31
Dec

Interest Rates Subsidies for SME Loans in Nigeria.

One major factor blamed for stunted SME growth in Nigeria is access to affordable/cheap or single digit loans. In response to this, various single digit loan propositions have been launched by the Central Bank and the Nation’s foremost development bank, Bank of Industry (BOI).

Whilst these schemes do not really address the core of the challenges inhibiting access to finance in the segment, they do very well in attempting to reduce the cost of debt for the eventual beneficiaries.

My concern however is that these solutions have succeeded in addressing a relatively non-core issue. Businesses generally are supposed to generate enough earnings to cover their cost of capital, otherwise businesses unable to do so should not exist.

Firstly, what is the actual cost of debt in Nigeria? To get us thinking in the right direction, I will use simple metrics to estimate:

  1. The Government currently pays approximately 18% to borrow Naira for 1 year through Treasury Bills. This means that a non-bank Lender should expect a minimum of 18.5%PA return on every loan created that has a 100% repayment guarantee. This rate I call the risk free rate.
  1. Because of the credit reserve ratio, banks can only lend out approximately 80% of deposits placed with them. This increases the expected risk free rate to approximately 23% (18.5 ÷ 0.8)

The implication is that ideally, today, no loan is meant to be created by banks for less than 23%PA. Note that we have not factored in  risk premium and other variables.

As a result, one would want to ask, who pays the subsidies on the single digit intervention loans? Have we measured the impact of these interventions to see that they are not enriching a few businesses that are even hardly SMEs? From experience we know that such subsidies many times lead to unhealthy arbitrage.

I personally do not think there should be interest rate subsidy for bank loans in our system. If a business cannot produce returns (EBIT) above the risk free interest rate for debt in the operating environment, then such business should really not exist. If they must remain, then they must increase the profit on their services by increasing prices or reducing costs sufficiently to cover their cost of capital.

I actually think interest rate intervention schemes only dare to treat the symptoms of the sickness. The real sickness is that the cost of running an SME business is high – from cost of power that we cannot readily control, to taxes and levies that can easily be dealt with. The real sickness is that primary producers can hardly price their products properly because they are fragmented and do not have access to the market. The real sickness is that undocumented payments for imports enable importers to under-declare invoices, hence pay lower duties thereby make locally produced substitute products seem more expensive… The sicknesses are quite a few.

Therefore, when next we think about single digit interest rate loans for SMEs in Nigeria, we should remember that the costs of these loans are over 20%. Whilst interest rate interventions are not sustainable solutions that will boost growth and competitiveness, someone will still bear the cost of such subsidies… Probably, unpaid public servants may just be the ones bearing this cost.

My View.

Compliments of the New Year!

Obinna | @ukachukwuwrites