The Central Bank of Nigeria (CBN), in its circular of July 10, 2019, requires banks to maintain a minimum Loan-to-Deposit Ratio (LDR) of 60 percent by the end of September 2019. The directive also requires that, effective from the next day, banks’ daily placements above N2 billion would no longer earn interest. Prior to that, banks earned interest from the CBN on deposits up to N7.5 billion.

The CBN also directs that any bank that fails to meet the 60 percent LDR will pay an additional cash reserve requirement equal to 50 percent of its lending shortfall.

This reduced capping of banks’ interest-bearing deposits at the apex bank marks the latest in a series of measures to improve market liquidity, encourage banks to increase lending to small businesses, retail, mortgage and consumers, with a view to invigorate the nation’s tottering economy. Now, the banks must lend more or face more stringent cash reserve requirements.

The new CBN directive creates additional loanable funds estimated at between
N750 billion and N1 trillion. United Bank for Africa Plc and Union Bank are expected to increase their loan portfolios by a combined N230 billion to meet the new requirement!

Given that bank revenues accrue largely from interests, treasury securities, fees and commissions, given that their income from deposits with the CBN is negligible, one question arises: Can the CBN directive force or cajole the banks into growing their lending portfolios?

The expectation is that banks are more likely to direct the additional liquidity into the inter-bank market and other secure investments rather than lend to small businesses and consumers, contrary to the intention of the CBN. The explanation is that, notwithstanding the CBN directive, it may remain difficult for Small Business Owners to secure funding through banks, for a variety of reasons, which include, but are not limited to, the following:

  1. Cash Flow: Banks prefer lending to businesses that have steady revenue streams, with consistent cash flowing in every month. Small businesses are hardly able to demonstrate this consistency, hence they are usually denied loans by banks.
  1. Collateral as Security: Small businesses either lack, or have inadequate, collateral to secure their credit. This makes it difficult, if not impossible, for them to obtain financing. Bank loan applications usually require collateral to secure the credit.
  1. Personal Guarantee: A personal guarantees from the Small Business Owner, which makes him or her personally responsible for repaying the loan, is almost always a requirement of the banks. This is often a tough call for a Small Business Owner with little or no assets and locked in a daily struggle to keep up with the expenses of running a business.
  1. Limited Track Record: Banks are more comfortable lending to businesses with long operating history. They are wary about funding businesses just starting out and lack a record of success. Banks want to see a business with a track record of profits over a specific period before they approve funding for it. A small business unable to show that is an unlikely candidate for a bank loan.
  1. Management Team: A small business that doesn’t have a strong management team, with a clear chain of command, will have great difficulty in securing credit from a bank. Banks look for proofs of sound corporate governance and signs of long-term success of a business.
  1. Accurate Bookkeeping: The accounting books of a business give a clear overview of the past, present and, possibly, the future of a business. A business that does not keep its books, or does not keep them accurately, stands a zero chance of securing a bank loan. For example, an astute lender can make a lending decision by simply looking at the bank statements of a business over a period of time!

It is known that banks don’t lend enough. It is also known that banks barely lend to individuals and Small and Medium Enterprises (SME). It is therefore understandable that the CBN wants banks to lend more, and to lend to individual consumers and SMEs which, together, are prime movers in economic development.

Will the banks heed the CBN directive? Or take the punishment of non-compliance? If the banks try to comply with the CBN directive to give out more loans, will there be effective demand from quality and bankable borrowers for banks to meet their targets?

The answer to this question rests with the CBN and the Bankers Committee
which should jointly address the underlying conditions that make it unattractive for banks to lend to small businesses.

For now, the CBN’s LDR Directive addresses the supply side of the problem, by creating a pool of loanable funds for small businesses and consumers. It, however, does not address the demand side, that is, the shortage of bankable small businesses.

For the CBN to achieve its objective of improving access of small businesses to credit, it must address both sides of the problem. The CBN and the banks need to fashion and implement a systematic and institutionalised framework for producing a pipeline of bankable small businesses with the absorptive capacity to access and leverage available loanable funds. Until this happens, the banks will continue parking their cash with the CBN for free or for a fee, or continue investing in risk-free government securities instead of lending to businesses or consumers.

Even worse, the banks will devise a thousand and one ways to circumvent the CBN directive, rather than lower their credit controls and suffer the consequent rise in non-performing loans, which will be akin to standing on Third Main Mainland Bridge and pouring their monies into the Lagoon.

The CBN must evaluate its entrepreneurship development programmes and ensure that they serve the purpose of breeding bankable entrepreneurs. Small Business Owners must help their businesses, by making their businesses, projects or proposals bankable; by assuring sufficient collateral, future cash flow, good probability of success, and is acceptable to lenders for financing.

When small businesses become bankable, they mitigate the lending risks of banks, and banks will begin to fall over each other to advance credit to them.

When bankable small businesses are available to effectively utilise loanable funds, then, the chemistry is right!