Sustainability of MSME Fund of Central Bank of Nigeria

7
through this funding window. After a series of consultations held with various
stakeholders, CBN has come out with revised guidelines of MDF in December, 20152
.
Though there are improvements in various areas, aimed at enhancing the utilizations,
sustainability of this funding still remains a critical issue. The MDF seeks to address
provision of the Revised Microfinance Policy to provide for the wholesale funding
requirements of MFBs/MFIs. If sustainability still remains an issue for the MFBs/MFIs,
then the broader objective of enhancing women’s access to financial services to eliminate
gender disparity may also be not very successful.
2. Review of Empirical studies and Literature
Globally, MSMEs are recognized as driver of growth of any economy. They not only add
to the national income, they also generate massive employment in the economies. As per
an IFC Issue Brief3
, SMEs account for about 90 percent of businesses and provide more
than 50 percent of employment worldwide. They are key engines of job creation and
economic growth in developing countries, particularly following the global financial
crisis of 2007-2008. This view also holds true for the Nigerian economy (Ogechukwu,
2009). The CBN Governor, during the opening ceremony of the seventh Annual Bankers’
Committee Retreat4
, in December 2015 had said that SMEs are seen as drivers of growth
and that the Nigerian banking sector must play an active role in supporting the MSMEs in
the economy.
It is in realization of the significant role of MSMEs in the development of economies that
not only developing economies but also developed economies place emphasis on the
promotion, development and finance of MSMEs. The European Commission5
considers
SMEs and entrepreneurship as key to ensuring economic growth, innovation, job creation,
and social integration in the EU, as SMEs represent 99% of all business in EU! The
Nigerian Government, on developing its MSME policy, relies on the global studies and
best practices (UNCTAD, 2012)
A number of studies have been conducted to understand the requirements of MSMEs
(Forbes6
, 2014; EFInA, 2014; MSME Report, Government of Nigeria, 2015; FATE
Foundation, MSME Report, 2015) as well as the problems faced by them and understand
the prospects of developing them (Fatai, 2009). While there are a number of factors at
macro level or country-wide level, there are also MSME specific factors, which need
targeted resolution (Bain and IIF, 2013). In Nigeria, for example, macro level or country-
wide factors relate to infrastructure such as power, transportation, security, etc. MSME
specific factors relate to technology, finance, market, competitiveness, etc. (CBN, 2016;
Oyeyinka, 2014)
2
www.cenbank.org/Out/2015/CCD/MSMEDF-Nov-2015_WIP%20161215_b.pdf
3
http://www.ifc.org/wps/wcm/connect/277d1680486a831abec2fff995bd23db/AM11IFC+IssueBrief_SME.pdf
4
http://businessnews.com.ng/2015/12/14/banks-not-doing-enough-to-support-smes-emefiele/
5
http://ec.europa.eu/growth/smes/
6
http://www.forbes.com/sites/babson/2014/04/03/what-do-small-businesses-really-need-to-grow/#19ebdd688bc7

8
Of all the problems facing MSMEs, financial constraint, which has been sought to be
addressed by most governments and Development Finance Institutions, has appeared to
be the most critical. Government interventions are often required to address deficiencies
in the enabling environment and residual market failures for enhancing SMEs access to
financing. There is often a mismatch between the demand for funding by MSMEs and
supply of financial services. This gap is less serious for formal MSMEs than for the
informal ones (World Bank, 2010), notwithstanding the fact that it is the informal SMEs
that largely impact the lives of majority of population of developing world. Despite the
fact that the need for promotion and finance of MSMEs is more significant and critical in
developing world (UNCTAD, 2001), the inability of MSMEs to obtain finance for
growth and expansion is more pronounced in developing economies (Dalberg Report,
2011). Often, even when debt funding becomes available, equity and venture finance
remains a big issue in the funding requirements of MSMEs in developing countries,
Nigeria inclusive (Abereijo & Fayomi, 2005; Terungwa, 2011)
Development of product, whether tangible or intangible, leading to a widely accepted
product, is a complicated process. This is evident in failure of products, especially in
modern times of technological evolution. Despite this complication, in modern day, it is
possible to use non-linear means for development of financial product (Naudé, Blackman,
Dengler, 1998) like MSME Development Fund. Linear theme of product development
implies that certain steps precede, or are preceded by, others. A variety of linear models
exist (Booz-Allen and Hamilton, 1982; Bowers, 1986; Cooper, 1988; Johnson et al.,
1986; Kotler, 1983).
Unlike earlier days of product development, when it was assumed that customers are not
well informed and products needed to be pushed (Wright and Cracknell, 2005), the
contemporary view is to have more customer centered products and services (Keith,
1960). It is important to understand the needs of customers or users properly to ensure the
sustainability of the product (Keelson, 2012; Britzelmaier et al, 2013). One of the
important factors that may be leading to lower draw-down rate of MDF by PFIs could be
lack of full understanding of the needs and requirements of PFIs, which are supposed to
eventually disburse to MSMEs. While developing product for microfinance sector, a four
stage process of product development had been suggested by Brand (Brand, 2001).
Similar to what is happening with MDF, The Tanzania Postal Bank had launched a
product with insufficient research resulting in less than expected positive result of uptake
of that product (Wright et al ., 2006).
While developing a product to ensure that every stakeholder has incentive in the usage of
the product, the most critical aspect of the product needs to be kept in mind. For MSMEs,
it’s not the cost of credit but the access to credit which is more important (OECD, 2006).
It’s a similar expectation for farming community (UNEP FI, 2008).

