2

3

4

5

6

7

through this funding window. After a series of consultations held with various

stakeholders, CBN has come out with revised guidelines of MDF in December, 20152.

Though there are improvements in various areas, aimed at enhancing the utilizations,

sustainability of this funding still remains a critical issue. The MDF seeks to address

provision of the Revised Microfinance Policy to provide for the wholesale funding

requirements of MFBs/MFIs. If sustainability still remains an issue for the MFBs/MFIs,

then the broader objective of enhancing women’s access to financial services to eliminate

gender disparity may also be not very successful.

2. Review of Empirical studies and Literature

Globally, MSMEs are recognized as driver of growth of any economy. They not only add

to the national income, they also generate massive employment in the economies. As per

an IFC Issue Brief3, SMEs account for about 90 percent of businesses and provide more

than 50 percent of employment worldwide. They are key engines of job creation and

economic growth in developing countries, particularly following the global financial

crisis of 2007-2008. This view also holds true for the Nigerian economy (Ogechukwu,

2009). The CBN Governor, during the opening ceremony of the seventh Annual Bankers’

Committee Retreat4, in December 2015 had said that SMEs are seen as drivers of growth

and that the Nigerian banking sector must play an active role in supporting the MSMEs in

the economy.

It is in realization of the significant role of MSMEs in the development of economies that

not only developing economies but also developed economies place emphasis on the

promotion, development and finance of MSMEs. The European Commission5 considers

SMEs and entrepreneurship as key to ensuring economic growth, innovation, job creation,

and social integration in the EU, as SMEs represent 99% of all business in EU! The

Nigerian Government, on developing its MSME policy, relies on the global studies and

best practices (UNCTAD, 2012)

A number of studies have been conducted to understand the requirements of MSMEs

(Forbes6, 2014; EFInA, 2014; MSME Report, Government of Nigeria, 2015; FATE

Foundation, MSME Report, 2015) as well as the problems faced by them and understand

the prospects of developing them (Fatai, 2009). While there are a number of factors at

macro level or country-wide level, there are also MSME specific factors, which need

targeted resolution (Bain and IIF, 2013). In Nigeria, for example, macro level or country-

wide factors relate to infrastructure such as power, transportation, security, etc. MSME

specific factors relate to technology, finance, market, competitiveness, etc. (CBN, 2016;

Oyeyinka, 2014)

2 www.cenbank.org/Out/2015/CCD/MSMEDF-Nov-2015_WIP%20161215_b.pdf 3 http://www.ifc.org/wps/wcm/connect/277d1680486a831abec2fff995bd23db/AM11IFC+IssueBrief_SME.pdf 4 http://businessnews.com.ng/2015/12/14/banks-not-doing-enough-to-support-smes-emefiele/ 5 http://ec.europa.eu/growth/smes/ 6 http://www.forbes.com/sites/babson/2014/04/03/what-do-small-businesses-really-need-to-grow/#19ebdd688bc7

8

Of all the problems facing MSMEs, financial constraint, which has been sought to be

addressed by most governments and Development Finance Institutions, has appeared to

be the most critical. Government interventions are often required to address deficiencies

in the enabling environment and residual market failures for enhancing SMEs access to

financing. There is often a mismatch between the demand for funding by MSMEs and

supply of financial services. This gap is less serious for formal MSMEs than for the

informal ones (World Bank, 2010), notwithstanding the fact that it is the informal SMEs

that largely impact the lives of majority of population of developing world. Despite the

fact that the need for promotion and finance of MSMEs is more significant and critical in

developing world (UNCTAD, 2001), the inability of MSMEs to obtain finance for

growth and expansion is more pronounced in developing economies (Dalberg Report,

2011). Often, even when debt funding becomes available, equity and venture finance

remains a big issue in the funding requirements of MSMEs in developing countries,

Nigeria inclusive (Abereijo & Fayomi, 2005; Terungwa, 2011)

Development of product, whether tangible or intangible, leading to a widely accepted

product, is a complicated process. This is evident in failure of products, especially in

modern times of technological evolution. Despite this complication, in modern day, it is

possible to use non-linear means for development of financial product (Naudé, Blackman,

Dengler, 1998) like MSME Development Fund. Linear theme of product development

implies that certain steps precede, or are preceded by, others. A variety of linear models

exist (Booz-Allen and Hamilton, 1982; Bowers, 1986; Cooper, 1988; Johnson et al.,

1986; Kotler, 1983).

Unlike earlier days of product development, when it was assumed that customers are not

well informed and products needed to be pushed (Wright and Cracknell, 2005), the

contemporary view is to have more customer centered products and services (Keith,

1960). It is important to understand the needs of customers or users properly to ensure the

sustainability of the product (Keelson, 2012; Britzelmaier et al, 2013). One of the

important factors that may be leading to lower draw-down rate of MDF by PFIs could be

lack of full understanding of the needs and requirements of PFIs, which are supposed to

eventually disburse to MSMEs. While developing product for microfinance sector, a four

stage process of product development had been suggested by Brand (Brand, 2001).

