IMPACT OF FORMAL AND INFORMAL MICRO FINANCE ON SMALL SCALE ENTERPRISES IN NIGERIA

Abstract

This research paper investigates the impact of formal and informal micro finance on small scale enterprises in Nigeria. The study employs data from Nigeria Investment Climate Survey or Enterprises Survey for 2014 to conduct the analysis. The dataset contains information on firm level access to formal and informal micro credit, firm performance indicators as well as other firm level characteristics. The method of propensity score matching (PSM) and multiple regression analysis were employed in data analysis. Overall, the findings show that formal micro credit has positive and significant impact on the performance indicators of micro enterprises. The propensity score matching results shows that there is significant impact of micro credit on the output performance. There is also positive and statistically significant impact of micro credit on labour employment, employment growth and investment for business expansion. The multiple regression results show that formal micro credit has positive and significant impact on all selected performance indicators namely output, employment growth, employment and capacity utilization. These findings are robust even after controlling  for  informal  credit.  The  findings  also  show  that  informal credit  does  not  have positive and significant impact on the firm performance indicators after controlling for formal micro credit. The summary of the overall results is that formal micro finance is important for the growth of small businesses in Nigeria. The policy implication of these findings among others is that there is the need to make credit available to small firms that need such funds. One way to do this effectively is through the formal micro finance institutions.

CHAPTER ONE

INTRODUCTION

1.1.     Background Information

Finance has continued to play a central role in the existence of business enterprises regardless of whether it is small, medium or large enterprise. Supporting small scale businesses through soft loans has gained global recognition since the huge successes recorded in micro lending activities in many developing Asian economies (World Bank, 2012). The development of adequate and sustainable access to financial services for the economically active poor has been recognised (CBN, 2013) as a major challenge facing many developing economies, and fast becoming an important condition for achieving robust economic development. The exclusion of access to the active poor from the financial services that conventional financial institutions provide has always been attributed to the risks and costs of rendering such services.

Micro finance has recorded successes in some developing countries that have continued to be the reference point. Some of the developing countries that pioneered the field of micro finance by successfully challenging the conventional wisdom are Bangladesh and Indonesia, two countries from Asia that may be called best practices from the Asian continent. A developing South American  country, Peru, and Kenya from Africa, in addition, serve as good examples  and lessons. Notable among the specialized NGOs through which they achieved successes are the Grameen Bank (Bangladesh), Bank Rayat Indonesia, Unit Desat (Indonesia), and Kenya Rural Enterprise Programme (popularly called K-Rep) (CBN, 2013).

The success stories of microfinance has led to the establishment of micro finance institutions in many countries and Nigeria is one country with many formal micro finance institutions popularly called microfinance banks. Many micro and small enterprises are believed to have benefitted from the lending activities of these institutions. Apart from the lending activities of the formal micro finance institutions, informal lending is very popular in Nigeria and is also the oldest type of lending. Informal lending which includes borrowing from friends, family members, borrowing

from money lenders, depletion of savings, and so on has provided soft and easy loans to small businesses although sometimes the collateral requirements may be difficult. Informal lending accounts for over 60% of the sources of finance to small scale enterprises in Nigeria and yet its relevance is always not recognised and encouraged.

In another vein, the history of micro finance bank in Nigeria came as a result of perceived deficiencies in the existing financing schemes for the poor and small businesses. In Nigeria, it has always existed since time immemorial, mainly through informal micro finance activities, but there were no established government policies and mechanisms for regulating and supervising activities in the sector. The Central Bank of Nigeria (2004) observed that the inability of the formal  financial  institutions  to  provide  financial  services  to  both  the  urban  and  rural  poor induced  the  growth  of  microfinance  institutions.  Hence  the  modern  day  micro  finance institutions provide access to credit for both the rural and urban low-income-earners.

However, the informal micro finance institutions made up self-help groups, savings collectors and co-operative societies generally, have limited outreach due to paucity of loanable funds. The major access to credit in the informal financial sector gives people access to credit through lending and borrowing directly from friends and family members, informal associations, daily contributions, money lenders, and through cooperatives arrangements like “Esusu” or “Isusu” or “Osusu” or Adashi (indigenous system of credit and thrift society among Nigerians). The Esusu is a contribution based savings scheme, which is operated on the basis of rotating savings and loans association. This is common in Nigeria especially among rural dwellers. Daily or Periodic Contribution looks like a savings scheme amongst traders in which an agreed amount of money is paid daily to convener, agreed upon by the traders.

Therefore, the presence of a large informal finance sector in Nigeria had been blamed on several factors, some of which are; population concentration in rural areas most of which are unbanked, low literary level, loss of confidence in the banking system due to distress, elitist banking practices and absence of other financial institutions in the rural areas (Acha, 2012).

It is in the light of this that CBN, in consultation with other relevant agencies, included the microfinance policy as one of its initiatives that started in 2004. The policy was designed to boost capacity of micro, small and medium enterprises towards economic growth and development through financial intermediation (Nwaogazi, 2010).