9
For higher MDF uptake, CBN can consider putting emphasis more on timely provision of
fund, and in required quantity, rather than on the cost of the loan to the MSME client.
2.1 What is MSME and why is the development of MSMEs important?
MSMEs play vital role in any economy, especially in terms of providing employment and
generating economic growth. The role of MSMEs is more critical in developing
economies, like Nigeria, where more development is required at the bottom of the
pyramid. It is because of significant contribution of MSMEs in the development of
nations that globally, not only major developing countries like China, India, Brazil, etc.
but also developed countries place strong emphasis on the development of the MSME
sector.
As per the 2013 National MSMEs Survey of Nigeria7
published in May 2015, there are
about 37.07 million MSMEs that contribute 48.5% to GDP growth and 7.3% to exports.
MSMEs employ about 59.7 million persons, representing 84% of the total labour force of
Nigeria. MSMEs in Nigeria are categorized along the lines defined in Table 1 below:
Table 1: Definition of different categories of MSMEs in Nigeria
Size Category Employment (Persons) Assets (N million)*
Micro Enterprises Less than 10 Less than 5
Small Enterprises 10 to 49 5 to less than 50
Medium Enterprises 50 to 199 50 to less than 500
*Excludes investment in land and buildings
The 2013 MSME8
Survey notes that apart from the broader role played by MSMEs in
GDP growth and employment generation, promotion and development of MSME is also
significant because MSMEs, and especially micro and small enterprises:
a. Require low level of capital, a scare resource in developing economy, to establish
them
b. Guarantee employment for a large number of persons, as these are numerous in the
economy and these use labour intensive production techniques.
c. commonly use and deploy inventions, adaptations, and general technological
development
d. help in a more equitable distribution of income in the society
e. assure industrial diversification and a relatively more balanced regional development
f. promote the evolution of indigenous enterprise amongst these establishments
g. contribute to general enhancement of the tempo of industrial development
h. become feeders of large-scale enterprises and service products made by the latter.
7
www.nigerianstat.gov.ng/pages/download/290
8
ibid

10
As can be seen above, MSMEs play an important role in not only economic growth but
also social development. The development and nurturing of MSMEs are important not
only for MSMEs themselves but also for other stakeholders who gain from the progress
and development of MSMEs.
These stakeholders are many and they not only contribute to the development of MSMEs
but also benefit from the progress and developments of MSMEs. The Figure 1 below
illustrates the stakeholders of MSMEs.
Fig 1: Stakeholders in MSME Development
It is in recognition of the significance of the role played by MSMEs, that various
governments have been taking initiatives to promote, develop and finance them. The new
MDF guideline 9
outlines the roles and expectations, especially in relation to the
development of MSMEs in the context of MDF, of most of the stakeholders, as illustrated
in Figure 1above.
2.2 Challenges faced by MSMEs in Nigeria
The MSMEs that are able to survive in the long run and to operate in a sustainable way
are those which are able to derive value out of their operation. Like any other segment of
economy, MSMEs also have a value chain that they use for creating value and generating
profit.
The value chain of a typically incorporated MSME, is as illustrated in Figure 2 below:
9
ibid
Stake in Development
of MSME
Regulators (CBN, SEC, etc.)
and Government (Federal
and State)
Social Groups
and Public in
general
Communities,
where MSME
operates
Business Partners,
suppliers, vendors
Employees
and Directors
Lenders and
Investors
End users/Customers of
products and services
of MSMEs
Industry peers
and forward
linked Enterprises

11
Fig 2: Value chain process of typical MSMEs
(Source: http://www.mbaskool.com/business- concepts/marketing-and-strategy-
terms/2516-porter-value-chain.html)
The Value Chain analysis diagram illustrated above, in a way, also depicts some of the
major challenges faced by MSMEs. Broadly, these challenges can be grouped under input
category and output category. The categorization of challenges can also be viewed as
those appearing in different stages of production and post-production as summarized in
Table 2 below:
Table 2: Major challenges faced by MSMEs
Inputs: Output:
• Raw material – quantity, quality,
price
• Technology
• Management skills
• Human Resources
• Finance
• Quality of product
• Marketing of finished product –
market linkages
While poor infrastructure, lack of other inputs and inadequate market linkages are key
factors which have constrained growth of the sector, it is the lack of adequate and timely
access to finance that is, unarguably, one of the biggest challenges. The financing needs
of the sector depend on the size of operation, industry, customer segment and stage of
development. Even though funding needs of MSMEs are growing, formal lending
institutions have only limited lending facility for MSMEs.

