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The Nigerian Financial Sector
In July 2004, the Central Bank of Nigeria (CBN) issued a recapitalization policy to clean up the country’s banking industry. Prior to the recapitalization policy the banking industry was overflowed by small size banks with high transaction costs and low capital. The requirement of the new policy was that the commercial banks should have a minimum capitalization of N25 billion with full compliance by December 2005. The policy led to mergers between small and large banks, and 89 commercial banks became 20 (Ailemen, 2010). The banks broadened their services by including retail banking1, leading to a rapid credit expansion. In 2011, six of the banks (five of which are domestic) dominated the banking system accounting for 60 percent of the total assets in the banking sector. The banking system in Nigeria appears to be profitable, liquid and well capitalized (International Monetary Fund, 2013).
The concept of microfinance is nothing new in Nigeria. Esusu is an example of an informal microfinance programme that has a long history in the country. It is a rotating savings and credit association (RoSCA) mainly used by the Yoruba, the largest ethnic group in Nigeria, with the main purpose of reducing poverty. The first trace of this type of financial institution in Nigeria dates back to as early as the 16th century (Seibel, 2004). It consists of groups where members contribute with a fixed amount of money at regular intervals. One member collects the contributions at each interval until every member has collected it once, and then it starts over again. For the people who collect the money at the end of the cycle, the programme serves as a savings mechanism (Akanji, 2006). Similar programmes used by other ethnic groups are Etoto in the east of Nigeria among the Igbos, and Adashi in the north among the Hausas (Anyawu, 2004).
The informal financial sector has long played a large financial role in Nigeria, especially in rural areas due to the lack of provision of formal financial services to the poor. For the Nigerian government, this means difficulties in economic management, as they cannot regulate nor monitor the financial activities in the informal sector (Acha, 2012).
The Nigerian government has introduced several poverty-reducing programmes over the years (Akanji, 2006). Five different Agricultural Development Projects (ADPs) was implemented between 1979 and 1990 as a response to a fall in productivity in the agricultural Retail banking is when banks serve individual customers, not only companies. sector. The goals of the programmes were to increase farm incomes and food production. Unfortunately, none of the projects met their expectations and only two of the projects had satisfactory outcomes. Some of the issues of these projects were the overoptimistic targets, unproven assumptions about agricultural technology and miscalculations in projecting the time it would take to adopt new technology (IEG, 2012). Other programmes introduced by the government to reduce poverty were the Directorate of Food, Roads, and Rural Infrastructure (DFRRI) in 1986, Family Support Programmes in 1993, and the National Poverty Eradication Programme (NAPEP) in 2001 (Obadan, 2001).
In 2005, the Central Bank of Nigeria (CBN) introduced the Microfinance Policy, Regulatory and Supervisory Framework to reduce poverty and incorporate poor who operate in the informal sector, as well as poor people with no prior interaction with financial institutions or services, into the formal sector (Acha, 2012). The policy was justified by the following seven arguments; (1) Weak institutional capacity due to several factors, including incompetent management and poor corporate governance in existing community banks, microfinance institutions and development finance institutions, (2) Weak capital base in existing institutions, particularly community banks, (3) The big un-served market, with less than two percent of households in rural areas having access to financial services, (4) Economic empowerment of the poor, employment generation and poverty reduction, (5) The need for increased savings opportunity with less risk and higher return than current savings methods,
- The interest of local and international communities in microfinancing to provide an opportunity for the interested investors to finance the economic activities of the poor, and
- Utilization of Small and Medium Enterprises Equity Investment Scheme (SMEEIS). Due to lack of framework and confidence in the institutions, ten percent of the fund intended for micro credit remained unutilized (CBN, 2005).
The objectives set by the CBN included creating access to financial services for a large part of the population which earlier had not been served by any banks, with the intentions of making use of their potential productivity. The targets of the policy included to cover the majority of the economically active poor by 2020, and by that decrease unemployment and reduce poverty. The microcredit in relation to total credit was set to increase from 0.9 percent in 2005 to 20 percent in 2020 and the microcredit to GDP ratio from 0.2 percent in 2005 to five percent in 2020 (CBN, 2005). In 2007, the microfinance institutions were licensed to start operations in Nigeria. Existing microfinance institutions and community banks could receive the license for microfinance institutions if they met the CBN’s condition of increasing their capital base to N20 million (equivalent of $63,448) by the end of 2007 (Acha, 2012).