Similar to what is happening with MDF, The Tanzania Postal Bank had launched a

product with insufficient research resulting in less than expected positive result of uptake

of that product (Wright et al ., 2006).

While developing a product to ensure that every stakeholder has incentive in the usage of

the product, the most critical aspect of the product needs to be kept in mind. For MSMEs,

it’s not the cost of credit but the access to credit which is more important (OECD, 2006).

It’s a similar expectation for farming community (UNEP FI, 2008).

9

For higher MDF uptake, CBN can consider putting emphasis more on timely provision of

fund, and in required quantity, rather than on the cost of the loan to the MSME client.

2.1 What is MSME and why is the development of MSMEs important?

MSMEs play vital role in any economy, especially in terms of providing employment and

generating economic growth. The role of MSMEs is more critical in developing

economies, like Nigeria, where more development is required at the bottom of the

pyramid. It is because of significant contribution of MSMEs in the development of

nations that globally, not only major developing countries like China, India, Brazil, etc.

but also developed countries place strong emphasis on the development of the MSME

sector.

As per the 2013 National MSMEs Survey of Nigeria7 published in May 2015, there are

about 37.07 million MSMEs that contribute 48.5% to GDP growth and 7.3% to exports.

MSMEs employ about 59.7 million persons, representing 84% of the total labour force of

Nigeria. MSMEs in Nigeria are categorized along the lines defined in Table 1 below:

Table 1: Definition of different categories of MSMEs in Nigeria

Size Category Employment (Persons) Assets (N million)*

Micro Enterprises Less than 10 Less than 5

Small Enterprises 10 to 49 5 to less than 50

Medium Enterprises 50 to 199 50 to less than 500

*Excludes investment in land and buildings

The 2013 MSME8 Survey notes that apart from the broader role played by MSMEs in

GDP growth and employment generation, promotion and development of MSME is also

significant because MSMEs, and especially micro and small enterprises:

a. Require low level of capital, a scare resource in developing economy, to establish

them

b. Guarantee employment for a large number of persons, as these are numerous in the

economy and these use labour intensive production techniques.

c. commonly use and deploy inventions, adaptations, and general technological

development

d. help in a more equitable distribution of income in the society

e. assure industrial diversification and a relatively more balanced regional development

f. promote the evolution of indigenous enterprise amongst these establishments

g. contribute to general enhancement of the tempo of industrial development

h. become feeders of large-scale enterprises and service products made by the latter.

7 www.nigerianstat.gov.ng/pages/download/290 8 ibid

10

As can be seen above, MSMEs play an important role in not only economic growth but

also social development. The development and nurturing of MSMEs are important not

only for MSMEs themselves but also for other stakeholders who gain from the progress

and development of MSMEs.

These stakeholders are many and they not only contribute to the development of MSMEs

but also benefit from the progress and developments of MSMEs. The Figure 1 below

illustrates the stakeholders of MSMEs.

Fig 1: Stakeholders in MSME Development

It is in recognition of the significance of the role played by MSMEs, that various

governments have been taking initiatives to promote, develop and finance them. The new

MDF guideline9 outlines the roles and expectations, especially in relation to the

development of MSMEs in the context of MDF, of most of the stakeholders, as illustrated

in Figure 1above.

2.2 Challenges faced by MSMEs in Nigeria

The MSMEs that are able to survive in the long run and to operate in a sustainable way

are those which are able to derive value out of their operation. Like any other segment of

economy, MSMEs also have a value chain that they use for creating value and generating

profit.

The value chain of a typically incorporated MSME, is as illustrated in Figure 2 below:

9 ibid

Stake in Development

of MSME

Regulators (CBN, SEC, etc.)

and Government (Federal

and State)

Social Groups

and Public in

general

Communities,

where MSME

operates

Business Partners,

suppliers, vendors

Employees

and Directors

Lenders and

Investors

End users/Customers of

products and services

of MSMEs

Industry peers

and forward

linked Enterprises

11

Fig 2: Value chain process of typical MSMEs

(Source: http://www.mbaskool.com/business- concepts/marketing-and-strategy-

terms/2516-porter-value-chain.html)

The Value Chain analysis diagram illustrated above, in a way, also depicts some of the

major challenges faced by MSMEs. Broadly, these challenges can be grouped under input

category and output category. The categorization of challenges can also be viewed as

those appearing in different stages of production and post-production as summarized in

Table 2 below:

Table 2: Major challenges faced by MSMEs

Inputs:

Output:

• Raw material – quantity, quality,

price

• Technology

• Management skills

• Human Resources

• Finance

• Quality of product

• Marketing of finished product –

market linkages

While poor infrastructure, lack of other inputs and inadequate market linkages are key

factors which have constrained growth of the sector, it is the lack of adequate and timely

access to finance that is, unarguably, one of the biggest challenges. The financing needs

of the sector depend on the size of operation, industry, customer segment and stage of

development. Even though funding needs of MSMEs are growing, formal lending

institutions have only limited lending facility for MSMEs.

