SMEs and Banks Where is the Disconnect – Need for Financial Inclusion

What is an SME within the Nigerian Context? The Central Bank of Nigeria (CBN) define SMEs as enterprises with asset base (excluding land) of between N5 million to N500 million and labour force of between 11 and 300.  

These enterprises according to the CBN definition have the following key features; an asset base of between N5 million to N500 million and staff strength of between 11 and 300 employees.

However, even this definition by the country’s primary financial sector regulator is fraught with limitations that ensure financial exclusion. Why should an SME be qualified by asset base and number of employees? 

What happens to SMEs that do not fit into this garb? Do we find another name for them?  Well most financial institutions have done just that, you hear of MSMEs these days, Micro, Small and Medium Scale Enterprises. The Micro denotes companies that do not fall within the CBN’s standard definition of SMEs.

I on the other hand prefer to qualify companies as SMEs using the following features:

• Have a relatively small share of its market;
• Are not a subset or part of a large enterprise;
• Serve as seed-bed for indigenous entrepreneurship;
• Promote indigenous technological know-how;
• Use mainly local resources, thus have little or no foreign exchange requirements;
• Cater mostly for the needs of low income earners; and
• Adapt easily to customer’s needs.

What then are the forms of funding available to most SMEs?  Funds available fit largely into the following categories:

• Equity Capital – Owner’s equity, equity from family and friends, venture capitals and private equity firms;
• Quasi Equity – Esusu, suppliers credits, customer’s advances and government intervention funds; and
• Debt Capital – Loans from commercial banks, microfinance banks, finance houses and loan sharks.

I will focus on debt capital and we will be examining why the financial exclusion for most SMEs with regards to accessing bank loans and advances.

What forms of funding are available to SMEs in financial institutions? Financial institutions channel funds to SMEs in form of:

Short term funds/Working capital finance – these are facilities with tenors of a year or less and include the following:

•       Overdraft facilities - these are flexible, short-term facilities which is used by small businesses to meet current financing needs e.g. buying input materials in manufacturing concerns.
•       Trade advances – are particularly suitable for small retail businesses in assisting them stock up goods and products.
•       Trade facilities - is tailored to meet the financial requirements of enterprises with need to  import raw materials or input products for their manufacturing processes.

Long term finance – these are facilities with typical tenors of between 2-5 years, examples are:

•      Term loans - These are non-revolving facilities with tenors beyond a year final maturity extending beyond one year, normally packaged to finance capital projects or a customer’s expansion programme.
•       Equipment lease finance - Leasing is a creative financing option that can be a valuable additional source of medium term finance suitable for SMEs. It’s a contract between equipment owner (Lessor) and user (Lessee), title resides with Lessor till the last installment is made by the Lessee.  Equipment lease finance is particularly suitable for small and medium manufacturing concerns and agriculture enterprises.

What then do SMEs need to do in order to access these forms of debt financing? To access these funds SMEs are required to:

1.        Operate a legal and duly registered business;
2.        Open enterprise accounts and operate same for a period of time usually between 3-   6  months;
3.        In addition, they need to provide the following:

•       Bankable business plans;
•       Historical financials and management accounts; and
•       Adequate security as required by the lending institution.

Why do we then have the gap in funding or this seeming financial exclusion? Significant numbers of SMEs do not have access to formal sector funding i.e. funding from financial institutions. Banks have always perceived SME lending as high risk due to the following factors:

• The informal nature of SMEs i.e. no clear organisational and operational structure;
• Inability of these enterprises to prepare/provide bankable business plans;
• Poor record keeping i.e. no accounting or business information;
• Lack of security required for conventional collateral based bank lending; and
• Discriminatory cultural practices which hinder transparency.

If  “MSMEs remain the backbone of the development of any economy and the driving force of national growth” as stated by the Minister of Industry, Trade and Investment; Mr. Olusegun Aganga, then something needs to be done on a national scale, a decisive policy/ programme of action to encourage lending to SMEs.

Financial institutions also need to create products that can best meet the needs of this core segment of our economy. It is worth noting that this is already happening, a lot of commercial banks are churning out products that are created specifically for these niche market.

SMEs on their own part need to work on being taken seriously, as I stated in my previous blog, there is need to have a business plan/plan of action which addresses the issues around operations, structure and even funding. It’s time to get our acts together and stop treating our business ventures as hobbies.