in 1979,following the withdrawal of theFederal Government.

ii Central Bank of Nigeria (CBN)As part of its developmental

functions, the CBN has since the1970s been instrumental to thepromotion and development ofSMEs, particularly, through itscredit guidelines which requiredthat commercial and merchantbanks allocate a minimum stipu-lated credit to sectors classifiedas'preferred,' including theSMEs. For instance, the CBN inthe 1979/80 fiscal year directedthat at least 1 0 per cent of theloans advanced to indigenousborrowers should be allocated toS[ttlEs. This was subsequentlyraised to 16 and 20 per cent oftotal loans and advances in April1980 and 1990, respectively. How-ever, given the excessive defaultrate and cumbersome administra-tion of such loans. banks pre-ferred to pay prescribed penaltiesfor non compliance, rather thanchannel credit to the SMEs. Thefailure of the banks to meet theprescribed credit allocation led

the CBN to mandate such default-ing banks, as from 1987 to makesuch tending shortfalls availableto it, for onward transfer to thesector through the NBCI.

As a result of the impositionof sanctions by the CBN, includ-ing mandatory transfer of lendingshortfalls by defaulting banks,most commercial and merchantbanks complied with CBN direc-tives, leading to credit expansionto SIVEs and micro enterprises.For example, banks' loans andadvances to these enterprisesrose from tV]113.4 million in 1980to N5,900, N42,302.1 andN46,824.00 million in 1990, 1996and '1999, respectively. This rep-resented 1.5, 22.9,26.8 and '13.8per cent of total bank loans andadvances in those years. respec-tively. The sectoral credit alloca-tion policy to preferred sectorswas, however, discontinued in Oc-tober, 1996. following the fullliberalisation of the financial sec-tor. ln spite of this, the CBN con-tinued its support for the sector.For example, recently it agreedwith the banks operating in Nige-ria to set aside 10 per cent of theirprofit before tax for equity invest-ments in small scale industries.

iii Nigerian Bank for Com-merce and lndustry NBCIThe NBCI was set up by the

Federal Government through De-cree 22 of 1973 to provide,among other things. financial ser-vices to the indigenous businesscommunity, particularly SMEs.The NBCI operated as the apexfinancial body for SMEs. lt alsoadministered the SMEl WorldBank Loan Scheme. As the mainFederal Government instrumentfor SME credit provision, the NBCIapproved a total of 797 projectswith a credit value amounting toN965.5 million between 1973 and1989 and disbursed N141.32 mil-lion between 1987 and 1988.Also, the Bank financed a total of126 projects under the WorldBank Loan Scheme. Some were,however, cancelled for the failureof project sponsors to contributetheir counterpart funding. TheNBCI has, however, suffered ma-

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jor operalional problems culminat-ing in a state of insolvencY since1 989.

iv Nigerian lndustrial DeveloP'ment Bank (NIDB)Although NIDB was estab-

lished mainly to Provide creditand other assistance to mediumand large-scale enterPrises,small-scale businesses with totalassets and working caPital of uP

to N750,000 have also been ac-commodated by the Bank. An at-tractive feature of NIDB's financ-ing is its policy of equity partici-pation in the paid up share capi-tal of some of the projects it fi-nanced. lt disbursed a total ofN174.6 million to the SSls be-tween 1980 and 19BB and wasalso responsible for the bulk ofcredit delivery to StVlEs under SMEll loans scheme, accounting formore than 80 per cent of the totalnumber of disbursements underthe scheme. Arising from financialand other constraints, NIDB'S di-rect project approval and dis-bursement to the sub-sectorsince 1989 has, however, beenlow.

v. World Bank SME ll LoanSchemeln order to encou rage the

emergence of a new generationof viable investments and ser-vices as well as improve the qual-ity and range of financial and ex-tension services available SI\IEs,The Federal Government se-cured a World Bank loan of$270.0 million in 1988. The CBNestablished an SME Apex Unit in1990 to administer the credit com-ponents and other related activi-ties for the World Bank loan inorder to facilitate project imple-mentation. The SME Apex Officeapproved a total of 211 projectsvalued at US$132.8 million be-tween 1990 and end March 1994when projects approval stopped.Total disbursements of $107.1million as at June 1996 resultedin the establishment of 85 newSMEs and the expansion, diver-sification and modernisation of102 existing ones.

vi. National Economic Recon'struction Fund (NERFUND)

The Federal Government es-tablished the National EconomicReconstruction Fund (NERFUND)in 1989 to provide soft, mediumto long term funds for whollY Ni-gerian owned SMEs in manufac-turing, agro-allied enterPrises,mining, quarrying, industrial suP-port services, equipment leasingand other ancillary projects. Theresources of NERFUND weremainly contributions from the Fed-eral Government, the CBN andforeign sources, including a