12

Financial institutions have limited their exposure to the sector due to a higher risk

perception and limited access of MSMEs to immovable collateral. Experiences of

Financial Institutions regarding their loans becoming NPAs have also restrained them

from having bigger exposure by way of loans to MSMEs. Apart from providing access to

finance, other priority areas where MSMEs need assistance are provision of infrastructure

and access to regular supply of power and water.

2.3 Background and Features of MSME Development Fund

The MDF was created in 2013 and the provisions of the instrument that created it were

revised for the first time in August 2014. The Fund was created in line with the concept

contained in Section 6.10 of the Revised Microfinance Policy, Regulatory and

Supervisory Framework for Nigeria, which had stipulated that ‘a Microfinance

Development Fund shall be set up, primarily to provide for the wholesale funding

requirements of MFBs/MFIs’. To fulfill the provisions of Section 4.2 (iv) of the Policy,

which stipulates that women’s access to financial services increase by at least 15 per cent

annually to eliminate gender disparity, 60 per cent of the Fund’s total loanable funds has

been earmarked for providing financial services to women.

The broad objective of the Fund10 is to channel low interest funds to the MSME sub-

sector of the Nigerian economy through PFIs with a view to:

• Making it possible for MSMEs have enhanced access to financial services;

• Increasing productivity and output of microenterprises;

• Increasing employment and create wealth; and

• Engendering inclusive growth

It is expected that this funding opportunity available to MSMEs will impact on the

Nigerian economy through employment creation and enhanced economic activity, which,

in turn, would lead to increase in the country’s GDP and its growth rate. The MDF

consists of two components, namely, the commercial component and the development

component.

The commercial component, which is ninety (90) percent of the Fund, will be disbursed

to Participating Financial Institutions (PFIs) at 2% p.a. This component will be used by

PFIs to on-lend at an interest rate not exceeding 9% p.a. to MSMEs. The development

component, which is the remaining ten (10) percent of the Fund, will be used for

developmental objectives such as for providing grants, for capacity building and for

meeting the administrative costs of the Fund.

2.4 Modifications in MSME Development Fund in November, 2015 – A

Comparative Analysis

10 http://www.cenbank.org/MSME/

13

The Guidelines were revised for the first time in August 2014. Deriving from wider

consultation with various stakeholders in the MSME sub sector in Nigeria, the CBN

again revised and published the Micro, Small and Medium Enterprises Development

Fund (MSMEDF) Guidelines11 through its Development Finance Department in

December, 2015 (Revised document is dated, November, 2015). While a few areas of

revisions are quite positive, there are still areas of concern, which makes one to believe

that these revisions may not lead to any quantum leap in the rate of utilization of the Fund.

The most significant changes in the latest guidelines, as compared to the revised

guidelines of August, 2014, and the impact of those changes are as articulated here under.

i. Change - The revised guidelines makes specific provision that 10% of the Fund

would go towards funding Start-up businesses. Restrictive clause contained in the

earlier guidelines (2014) which had stipulated that only new SMEs were allowed to

be financed by Deposit Money Banks (DMBs) under the MSMEDF has been

removed from the new guidelines.

Impact – a) There is focus on start-up businesses in line with global recognition of

the successes of start-up businesses, especially in the area of ICT

b) Existing SMEs can be financed by DMBs

ii. Change - Qualifications of the PFI for obtaining grants (10% of the Fund has been

earmarked for developmental programmes in form of Grants) have been changed.

Earlier, PFIs were to qualify for the grant component based on their performance

rating in poverty reduction, job creation and financial inclusion. Now, in order to

qualify for the grant, PFIs shall be considered based on their outreach, loan

repayment and percentage of women enterprises financed.

Impact - Rationalization of qualifications would lead to grants being targeted to

deserving PFIs

iii. Change – 2014 guidelines had indicated the eligible services for microenterprises

that could be financed such as hotels, schools, restaurants, laundry, etc. This

specification of services has been done away with in the new guidelines to ensure

wider coverage.

Impact - Though, the list of services was only indicative, a few PFIs interpreted the

list of services to be restrictive. With the removal of even the indicative list all

services can be funded.

iv. Change – Coverage of Insurance for Agriculture - The new guideline has added that

insurance coverage by the “Nigerian Agricultural Insurance Corporation (NAIC)

Insurance is compulsory for primary agricultural production”

11 http://www.cenbank.org/Out/2015/CCD/MSMEDF-Nov-2015_WIP%20161215_b.pdf

14

Impact - With insurance coverage, the risk of lending to the agro-allied sub-sector

would be mitigated

v. Change – Submission of documents required by Microfinance Banks & Finance

Companies, while applying for funding has been rationalized.

The new guideline has done away with the earlier requirements such as:

a) Acceptable Risk Management Framework

b) Sound Corporate Governance Culture indicated by:

i) Adherence to Ethical Values

ii) Degree of separation of ownership from control/management

iii) Number of non-performing insider-related facilities

iv) Compliance with up-to-date and timely rendition of monthly returns to the

CBN as stipulated in the Revised Microfinance Policy, Regulatory and

Supervisory Framework for Nigeria.