12
Financial institutions have limited their exposure to the sector due to a higher risk
perception and limited access of MSMEs to immovable collateral. Experiences of
Financial Institutions regarding their loans becoming NPAs have also restrained them
from having bigger exposure by way of loans to MSMEs. Apart from providing access to
finance, other priority areas where MSMEs need assistance are provision of infrastructure
and access to regular supply of power and water.
2.3 Background and Features of MSME Development Fund
The MDF was created in 2013 and the provisions of the instrument that created it were
revised for the first time in August 2014. The Fund was created in line with the concept
contained in Section 6.10 of the Revised Microfinance Policy, Regulatory and
Supervisory Framework for Nigeria, which had stipulated that ‘a Microfinance
Development Fund shall be set up, primarily to provide for the wholesale funding
requirements of MFBs/MFIs’. To fulfill the provisions of Section 4.2 (iv) of the Policy,
which stipulates that women’s access to financial services increase by at least 15 per cent
annually to eliminate gender disparity, 60 per cent of the Fund’s total loanable funds has
been earmarked for providing financial services to women.
The broad objective of the Fund10
is to channel low interest funds to the MSME sub-
sector of the Nigerian economy through PFIs with a view to:
• Making it possible for MSMEs have enhanced access to financial services;
• Increasing productivity and output of microenterprises;
• Increasing employment and create wealth; and
• Engendering inclusive growth
It is expected that this funding opportunity available to MSMEs will impact on the
Nigerian economy through employment creation and enhanced economic activity, which,
in turn, would lead to increase in the country’s GDP and its growth rate. The MDF
consists of two components, namely, the commercial component and the development
component.
The commercial component, which is ninety (90) percent of the Fund, will be disbursed
to Participating Financial Institutions (PFIs) at 2% p.a. This component will be used by
PFIs to on-lend at an interest rate not exceeding 9% p.a. to MSMEs. The development
component, which is the remaining ten (10) percent of the Fund, will be used for
developmental objectives such as for providing grants, for capacity building and for
meeting the administrative costs of the Fund.
2.4 Modifications in MSME Development Fund in November, 2015 – A
Comparative Analysis
10
http://www.cenbank.org/MSME/

13
The Guidelines were revised for the first time in August 2014. Deriving from wider
consultation with various stakeholders in the MSME sub sector in Nigeria, the CBN
again revised and published the Micro, Small and Medium Enterprises Development
Fund (MSMEDF) Guidelines 11
through its Development Finance Department in
December, 2015 (Revised document is dated, November, 2015). While a few areas of
revisions are quite positive, there are still areas of concern, which makes one to believe
that these revisions may not lead to any quantum leap in the rate of utilization of the Fund.
The most significant changes in the latest guidelines, as compared to the revised
guidelines of August, 2014, and the impact of those changes are as articulated here under.
i. Change - The revised guidelines makes specific provision that 10% of the Fund
would go towards funding Start-up businesses. Restrictive clause contained in the
earlier guidelines (2014) which had stipulated that only new SMEs were allowed to
be financed by Deposit Money Banks (DMBs) under the MSMEDF has been
removed from the new guidelines.
Impact – a) There is focus on start-up businesses in line with global recognition of
the successes of start-up businesses, especially in the area of ICT
b) Existing SMEs can be financed by DMBs
ii. Change - Qualifications of the PFI for obtaining grants (10% of the Fund has been
earmarked for developmental programmes in form of Grants) have been changed.
Earlier, PFIs were to qualify for the grant component based on their performance
rating in poverty reduction, job creation and financial inclusion. Now, in order to
qualify for the grant, PFIs shall be considered based on their outreach, loan
repayment and percentage of women enterprises financed.
Impact - Rationalization of qualifications would lead to grants being targeted to
deserving PFIs
iii. Change – 2014 guidelines had indicated the eligible services for microenterprises
that could be financed such as hotels, schools, restaurants, laundry, etc. This
specification of services has been done away with in the new guidelines to ensure
wider coverage.
Impact - Though, the list of services was only indicative, a few PFIs interpreted the
list of services to be restrictive. With the removal of even the indicative list all
services can be funded.
iv. Change – Coverage of Insurance for Agriculture - The new guideline has added that
insurance coverage by the “Nigerian Agricultural Insurance Corporation (NAIC)
Insurance is compulsory for primary agricultural production”
11
http://www.cenbank.org/Out/2015/CCD/MSMEDF-Nov-2015_WIP%20161215_b.pdf

