THE IMPACT OF MICROCREDIT FINANCE IN THE PERFORMANCE OF SMALL AND MEDIUMS BUSINESS ENTERPISES

CHAPTER TWO

REVIEW OF LITERATURE

INTRODUCTION

Our focus in this chapter is to critically examine relevant literatures that would assist in explaining the research problem and furthermore recognize the efforts of scholars who had previously contributed immensely to similar research. The chapter intends to deepen the understanding of the study and close the perceived gaps.

Precisely, the chapter will be considered in three sub-headings:

 Conceptual Framework

 Theoretical Framework

 Empirical framework

2.1 CONCEPTUAL FRAMEWORK

The Concept of Microfinance

Microfinance is the provision of financial services adapted to the needs of low income people especially the provision of small loans, acceptance of small savings deposits, and simple payments services needed by micro and small entrepreneurs and other poor people (USAID, 2000). Nyor, et. al. (2013) noted that microfinance is about providing financial services to the active poor who are traditionally not served by the conventional financial institutions. The concept of microfinance was perceived as the provision of financial and non-financial services by MFBs/MFIs to low income groups without tangible collateral but whose activities are linked to income-generating ventures (Ledgewood 2000, Christen and Rosenberg 2000). Furthermore, Ledge wood (2000) viewed microfinance as an economic development approach intended to benefit low income women and men. It means that the purpose of microfinance is to reach the low income entreprenuers with financial services that will enable them creates wealth without any discrepancy as to sex of such person (Idowu and Salami, 2011). Gert Van Maanen (2004) cited in Babajide (2011) describes microfinance as banking the unbankables, bringing credit, savings and other essential financial services within the reach of people who are poor to be served by regular banks, due to lack of sufficient collateral. Therefore, microfinance is the practice of offering small and short term loans to entrepreneurs who otherwise would not have access to capital to begin small business or other income generating activities. Microfinance idea became popular in the development discourse of the early 1980s (Iyoha and Igbatayo 2008). In general, microfinance has five features that distinguish it from credit supplied by the conventional financial institutions. First, the loan size is small; however, this general feature differs from one country to another and depends upon the differences in the levels of the country’s socio-economic development. Secondly, the primary customers of these loans are the people who have little access to conventional banking facilities. Thirdly, the purpose of these loans is to create income-generating activities. Fourthly, tangible collateral is not necessarily required for taking this kind of loan. Finally, this is another aspect of micro credit programme that distinguishes itself from conventional banking. But the microfinance ventures have integrated loaning and savings mobilization functions, in order words, regular savings are a pre-condition for granting loans (Iyoha & Igbatayo, 2008). Microfinance, with regard to this study, is the practice of offering financial and non-financial services, to entrepreneurs who hitherto cannot access the conventional financial institutions, at a fee that is affordable and economic to the users of such services. This will enable them to start or build up their own enterprises. The Microfinance Policy defined the framework for the delivery of these financial services on sustainable basis to the Micro, Small and Medium Enterprises (MSMEs) through Microfinance Banks (CBN, 2005). Microfinance Bank, according to the Central Bank of Nigeria (CBN, 2009 & 2012), is a company licensed to carry out the business of providing microfinance services such as savings,loans, insurance, money transfer and other financial services that are needed by the economically poor, micro, small and medium enterprises. Based on their minimum paid up capital, Microfinance banks are categorized in to Unit, State and National. Unit Microfinance Bank is authorized to operate in one location and it has a minimum paid up capital of N20,000,000.00 (Twenty million Naira). A State Microfinance bank is authorized to operate in one State or the Federal Capital Territory (F.C.T) and has a minimum paid up capital of N100,000,000.00 (One hundred million Naira). A National Microfinance bank is authorized to operate in more than one State including FCT and has a minimum paid up capital of N2,000,000,000 (Two billion Naira). It has been observed that microfinance and MFBs are intended to fill a definite gap in the finance market and the financial system respectively, to assist the financing requirements of some neglected groups who may be unable to obtain finance from the formal financial system. These

neglected groups that constitute the target users of such microfinance are mainly in the informal sector of the economy and are predominantly engaged in small and medium scale farming, commercial/trading and industrial activities. Through microfinance, entrepreneurs in most countries were able to have access to variety of

financial and non financial services. These financial services include savings, loans/credit, payment facilities, money transfer and insurance. The non-financial services mainly entail training in MSMEs investment and business skills which mainly addresses capital investment decisions, general business management and risk management. The accessibility has resulted in employment generation, poverty reduction and consequently economic growth and development (Taiwo, 2012).

