Addressing Nigeria’s Overlooked Lending Opportunities

Introduction

Improving access to credit has been high on the agenda of several international organizations and policymakers for many years. This is mostly because a large part of the world lives in poverty, with individuals and businesses lacking access to credit [1]. Nigeria has a high poverty rate, with about 86 million people living in extreme poverty and about 146 million people living below the upper-middle-income line [2]. These contribute to why a lot of individuals require access to credit to meet short, medium- and long-term financial needs.

Access to credit and financial inclusion are closely related [1], and they both play an essential role in improving the structure and quality of a country’s financial system, which drives economic growth [4]. According to CBN’s National Financial Inclusion Strategy (NFIS), credit has been identified as a key product to increase the country’s financial inclusion [4]. CBN has set a 2020 target of the Nigerian adult population having access to credit at 40%, which means that about 42 million Nigerians should have access to loans. We are, however, far from this, as only about 2% of the Nigerian adult population have been able to access loans from banks and other financial institutions [3], leaving a variance of about 38%.

This huge variance presents a tremendous opportunity for lenders (commercial banks, microfinance banks, Fintechs, and other lending companies). This article explores the potential credit gap in Nigeria that lenders can address, as well as the extent of value which stakeholders within the lending ecosystem can create. The article also focuses on significant challenges being faced by lenders today and ways these challenges can be addressed to effectively meet the country’s credit deficit and financial inclusion targets.

A quick look at Nigeria’s Credit Conditions

Before arriving at an estimated credit gap for Nigeria, it would be vital to consider the different types of credit and the various segments of borrowers. It would also be important to explore lending trends and conditions within the country. Regarding loan types, loans to customers are either secured or unsecured. Secured loans (e.g., mortgage, car loan, etc.) are connected to tangible collaterals and typically come with lower interest rates because of the lower financial risk attached. Unsecured loans (e.g., personal loans, payday loans, credit cards, etc.) are not protected by any collateral, and they typically have higher interest rates due to the financial risk involved. While unsecured, there should be legal frameworks and policies in place to protect lenders especially in situations where borrowers default on their loan payments.

According to CBN’s Credit Conditions Report (Q4, 2019), the availability of secured credit to households increased over the year and is expected to keep increasing in the next quarter. This expected growth in the supply of secured credit is met with a corresponding expected increase in demand for secured credit by borrowers [17], which is complemented by CBN’s directive to increase loans to individuals and businesses [8]. A growth trend is also the case for unsecured credit, as lenders expect the availability and demand of unsecured loans to increase in the next quarter [17]. This expected increase in unsecured loans to Nigerian households is complemented by a forecasted general growth of unsecured lending in Nigeria, which is mostly driven by the proliferation of digital lenders that are using data and technology to grow consumer and SME financing in the country.

Loan default rate, which represents the percentage of outstanding loans written off by lenders due to the inability or unwillingness of borrowers to pay back, or after an extended period of missed payments, has also improved in recent times and is expected to keep growing in the next quarter [17]. Lenders are, however, forecasting that loan pricing and interest rates will remain unchanged in the coming quarter. This means that a lot of lending organizations in Nigeria have not leveraged data and analytics to improve the risk management process, which can create opportunities for lower interest rates. There is the opportunity for lenders to adopt open banking, which creates an opportunity to share data using standard Application Programming Interfaces (APIs) and has the potential to reduce delinquency and make loans cheaper and more accessible.

NGN 51.8 Trillion and counting – Estimated credit gap in Nigeria

Improving access to credit to Nigerian individuals and businesses has been high on CBN’s agenda in recent times, with the apex bank unfolding measures to increase lending to consumer, mortgage, micro, and SME sectors. One of these measures is the increase in the Loan-to-Deposit ratio from 60% to 65% [8], which has led banks to give out more loans to comply with CBN’s directive. According to CBN, Nigeria’s credit gap is about NGN 1.7 trillion [9,10]. This has been estimated as the difference between loans currently being given out by financial institutions and the loan amount that financial institutions will be required to give out to maintain LDR of 65% (assuming current deposit figures). Based on 2019 figures, Nigerian banks gave out about NGN 13.6 trillion loans [8], which were about NGN 1.7 trillion short of the loan amount required to maintain LDR of 65% (NGN 15.3 trillion).

This approach to estimating the credit gap in Nigeria might not be holistic as it solely leverages LDR as an instrument to ascertain what the credit needs of individuals and businesses are. The approach has a limited view of consumer credit need, especially with how this can be mirrored to Nigeria’s working population. Also, the approach focuses on only commercial banks as lenders. It does not consider other lending institutions (Fintechs, microfinance banks, Credit associations, etc.). It is, therefore, important to make other key considerations while estimating the available credit deficit, which can be addressed by lenders in Nigeria. This credit gap estimation will focus on only consumer, micro and SME lending, as 95% of loans currently provided in Nigeria have a value of above NGN 50 million [11], meaning most of the loans are already being provided to large corporates.