14
Impact - With insurance coverage, the risk of lending to the agro-allied sub-sector
would be mitigated
v. Change – Submission of documents required by Microfinance Banks & Finance
Companies, while applying for funding has been rationalized.
The new guideline has done away with the earlier requirements such as:
a) Acceptable Risk Management Framework
b) Sound Corporate Governance Culture indicated by:
i) Adherence to Ethical Values
ii) Degree of separation of ownership from control/management
iii) Number of non-performing insider-related facilities
iv) Compliance with up-to-date and timely rendition of monthly returns to the
CBN as stipulated in the Revised Microfinance Policy, Regulatory and
Supervisory Framework for Nigeria.
While doing away with these required submissions, additional requirements, as
itemized here under, have been put in place:
a) Certificate of Incorporation or Registration
b) Board Resolution or Trustee consent to access the Fund
Similar conditions for Microfinance Institutions (NGO-MFIs and Financial
Cooperatives) and Deposit Money Banks (DMBs)/ Development Finance
Institutions (DFIs) have also been done away with to simplify the procedure.
Impact – PFIs would find it easier to apply for loans under MSME Development
Fund. CBN would expect to have a higher draw-down rate and better utilization of
the Fund.
vi. Change – While the loan tenor (fund received from CBN) has been retained (the
facility shall have a maximum tenor of one (1) year for micro enterprises and up to
five (5) years for SMEs with an option of moratorium), the new guideline has clearly
specified that “Principal and Interest repayment for micro and SME loans shall be
annually”.
Impact - The implication is that there would be bullet repayment of loans (with
interest payment at the end of the tenor) by borrowers for micro-enterprises.
vii. Change – Interest rate - while the on-lending rate by PFIs has been retained at 9%
per annum, inclusive of all charges, the rate of interest at which PFIs borrow from the
CBN has been brought down from 3% p.a. to 2% p.a.
Impact - The cost of borrowing by PFIs has declined by 33% p.a., thus making this
line of credit more attractive to them
viii. Change – Collateral – The new guideline stipulates that Acceptable Collateral from
PFIs (excluding DMBs and DFIs) under the Fund would be a minimum of 30% of the
loan amount requested. This has been reduced from the earlier requirement of 75% of
the loan amount. There is further relaxation for performing MFBs; collateral shall be

15
waived for Microfinance Banks with Portfolio at Risk (PAR) of 10% and below, as
indicated in their latest CBN/NDIC Examination Report.
The new guideline has an additional provision that acceptable collateral from DMBs
would be a “Signed MoU with CBN and undertaking to bear all credit risks for
projects presented”
Impact - These steps would facilitate drawn-down of funds. Perhaps, the larger
message is also to the banking sector that lending to the Microfinance Sector can be
considered without collateral (if MFBs have better quality of assets, i.e. PAR<10%)
ix. Change – Provide impetus to start-ups, especially those who do not have tangible
collateral to offer. To this end, the new guideline stipulates that:
a) Collateral requirement from start-ups by PFIs (DMBs and DFIs) shall be
educational certificates such as SSCE, National Diploma (ND), National
Certificate of Education (NCE), National Business and Technical Examination
Board (NABTEB), Higher National Diploma (HND), University degree (NYSC
Certificate where applicable) and a guarantor. The start-ups to access the
MSMEDF must present their Bank Verification Number (BVN)
b) Venture Capital Firms (VCFs) that wish to finance start-ups in form of equity
participation shall be eligible to access the MSMEDF at 2% for investment in
start-up projects. The collateral for such facility to the VCF shall be bank
guarantee.
c) To encourage DMBs and DFIs to fund start-up projects, some incentives shall
apply:
(i) DMBs/DFIs playing in this space, shall access MSMEDF facility at 0%
interest for on-lending at 9% (all-inclusive) to start-ups.
(ii) The PFIs shall qualify for a 50% risk shared on the net outstanding balance in
the case of default.
Impact - This is really an innovative and ground-breaking modification in the
guidelines. Changing the nature of collateral required to be submitted by start-ups,
especially from the educated unemployed youth, who may not have tangible/cash
collateral, will help initiate a movement of start-ups in Nigeria. Funding by VCFs in
the country will also get boosted.
x. Change – In view of the observed low patronage of the Fund by PFIs, the earlier
incentives that provided for higher amount (2-4 times of earlier loans) of loans
(within lesser time of 4-8 working days) to PFIs on timely repayment of earlier loan
has been done away with.
Impact - This shows revision of earlier assumptions that once CBN gets flooded with
demand for funding, performing PFIs would be encouraged to further access the
Fund. In view of the limited demand for funding by PFIs having regard to the store
reality, this stipulation has been done away with.