MICROCREDIT AND MICROFINANCE

Microcredit and microfinance are different terms and they differ in content, although the two terms are used interchangeably because they are related. Therefore according to the study conducted by Sinha (1998) states that “microcredit refers to micro loan, whereas microfinance is appropriate when involves NGO’s and other financial And some argued that, microcredit is a component of microfinance which only involved in providing credit to the poor, whereas microfinance is far from that since it also provides non-financial service to un-served markets. Basically the primary social objective of microfinance is to reach under-served market both in urban and rural areas. institutions in the loan supplement along with non-financial facilities.”

SMALL AND MEDIUM SCALE ENTERPRISES

The concept and definition of small and medium scale enterprise is dynamic in character and varies with time and also varies among institutions and countries. Not with standing, the basic definitional parameters are not the same. They include numbers of employees, Assets and turnover. Sule (1986) stated that, it is evidence around the world that small and medium scale enterprise provide an effective means of stimulating indigenous entrepreneurship, enhancing greater employment opportunities per unit capital invested and aiding the developing of local technology. Small scale enterprise: An enterprises with a labour size of 11-100 workers or a total cost of not more than 50 million including working capital but excluding cost of land (Sule, 1986:2007) while medium scale enterprises is an industry with a labour size of between 101-300 workers or a total cost of over 50 million, but not more than 200 million including working capital but excluding cost of land (Clifford, 1972:85). SMEs and NERFUND (2004) define SMEs as an enterprise with an asset base not exceeding N200,000,000.00 excluding land and working capital with staff strength of not less than 10 and not more than 300. A cursory glance a the structure of SMEs in Nigeria reveals that 50% are engage in distributive trade, 10% in manufacturing, 30% in agriculture and the rest 10% in services. A special feature of Nigeria SMEs is that distributive trade component is generally considered more commercially viable than the manufacturing component hence they attract more funding from bank and other financial institutions (Ibru, 2004). In summary SMEs can therefore

be said to be conducted in the following terms: i. As a proprietorship: Single ownership ii. As a partnership: Where (2-20) 2 to 20 people polled their resources together iii. As a legally, incorporated Entity: having the characteristics of a legal person and this could be a private limited sole company. However, in Nigeria more than 83% of the SMEs operate under the first two businesses type, while the third one operate mainly as family business (Ibru, 2004). According to Ranjami (2012) SMEs and entrepreneurship are now recognized worldwide as key source of economic growth and development. Kolawole (2013) contends that small and medium scale enterprises play a very important role in developing economies. This view appears to be supported by Chijah and Forchu (2010) when they argue that the promotion of micro enterprises in developing countries is justified in their abilities to faster economic growth, alleviate poverty and generate employment. According to the Nigeria’s national Council on Industry; an SME is define in terms of employment i.e. as one with between 10 and 300 employees. Currently small and medium sized enterprises are defined by their size. In the European Union, SMEs are defined as small or medium sized if it has not more than 250 employees and not more than 50

Million Euros turnover respectively, a balance sheet total of less than 43 Million Euro and if not more than 25% of the shares of such an enterprise are in the ownership of another enterprise. The Small and Medium Industries Equity Investment Scheme(SMIEIS) in Nigeria, defines small and medium enterprises(SMEs) as “enterprises with a total capital employed of not less than N1.5 million, but not exceeding N200 million, including working capital, but excluding cost of land and/or with a staff strength of not less than 10 and not more than 300”.The benefits of SMEs cannot be overemphasized they include; contributions to the economy in terms of output of goods and services, and creation of jobs at relatively low capital cost.. It is a vehicle for the reduction of income disparities thus developing a pool of skilled or semi-skilled workers as a basis for the future industrial expansion; improve forward and backward linkages between economically, Socially and geographically diverse sectors of the economy provide opportunities for developing and adapting appropriate technological approaches and also offer an excellent breeding ground for entrepreneurial and managerial talent. Kolawole (2013) suggests five essential and inter-related gaps in small enterprise performance comparing stylized enterprises in developing and industrialized economies. These five “gaps” needs to be addressed in order to improve prospects for high-impact small enterprise development in developing economies: •

1. Role of entrepreneurship. In many developing countries, “necessity entrepreneurship” prevails, versus greater levels of “opportunity entrepreneurship” in industrialized countries, which tend to be led by higher skilled and better-capitalized entrepreneurs.

