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THE IMPACT
OF BANK LOANS ON SMEs IN NIGERIA
ABSTRACT
Small and
Medium enterprises are the catalyst for economic growth in most economies thus,
the fundamental objective of this study is to investigate the impact of loans
on Small and Medium Enterprises (SMEs) in Nigeria. So that the ability of SMEs
to develop positively and drive economic growth in the Nigeria will become
real. Simple random sampling technique was employed in selecting the 100 SMEs
that constituted the sample size of the research. Structured questionnaire was
designed to facilitate the acquisition of relevant data which was used for
analysis. Descriptive statistics which involves simple percentage graphical
charts and illustrations was tactically applied in data presentations and
analysis. The findings of the study reveal that significant number of the SMEs
benefitted from the loans even though only few of them were capable enough to
secure the required amount needed. Interestingly, majority of the SMEs
acknowledge positive contributions of loans towards increasing their returns
and sales thus placing them in the competitive arena. It is recommended that
Banks should review their interest rate downwards and also share best practices
with their SME customers especially on the efficient use of loans; this will
boost their productivity and support SMEs in Nigeria.
CHAPTER ONE
INTRODUCTION
1.1
Introduction and Background
In Nigeria,
available data from the Registrar General Department indicates that 90% of
companies registered are micro, small and medium enterprises (Mensah, 2004).
This target group has been identified as the catalyst for economic growth of
the country as they are a major source of income and employment to many
Nigeriaians. According to Mensah (2004) Small enterprises employ between 6 and
29 employees with fixed assets of $100 Thousand with Medium enterprises
employing between 30 and 99 employees with fixed assets of up to $1 Million,
Hallberg (2001) put forward that SMEs account for majority of firms in an
economy and a significant share of employment. Like other countries of the
world, SMEs in Nigeria have the tendency to serve as sources of livelihood to
the poor, create employment opportunities, generate income and contribute
immensely to economic growth. Small firms are the engines for economic
development of several developed countries such as the US and Japan (Hallberg,
2001).
Developing
countries such as Zimbabwe have also identified the potential of small firms to
turn economies with negative growth into vibrant ones. For this reason, several
governments in developing countries offer funding to small firms either
directly or by guaranteeing the payment of such loans as lack of funding is
cited as one of the major challenges faced by small businesses. Obert and
Olawale (2010) argues that due to limited resources by governments, not all
small firms receive funding from the government; therefore, the other option
would be to go for bank loans Obert and Olawale (2010). Despite its increasing
roles, access to credit by
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SMEs remains
one major constraint to Nigeriaian SMEs. According to Augusto et al (2008),
most large companies usually start as small enterprises, so the ability of SMEs
to develop and invest becomes crucial to any economy wishing to prosper.
Although
countries’ definitions of what constitutes an SME for legal or statistical
purposes are typically based on the number of employees, banks generally define
SMEs in terms of average annual sale; an indicator that is more easily
observable, a good proxy of an SME level of business activity, and, thus, more
useful to banks’ business and risk management purposes (Augusto et al 2008).
Augusto et al (2008) further points out that the threshold of annual sales used
by banks varies by country, according to the size of the economies and
structure of their corporate sector. Augusto et al (2008) hints that in
Argentina, a company is considered to be an SME when its average annual sales
are approximately between 300,000 and 30 million US dollars. In Chile, the
range goes from around 90,000 to 24 million US dollars.
In Colombia,
banks consider SMEs those firms with annual sales between 400,000 and 13
million US dollars (although for most domestic banks the range is between
100,000 and 5 million. In Serbia, SMEs are typically defined as having annual
sales between 500,000 and 10 million Euros. A vast number of data on SMEs in
Nigeria also suggest SMEs are more financially constrained than large firms.
For example, using data from 10,000 firms in 80 countries, Beck et al (2006)
showed that the probability that a firm rates financing as a major obstacle is
39% for small firms, 38% for medium-size firms, and 29% for large firms.
Mensah
(2004) states that a major barrier to rapid development of the SME sector is a
shortage of both debt and equity financing. However Mensah (2004) postulate
that
equity
shortage occurs because Equity investors seek highest return consistent with
2
the risk of
the investment and since SME investments are difficult to evaluate, their
investments take time to mature and among others major institutional investors
such as insurance companies are not allowed to invest in private SMEs. Hence
there are many who believe that the single most important factor constraining
the growth of the SME sector is the lack of finance.