In December, 2005, the micro finance policy, regulatory and supervisory framework for Nigeria was released by the Central Bank of Nigeria. Its main objective is to support the delivery of very small, uncollaterized or less than normally collaterized loans or other financial services such as savings or insurance for low income clients. In spite of these programs and policies, most of the poor  entrepreneurs  are  yet  to  have  access  to  micro  finance  thereby,  making  civil  servants dominate the market rather than entrepreneurs who indulge in micro businesses. This is due to the inability of these entrepreneurs to provide the necessary collaterals for loans.  The civil servants would always use their place of work to obtain loan while the principal and the interest rate are being deducted gradually from the persons salary (account). Because of this, micro finance banks find it more confident giving loans to civil servants rather than players in micro businesses.

Therefore, in 2007, CBN reviewed its policy and formally licensed existing community banks and NGO microfinance institutions to begin operations in 2007 with the existing community banks and NGO microfinance institutions that met the conditions spelt out by CBN for licensing were allowed to transmute into microfinance banks. To qualify for a microfinance license an existing community bank was required to increase its paid-up capital from N5m to N20m. Unlike the community banking policy framework which compulsorily confined all community banks to unit banking, the microfinance banking guideline permitted the branching of microfinance banks within a state. For the microfinance banks intending to open branches within a state their paid-up capital was put at N1 billion (Acha, 2012).

As a result of this, the number of formal micro finance banks increased overtime in Nigeria. This can be seen summarily in the figure (Fig.1) given below:

Fig.1: Number of Microfinance Banks

902

Number of Microfinance Banks

881

769 774

828 801 821

883

825

891

611

745 693 674

552 550

747

753 757 750 709 733

334

Source: Authors’ computation from CBN Bulletin (2014)

From fig.1 above it can be seen that the number of micro finance banks in Nigeria fluctuated over the years. It was 334 in 1992 but skyrocated to 902 in 1994 but fall gradually until it reached 550 in 1999. After this period, it rose to 881 in the year 2000 but reduced to 747 in 2001. Between 2002 and 2008, it fluctuated around 769 and 733 but in 2009, it rose to 828. In 2010, it fall to 801 but continued to fluctuate until it reached its apex in 2014 with the number of microfinance banks amounting to 891.

Consequently, changes in the policy framework establishing microfinance were due to the perceived failure of the existing microfinance framework. However, despite decades of public provision and direction of provision of microcredit, policy orientation, and the entry of new players, the supply of microcredit is still inadequate.

Small and medium Enterprises (SMEs) are key drivers of growth and development in developing economies through their employment generation and poverty alleviation activities. SMEs are viewed as important elements in the quest for sustained economic growth in Nigeria. According to CBN (2014), ‘in contributing meaningfully to economic development, access to finance by SME operators has become critical, especially as these SMEs have to reply on Deposit Money Banks and other financial institutions for investment financing.” CBN (2014) further argues that

finance constraint ismore pronounced among very small firms, with 59 percent of small firms reporting difficulties in accessing finance, 35 percent of medium firms and 11 percent of the large SME firms facing difficulties with access to credit.

1.2.     The problem Statement

Despite the proliferation of micro finance institutions in Nigeria and more than N80 billion naira debts owed to the institutions, the performance of micro and small enterprises in Nigeria is far from being impressive. The idea is that micro finance institutions were created to help small businesses get soft loans to fund their activities at affordable terms. This would eventually help micro and small businesses metamorphose into medium enterprises in the long run. According to Moruf (2013) the major purpose of Micro Finance Banks is to direct attention of purveying credit to low income group and Micro, Small and Medium Enterprises (MSMEs).A review of SME financing in Nigeria has shown that funding for the sub-sector is derived from deposit money banks, micro finance banks, governments and agencies in the form of soft loans and interventions (CBN, 2014). A World Bank report (2012) further showed that only 3 percent of SMEs working capital, 2 percent of their fixed assets was financed from private funding sources thus creating a huge financing gap to the public sector.

Some researchers (Akanji 2006; Oladejo 2008) have observed that with the establishment of community banking system the Micro Small and Medium Enterprises access to credit had greatly improved. But on the contrary what is being observed in the case of Nigeria is micro finance that is dominated by lending to no business sector such as civil servants and politicians in order to fund their consumption or political activities. As a result, more and more of micro enterprises are being left out of micro finance lending (Dada and Salisu, 2008) because of their inability to provide reasonable collateral  or high  rate of default  of these enterprises  when  it  comes  to repayment.