16
xi. Change – Sanctions for DMBs/DFIs on infractions have also been revised. For
example, as per the new guideline, “Established cases of collusion with other PFIs to
either divert monies into private accounts or unduly with-hold any part or outright
conversion of the purpose of the released funds by DMBs under the MSMEDF shall
attract a penalty of MPR+300 basis points at the time of infraction”.
Earlier, such Diversion of funds by DMBs attracted a penalty at the bank’s prime
lending rate at the time of infraction.
Impact - With the provision of penalty of “MPR+300 basis points at the time of
infraction” the guideline has been now linked to the Monetary Policy Rate. This will
likely minimized the likelihood of diversion of funds by PFIs
xii. Change – DMBs/DFIs now have 10 working days (as against earlier time window of
5 working days) - from the date of receipt of Fund from CBN - to disburse the fund to
the borrower.
Impact - This provides more time for PFIs to make disbursements. This would be
especially helpful to those PFIs and MFBs who have widely dispersed clients to
serve, thus possibly also raising their levels of disbursement.
xiii. Change – There are a few modifications in the new guideline that relate to the state
governments and the FCT. These include:
a) State Governments no longer have to operate a Sinking Fund Account with the
CBN, into which any outstanding balance of disbursed amount shall be paid at the
expiration of the loan.
b) Clarification on - State-Special Purpose Vehicle (S-SPV). S-SPV will be an entity
established or nominated by a State Government for the sole purpose of
coordinating the activities of the PFIs that shall access funds under the MSMEDF.
A PFI is therefore not eligible to function as an S-SPV under the Fund.
Impact - Doing away with the “Sinking Fund Account with the CBN” gives more
freedom on the utilization of the Fund. The new guideline that “a PFI is not eligible to
function as an S-SPV under the Fund” has been put in to, perhaps, clarify the
misconception - that the State Governments might have had - that the PFIs could
function as an S-SPV.
Even though none can deny that a lot of thought has gone into the modification of the
guidelines of the MSMEDF and the expectation of the CBN that the Fund would have
better acceptance from PFIs leading to higher draw-down, the issue of absence of
“business case” for the PFI still remains largely unaddressed.
2.5 Evaluation of sustainability of MSME Development Fund – why is the patronage
low?

17
MDF has been conceptualized with the basic objective of meeting the financing needs of
MSMEs. At the time of conception, it seemed that the primary goal of the fund was to
provide funding to MSME at as low a rate of interest as possible. The background of this
conception was development objective of earlier CBN Funds provided for agriculture
sector, infrastructure sector, etc. This conception lacked the basic rationale that each
broad sector of the economy such as agriculture, infrastructure, industry, etc. has its own
dynamics. For example, due diligence, process of disbursement, the security covering the
loan disbursed, post-disbursement monitoring and follow-up, etc. for funding a power
project could be quite different from that of funding a microenterprise. Even for a loan to
a microenterprise, these processes of credit disbursement takes on entirely new meaning,
when an MFB provides credit to a microenterprise through group lending methodology.
Though, the revision (of Dec 2015) of the Fund’s guidelines, which brought some new
features into the revised guidelines showed some realization of the deficiencies of the
original guidelines, the basic issue of sustainability of funds for PFIs remains yet to be
yet completely sorted out. We will evaluate the sustainability issue of the Fund from the
perspective of the principal players in the Fund’s activities and will proffer suggestions to
enhance the patronage of the fund for its impact on the economy to be more meaningful.
The principal parties to the Fund’s activities are illustrated schematically in the fig 3
below:
Fig 3: Schematic illustration of the key players in the activities of the MDF
a) Sustainability for the CBN
From the lending of the MDF, the CBN earns interest income of 2% p.a. on its loans.
Given the macroeconomic factors prevalent in Nigeria, it needs to be evaluated if, strictly
on the basis of stand-alone business case, this return of 2% p.a. is enough to sustain the
maintenance of this fund by the CBN. Even though it can be argued that CBN has
developmental role to play in the economy and the Bank has to also ensure stability of the
financial markets, it must be kept in mind that there is opportunity cost for each Naira
and Kobo. Given that there would be cost of administering this Fund (which may be
partly met from the provision of 10% of the Fund that is set aside for the grant), with an
inflation rate of about 10%12
, and the high cost of raising fund, it becomes important to
ponder on and indeed question the effective return on this Fund for the CBN. As per the
CBN report13
, CBN Balance Sheet at the end of December, 2014 showed that outstanding
12
http://www.cenbank.org/ (Accessed on Feb 4, 2016)
13
www.cenbank.org/Out/2015/CCD/CBN/2014/Draft/IFRS/Financial/Statements/28/May/2015/
(NEW).pdf Page 76-77 of 2014 Annual report (item 29-30)
CBN
Repays
PFIs (e.g. MFBs) Borrower Clients
Lends Lends
Repays

18
of CBN Bills (money raised using open market operations in 2014) was about N2.76
trillion. This was approximately 20% of the total liability and equity of N13.74 trillion of
the CBN. Furthermore, the financial statements show 14
that the “Central Bank of
Nigeria’s bills issued to commercial banks as a liquidity management tool and as a means
of implementing monetary policy have tenors ranging from 7 days - 364 days and they
carry discount rates ranging from 11.55% - 13.30% per annum.” Thus, this rate of
11.55% - 13.30% p.a. can be assumed to represent the cost of raising funds for CBN,
which, in turn, is used, at least partly, for lending under Development Funds like MDF.
Table 3 below shows the total liabilities and effort of the CBN in 2013 and 2014.
Table 3: Total Liabilities and Equity (Nm) of CBN, 2013 and 2014
Heads Notes Year 2014 Year 2013
Towards meeting the imputed cost of lending at lower than market rate of interest, the
CBN makes provisions for “financial sector intervention expenses”. This provision
represents the amortization of prepaid intervention expenses arising from the fair
valuation of below market interest rate loans to financial institutions for the purposes of
14
www.cenbank.org/Out/2015/CCD/CBN/2014/Draft/IFRS/Financial/Statements/28/May/2015/
(NEW).pdf - Page 77 of 2014 Annual report (Note 30)