US$50 million loan from the gov-errrntent of former Czechoslova-kia and U5$230 million from theADB. NERFUND funded a total of474 projects between 198ga nd 1 995, wh ile between 1 996and 1998 only 87 projects wereapproved. From its inception to1998, NERFUND disbursed aboutUS$144.9 million and N68'1.5 mil-lion to approved projects. Despitethese successes, NERFUNDfaced a number of problems, in-cluding poor loan recovery rateand low demand for loans af-terl 990 because of concern forforeign exchange risk which wasborne by borrowers.

vii). The Capital Market:ln order to deal with the bias ofthe capita market in favour oflarge enterprises, the Second TierSecurities Market (SSM) was es-tablished in 1985 to assist smalland medium sized indigenous en-terprises to access funds from thecapital market for expansion andmodernisation. Available data re-veal that the number SMSs listedon the SSM have risen to about20, while 4 moved to the main listof the market.

1.2 SOME LINGERING CON.STRA!NTS ON SMALL BUSINSSFINANCING

Despite the effforts made atproviding finance and ensuringthat the regulatory environment isconducive, though the repealingof regulations that were inimicalto orderly growth and develop-ment of small businesses, thereare still areas that have not been

adequately addressed. Some ofthese areas are discussed below:

'l.Lack of Depth of the Finan-cial SytemThe support which SMEs have sofar received from the financialsystem is grossly inadequate.The system has not attained thedesired level of sophistication tofacilitate the funding of SMEs.Recent studies by the United Na-tions Dvelopment Programme(UNDP) and the Federal Ministryof lndustry (FMl) revealed that1036 out of the 't498 SMEs (or69.20o/o) surveyed were fundedby personal savings and only 3.6per cent obtained credit facilitiesfrom banks. Banks are unwillingto do business with SSls becausethey are perceived as high riskventures. As a result, workingcapital is still a major constrainton production, as most SMEs arerestricted to funds from familymembers and friends and aretherefore unable to respondtimely to unanticipated chal-lenges. Similarly, the Stock Ex-change is yet to appreciably ac-commodate the long term finan-cial needs of the SMEs. This hasbeen attributed to low awareness,as well as SMEs aversion to own-ership dilution and disclosure ofinformation.

iii) lnadequate lnfrastructuralBaselnadequate provision of es-

sential services such as telecom-munication. access roads, elec-tricity and water supply consti-tutes one of the greatest con-straint to SME development. MostSMEs resort to private provision-ing of these facilities at greatcosts, thereby reducing availablefunds for their operations. AWorld Bank Study (1989), esti-mated that such cost accountedfor 15 - 20 per cent of the cost ofestablishing a small scale enter-prise in Nigeria. This is likely tobe much higher today, given thehigh level of deterioration of ourbasic infrastructure. Contempo-rary evidence have shown that therelative burden of the compensa-tory provision of infrastructural fa-

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Volume 25 No. 3 JULY/SEPTEMBER,2OOI.

cilities is much heavier on SMEsthan on large enterprises.

(iii) Poor Management practicesand Low EntrepreneurialSkillslVlany S tM Es do not keep

proper accounts of transactions.This hinders effective control andplanning [Vloreover, lack of rel-evant educational backgroundand thorough business exposureconstrain their ability to seizebusiness opportunities that couldlead to growth and expansion.

(iv) Distress in the BankingSector

The distress in the bankingindustry adversely affected theperformance of SMEs. ln particu-lar, those that were sponsored bythe distressed banks could notprovide working capital for theiroperations. The need to reviewexisting financing arrangementand fashion out new relationshipswith healthy banks continues topose challenges to the SttlEs.

(v) Overbearing Regulatoryand Operational Environ-ment

The plethora of regulatoryagencies, multiple taxes, cumber-some importation procedures andhigh port charges have continuedto exert serious burden on the op-erations of the SMEs. Many SMEshave to deal with myriad of agen-cies at great cost.

2.THE CURRENT INITIATIVE OFTHE BANKERS'COMMITTEE

2.1 The Banks' lnitiativeThe need for a sustainable

source of financing for SSls. fol-lowing the failure of various ar-rangements described above,necessitated the Bankers' Com-mittee initiative, with the CBN asthe prime mover. Under thescheme, all banks in Nigeria arerequired to set aside 10.0 percent of their annual profit beforetax for equity investments in smallscale industries (SSls). A compre-hensive Report on the prog-

ramme produced by a consultanthas been discussed and acceptedby the Bankers' Committee, whilethe guidelines for operations arebeing finalised. lt is estimated thataggregate pre-tax profit of bankswould be about N573.7 billion inthe first five years. 2001 - 2OOS.and 10.0 per cent of that sumwould be N57.37 billion. This is asubstantial amount that could re-vive the small industry sector if allthe stakeholders play their rolesas expected. The initiative, in ad-dition to providing finance, alsorequires banks to identify, de-velop and package viable indus-tries with the entrepreneurs.Through the scheme, banks areexpected to spearhead the re-structuring and financing or refi-nancing of SSls. many of whichare now moribund, owing partly topoor funding. ln order to give fur-ther support to the initiative, theCentral Bank has contacted thelnternational Finance Corporation(lFC) which has agreed to bringin resources for on-lendingthrough the banks, when an en-abling environment has been cre-ated.