There are
many factors that can be adduced for this lack of finance according to Mensah
(2004). For instance a relatively undeveloped financial sector with low levels
of intermediation; Lack of institutional and legal structures that facilitate
the management of SME lending risk; High cost of borrowing and rigidities
interest rates. Thus Because of the persistent financing gap, many interventions
have been launched by governments and development partners to stimulate the
flow of financing to SMEs over and above what is available from exiting private
sector financial institutions. Karimunda and Barumwete (2006) put forward the
fact that, there are several reasons why a SME need a loan such us the
financing of new branches, of new projects and more. Companies do not always
have the capacity for finance their own business that is why they have
sometimes to turn to other financers. However, when companies need new capital,
they firstly resort to their internal generated funds.
After these
sources, SMEs turn to equity financing by addressing closely related investors.
These sources exhibit very low costs and may be for example equity capital from
the owner, family or friends. Despite these, there are others types of
financing that one can use: external equity financing and external debt
financing. For SMEs, possibilities for using external equity finance are
limited since the majority of these companies are privately managed. Companies
can also use venture capitalist as alternative means of equity financing.
3
However,
these possibilities are difficult for SMEs since most of them do not always
meet the return expectations. They thereby become less attractive for this
group of investors. Other alternatives to financing are private placements and
corporate bonds. Unfortunately, these types of financing are too expensive for
SMEs or have limited resources. Therefore bank loans seem to be an appropriate
way to finance SMEs’ capital requirements and seem to be an appropriate way. As
a result, SMEs prefer most frequently debt funding by bank loans. The bank
financing is tremendously attractive and seems to be realistic and a more
reliable source to SMEs. Mensah (2004) states that recently, as banks and other
financial institutions have sought to broaden their loan portfolio, SMEs have
become an increasingly attractive customer group. Traditionally, however,
financial institutions in Nigeria have been cautious with lending to SME groups
because of high default rates and risks associated with the sector. Few banks
have therefore developed an explicit policy for SME target groups taking the
particular requirements and needs into consideration, an example is the
development of customized financial products and appropriate credit management
systems.
Only few
banks have SME specific loan products, and many of these are donor funded.
Since SMEs are scarcely finance by equity due to risk in its operation amongst
others, the last resort is thus debt financing and this is usually financed by
financial institutions through the granting of loans. Debt financing according
to Ayadi et al (2009) continues to be the primary source of financing for SMEs
in Europe, much more important than venture capital. This implies, for one
thing, that an efficient functioning of credit markets is of utmost importance
for SMEs – and the economy at large – to thrive. This problem seems to be
particularly severe in transition economies, whose catching-up may suffer from
continued wide-spread
exclusion of
SMEs from external bank finance. Of recent, there has been an increase
4
in the
recognition of the role played by small firms in national economies. Their
contribution to job creation and poverty alleviation has been recognized by
several governments of developing countries to the extent that they now include
them in their development plans.
Abor (2005)
proposed among the support structures include offering funding to the small
firms’ sector, usually at concessionary rates. But whether the use of such debt
improves the profitability, thereby enhancing sustainability, is not well known
Abor (2005). However, despite the importance of the small business sector,
access to finance is a frequently cited problem. Sources of capital are more
limited for SMEs compared to large firms.
Therefore,
unlike large, particularly publicly-listed firms, SMEs do not have the option
of issuing shares or debentures in the capital market. Even if they are allowed
to participate in the capital market, the high transaction costs associated
with publicly issued debt and equity will be too expensive for them. Owing to
their inability to access the public debt and equity markets, SMEs tend to be
heavily reliant on commercial banks as a source of debt financing (Berry et
al., 2002). Research by Berry et al. (2002), documents the reliance of SMEs on
bank debt as a source of financing. These researchers, however, point out that
access to bank debt is, paradoxically, a frequently cited challenge for SMEs.
SMEs are
often relatively new and lack a consistent track record of profitability that
would demonstrate the capability to repay a loan. In addition, many SMEs lack
assets that could be used as collateral. SMEs are also more prone to financial
distress and failure. Commercial banks, because of these factors, consider
lending to SMEs a high risk. Therefore, commercial banks often deny loans or
offer loans to SMEs at higher
rates of
interest to accommodate the perceived high credit risk of SMEs according
5
Coleman and
Cohn (2001). The inaccessibility of debt finance to SMEs can further be
attributed to information asymmetry. Rwelamila et al. (2004) indicates that
this arises when one party to a transaction has better information than the
other.