19
onward lending to the agricultural sector, the AMCON notes, etc. Perhaps, the
assumption of providing loans at “below market interest rate” should be reevaluated,
especially in view of the efficiency of the Fund. We can also view, alternatively, whether
it would be more efficient for the Nigerian economy in the long run if market interest
rates were charged on the loans! It may not be a sufficiently strong argument that since
Agriculture Developmental Fund and other Development Funds have been created and
are being funded by the CBN at very low rate of interest, the MSME Development Fund
must also be funded by the CBN at a low rate of interest of 2%. Each broad sector of
Nigerian economy has its own dynamics, risk profile and requirements; all should be
taken into account before arriving at the rate of interest to be charged on the Fund
established for each.
b) Sustainability for PFIs
Primary Financial Institutions (PFIs) play a vital role in the successful operations of the
MDF. From the interaction held with a few of the PFIs, it is clear that the PFIs do not feel
motivated to borrow at 2% p.a. and lend at 9% p.a. It becomes a more serious matter
when it is realized that Microfinance Banks and Microfinance Institutions, who are main
sources of funding to micro-enterprises find it even less attractive to borrow and lend
than the Commercial Banks and Development Finance Institutions. This is mainly on
account of the differences in the operational model followed by Microfinance Banks and
Microfinance Institutions on the one hand and Commercial Banks and Development
Finance Institutions or the other. Thus, two significant challenges to the patronage of the
funds provided by the CBN, for the operations of the MDFs are:
1) Banks view lending to MSMEs as challenging (as compared to lending to big
businesses) and lending at 9% is certainly not attractive, when these Banks
normally lend at 18-20% per annum rate of interest.
2) MFBs, because of high operating expense, don’t find it economically viable to
use this fund at a margin of 7%, being the difference between their lending
rate of 9% and borrowing rate of 2%. A clearer picture of these issues can be
obtained by further analyzing the reasons for what appears to be the weak
patronage of the MDF by the Banks and the microfinance institutions.
A further examination of the perspectives of Commercial Banks and of Microfinance
Banks would make possible, a better understanding of their apparent lack of interest to
access the funding opportunities that are available under MDF.

20
i) Perspective of Banks
It is not difficult to see the alternatives to the MDF that are available to the banks. Table
4 below summarizes the inhibiting issues from the banks’ viewpoint.
Table: 4: Comparative analysis of financials of MDF for banks
MSME
Development Fund
Existing model of funding (when banks
don’t access MDF)
Cost of fund
(Liability/Exp)
Borrowing @ 2% Savings @ 2%
Return from fund
(Asset/Income)
Lend at 9% Free to lend at commercial rate of 18-22%
Even risk free investment, i.e. investing in
TB and FGN bonds could yield higher than
9% (rate at which MSME Fund is to be
lent)
Other factors such as cost of loan administration, risk in lending and recovery, etc.
remain the same for the Bank whether the money comes from CBN (through MDF) or
from depositors.
It’s not difficult to see why banks may not be very keen on accessing the MDF. Along
with the above illustrated factors, it is also a fact that banks have more deposit funds than
they can lend. This is unlike what is faced by Microfinance Banks, whose lending
portfolio is typically higher than savings deposits. The comparative asset-liability
position of MFBs/MFIs, as compared to that of commercial banks, would imply that
MFBs/MFIs would be more willing to access this cheap source of Fund! The question
then is why is the patronage of the MDF by MFIs also very low? Why are MFBs
(especially, National and State MFBs, whose requirement of fund every year is in billions
of naira) not fully accessing the MDF and utilizing the credit limits that are available for
them in the MDF Guidelines? CBN needs to understand why the MFBs, especially the
better performing ones, having PAR less than 10% want to take loans from commercial
banks in Nigeria and from international lenders at around 20% and not access this MDF
which is readily available at a much lower cost of 2%. We are of the view that the reason
lies in different methodology of credit administrative used by MFBs, which is highly
labour intensive, resulting in significantly higher cost of lending.
By flatly retaining the lending rate under MDF at 9%, for the sake of also aligning it with
other CBN intervention funds, policymakers, perhaps, show lack of full understanding
and appreciation of the fact that the dynamics of micro financing (lending and recovering
a loan of typically less than USD 500) is quite different from financing of a power project
(which would involve lending and recovering a loan of USD 500 million) by a bank.
ii) Perspective of MFB/MFI
MFBs/MFIs, like any other PFI, have a margin of just 7% (lending at 9% and borrowing
at 2%) under the MDF. Given the nature of services provided by MFBs/MFIs and the