2.2 SOME LIKELY IMPACTOF THE CURREN INITIA.TIVElf the scheme is well managed,

the Bankers' Committee initiativehas good prospects of fosteringan enduring private sector led fi-nancing support for a viablesmall-scale industry sector whichis needed to provided a solid in-digenous base from the nation'sindustrialisation drive. lt would,among other things:

(a) Boost and Deepen SMI Fi-nancingThe programme is expected to

reverse the age-long lukewarmattitude of the banking sector inmeeting the credit needs of theSMls. Substantial funds will bepooled annually from the bankingsector to boost SMI operations.This is aside of the anticipatedIFC financing in foreign exchane

which would further deepensources of financing in the coun-try.

(b) Facilitate Access to TheCapital MarketAccess to the capital market

will be facilitated as the Bankers,initiative is expected to broadenequity participation in SMls,thereby resolving operator,scharacteristic aversion to disclo-sure and ownership dilution.Through this, the prospects formany more SMls satisfying thelisting requirements on the Sec-ond Tier Market (SSM) and exist-ing ones moving to the First Tierof the market appear bright.

(c) Stimulate Activities in theSub-SectorWith enhanced funding and

improved infrastructural facilities,capacity utilization in existing firmswould be boosted and this wouldprovide incentive for prospectiveinvestors, thereby stimulating pro-ductive activities in the eco-nomy.The step-up activities will inturn facilitate employment gen-eration and utilization of local re-sources for which small industriesare noted for, wih the attendantmultiplier effects on the overalleconomy.

(d) Widen Banks' ServiceDelivery to the Economy

The new initiative provides averitable avenue for all the banksin the country to participate in theownership of business enter-prises through equity participa-tion, thereby widening their ser-vice delivery to the economy. ln-creased availability of equitycapital to SMls will in turn helpin restructuring their capitalbases for revival and growth.

(e) lmprove Operators' Man-agement Practices

As the new initiative wouldinfluence banks to be involvedin the ownership of enterprises,there will be improvement in themanagement practices of SMls.

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For instance, with banks' exPertadvice, the Problem of Poorrecord keeping and lack of ad-equate delianation of owners'funds from enterPrises would be

overcome, leading to efficientmanagement of such busi-nesses and growth of entrePre-neurship in the economY.

(f) Reduce Rate of DefaultAs banks. under normal cir-

cumstances, would ensureproper loan administration andmonitoring, the erstwhile notionof seeing every loan facility asnational cake will be mitigated,thereby reducing the rate of de-fa u lt.

2.2 Complementary PolicyProposals

ln order to ensure that the ob-jectives of the new initiative isachieved and the pitfalls of pastschemes avoided, the fundingscheme needs to be comple-mented with other remedialmeasures to address some ofthe constraints earlier identi-fied. These include:

Creation of an SMI Window infhe New Bank for lndustryThe emerging corporation fromthe proposed merger of thethree development financial in-stitutions (NlDB, NBCI andNERFUND) should operate as a

financial conglomerate with dif-ferent windows. A windowshould be specifically createdto serve as a successor schemeto the SME ll loan programmeto provide additional medium tolong-term funding.

Establishment of SME CreditGuarantee SchemeThe proposed credit guaranteescheme meant to relieve thebanks of some risks that are in-herent in SME financing shouldbe implemented expeditiously.As an entry point, the currentAgricultural Credit GuaranteeScheme (ACGS) could be ex-panded to incorporate SSls,

through apProPriate legal re-forms.

Creation and Susfenance ofEnabling Environmentln order to reduce the cost ofoperations for both the SMI oP-

erators and credit deliverYagencies, adequate infrast-ructural facilities should be pro-vided and sustained. This willinclude good road network,regular and constant electricitYand water supply, as well as ad-equate security surveillance toensure the security of lives andprope rty.

3. SUMMARY AND CONCLUs/oN

ln this paper, an attempt hasbeen made to assess the likelyimpact of the CBN driven, bank-ing sector financing initiative. inthis regard, a review and ap-praisal of government's past ef-forts at establishing financingschemes and programmes di-rected al the StvlEs sub-sectorwas found to have performedless satisfactorily - largely be-cause of operational bottle-necks, including lack of depthof the f inancial system, inad-equate infrastructural facilities,poor management practicesand low entrepreneurial skill, tomention but a few. The Bankers'Committee initiative which wasnecessitated partly by pastprogramme failures and also bythe need for evolving a sustain-able source of financing, there-fore, possesses great poten-tials if it is well implemented,with adequate complementarypolicy measures. We are opti-mistic that the initiative shalllead to the funding of SMEs ona sustainable basis

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