While doing away with these required submissions, additional requirements, as

itemized here under, have been put in place:

a) Certificate of Incorporation or Registration

b) Board Resolution or Trustee consent to access the Fund

Similar conditions for Microfinance Institutions (NGO-MFIs and Financial

Cooperatives) and Deposit Money Banks (DMBs)/ Development Finance

Institutions (DFIs) have also been done away with to simplify the procedure.

Impact – PFIs would find it easier to apply for loans under MSME Development

Fund. CBN would expect to have a higher draw-down rate and better utilization of

the Fund.

vi. Change – While the loan tenor (fund received from CBN) has been retained (the

facility shall have a maximum tenor of one (1) year for micro enterprises and up to

five (5) years for SMEs with an option of moratorium), the new guideline has clearly

specified that “Principal and Interest repayment for micro and SME loans shall be

annually”.

Impact - The implication is that there would be bullet repayment of loans (with

interest payment at the end of the tenor) by borrowers for micro-enterprises.

vii. Change – Interest rate - while the on-lending rate by PFIs has been retained at 9%

per annum, inclusive of all charges, the rate of interest at which PFIs borrow from the

CBN has been brought down from 3% p.a. to 2% p.a.

Impact - The cost of borrowing by PFIs has declined by 33% p.a., thus making this

line of credit more attractive to them

viii. Change – Collateral – The new guideline stipulates that Acceptable Collateral from

PFIs (excluding DMBs and DFIs) under the Fund would be a minimum of 30% of the

loan amount requested. This has been reduced from the earlier requirement of 75% of

the loan amount. There is further relaxation for performing MFBs; collateral shall be

15

waived for Microfinance Banks with Portfolio at Risk (PAR) of 10% and below, as

indicated in their latest CBN/NDIC Examination Report.

The new guideline has an additional provision that acceptable collateral from DMBs

would be a “Signed MoU with CBN and undertaking to bear all credit risks for

projects presented”

Impact - These steps would facilitate drawn-down of funds. Perhaps, the larger

message is also to the banking sector that lending to the Microfinance Sector can be

considered without collateral (if MFBs have better quality of assets, i.e. PAR<10%)

ix. Change – Provide impetus to start-ups, especially those who do not have tangible

collateral to offer. To this end, the new guideline stipulates that:

a) Collateral requirement from start-ups by PFIs (DMBs and DFIs) shall be

educational certificates such as SSCE, National Diploma (ND), National

Certificate of Education (NCE), National Business and Technical Examination

Board (NABTEB), Higher National Diploma (HND), University degree (NYSC

Certificate where applicable) and a guarantor. The start-ups to access the

MSMEDF must present their Bank Verification Number (BVN)

b) Venture Capital Firms (VCFs) that wish to finance start-ups in form of equity

participation shall be eligible to access the MSMEDF at 2% for investment in

start-up projects. The collateral for such facility to the VCF shall be bank

guarantee.

c) To encourage DMBs and DFIs to fund start-up projects, some incentives shall

apply:

(i) DMBs/DFIs playing in this space, shall access MSMEDF facility at 0%

interest for on-lending at 9% (all-inclusive) to start-ups.

(ii) The PFIs shall qualify for a 50% risk shared on the net outstanding balance in

the case of default.

Impact - This is really an innovative and ground-breaking modification in the

guidelines. Changing the nature of collateral required to be submitted by start-ups,

especially from the educated unemployed youth, who may not have tangible/cash

collateral, will help initiate a movement of start-ups in Nigeria. Funding by VCFs in

the country will also get boosted.

x. Change – In view of the observed low patronage of the Fund by PFIs, the earlier

incentives that provided for higher amount (2-4 times of earlier loans) of loans

(within lesser time of 4-8 working days) to PFIs on timely repayment of earlier loan

has been done away with.

Impact - This shows revision of earlier assumptions that once CBN gets flooded with

demand for funding, performing PFIs would be encouraged to further access the

Fund. In view of the limited demand for funding by PFIs having regard to the store

reality, this stipulation has been done away with.

16

xi. Change – Sanctions for DMBs/DFIs on infractions have also been revised. For

example, as per the new guideline, “Established cases of collusion with other PFIs to

either divert monies into private accounts or unduly with-hold any part or outright

conversion of the purpose of the released funds by DMBs under the MSMEDF shall

attract a penalty of MPR+300 basis points at the time of infraction”.

Earlier, such Diversion of funds by DMBs attracted a penalty at the bank’s prime

lending rate at the time of infraction.

Impact - With the provision of penalty of “MPR+300 basis points at the time of

infraction” the guideline has been now linked to the Monetary Policy Rate. This will

likely minimized the likelihood of diversion of funds by PFIs

xii. Change – DMBs/DFIs now have 10 working days (as against earlier time window of

5 working days) - from the date of receipt of Fund from CBN - to disburse the fund to

the borrower.