21
operational methodology typically used by MFBs/MFIs, the question to ask is, how
sustainable is this margin?
By considering a few scenarios, we can evaluate the sustainability of accessing credit
under MDF and using such credit for onward lending:
i) Typically in Nigeria, MFBs, especially those primarily serving microenterprises
have operating expense ratio (ratio of Operating Expense for a period to the
Average Gross Portfolio for the period) of about 25%-35%. Leaving aside other
aspect of cost associated with the microcredit product, if just operating a loan
(disbursement, repayment, etc.) to microenterprise under MDF gives a NET
negative margin of 20%, the question that arises then borders on the economic
and business sense in delivering such a loan product.
ii) Imagine, if 7% of the loan provided by MFBs is not recovered! After all, by
stating in the policy that the MFBs with less than 10% PAR (Portfolio at Risk)
can access MDF loans without offering any collateral to CBN, the implicit
assumption being made is that it’s not very abnormal, if upto 10% of microcredit
are not recovered on time. MFBs would not be making any return on the fund lent,
if the loan loss ratio is 7% or more
A paper published by the World Bank (CGAP)15
suggests the following formula for
calculating a sustainable rate of interest for microloans extended by microfinance
institutions in order to ensure sustainability of the credit products that they offer to their
clients:
AE + LL + CF + K - II
R = ---------------------------
(1 – LL)
The formula shows that sustainable rate of interest (the annualized effective interest rate -
R) to be charged on loan/microcredit will be a function of five elements, each expressed
as a percentage of average outstanding loan portfolio, namely, administrative expenses
(AE), loan losses (LL), the cost of funds (CF), the desired capitalization rate (K), and
investment income (II):
If, for example, admin expense ratio is 25%, loan loss is 2%, cost of fund is 21% (rates
charged by commercial banks in Nigeria, when they lend to MFBs), the desired
capitalization rate is 15% and investment income is 1.5%, then sustainable annualized
effective rate of interest (R) would be 62.8%. Ceteris Paribus, if we replace the rate of
interest applicable on loans provided by commercial banks in Nigeria with rate of interest
15
www.cgap.org/sites/default/files/CGAP-Occasional-Paper-Microcredit-Interest-Rates-Nov-
2002.pdf

22
charged under MDF (2%), then sustainable annualized effective rate of interest (R)
would be 43.4%.
It is evident from above calculation that for the stipulated lending rate of CBN under
MDF (of 2%) to make business sense to MFBs, these MFBs would have to charge their
borrowers 43.4% and not 9% (as stipulated under the MDF Guidelines). It is no surprise,
therefore, that there are only a few MFBs taking advantage of the MDF; these are the
conscientious ones, who want their long associated borrowers to benefit from the MDF.
The foregoing issues surrounding the sustainable rate of interest for MFBs could be taken
as a pointer to critically review rate of interest under MDF, especially, in view of the fact
that MFBs are willing to take loans from international lenders and Nigerian commercial
banks at 20% p.a., while they are at the same time reluctant to avail themselves of the
relatively cheaper funds that are available in the MDF at just 2% p.a. rate of interest!
iii) Sustainability for Borrowers
Could there be any issue of sustainability for borrowers, who get MDF at 9%?
Apparently, 9% rate of interest on loans in Nigeria, where, the rate of inflation itself is
over 10%, implies a negative real cost of fund to the borrower. At the end of the year, the
borrower would be better-off in real terms.
If such funding could be made available in the long-term, then, obviously it would be
good for the borrowers as well as for the economy. However, if the MDF has
sustainability issues for not only PFIs, but also for the CBN and there are chances that
such funding may not become available for long run, then borrowers may have issues
bordering on the success of their project, as those projects may become dependent on and
used to low cost fund! In any case, from the borrowers’ perspective, especially
microenterprise borrowers, who may be making 5-10% return on their business on a daily
basis, it’s not the cost of fund, but the availability and timely access to required amount
of fund that is more important.
It would be pertinent to not ignore the impact that this Fund (that makes borrowing at 9%
p.a. rate of interest possible) may have on the credit discipline of those borrowers, who
are able to obtain credit under the MDF only for some time and the effect that this Fund
may have on those borrowers who are not able to get funding under MDF, but have to
borrow at more regular rates from formal sources. The dichotomous nature of lending-
borrowing environment may give rise to socio-economic issues in society.
2.6 Issue with product design
Evaluation of issues around sustainability of MSME Development Fund throws up a a
major question, namely, are there issues with the designing of the “MSME Development
Fund” product? As product designers would know, there is a process of product

