Wednesday, July 18, 2018 11:55 AM /FDC
It is well known that micro, small and medium enterprises (MSMEs) play an important role in developing a robust economy. At a time when unemployment is as high as 18%, credit support for small business owners might be what is needed to create jobs and strengthen the market place. Unfortunately, Nigeria has never taken credit availability seriously. It is notoriously difficult to borrow at affordable interest rates, without valuable collateral or a recognizable family name.
Anecdotal evidence suggests that very few MSMEs can obtain loans from financial institutions in Nigeria. Apart from government debt crowding out private credit, the lack of a vi-able credit history database has deterred domestic banks from injecting more credit into the economy. Nigeria’s credit-to-GDP ratio is 23%, considerably lower than Ghana (35%) and South Africa (178%). Even with legislative efforts to remove internal credit barriers, such as the Credit Reporting Act 2017 and the Secured Transactions in Movable Assets Act 2017, Nigeria’s financial capital remains shallow.
More can be done to improve access to external credit for Nigerian businesses and reduce their dependency on domestic banks. With the support of neighboring countries, i.e. financial integration, the challenge of limited access to credit can be assuaged. In essence, a financially integrated Nigeria would see capital move from Lagos to Abidjan, the capital city of Ivory Coast, as easily as it can move to Kano in northern Nigeria. This would increase the capital options available to MSMEs which in turn should drive down the cost of access to capital as competition increases.
To understand the importance of financial integration it is best to look to one of the most successful examples, the European Union. The free movement of capital is a long-standing objective of the European Un-ion (EU) and a fundamental freedom at the core of the European single market. Before the establishment of the single market, European capital markets were fragmented along national lines and European economies were heavily reliant on their banking sectors to meet their funding needs. This made them more vulnerable to tightening monetary conditions. Today, European businesses can tap into diverse sources of capital from anywhere within the EU. More-over, by opening up a wider range of funding sources and more long term investments, the vulnerability of EU citizens and businesses to banking shocks has reduced drastically.
If Nigeria, by comparison, was more financially integrated into the ECOWAS region, Nigerian companies would face significantly lower barriers to raising capital outside the country. Currently, Nigeria is ranked 13th out of 15 ECOWAS states for financial integration, which highlights the scope for improve-ment.18 One notable cause of this is the poor exchangeability of the naira in the ECOWAS region.
A more convertible currency would reduce the cost of financial transactions and thereby the cost of capital by freeing up funds that would have otherwise been used to cover fees and expenses associated with currency exchange. This is one accepted benefit of the common currency of the Euro zone. Linking a more convertible naira with the potential for banks and investors to grow in size and efficiency, ECOWAS would have a larger and more efficient pool of capital to deploy into the private sector. The Eco has been proposed as a common currency for the region by the West African Monetary Zone.
The aim is to merge Eco with the West African CFA Franc, and then ultimately create a common currency for West Africa. However, given the extensive convergence criteria, implementation of a common currency is still a long way off.
Financial integration would also allow Nigerian financial sector companies to benefit from economies of scale and scope, leading to improved and more innovative products and services at lower prices. For instance, banks in Senegal and Ghana could compete to provide the most attractive rate, and this process could help reduce notoriously high interest rates in Nigeria and the wider ECOWAS region.
Markets could also become more resilient as lending institutions can diversify their risk. This would reduce the impact of naira depreciation on the banking system as banks would also have non-naira/non-dollar assets. The same applies to investors as more diversification allows them to invest in riskier businesses without having a large impact on their overall investment risks.
Subsequently, a lack of viable investment or lending opportunities in other countries could motivate banks and investors in those countries to deploy their funds in more sustainable opportunities, e.g. Nigeria. International financial integration makes it easier for them to do so, and in order to take advantage, Nigerian companies would need to showcase themselves as innovative and efficient. Such an incentive would have a significant beneficial impact on the real economy.
Disadvantages of financial integration
One drawback of financial integration is that it could increase Nigeria's susceptibility to capital flow reversals. Economists would argue that a quick injection of liquidity into the Nigerian economy could generate inflationary pressures, while a sudden exit of capital could exacerbate any shocks to the economy, such as a decline in the oil price. Additionally, any reductions in interest rate could result in excessive borrowing and lead to a potential debt crisis. However, a crisis could be easily avoided if the proper levels of banking supervision are in place to ensure lending rules are robust and debt capacities sustainable.
Both internal and external focus is required for Nigeria to ensure a healthy environment for the private sector to play a greater role in the growth of the economy. Improving the access of external capital into Nigeria from other African states could result in a larger and cheaper financial capital market for the private sector to thrive on.
Financial integration unlikely in Nigeria’s near future
Efforts to further integrate Nigeria into the African financial ecosystem could reduce the time spent in seeking for capital. However, there is little hope of Nigeria being part of a financially integrated region. The country’s recent hesitation at joining the African Continental Free Trade Area (AfCFTA) reflects a strong protectionist inclination among the country's political, business and labor elites. One of the biggest obstacles to progress will remain the lack of political will to open up domestic capital markets to greater external competition.