Banks are generally wary of providing credit to the SME sector due to many issues including lack of collateral and identification. As such, microfinance loans in Nigeria provide the funding needed by 32 million SMEs in Nigeria to grow their business and the economy.
What is a Microfinance loan?
Microfinance is the business of providing financial services to vast numbers of poor people in developing economies. Microfinance loans in Nigeria to poor individuals promotes entrepreneurship. These individuals lack collateral (assets on which they can borrow), steady employment or a verifiable credit history. They cannot meet even the most minimal qualifications to gain access to traditional financial services.
Three features distinguish microfinance from other formal financial products:
- smallness of loans and savings,
- absence or reduced emphasis on collateral, and
- simplicity of operations.
The history of Microfinance
Microfinance has been a success story since starting in 1970s, pioneered by Grameen Bank in Bangladesh. Microfinance was seen as the private sector successor to state-owned agricultural development banks. They had been present in developing countries from the 1950s, providing subsidized agricultural credit to small and marginal farmers in hopes of raising productivity and incomes. But in this they largely failed.
During the 1980s, micro enterprise credit concentrated on providing loans to poor women (considered a safer and more conscientious customer base than men) to invest in tiny businesses, enabling them to accumulate assets and raise household income and welfare. Grameen Bank was able to build its success by serving a tightly-knit population and initially requiring groups of borrowers to guarantee loans to their individual members.
There are over 4,000 microfinance institution (MFIs) serving over 150 million people in 100 developing countries, with about $30 billion out on loan and $15 billion in deposits. Seven out of 10 are in Asia and two out of 10 in Latin America. The bulk of MFIs are found in India and Bangladesh (home to a third of the world’s poorest people) but the top 50 MFIs are found in countries as diverse as morocco, Ecuador, Ethiopia, Serbia, Bosnia and Herzegovina as well as Russia.
Challenges facing the Microfinance industry in Nigeria
The microfinance industry in Nigeria faces challenges. The first is outreach – the ability of an MFI to reach poorer and more remote people. But while microfinance has achieved a great deal, especially in urban and near-urban areas and with entrepreneurial families, its progress in delivering financial services in less densely populated rural areas has been slow.
The second is sustainability – the ability of MFIs to cover their costs, in particular the transaction costs of lending very small amounts to very many people. It’s an issue faced by all retail commercial banks – the operating costs of maintaining customer accounts. There is a break-even point in providing loans or deposits below which banks lose money on each transaction they make. Poor people usually fall below it and this is compounded amongst thinly-spread rural populations where the cost of a rural branch network is prohibitive.
MFIs survive by charging high rates of interest which can appear abusive, especially when the borrowers are poor. But lending small amounts of money is expensive. Since microloans tend to be for short periods, annualized interest rates may appear high. MFIs argue that they are preferable to moneylenders extorting many times as much. Interest rate ceilings intended to reduce exploitative practices can actually hurt poor people by preventing MFIs from covering their costs, which in turn chokes off the supply of credit.
Funnily enough, those most affected, the micro borrowers themselves, are least concerned. They prefer to stick with the moneylenders they are familiar with. They are prepared to pay high interest rates for services like quick loan disbursement, confidentiality and flexible repayment schedules.
They don’t always see lower interest rates as adequate compensation for having to attend meetings, to undertake training courses to qualify for disbursements, or to make monthly collateral contributions. They also don’t like being forced to pretend they are borrowing to start a business, when they often borrow for other reasons (such as school fees, health costs or the family food bill).
Issues specific to CBN microfinance institutions include:
- weak internal controls and lack of deposit insurance schemes
- absence of ICT
- weak capital base
- low training level of staff
- high interest rate charged
- low financial inclusion rate
- low financial literacy
- lending to unsuitable customers
Providers of Microfinance loans in Nigeria
Currently there is a vast array of MFBs in Nigeria (over 1000 with over 200 in Lagos) which include unit MFBs, state MFBs and national MFBs. Collectively MFBs are much smaller than the banks with a total lending portfolio of N 53 billion (USD 342 million) to the sector. Regulations by the Central Bank of Nigeria require MFBs to lend at least 80% of their loan portfolio to micro enterprises. The National Association of Microfinance Banks NAMB’s 900 member banks in 2012 generated NGN 125 billion (USD 770 million) in revenue for a total of NGN 97 billion (USD 600 million) in disbursed microloans to a client list of approximately 6 million members.
Developments in the Microfinance industry
Microfinance is attracting a flow of private sector money from institutional investors and has even led to securitization issues, refinancing microloan portfolios through the bond market. Multilateral agencies (especially parts of the world Bank) have also provided funding to MFIs at below-market rates. The widespread success of the microfinance movement has made the traditional banking industry realize that microcredit borrowers should be more correctly categorized as pre-bankable.
The slow progress in developing quality savings service for poor people has led to peer-to-peer platforms which enable individual lenders in the developed world to provide microloans directly to borrowers (also called P2P loans). P2P lenders are also known as direct or marketplace lenders and they operate in developed markets too.