According to lending data from a large commercial bank and leading FinTech, the average working adult in Nigeria takes a loan of about NGN 23,000, seven (7) times in a year], which amounts to an annual figure of NGN 161,000. World Bank has estimated the number of working adults in Nigeria to be at 62.4 million in 2019 [12]. This means that the estimated market size for consumer loans is about NGN 10.1 trillion. To ascertain what portion of the market size represents a ‘credit gap’ that needs to be addressed, we can apply the credit variance of 38%, as only 2% of the targeted 40% of the Nigerian adult population currently have access to loans [3]. This brings the estimated consumer credit gap to about NGN 3.8 trillion.

Micro, Small, and Medium Enterprises generally experience greater financial obstacles compared to large corporates. MSMEs enjoy less access to credit and other forms of external finance and face higher transaction costs and higher risk premiums [13]. This is mostly because financial institutions are often reluctant to lend money or provide financing to companies with limited or no credit history [14]. This has resulted in an MSME credit gap that lenders can address. According to CBN, the existing financing gap for MSMEs is about NGN 48 trillion, with more than 17.5 million MSMEs seeking credit and other forms of financing [15].

Combining the credit gap for consumer and MSME segments, lenders can address a credit gap of NGN 51.8 trillion through secured and unsecured loan products that will help to boost financial inclusion and economic growth. However, it is also vital to note that very excessive credit growth, coupled with high inflation and default rates, can lead to a financial crisis [6]. Strong growth in credit has preceded many episodes of financial instability in the past, resulting in the materialization of systemic banking crisis [7]. Hence, it is important to not get carried away while implementing measures to address Nigeria’s credit gap and drive credit growth. There should be a focus on ensuring credit growth is not too excessive that it leads to a national financial crisis. Further studies and statistical analysis can be carried out to measure excessive credit provision in the economy and identify optimal interactions between Nigeria’s credit demand and supply factors, towards ensuring credit growth is not too excessive that it leads to financial instability.

Impact of the estimated NGN 51.8 Trillion Credit Gap

The credit gap, which is characterized by limited access to credit for individuals and SMEs, has led to hampered growth in financial inclusion and, consequently, stunted economic growth. Limited access to consumer credit also hinders consumer spending and consumption [1]. This directly impacts the ability of consumers to meet their immediate, medium-term, and long-term financial needs. Some of the practical issues being faced by Nigerians include limited ability to conduct an upfront purchase of assets (cars, houses, phones, etc.) and make upfront payments for experiences and services (travel, education, rent, etc.). This had led to Nigerians mostly having to save to meet financial targets, which can be very difficult.

Furthermore, limited access to credit has led to limited growth for MSMEs, as a lot of these companies do not have the required financing to scale the business and invest in appropriate resources and capabilities (people, technology, processes, etc.) [18]. MSMEs are vital to the development of any economy as they provide opportunities for employment generation, the advancement of local technology capabilities, economic diversification, development of local entrepreneurship skills, and forward integration with large-scale industries [16]. Hence, it is very crucial for participants of the lending ecosystem to develop the right capabilities to improve access to credit for individuals and MSMEs.

Other benefits to be derived if the credit gap is addressed include improvement in the country’s manufacturing and agricultural industries [19], increased opportunities to improve health, education and innovation, and general improvement in the quality of living [20].

Major challenges faced by lenders and other participants of the lending ecosystem

• Poor credit reporting – One of the key processes within lending is the management of credit risk. Nigerian lenders currently combine customer information with credit reports from Credit Bureaus to ascertain customers’ risk and determine creditworthiness. This is not holistic, and it may leave out key information about a customer’s financial health, which could be crucial to determining what the customer’s risk profile should be. This also limits the extent to which lending organizations understand potential borrowers, as well as keeping loan prices and interest rates high.

Also, the traditional credit scoring process does not serve MSMEs well [14]. Often, one single piece of unavailable information about the MSME can prevent the assessment and consideration of the organization. Due to this limited access to rich customer data, lending organizations mostly provide loans to individuals and organizations that have adequate credit information history, thus leaving out potential borrowers with ‘thin-credit-files’ (potential borrowers with limited or no credit history).

• High cost of processing micro-loans – The cost of processing loans (loan origination and credit risk assessment) is typically high, especially for micro loans. The CBN has capped management fees (covering loan processing, appraisal etc.) that can be passed to borrowers at a maximum of 1% of the principal amount disbursed. This means that lenders still bear most of the cost of processing a loan, especially if the loans are for small amounts. Also, lenders bear all the cost of originating and conducting credit risk assessment for a potential borrower that gets rejected.