23
development. This process of product development is not very different for developing
new financial products, like MDF. The process can be depicted as illustrated below:
Fig 4: Process of Product Development, with feedback loop
In the age when more focused and responsive human centric designs (HCDs) are being
developed, it would be unfair to assume that designers of financial products would be
unaware about the nitty-gritty if financial products like MDF. Perhaps, various steps of
product design were not rigorously thought out in advance, or if thought out in advance,
then not fully executed at the time of designing the features of Fund (step 2 and 3 of Fig 4
above). May be it would have helped to launch a smaller Fund for a short period (step 4
of Fig 4 above) to test the uptake and reaction from takers.
The revision in MDF in 2014 and in 2015 shows that there is already a mechanism for
receiving feedback from stakeholders and incorporating the feedback in the loop of
decision making on revising the MDF guidelines. However, mechanism of feedback is
not yielding result to the extent expected to ensure larger uptake of the Fund. What needs
to be done additionally is take into account the business case, especially of the lending
MFIs, so that better utilization of the MDF can be ensured.
Unless financial sustainability, reflecting business case of the product, of any credit
programme is established and lenders see net profit generated out of the credit operation,
the PFIs may not be willing to borrow from CBN and lend to borrowers. Given the
current macroeconomic situation in Nigeria, it would be helpful if the economic growth
in Nigeria can be driven from the bottom of the economy. Proper designing of such
products as the MDF would ensure better impact on the ground created by such products.
Feedback from
stakeholders (6)
Design and
Development
(3)
Product
Launch (5)
Pilot Testing
(4)
Idea generation around
a product (MDF, for
example) (1)
Evaluation and
Preparation of
features of the
Product (2)
Revision in
features and
design (7)

24
Better product designs and positive impact created by such financial products aimed at
serving the marginally served section of economy, will not only improve the economy,
but also save the country from facing socio-political problems.
3. Conclusion and Suggestion
There is no gainsaying that the broader objective of creating MDF is laudable. However,
given the response to Fund, there needs to be retrospection about the issues and
mechanism of the Fund. It is disturbing to note that many potential borrowers are
bemoaning their inability to access the Fund as envisaged by CBN and the Federal
Government. At the same time, the feedback shows that lending institutions are not
finding it attractive to borrow from CBN and lend under the terms of the Fund. Given the
challenges faced in ensuring larger disbursement of Fund to the targeted segment of
borrowers, specific recommendations and suggestions for making the MDF more
meaningful and yielding better impact could be:
a) Generally, this scheme tries to cover too many segments of industry such as
microenterprises, small scale industries, medium sector industries, etc. and involves
too many categories of lending institutions such as MFBs/MFIs, Commercial Banks,
State Governments, etc., whose model of lending are very diverse due to the nature of
their operations. It could be good idea to have different features of loans for
microenterprises as compared to those for SMEs. This would take into account
difference in client segment served by MFBs/MFIs and by Commercial Banks/DFIs
as well as the difference in lending methodology adopted by these institutions.
b) Given the current uncertainty related to payment of interest and repayment of
principal to foreign lenders by MFBs/MFIs, the CBN can consider taking over the
loans. This would mean that CBN can earn substantial returns on its loan to the
MFBs/MFIs and the MFBs/MFIs are also saved the cost, pain and risk of making
timely payment to foreign lenders.
c) Provision of lending to State Governments, who in turn can lend to PFIs, takes
cognizance of the fact that as the State Governments are more on the ground, they can
better relate with the development in their State through creation of SPV and relating
with PFIs operating in their State. However, it should be evaluated and considered
whether all the States have the same capacity to take the same loan from the CBN and
efficiently deploy with PFIs for the purpose of on-lending.
d) From the macroeconomic perspective, there is the question as to whether this
mechanism puts too much money into the economy. In addition, such questions as to
whether this mechanism leads to distortion in the credit market and whether the CBN
needs to develop a standalone mechanism to monitor the macroeconomic impact of
liquidity infused in the economy through such interventions Funds as the MDF.

25
e) CBN needs to use a better iteration process for re-development of this product (MDF).
More responsive features embedded in the MDF will ensure better acceptability of the
product, leading to higher draw-down from CBN and increasing the outreach to more
MSMEs.
f) CBN and the Federal Government could consider arranging for a market survey to be
done to better understand the rate of return earned by typical micro-enterprises. A
sample survey of microenterprises like small shopkeepers, fruit and vegetable
vendors, etc. could provide insight into the return generated on their economic
activity, which, in turn, could serve as a guide in better understanding of the interest
rate that those borrowers would be willing to pay to have the microcredit facility. It
would be easier for PFIs to charge sustainable rate of interest as well as for the
regulatory authorities to monitor and check charge of usurious rates.
g) On making the rates more market based, the CBN could consider making the MDF
accessible to PFIs at TB/FGN rate of relevant tenor and ensuring that PFIs (especially,
MFBs/MFIs) are able to charge only sustainable rate from MSME borrowers.
h) Along with funding, capacity development programmes for MSMEs also need to be
provided. Such capacity development programmes would not only ensure better
utilization of the MDF but also make more meaningful the impact created in the
economy by funding MSMEs.
As a way forward, more focused research needs to be carried out to (in) validate the
assumptions of this MDF model, which include:
1) Poor people require only fund/finance
2) These people cannot afford to pay commercial rate of interest on the funding
provided to them. Does this view arises from the fact that microenterprises are
majorly owned by poor or is it that their businesses do not yield high returns?
3) Government must do something for their development, as there are no other non-
government agencies or institutions, whether private or NGO, who can help them
in development
4) Even while routing the money through the CBN, it is reasoned that because of
low creditworthiness of wholesale borrowing institutions or because of lack of
evaluation of creditworthiness of wholesale borrowing institutions, collateral must
be taken from those institutions

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