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 bank loans on Small and Medium Enterprises (SMEs) in Nigeria looking at United bank of Africa. 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 Nigerians. 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

1

SMEs remain one major constraint to Nigerian 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

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