Impact - This provides more time for PFIs to make disbursements. This would be

especially helpful to those PFIs and MFBs who have widely dispersed clients to

serve, thus possibly also raising their levels of disbursement.

xiii. Change – There are a few modifications in the new guideline that relate to the state

governments and the FCT. These include:

a) State Governments no longer have to operate a Sinking Fund Account with the CBN, into which any outstanding balance of disbursed amount shall be paid at the

expiration of the loan.

b) Clarification on - State-Special Purpose Vehicle (S-SPV). S-SPV will be an entity

established or nominated by a State Government for the sole purpose of

coordinating the activities of the PFIs that shall access funds under the MSMEDF.

A PFI is therefore not eligible to function as an S-SPV under the Fund.

Impact - Doing away with the “Sinking Fund Account with the CBN” gives more

freedom on the utilization of the Fund. The new guideline that “a PFI is not eligible to

function as an S-SPV under the Fund” has been put in to, perhaps, clarify the

misconception - that the State Governments might have had - that the PFIs could

function as an S-SPV.

Even though none can deny that a lot of thought has gone into the modification of the

guidelines of the MSMEDF and the expectation of the CBN that the Fund would have

better acceptance from PFIs leading to higher draw-down, the issue of absence of

“business case” for the PFI still remains largely unaddressed.

2.5 Evaluation of sustainability of MSME Development Fund – why is the patronage

low?

17

MDF has been conceptualized with the basic objective of meeting the financing needs of

MSMEs. At the time of conception, it seemed that the primary goal of the fund was to

provide funding to MSME at as low a rate of interest as possible. The background of this

conception was development objective of earlier CBN Funds provided for agriculture

sector, infrastructure sector, etc. This conception lacked the basic rationale that each

broad sector of the economy such as agriculture, infrastructure, industry, etc. has its own

dynamics. For example, due diligence, process of disbursement, the security covering the

loan disbursed, post-disbursement monitoring and follow-up, etc. for funding a power

project could be quite different from that of funding a microenterprise. Even for a loan to

a microenterprise, these processes of credit disbursement takes on entirely new meaning,

when an MFB provides credit to a microenterprise through group lending methodology.

Though, the revision (of Dec 2015) of the Fund’s guidelines, which brought some new

features into the revised guidelines showed some realization of the deficiencies of the

original guidelines, the basic issue of sustainability of funds for PFIs remains yet to be

yet completely sorted out. We will evaluate the sustainability issue of the Fund from the

perspective of the principal players in the Fund’s activities and will proffer suggestions to

enhance the patronage of the fund for its impact on the economy to be more meaningful.

The principal parties to the Fund’s activities are illustrated schematically in the fig 3

below:

Fig 3: Schematic illustration of the key players in the activities of the MDF

a) Sustainability for the CBN

From the lending of the MDF, the CBN earns interest income of 2% p.a. on its loans.

Given the macroeconomic factors prevalent in Nigeria, it needs to be evaluated if, strictly

on the basis of stand-alone business case, this return of 2% p.a. is enough to sustain the

maintenance of this fund by the CBN. Even though it can be argued that CBN has

developmental role to play in the economy and the Bank has to also ensure stability of the

financial markets, it must be kept in mind that there is opportunity cost for each Naira

and Kobo. Given that there would be cost of administering this Fund (which may be

partly met from the provision of 10% of the Fund that is set aside for the grant), with an

inflation rate of about 10%12, and the high cost of raising fund, it becomes important to

ponder on and indeed question the effective return on this Fund for the CBN. As per the

CBN report13, CBN Balance Sheet at the end of December, 2014 showed that outstanding

12 http://www.cenbank.org/ (Accessed on Feb 4, 2016)

13 www.cenbank.org/Out/2015/CCD/CBN/2014/Draft/IFRS/Financial/Statements/28/May/2015/

(NEW).pdf Page 76-77 of 2014 Annual report (item 29-30)

CBN

Repays

PFIs (e.g. MFBs) Borrower Clients

Lends Lends

Repays

18

of CBN Bills (money raised using open market operations in 2014) was about N2.76

trillion. This was approximately 20% of the total liability and equity of N13.74 trillion of

the CBN. Furthermore, the financial statements show14 that the “Central Bank of

Nigeria’s bills issued to commercial banks as a liquidity management tool and as a means

of implementing monetary policy have tenors ranging from 7 days - 364 days and they

carry discount rates ranging from 11.55% - 13.30% per annum.” Thus, this rate of

11.55% - 13.30% p.a. can be assumed to represent the cost of raising funds for CBN,

which, in turn, is used, at least partly, for lending under Development Funds like MDF.

Table 3 below shows the total liabilities and effort of the CBN in 2013 and 2014.

