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Can LendingTech Close Nigeria’s Huge SME Financing Gap?

Governor of Central Bank of Nigeria (CBN), Mr. Godwin Emefiele


Scores of traditional and lending technology firms are addressing consumers lending gaps in Nigeria. Can they apply similar strategy to close the huge SME financing gap? If they succeed, this could be a boon not only for growth and innovation, but also for broader financial inclusion

The Nigerian economy is expected to plunge into severe economic recession, the worst in almost 40 years due to the collapse of oil prices and the outbreak of the COVID-19 disease, according to the latest World Bank Nigeria Development Update (NDU). 

This was disclosed in a report released by the World Bank, titled, “Nigeria in Times of COVID-19: Laying Foundations for a Strong Recovery.” The report estimates that Nigeria’s economy would likely contract by 3.2% in 2020.

This is with the assumption that the spread of COVID-19 in Nigeria is contained by the third quarter of 2020.  However, if the spread of the virus becomes more severe, the economy could contract further.

It should be noted that the Nigerian economy was expected to grow by 2.1% in 2020 before the COVID-19 pandemic, which means that the pandemic has led to a reduction in growth by more than 5%. 

According to the report, “The macroeconomic impact of the COVID-19 pandemic will likely be significant, even if Nigeria manages to contain the spread of the virus. Oil represents more than 80% of Nigeria’s exports, 30% of its banking-sector credit, and 50% of the overall government revenue. With the drop in oil prices, government revenues are expected to fall from an already low 8% of GDP in 2019 to a projected 5% in 2020.’’

The pandemic is projected to push about five million more Nigerians into the poverty hole in 2020. When this is added to the number of already poor Nigerians who are expected to increase by about two million largely due to population growth, the number would now increase by seven million – with a poverty rate projected to rise from 40.1% in 2019 to 42.5% in 2020.

But if the country’s nearly 40 million small and medium-size enterprises (SMEs) could overcome a lack of access to funding, they could become a powerful engine of economic dynamism and recovery. Can digital innovators close the SME financing gap?

Nigeria’s government has certainly tried. Over the past decade the government has become more interested in boosting activities in the SME space and filling the financing gap left open by the private financial institutions.

Policymakers have been working to expand access to financial services for SMEs, as well as for low-income households. Measures have included the establishment of the Bank of Industry (BOI) Intervention funds, Agric Small Medium Enterprise Scheme (AGSMEIS), Development Bank of Nigeria Loans, Micro, Small and Medium Enterprises Development Fund (MSMEDF), CBN Creative Industry Fund.

The Central Bank of Nigeria (CBN) has also introduced a N50 billion Targeted Credit Facility (TCF) as a stimulus package to support households and micro, small and medium enterprises (MSMEs) that are affected by the coronavirus pandemic

Yet, despite these efforts, not up to 5% of Nigerian SMEs ever borrow from banks. One reason for this is that SMEs, while plentiful, are not always easy to find, given their small size and geographical diffusion. A more important reason is that many banks are unable to employ market-based risk pricing effectively for SMEs.

With the average Nigerian SME surviving for fewer than five years, one cannot claim that lending to them is not risky. But mandatory lower borrowing costs for SMEs mean that banks cannot use interest rates to offset the higher risks, and the government hasn’t offered compensatory subsidies.

For most of the banks, lending to SMEs means risking the health of their balance sheets. In addition, bank employees are required to take lifelong responsibility for any non-performing loans. So rather than risk extending non-performing loans (NPLs), many banks simply lie about meeting the regulatory requirement.

But even if regulators were not demanding artificially low interest rates for SMEs, the banks would struggle to implement effective risk pricing. Traditional credit-scoring models emphasize a borrower’s financial history and fixed assets (collateral), as well as any implicit government guarantee. SMEs typically don’t have any of these things.

The challenge ahead is thus twofold. In order to encourage the banks to lend more, the authorities must allow more flexible lending rates, rather than imposing excessively low interest-rate requirements that leave banks’ balance sheets vulnerable.

At the same time, the banks need to find effective ways of conducting risk assessments for SMEs. This is where digital lenders can be of great asset to the economy. The real revolution of risk assessment is happening online now with consumers lending. It is high time tech lenders adapted these innovations for SME lending.

 A technology platform records data about users’ digital footprints; cloud computing enables relevant information-sharing; and machine learning boosts speed, efficiency, and accuracy. Such tech-based credit-scoring models would be better at predicting default risk for SME loans than traditional banks’ models, for at least three reasons. First, the new models include behavioural variables and network indicators, which are more stable than balance-sheet information.

Second, they use some real-time transaction data – including on cash flows and the business environment – instead of far less up-to-date finance indicators. And, third, machine-learning methods can better capture non-linear interactive relations among individual variables than banks’ traditional linear models.

The “long tail” nature of digital technology provides an additional advantage. Once the platform is established, the marginal cost of serving additional customers is almost zero.

And, of course, digital technology works fast. The online platforms that are pioneering this approach to consumer credit – Mines, Branch, Carbon and host of others  – process loan applications almost instantly. They can extend these to SME lending with institutional supports from the government.

To be sure, there are challenges to overcome – beginning with data inequality. But this remains a more severe constraint for traditional banks, which focus only on past financial records, than online banks, which use more varied data.

Nigeria has long recognized the importance of increasing SMEs’ access to finance. It is high time Fintech lenders helped to provide solutions the country needs. This could be an advantage not only for economic growth and innovation but also for broader financial inclusion – in Nigeria and beyond.