In general, a credit system refers to a platform where financial institutions or lenders act as intermediaries in transactions. It provides funds to various economic agents and stimulates activity. Forms of credit range from loans to lines of credit, mortgages and credit cards. This system works to improve market efficiencies and fill the gap in consumption.
Importance of financial credit
A robust credit system is necessary for Nigeria’s economic growth: When additional funds are made available to consumers, producers and other corporate participants, activity in the economy increases. Ultimately, more jobs are created, wages grow, private consumption accelerates and living standards improves.
Credit is essential for business performance: Access to finance re-mains one of the largest constraints to micro-small-medium enterprises (MSMEs). In-creased credit invested in physical infrastructure or human capital has a multiplier effect on business performance, as it helps boost productivity. Businesses can invest in infra-structure, inventory, and innovation and make more sales.
Credit is essential for private consumption growth: A look at developed countries shows how much of a contribution an effective credit system makes to private consumption. The US private debt to gross domestic product (GDP) ratio equals 200%. Household debt alone soared to $13.15 trillion as of December 2017, equivalent to 70% of GDP18. Similarly, the UK recorded a private debt to GDP ratio of 217% in 201719. Total household debt stood at a modest $1.93trn (as of October 2017)20. Consequently, this implies that there is a direct relationship between credit availability to the private sector and living standards. Credit gives access to consumption that will have otherwise been unavailable.
By providing the funds needed to finance spending on health care, education, consumer products and services, an effective credit system will improve the quality of life. A study of Latin America shows that growth in the credit system led to an increase in the share of middle class house-holds to 40.7% in 2010 from 20.9% in 1995. In this period, poverty decreased by 50%21. Thus, a financial credit system is paramount for income growth and middle-class expansion.
Nigeria’s credit system is growing in baby steps, especially when it concerns credit infrastructure, sets of laws and institutions that facilitate access to finance.
The country ranks sixth globally on the Getting Credit sub-index of the Ease of Doing Business. The index focuses on the credit infrastructure and assesses the laws that surround credit information gathering and movable collateral.
In 2017, the Central Bank of Nigeria (CBN), in partnership with the International Finance Corporation (IFC), established a National Collateral Registry. The centralized system allows lenders to register their security interests over movable assets owned by borrowers. Additionally, Nigeria currently has three credit bureaus which provide credit profiles on both corporate and individual entities, making it easier for lenders to make in-formed decisions. They are supported by the Bank Verification Number (BVN), which collates biometric data.
However, when it comes to credit availability, there appears to be significant gaps. Domestic credit to the private sector has been weak, easing 0.18% (YTD) to N22.25trn as at April 2018. This is equivalent to 17.02% of GDP, compared to the SSA average ratio of 45.5% and the global average of 129%. On the other hand, credit to the government has risen 46.63% YTD to N5.22trn.
A survey by IFC, shows that only 31% of Nigerian MSMEs have ever obtained a loan from a commercial or microfinance bank28. The main reason for this low figure is that MSMEs lack the assets or collateral required by banks to guarantee the borrowed funds29. Thus, lending remains concentrated to sectors where tangible assets are available. In Q1, 21.9% of total banking credit was allocated to the Oil & Gas sec-tor, while another 13.29% was given to the manufacturing sector. On the other hand, sectors such as Agriculture and Education account for only 3.21% and 0.47% respectively
In addition, credit options are limited. While more developed countries have an array of formal financial institutions offering credit in the form of private equity, venture capital, credit union loans and peer to peer-financing, Nigeria’s formal sector is limited to banks and non-banks. In Q1 2018, commercial banks accounted for 69.5% of total private sector credit.
The current high interest rate environment makes credit an expensive option for MSMEs. With the monetary policy rate (MPR) stagnant at 14%, commercial bank official lending rates range from 20-25% pa while microfinance banks offer as much as 40% to 50%. Thus, it is no surprise that while the economy is growing at 1.95% (Q1’18), interest-rate sensitive sectors such as Trade, Real Estate and Construction continue to contract.
Lastly, in a bid to reduce non-performing loans (NPLs), lending houses appear to have become rigid and risk averse, especially when it comes to individual or household lending. Thus, facilities Nigeria’s credit economy is still very much at its infancy stage. Although the country has made significant progress when it comes to developing the accompanying infrastructure, it still lags when it comes to actual credit availability and provision. High interest rates, lack of collateral and a low risk appetite from financial institutions will continue to hinder the growth of credit provision in the country. This means that private sector activity will remain subdued and private consumption growth will remain at sub-optimal levels.
The introduction of an accommodative interest rate environment will help resolve this issue. A reduction in the MPR will have a trickle-down effect on lending rates of financial institutions and, boost the appeal of credit to MSMEs and private citizens. MSMEs account for over 90% of private sector activity, 80% of job creation and 50% of GDP. Thus, a boost in their performance, supported by credit financing, will have a positive impact on the economy as a whole.