Table 3: Total Liabilities and Equity (Nm) of CBN, 2013 and 2014

Heads Notes Year 2014 Year 2013

Towards meeting the imputed cost of lending at lower than market rate of interest, the

CBN makes provisions for “financial sector intervention expenses”. This provision

represents the amortization of prepaid intervention expenses arising from the fair

valuation of below market interest rate loans to financial institutions for the purposes of

14 www.cenbank.org/Out/2015/CCD/CBN/2014/Draft/IFRS/Financial/Statements/28/May/2015/

(NEW).pdf - Page 77 of 2014 Annual report (Note 30)

19

onward lending to the agricultural sector, the AMCON notes, etc. Perhaps, the

assumption of providing loans at “below market interest rate” should be reevaluated,

especially in view of the efficiency of the Fund. We can also view, alternatively, whether

it would be more efficient for the Nigerian economy in the long run if market interest

rates were charged on the loans! It may not be a sufficiently strong argument that since

Agriculture Developmental Fund and other Development Funds have been created and

are being funded by the CBN at very low rate of interest, the MSME Development Fund

must also be funded by the CBN at a low rate of interest of 2%. Each broad sector of

Nigerian economy has its own dynamics, risk profile and requirements; all should be

taken into account before arriving at the rate of interest to be charged on the Fund

established for each.

b) Sustainability for PFIs

Primary Financial Institutions (PFIs) play a vital role in the successful operations of the

MDF. From the interaction held with a few of the PFIs, it is clear that the PFIs do not feel

motivated to borrow at 2% p.a. and lend at 9% p.a. It becomes a more serious matter

when it is realized that Microfinance Banks and Microfinance Institutions, who are main

sources of funding to micro-enterprises find it even less attractive to borrow and lend

than the Commercial Banks and Development Finance Institutions. This is mainly on

account of the differences in the operational model followed by Microfinance Banks and

Microfinance Institutions on the one hand and Commercial Banks and Development

Finance Institutions or the other. Thus, two significant challenges to the patronage of the

funds provided by the CBN, for the operations of the MDFs are:

1) Banks view lending to MSMEs as challenging (as compared to lending to big

businesses) and lending at 9% is certainly not attractive, when these Banks

normally lend at 18-20% per annum rate of interest.

2) MFBs, because of high operating expense, don’t find it economically viable to

use this fund at a margin of 7%, being the difference between their lending

rate of 9% and borrowing rate of 2%. A clearer picture of these issues can be

obtained by further analyzing the reasons for what appears to be the weak

patronage of the MDF by the Banks and the microfinance institutions.

A further examination of the perspectives of Commercial Banks and of Microfinance

Banks would make possible, a better understanding of their apparent lack of interest to

access the funding opportunities that are available under MDF.

20

i) Perspective of Banks

It is not difficult to see the alternatives to the MDF that are available to the banks. Table

4 below summarizes the inhibiting issues from the banks’ viewpoint.

Table: 4: Comparative analysis of financials of MDF for banks

MSME

Development Fund

Existing model of funding (when banks

don’t access MDF)

Cost of fund

(Liability/Exp)

Borrowing @ 2% Savings @ 2%

Return from fund

(Asset/Income)

Lend at 9% Free to lend at commercial rate of 18-22%

Even risk free investment, i.e. investing in

TB and FGN bonds could yield higher than

9% (rate at which MSME Fund is to be

lent)

Other factors such as cost of loan administration, risk in lending and recovery, etc.

remain the same for the Bank whether the money comes from CBN (through MDF) or

from depositors.

It’s not difficult to see why banks may not be very keen on accessing the MDF. Along

with the above illustrated factors, it is also a fact that banks have more deposit funds than

they can lend. This is unlike what is faced by Microfinance Banks, whose lending

portfolio is typically higher than savings deposits. The comparative asset-liability

position of MFBs/MFIs, as compared to that of commercial banks, would imply that

MFBs/MFIs would be more willing to access this cheap source of Fund! The question

then is why is the patronage of the MDF by MFIs also very low? Why are MFBs

(especially, National and State MFBs, whose requirement of fund every year is in billions

of naira) not fully accessing the MDF and utilizing the credit limits that are available for

them in the MDF Guidelines? CBN needs to understand why the MFBs, especially the

better performing ones, having PAR less than 10% want to take loans from commercial

banks in Nigeria and from international lenders at around 20% and not access this MDF

which is readily available at a much lower cost of 2%. We are of the view that the reason

lies in different methodology of credit administrative used by MFBs, which is highly

labour intensive, resulting in significantly higher cost of lending.

By flatly retaining the lending rate under MDF at 9%, for the sake of also aligning it with

other CBN intervention funds, policymakers, perhaps, show lack of full understanding

and appreciation of the fact that the dynamics of micro financing (lending and recovering

a loan of typically less than USD 500) is quite different from financing of a power project

(which would involve lending and recovering a loan of USD 500 million) by a bank.

ii) Perspective of MFB/MFI

MFBs/MFIs, like any other PFI, have a margin of just 7% (lending at 9% and borrowing

at 2%) under the MDF. Given the nature of services provided by MFBs/MFIs and the

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operational methodology typically used by MFBs/MFIs, the question to ask is, how

sustainable is this margin?

