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That’s a major drawback for enterprises in Nigeria. Businesses can’t always rely on their own cash flows to meet urgent or operational expansion needs; and if they don’t find financial support from other sources, there’s a reduced chance that they’ll sustain or raise productivity. This hurts the economy as a whole. SMEs have contributed about 48% of Nigeria’s GDP over the past five years. If their growth is constrained by a paucity of funds, the economy will fail to attain its potential. But if small businesses are this important, why aren’t they receiving the financial backing they crave?
Why Traditional Financial Institutions Don’t Lend to More Businesses
Banks say that many loan requests don’t meet their criteria. Loan applicants may fail to present a business plan, or may have one that isn’t properly prepared; their accounting records may be inadequate. Poor credit history, a faulty business model, and the lack of suitable collateral are other reasons often cited by banks. But these don’t cover the extent of banks’ reluctance to provide credit to small businesses. At the heart of their wariness, there’s the fear that SMEs are a risky investment. They are more likely to fail, compared to bigger companies. Financial institutions point to numerous instances in which loans have been wasted or deployed injudiciously. They say that voluntary repayment rates are often too low to justify expanding loans to SMEs. This perceived risk is reflected in the interest rates attached to bank loans. Often in double-digit territory, these rates constitute a prohibitively high cost of credit in the eyes of most would-be loan applicants. About 50% of businesses reject loans due to interest repayment terms, according to a PwC survey.Popular Alternatives to Traditional Financing
The principal source of external funding for Nigeria’s small businesses is the family and friends of the entrepreneurs who own them. Almost half the population of SMEs in Nigeria receives this type of support.Sign up to the Connect Nigeria daily newsletter
But it comes with drawbacks, including the possibility of frictions in relationships due to the ‘interference’ of lenders in the borrowers’ business. Personal savings are an option for a segment of the small business demographic. But given the country’s low savings capacity, the amounts generated via this means are often insufficient to meet business needs.
More Alternative Funding Sources
SMEs are now reaching beyond their immediate circles for the financial support they need. They are taking advantage of funding programs set up by local and international organizations, such as the Tony Elumelu Foundation (TEF), the African Women’s Development Fund (AWDF), GroFin, and the AYEEN financial grants. Government-backed institutions are also stepping in to provide funding at single-digit interest rates. The Bank of Industry and the Lagos State Employment Trust Fund (LSETF) are two prominent examples. Several digital lending platforms (such as Lidya, Renmoney, and Carbon) have sprung up within the past decade. They offer small businesses loans, often without collateral. The relative ease and comfort with which these loans can be accessed make such platforms an attractive option for SMEs. Venture capital firms are also increasingly active in Nigeria’s business landscape. They are identifying and investing in more businesses with significant potential for growth. Angel investors are playing a similar role.A Lasting Solution to the SME Funding Gap
Unfortunately, these solutions won’t cover the needs of all 41 million SMEs in the country. And there’s no silver bullet to eliminate the challenge of funding SMEs in Nigeria. Any successful approach to closing the small business funding gap will have to be multi-pronged and involve all parties concerned—including financial institutions, government, and the businesses they seek to help. Businesses have to improve their internal management and operations. Business planning and financial record keeping should be a priority. Entrepreneurs should run with viable business models, and cut waste where it exists. With stronger leadership and management practices, many barriers to receiving external financial support can be removed. Financial institutions can minimize lending risk by adopting Machine Learning and Artificial Intelligence technologies that can help them model and analyze individual credit risk. This should enable them to better identify entities that are likely to meet their obligations and offer them loans on better terms. The government could also encourage banks to lend more to businesses. There’s recently been some action in this direction, with the CBN increasing banks’ Loan-to-Deposit Ratio (LDR) from 60% to 65% in 2019. More, preferably incentive-driven measures could considerably improve the lending situation with SMEs in Nigeria. Featured Image Source: WeeTrackerGot a suggestion? Contact us: editor@connectnigeria.com
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