SMEs may have
more information about their future prospects than the banks. Since banks do
not have the necessary information, even small firms with profitable investment
opportunities are turned down when requesting credit facilities. Banks,
therefore, introduce restrictive covenants and also collect collateral from
small firms to mitigate this problem Bose and Cotheren (1997).The question is
what the impact of this loan on these SMEs is? Traditionally, debt finance has
been viewed as less expensive than equity. It furthermore has been used both to
decrease the average cost of capital and enhance shareholders returns.
However,
there is a negative side to debt, since interest payments must be made
regardless of market conditions. This vulnerability is an important factor that
firms must consider when making capital structure decisions. In addition Glen
(2004) states, there is a very strong economic and statistical link between
macroeconomic variables and a firm’s ability to meet debt obligations. The
macro-economic environment implies the level of aggregate demand, the level of
interest rates, and the level of inflation. A positive macro-economic
environment results in a rise in aggregate demand and positively impacts on the
ability of a firm to meet debt obligations.
The ability
to service debt becomes problematic when the macro-economic environment
deteriorates; resulting in the insolvency of firms (Glen, 2004). Rwelamila et
al. (2004) affirm that, during the early stages of starting a firm, many
owners
commit themselves to the use of debt, which might be one of the sources of
6
finance
available to them. The use of debt can be disastrous, as high interest rates
and unfavorable repayment schedules are often overlooked due to the pressure of
financing the firm.
Against this
background, the study investigates whether SMEs in developing countries can use
debt and still remain solvent in this era of high interest rates. Furthermore,
SMEs often pay interest premiums and a host of non-interest fees such as
application and other transaction fees when borrowing from commercial banks.
The cause of this is that SMEs are considered a high credit risk compared to
large firms. This high cost of funds because of increased risk increases the
costs of debt for small firms.
1.2 Problem
statement
Inferring
from the above, SMEs serve as sources of livelihood to the poor, create
employment opportunities, generate income and contribute to economic growth.
There is also the potential of small firms to turn economies with negative
growth into vibrant ones, not to mention the fact that most large companies
usually start as small enterprises, so the ability of SMEs to develop and
invest becomes crucial to any economy wishing to prosper. From the argument
above the only easier finance options for SMEs are loans (Debt financing)
assess from financial institutions, thus it’s necessary to examine the impact
of these loans on the performance of SMEs. Are they having negative or positive
impact on their performance .this is worth investigating because majority of
the businesses fall within the SME category especially in developing countries.
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1.3
Objectives
The general
objective of this work therefore is to investigate the contributions of
loans to
SMEs performance.
The specific
objectives of the study are:
To find out
what SMEs classify as disadvantages and advantages of accessing loans.
To find out
how loans provided by financial institutions are utilized by the SMEs.
To
investigate whether loans to SMEs actually lead to increase in stated
performance or otherwise.
Research
questions
What are the
disadvantages and advantages of taking a Bank Facility?
How do SMEs
utilize loans?
Do SME loans
affect performance ?
1.5
Relevance of the study
A research
of this sort is necessary with respect to the fact that;
Worldwide,
the SMEs have been accepted as the engine of economic growth and for promoting
equitable development. Thus its leverage should be of great concern.
Accessing
finance has been identified as a key element for SMEs to succeed in their drive
to build productive capacity, to compete, to create jobs and to contribute to
poverty alleviation in developing countries.
Small
business especially in Africa can rarely meet the conditions set by financial
institutions, which see SMEs as a risk because of poor guarantees and lack of
8
information
about their ability to repay loans. Without finance, SMEs cannot acquire or
absorb new technologies nor can they expand to compete in global markets or
even strike business linkages with larger firms (UNCTAD, 2002).
1.6 Research
Methodology
1.6.1 Type
of research
The research
will be descriptive in nature and employs the survey method in assessing the
impact of loans on SMEs development Nigeria. In order to effectively conduct a
valid analysis in the presentation and analysis of the data collected on the
research field, the researcher will use descriptive statistics such as tables
and charts to depict the relevant data. The study will utilize primary sources
of data in which structured questionnaire are extensively used.
The purpose
is to generate data about the opinion and perceptions of SMEs owners in
relation to the effectiveness of loans to the performance of their companies.
Thus, in addition provide means of analyzing the likely impact of loans on
SMEs.
1.7 Scope of
study
The research
covered the whole SME industry in Nigeria since one SME was picked randomly
from each sector .namely primary, secondary and tertiary. Thus making it more
representative of the overall Nigerian industrial sector.
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