By considering a few scenarios, we can evaluate the sustainability of accessing credit

under MDF and using such credit for onward lending:

i) Typically in Nigeria, MFBs, especially those primarily serving microenterprises

have operating expense ratio (ratio of Operating Expense for a period to the

Average Gross Portfolio for the period) of about 25%-35%. Leaving aside other

aspect of cost associated with the microcredit product, if just operating a loan

(disbursement, repayment, etc.) to microenterprise under MDF gives a NET

negative margin of 20%, the question that arises then borders on the economic

and business sense in delivering such a loan product.

ii) Imagine, if 7% of the loan provided by MFBs is not recovered! After all, by

stating in the policy that the MFBs with less than 10% PAR (Portfolio at Risk)

can access MDF loans without offering any collateral to CBN, the implicit

assumption being made is that it’s not very abnormal, if upto 10% of microcredit

are not recovered on time. MFBs would not be making any return on the fund lent,

if the loan loss ratio is 7% or more

A paper published by the World Bank (CGAP)15 suggests the following formula for

calculating a sustainable rate of interest for microloans extended by microfinance

institutions in order to ensure sustainability of the credit products that they offer to their

clients:

AE + LL + CF + K - II

R = ---------------------------

(1 – LL)

The formula shows that sustainable rate of interest (the annualized effective interest rate -

R) to be charged on loan/microcredit will be a function of five elements, each expressed

as a percentage of average outstanding loan portfolio, namely, administrative expenses

(AE), loan losses (LL), the cost of funds (CF), the desired capitalization rate (K), and

investment income (II):

If, for example, admin expense ratio is 25%, loan loss is 2%, cost of fund is 21% (rates

charged by commercial banks in Nigeria, when they lend to MFBs), the desired

capitalization rate is 15% and investment income is 1.5%, then sustainable annualized

effective rate of interest (R) would be 62.8%. Ceteris Paribus, if we replace the rate of

interest applicable on loans provided by commercial banks in Nigeria with rate of interest

15 www.cgap.org/sites/default/files/CGAP-Occasional-Paper-Microcredit-Interest-Rates-Nov-

2002.pdf

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charged under MDF (2%), then sustainable annualized effective rate of interest (R)

would be 43.4%.

It is evident from above calculation that for the stipulated lending rate of CBN under

MDF (of 2%) to make business sense to MFBs, these MFBs would have to charge their

borrowers 43.4% and not 9% (as stipulated under the MDF Guidelines). It is no surprise,

therefore, that there are only a few MFBs taking advantage of the MDF; these are the

conscientious ones, who want their long associated borrowers to benefit from the MDF.

The foregoing issues surrounding the sustainable rate of interest for MFBs could be taken

as a pointer to critically review rate of interest under MDF, especially, in view of the fact

that MFBs are willing to take loans from international lenders and Nigerian commercial

banks at 20% p.a., while they are at the same time reluctant to avail themselves of the

relatively cheaper funds that are available in the MDF at just 2% p.a. rate of interest!

iii) Sustainability for Borrowers

Could there be any issue of sustainability for borrowers, who get MDF at 9%?

Apparently, 9% rate of interest on loans in Nigeria, where, the rate of inflation itself is

over 10%, implies a negative real cost of fund to the borrower. At the end of the year, the

borrower would be better-off in real terms.

If such funding could be made available in the long-term, then, obviously it would be

good for the borrowers as well as for the economy. However, if the MDF has

sustainability issues for not only PFIs, but also for the CBN and there are chances that

such funding may not become available for long run, then borrowers may have issues

bordering on the success of their project, as those projects may become dependent on and

used to low cost fund! In any case, from the borrowers’ perspective, especially

microenterprise borrowers, who may be making 5-10% return on their business on a daily

basis, it’s not the cost of fund, but the availability and timely access to required amount

of fund that is more important.

It would be pertinent to not ignore the impact that this Fund (that makes borrowing at 9%

p.a. rate of interest possible) may have on the credit discipline of those borrowers, who

are able to obtain credit under the MDF only for some time and the effect that this Fund

may have on those borrowers who are not able to get funding under MDF, but have to

borrow at more regular rates from formal sources. The dichotomous nature of lending-

borrowing environment may give rise to socio-economic issues in society.

2.6 Issue with product design

Evaluation of issues around sustainability of MSME Development Fund throws up a a

major question, namely, are there issues with the designing of the “MSME Development

Fund” product? As product designers would know, there is a process of product

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development. This process of product development is not very different for developing

new financial products, like MDF. The process can be depicted as illustrated below:

Fig 4: Process of Product Development, with feedback loop

In the age when more focused and responsive human centric designs (HCDs) are being

developed, it would be unfair to assume that designers of financial products would be

unaware about the nitty-gritty if financial products like MDF. Perhaps, various steps of

product design were not rigorously thought out in advance, or if thought out in advance,

then not fully executed at the time of designing the features of Fund (step 2 and 3 of Fig 4

above). May be it would have helped to launch a smaller Fund for a short period (step 4

of Fig 4 above) to test the uptake and reaction from takers.