In general, even though micro finance banks have continued to grant credit, access to micro finance loans has not been easy for small and micro enterprises in Nigeria (Arogundade, 2010) due to a number of reasons including collateral issues, policy bottleneck, poor knowledge of bookkeeping, and lack of trust in group membership when it comes to group loan. My personal

experience as an operator of MFB is that obtaining loan of any amount from the bank requires one form of collateral or another even when it is being given by the government or central bank of Nigeria via any micro finance bank. Even though the government might always announce to the public that it does not require collateral yet in practice, a collateral or sort of guarantee that will be equally seen as collateral will be required. In Enugu State for instance, loan to SME’s below N500,000 is said not to require collateral. But such loans will be required to be guaranteed by civil servant of not less than grade level 11, who will guarantee the small enterprise with his undated cheques. This equally means that the loan is collaterised with the civil servants salary. This makes it difficult for those who do not have relations in civil services of up to such grade level access the loan. Thus, many critics show that microfinance does not reach the poorest of the poor (Scully, 2004), or that the poorest are deliberately excluded from microfinance programs (Simanowitz, 2002; Moruf, 2013).

The policy of the Central bank of Nigeria (CBN, 2005) has it that every loan above N50,000 must be collaterised. However, the CBN equally goes on introducing products that do not require collateral for microfinance bank’s without amending the policy. Hence while giving out these amounts in bulk to banks, the banks are expected to fully collaterise the amount with CBN and give out without collateral in small amount to artisans or microfinance customers. But in practice it is difficult for the banks to equally give out such loans without collateral because CBN does not guarantee the payment of such loan’s in case of any default.

Most small and micro businesses do not keep proper record of transactions and yet they need financing from a formal institution. Unfortunately to such enterprises, banks do not give out loans, which they are not sure of recovering. Therefore some measure of evidence of the profitability and continuity of any business is required and as a guarantee, that the business can pay back whatever you put into it. Without proper bookkeeping it would be hard to convince formal lenders on the viability of the business in terms of turnover ratio and profitability.

While little attention has been given to the impact of formal micro finance activities on small scale enterprises in Nigeria, the impact of informal micro finance activities on the performance of small scale businesses is under studied. While the Central Bank and other regulatory bodies in

the financial sector have continued to emphasize the importance of the formal micro lending institutions and how to sustain these institutions little attention is given to how lending activities of the micro finance institutions impact on small scale enterprises.

Empirical literature abounds in Nigeria as well. While, Olusanya et al (2014), Ijaiya (2011), Onyebinama and Onyebinama (2010), Oluyombo (2011), Lawal and Abdullahi (2011) and Oloyode (2008) examined how Informal microfinances impacted on the performance, development and growth of SMEs, there were many other studies that looked at SMEs in general. They include; Akande (2012), Akande and Yinus (2015), Duru and Ogbe (2013), Kogi State, Oleka et al (2014), Olaniyi (2011), Olowe et al., (2013), Abiola (2012), Yusuf et al., (2014), Ndife (2013), Ojelabi et al (2015), Ashamu (2014) and Idowu (2011). It is worthy of note that most of these studies were done at state and regional level. Only Abiola (2012) and Onyebinama and Onyebinama (2010) seem to have covered nationwide but their sample sizes are relatively very small and prone to bias. Also, most of these studies used descriptive analysis with a few others that use multiple regression analysis, ANOVA and correlation analysis. However, very little has been done on the impact of formal and informal micro finance on the performance of small scale enterprises using countrywide survey. It could be that most of the successes recorded by the small businesses in Nigeria may have resulted from informal sources of funding.Hence, this research work adds value to existing finance and business performance literature by jointly studying formal and informal sources of microfinance on the performance of small scale businesses in Nigeria.

1.3.     Research Questions

i.          How does lending by formal micro finance institutions impact on the performance of small scale enterprises in Nigeria?

ii.         How does lending by informal micro finance institutions impact on the performance of small scale enterprises in Nigeria?

iii.        Does formal micro finance lending have any significant impact on the performance of small scale businesses after controlling for informal lending?

1.4.     Research Objectives

The broad objective of this research work is to ascertain the impact of micro finance lending on the performance of small scale enterprises in Nigeria. The specific objectives are:

i.          To ascertain how formal micro finance lending impact on the performance of small scale enterprises in Nigeria.

ii.         To ascertain how informal microfinance institutions impact on the performance of small scale enterprises in Nigeria.

iii.        To ascertain if formal micro finance lending has any significant impact on small scale businesses after accounting for informal micro lending.

1.5.     Research Hypotheses

H01:  Formal  micro  finance  has  no  significant  impact  on  the  performance  of  small  scale businesses in Nigeria.

H02: Informal micro lending has no significant impact on the performance of small scale businesses in Nigeria.

H03: Formal micro lending does not have significant impact on the performance of enterprises after controlling for informal sector lending.

1.6.     Scope of the Study

This study covers the 26 states of the Federation selected from the 6 geopolitical zones as contained in the Nigeria Enterprises Survey 2014 dataset which the study intends to use in this research. Covering all the 26 states from which data were collected will make it possible to estimate the models with enough observations on both formal and informal lending. The enterprise survey covers about 2,676 micro, small, medium and large enterprises and about 60% of the enterprises in the sample are small firms. The dataset contains important variables that can be used to measure firm performance such as output per worker, profit, capacity utilization, investment in fixed assets among others. Full description of the data is provided in the methodology chapter.

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