If we consider a real-life scenario, a Credit Bureau API check costs between NGN 200 – NGN 500 and obtaining a transaction statement for a loan applicant from NIBSS’ mybankstatement service costs NGN 400 for a JSON file and NGN 250 for a pdf. If we assume a lender assesses 1,000 potential borrowers, that’s already a cost of about NGN 500,000 on just conducting credit checks, and there is no guarantee that all the loan applications will be approved. If the loan amounts are small, the lender will only be able to pass on a maximum of 1% of the loan disbursed to the borrower which would not be enough to cover the cost of processing.

• Limited collaboration between participants of the lending ecosystem – Participants of the lending ecosystem (commercial banks, Fintechs, microfinance banks, credit associations, other non-bank lenders, credit bureaus, regulators, etc.) play different roles across the lending value chain. There currently is no standard framework (such as open banking) that drives collaboration within the ecosystem. Data currently exist in silos, with each participant having a fragmented understanding of each customer, as opposed to a holistic and detailed understanding, which would be the case if participants adopt full collaboration and standardized data sharing.
  
• Inadequate technology infrastructure – Some lending organizations in the country have invested in technology capabilities (applications, infrastructure, network, etc.) to automate the lending process and ensure efficiency and speed. Interactions with multiple lending organizations in Nigeria have, however, shown that there is limited reliance on relevant digital and emerging technologies to support the end-to-end lending process (loan origination, credit risk management, loan disbursement, loan performance monitoring and loan collections). Also, these technology capabilities are not nimble enough to cater to the growing availability and demand for secured and unsecured lending. Many financial institutions also lack robust technology platforms that seamlessly integrate risk modeling with reporting [22].

Lenders will need to invest in digital and technology capabilities (core lending applications, predictive analytics, omnichannel experience, etc.) to remain agile in the provision of tailored loan products and services to Nigeria’s credit market.

• High default rates – According to the CBN’s credit conditions report, loan default rates are expected to reduce in the coming years [17]. However, due to limited access to customer information across the financial ecosystem, lenders currently don’t have a full view of customers’ financial health. Hence, it is difficult to accurately identify and separate potential borrowers that will have difficulty in paying back their loans from those that won’t. This has led to an automatic reduction of the potential credit market size and has also kept loan prices high, as lenders tend to price loans high enough to cover the risk of loan defaults.
  
• Inadequate legal infrastructure – The legal infrastructure in place to protect lenders, borrowers and other participants of the legal ecosystem is not adequate to drive credit growth. There are a lot of cases where borrowers are easily cheated or have to pay very high-risk premiums to access credit. There are also cases where lenders are exposed to financial loss when borrowers are unable or unwilling to repay loans. In cases like this, the cost of debt recovery can be very high and most times, lenders have to let go of these defaulted loans. An adequate legal structure should provide the relevant protection to ensure lenders and borrowers are not hesitant with providing and accessing credit.

Initiatives to address Nigeria’s Credit Gap

• Improve credit risk management and reporting. Borrowers shouldn’t know more about their financial situation than lenders do [22]. Lenders should have sufficient information about potential borrowers and have the right tools to conduct a detailed risk assessment to understand customers’ financial health and risk profiles, even more than the borrowers understand themselves. Lenders should integrate alternative sources of data, leveraging concepts such as open APIs, blacklists, etc. to improve credit reporting.
  
• Explore new and innovative loan products to address the needs of Nigerians. In essence, Nigerian lenders need to be creative to develop loan products and services that are tailored to the needs of Nigerians. Due to the availability of data, lenders can fully understand their prospective and existing customers and develop custom offerings that will meet their needs. An example is how Flipkart, an Indian ecommerce company, commenced the provision of loan products to consumers and sellers on its platform to increase consumer credit growth. Another example is Branch, a Fintech organization, providing loan products to merchants based on their sales history and financial projections, which are available online. Other examples include how lenders can price loans differently for customers based on the result of their credit assessment and risk profiling.
  
• Increase lending to underserved borrower segments. While addressing Nigeria’s credit gap, lenders should also focus on underserved borrower segments, such as thin-credit-filed customers and potential borrowers from the untapped informal sector of the country. For these segments of customers, lenders can build risk models that consider other forms of data (social networking data, telecommunication usage data, sales data, etc.) in other to gain a detailed understanding of each customer and ascertain if they’re creditworthy. Lenders can also implement channels (mobile, online, agents, USSD) to provide accessibility and convenience to these customers.
  
• Governments and Regulators should create an enabling environment and policies to drive credit growth.
  While the CBN has taken some measures (such as the LDR directive) to improve
  access to credit, additional steps should be taken to ensure that both lenders
  and borrowers are protected. Governments have also made some steps to increase access to credit (TraderMoni, MarketMoni, FarmerMoni, National Collateral Registry, etc.). Governments should continue to contribute to developing and implementing policies that will create an enabling environment for credit growth.
  