Individuals, groups of individuals, private corporate entities, community development associations, or foreign investors can all establish microfinance institutions (CBN, 2005). There are currently 1017 licensed microfinance institutions operating in the 37 states of Nigeria. Figure 1 shows the distribution of microfinance institutions by state. The number of microfinance institutions vary from one in the state with the fewest – Yobe, to 191 in the state with the highest – Lagos. To put this in relation to population, 2.6 percent of the population lives in Yobe, where 0.1 percent of the microfinance institutions are located, while 4.6 percent lives in Lagos, where 18.8 percent of the microfinance institutions are located. In Kano, which is the state with the highest population rate, 8.9 percent, 3.4 percent of the microfinance institutions are located (CBN, 2016). Thus, the figure shows a high dispersion in access to microfinance institutions. This thesis intends to analyse if the distribution has a relationship with poverty.
Microfinance and Poverty Reduction2
The importance of financial development
Studies have shown that financial development increases average growth in a country (Levine 1997; Levine 2005), but what impact does it have on the poor? Beck et. al (2007) examined the impact of financial development on poverty. They found that financial development helps the poorest, as it disproportionately increases the income of the poor, that is, the income of the poor grows faster than average GDP per capita and thereby reduces income equality. Beck et. al (2007) also found a relationship between financial development and a decrease in the part of the population living on less than $1 per day.
Financial development reduces poverty indirect through economic growth. It can generate more jobs and thereby decrease the unemployment rate which is positively correlated with poverty (Zhuang et al., 2009). In the early stages of financial development, evidence show an increase in wage difference between skilled and unskilled workers. In a later stage of financial development however, the wage difference decreases and hence, has a positive impact on poverty reduction (Galor & Tsiddon, 1996). Financial development also reduces poverty directly through the use of financial services. Access to savings, credit, and insurance services promotes poverty reduction as it increases overall income and reduces income equality through for example investments in business expansions and protection against risks such as natural disasters. The use of financial services also smooths consumption over time preventing undernourishment in the face of shocks, and reduces general undernourishment through investments in productivity enhancing equipment (Claessens & Feijen, 2007).
Aportela (1999) showed the importance of access to financial services when analysing the income and expenditure of Mexican households. He found that people with low income level did not save due to the lack of formal instruments available to them. An increase in number of savings institutions in Mexico led to an increase in savings in low income households by eight percent. Similar results were obtained by Bae et al. (2012) who studied the access to finance on poverty and income inequality on state level in the US. Access was measured by number of banks per 100 000 people, (2) number of banks per 100 square miles, and (3) average deposit size to GDP per capita ratio. Bae et al (2012) found that access to finance reduced both the poverty level and income equality. Not all three variables for access were significant in all the models, but at least one variable was significant in each model, meaning access always had an impact on the poverty level and income equality.
Negative effects also occur when increasing access to financial services. This will be discussed further in the following sections.
Cross-country studies on the impact of microfinance
In an early study of microfinance, Adams and Von Pischke (1992) compared the modern (1990’s) microfinance institutions to the rural credit agencies introduced by Least Developed Countries (LDC) governments in the 1960’s and 1970’s. The credit agencies not only failed to promote poverty alleviation but also cost the governments millions of dollars. The authors argue that the operational framework of the 1990’s microfinance institutions are so similar to the ones of the rural credit agencies that they are destined to fail. Woller et. al (1999) however disagree with the statements made by Adams and Von Pischke. They say that the microfinance 1990’s microfinance institutions are much different from the rural credit agencies of the 60’s and 70’s, one of the fundamental differences being technical innovations that decrease transaction costs and information asymmetry, and it is therefore inaccurate to use them as a prophecy for the success of microfinance institutions (Woller et. al, 1999).
Further, Adams and Von Pischke (1992) claimed that debt is not an appropriate tool when trying to raise poor people out of poverty as it can backfire and pull people further into poverty. If a person fails to make a profitable investment and thereby fails to pay back the loan, the debt will increase and he or she will be worse off than prior to taking the loan. Schicks and Rosenberg (2011) agree with the statements of Adams and Von Pischke (1992). They highlight the downside of access to credit as they analyse the over-indebtness in microfinance. They discuss the concerns with increased competition in microfinance and the uninformed borrowers leading to overborrowing. This would put the low-income clients in excessive indebtness and borrowers who feel forced to repay even if they do not have the resources to do so gets pushed further into poverty.
1 Introduction
2 The Nigerian Financial Sector
3 Microfinance and Poverty Reduction
3.1 The importance of financial development
3.2 Cross-country studies on the impact of microfinance
3.3 The impact of microfinance in Asia
3.4 Evidence from South America, North America and Europe
3.5 Microfinance in Africa
4 Empirical Design
4.1 Variables and Data
4.1.1 Dependent variable
4.1.2 Independent Variables
4.2 Method
4.3 Empirical testing
4.4 Heteroscedasticity
5 Empirical Analysis
5.1 Descriptive Statistics
5.2 Correlation
5.3 Regression Analysis
5.3.1 Access to microfinance institutions
5.3.2 Control variables
6 Conclusions
Appendix
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