The revision in MDF in 2014 and in 2015 shows that there is already a mechanism for

receiving feedback from stakeholders and incorporating the feedback in the loop of

decision making on revising the MDF guidelines. However, mechanism of feedback is

not yielding result to the extent expected to ensure larger uptake of the Fund. What needs

to be done additionally is take into account the business case, especially of the lending

MFIs, so that better utilization of the MDF can be ensured.

Unless financial sustainability, reflecting business case of the product, of any credit

programme is established and lenders see net profit generated out of the credit operation,

the PFIs may not be willing to borrow from CBN and lend to borrowers. Given the

current macroeconomic situation in Nigeria, it would be helpful if the economic growth

in Nigeria can be driven from the bottom of the economy. Proper designing of such

products as the MDF would ensure better impact on the ground created by such products.

Feedback from

stakeholders (6)

Design and

Development

(3)

Product

Launch (5)

Pilot Testing

(4)

Idea generation around

a product (MDF, for

example) (1)

Evaluation and

Preparation of

features of the

Product (2)

Revision in

features and

design (7)

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Better product designs and positive impact created by such financial products aimed at

serving the marginally served section of economy, will not only improve the economy,

but also save the country from facing socio-political problems.

3. Conclusion and Suggestion

There is no gainsaying that the broader objective of creating MDF is laudable. However,

given the response to Fund, there needs to be retrospection about the issues and

mechanism of the Fund. It is disturbing to note that many potential borrowers are

bemoaning their inability to access the Fund as envisaged by CBN and the Federal

Government. At the same time, the feedback shows that lending institutions are not

finding it attractive to borrow from CBN and lend under the terms of the Fund. Given the

challenges faced in ensuring larger disbursement of Fund to the targeted segment of

borrowers, specific recommendations and suggestions for making the MDF more

meaningful and yielding better impact could be:

a) Generally, this scheme tries to cover too many segments of industry such as

microenterprises, small scale industries, medium sector industries, etc. and involves

too many categories of lending institutions such as MFBs/MFIs, Commercial Banks,

State Governments, etc., whose model of lending are very diverse due to the nature of

their operations. It could be good idea to have different features of loans for

microenterprises as compared to those for SMEs. This would take into account

difference in client segment served by MFBs/MFIs and by Commercial Banks/DFIs

as well as the difference in lending methodology adopted by these institutions.

b) Given the current uncertainty related to payment of interest and repayment of

principal to foreign lenders by MFBs/MFIs, the CBN can consider taking over the

loans. This would mean that CBN can earn substantial returns on its loan to the

MFBs/MFIs and the MFBs/MFIs are also saved the cost, pain and risk of making

timely payment to foreign lenders.

c) Provision of lending to State Governments, who in turn can lend to PFIs, takes

cognizance of the fact that as the State Governments are more on the ground, they can

better relate with the development in their State through creation of SPV and relating

with PFIs operating in their State. However, it should be evaluated and considered

whether all the States have the same capacity to take the same loan from the CBN and

efficiently deploy with PFIs for the purpose of on-lending.

d) From the macroeconomic perspective, there is the question as to whether this

mechanism puts too much money into the economy. In addition, such questions as to

whether this mechanism leads to distortion in the credit market and whether the CBN

needs to develop a standalone mechanism to monitor the macroeconomic impact of

liquidity infused in the economy through such interventions Funds as the MDF.

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e) CBN needs to use a better iteration process for re-development of this product (MDF).

More responsive features embedded in the MDF will ensure better acceptability of the

product, leading to higher draw-down from CBN and increasing the outreach to more

MSMEs.

f) CBN and the Federal Government could consider arranging for a market survey to be

done to better understand the rate of return earned by typical micro-enterprises. A

sample survey of microenterprises like small shopkeepers, fruit and vegetable

vendors, etc. could provide insight into the return generated on their economic

activity, which, in turn, could serve as a guide in better understanding of the interest

rate that those borrowers would be willing to pay to have the microcredit facility. It

would be easier for PFIs to charge sustainable rate of interest as well as for the

regulatory authorities to monitor and check charge of usurious rates.

g) On making the rates more market based, the CBN could consider making the MDF

accessible to PFIs at TB/FGN rate of relevant tenor and ensuring that PFIs (especially,

MFBs/MFIs) are able to charge only sustainable rate from MSME borrowers.

h) Along with funding, capacity development programmes for MSMEs also need to be

provided. Such capacity development programmes would not only ensure better

utilization of the MDF but also make more meaningful the impact created in the

economy by funding MSMEs.

As a way forward, more focused research needs to be carried out to (in) validate the

assumptions of this MDF model, which include:

1) Poor people require only fund/finance

2) These people cannot afford to pay commercial rate of interest on the funding

provided to them. Does this view arises from the fact that microenterprises are

majorly owned by poor or is it that their businesses do not yield high returns?

3) Government must do something for their development, as there are no other non-

government agencies or institutions, whether private or NGO, who can help them

in development

4) Even while routing the money through the CBN, it is reasoned that because of

low creditworthiness of wholesale borrowing institutions or because of lack of

evaluation of creditworthiness of wholesale borrowing institutions, collateral must

be taken from those institutions

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