• Transformation of lending operations – Traditional lenders, need to undergo digital transformation to transition into agile lenders. Lenders will have to deploy a robust technology platform with seamlessly integrated capabilities to support risk modeling, reporting, loan origination, loan performance management, API management, etc. Lenders will also need to provide an omnichannel experience to individuals and MSMEs to ensure that they have access to loans, at any time, and on any channel of their choice.

Conclusion

Nigeria has an estimated consumer and MSME credit gap of about NGN 51.8 trillion. This presents a very huge opportunity for lenders, but closing the credit gap will require significant effort from private institutions, governments, and regulators. Lenders will need to develop key capabilities that will make them more agile and positioned to meet the needs of customers. They will need to implement sound business models that will adequately serve the different segments of individual and MSME borrowers. Governments and regulators will need to create the enabling environments that will improve access to credit, while also contributing significantly to economic development and job creation.

References

1. Velpuri M, Sharma M, Maringanti C, Pidugu A and Velpuri J Improving Access to Credit in Property Markets Using Blockchain – FIG Proceedings (2017) [online]. Available: https://www.fig.net/resources/proceedings/fig_proceedings/fig2017/papers/ts01i/TS01I_velpuri_aman_sharma_et_al_8515.pdf
2. World Bank Data [online]. Available: http://povertydata.worldbank.org/poverty/country/NGA
3. EFInA Access to Financial Services in Nigeria 2018 survey
4. Sulong, Z. and Bakar, H.O., 2018. The role of financial inclusion on economic growth: Theoretical and empirical literature review analysis. J Bus Fin Aff, 7(356), pp.2167-0234
5. Access Bank [online]. Available: https://www.accessbankplc.com/pages/Media/access-news/Access-Bank-Hits-over-N1Billion-in-Digital-Lending.aspx
6. Lang, J.H. and Welz, P., 2017. Measuring credit gaps for macroprudential policy. Financial Stability Review, 1.
7. The theory-based household credit gaps in this special feature are based on the
   methodology and results in Lang, J. H. and Welz, P., “Semi-Structural
   Credit Gap Estimation”, mimeo, 2017
8. Fitch Solutions: formerly BMI – Nigeria Banking & Financial Services Report, Q4 2019
9. A Lever for Consumer Lending (This Day), 2019 [online]. Available: https://www.thisdaylive.com/index.php/2019/08/28/a-lever-for-consumer-lending/
10. Can
    Retail Lending Change in Nigerian Banks? (Business Day), 2019 [online].
    Available: https://businessday.ng/technology/article/can-retail-lending-change-in-nigerian-banks/
11. National Bureau of Statistics (NBS) – Selected Banking Sector Data: Sectorial Breakdown of Credit, ePayment Channels and Staff Strength – December 2019
12. World bank data [online]. Available: https://data.worldbank.org/indicator/SL.TLF.TOTL.IN?locations=NG
13. Beck, Thorsten & Demirguc-Kunt, Asli, 2006. “Small and medium-size enterprises: Access to finance as a growth constraint,” Journal of Banking & Finance, Elsevier, vol. 30(11), pages 2931-2943, November.
14. Big Data, Smart Credit – Closing the SME finance gap through artificial intelligence and machine learning. White Paper (2018)
15. Nigeria’s small businesses suffer N48 trillion funding gap (Guardian), 2019 [online]. Available: https://guardian.ng/news/nigerias-small-businesses-suffer-n48-trillion-funding-gap/
16. Central Bank of Nigeria (CBN), Development Finance [online]. Available: https://www.cbn.gov.ng/devfin/smefinance.asp
17. Central Bank of Nigeria (CBN) – Credit Conditions Survey Report Q4 2019
18. Oaya, Z.C.T., 2017. The impact of SMEs financing on business growth in Nigeria: A study of Keffi and Mararaba metropolis. International Journal of Innovation and Economic Development, 3(2), pp.44-55.
19. Aina, O.C. and RTP, A., 2007. The role of SMEs in poverty alleviation in Nigeria. Journal of Land Use and Development Studies, 3(1), pp.124-131.
20. Lederle, N., 2009. Exploring the impacts of improved financial inclusion on the lives of disadvantaged people (Doctoral dissertation, Heriot-Watt University).
21. KPMG – Ten key credit risk & lending challenges, 2017 [online]. Available: https://advisory.kpmg.us/content/dam/advisory/en/pdfs/top-ten-credit-challenges-brochurev5.pdf
22. World Bank Group – Improving access to Finance for SMEs, 2018
23. Central Bank of Nigeria (CBN) – Guide to Charges by Banks and other Financial
    Institutions in Nigeria [online]. Available: https://www.cbn.gov.ng/out/2017/fprd/guide%20to%20bank%20charges%20circular%20to%20all%20banks%20other%20financial%20institutions%20and%20mobile%20payments%20operators.pdf