2. Firm growth and upgrading. In many developing countries, only a small proportion of micro and small firms grow beyond a certain threshold, due mainly to lack of specific management and/or marketing skills.

3. The lack of trust in society is another impediment, limiting many small firms to what their families and immediate communities can control or supervise. The result is a lack of more specialist and sophisticated medium-sized companies, often called the ‘missing middle.’

4. • Technological capabilities. Small enterprises in developing countries mostly focus on lowtech routine operations and use mature technologies as blue prints. On average, compared to their industrialized economy counterparts they are less capable of creating knowledge, applying new technologies and rarely performing R&D, often due to the lack of human capital, business competencies and skills.

5. Export competitiveness. In developing countries, the export share of small enterprises tends to be much lower than in industrialized countries, with a few remarkable exceptions in Asia such as China, Taiwan and increasingly, Vietnam. This situation reflects the technology gap, and in turn, results in small enterprises being excluded from international best practices and sources of knowledge.

MICROCREDIT BANK AND SMES GROWTH

Access to finance is only key to SMEs growth globally, Nigeria inclusive. In Nigeria, financial inclusion has been recognized as an essential tool for SMEs development. Lack of access to financial institutions also hinders the ability for entrepreneurs in Nigeria to engage in new business ventures, inhibiting economic growth and often the sources and consequences of entrepreneurial activities are neither financially nor environmentally sustained. Idowu, (2008)agrees that access to loans is one of the major problems facing SMEs in Nigeria. Diagne and Zeller (2001) also argue that insufficient access to credit by the poor may have negative consequences for SMEs and overall welfare. Access to credit further increases SMEs riskbearing abilities; improve risk-copying strategies and enables consumption smoothing overtime. The idea of creating Micro Finance Institutions (MFIs) is to provide an easy accessibility of SMEs to finance/ fund particularly those which cannot access formal bank loans. Microfinance banks serve as a means to empower the poor and provide valuable tool to assist the economic development process. Kolawole (2013) is of opinion that the promotion of micro enterprises in developing countries is justified because of their abilities to foster economic development. The main objective of micro credit according to Sunitha,(2010) is to improve the welfare of the poor as a result of better access to small loans that are not offered by the formal financial institutions

FUNDING OF SMALL MEDIUM BUSINESS ENTERPRISES

A major barrier to rapid development of the small scale enterprises is a shortage to both debt and equity financing. Accessing finance has been identified as a key element for small scale enterprises to succeed in their drive to build productive capacity, to compete, to create jobs and contributes to poverty alleviation in developing countries. Without finance in small scale enterprises cannot acquire or absorbed new technologies. Although the banking sector is the largest and most important source of external financing for scale enterprises, by and large, it is believed to be under serving the needs of this sector. Small Scale enterprises alternatively draw financing form a variety of sources. Small firms rely proportionally more on non-bank services such as internal funds (savings, reformed earning family network) and the informal sector (money lender) as a result of their inability to produce the collateral needed by the money deposit bank (Salta, 2012)In Nigeria, it is common practice in the country for small business owners to organize themselves into cooperatives commonly called “esusu” members of an esusu would generally contribute a fixed amount freely, weekly or monthly to be pulled and when collected in turns to find their business or personal projects.The microfinance institutions have gone a long way to improve the small scale enterprises by granting them loans and also they help the small scale industries or enterprise to finance their projects. Without microfinance institutions loans the small scale enterprises will suffer, since they lack huge capital base.

THE IMPORTANCE OF SMALL AND MEDIUM ENTERPRISES IN THE DEVELOPMENT OF A NATION

The general characteristics of less developed regions indicate the nature of the needs and these include: unemployed and underemployed labor, a small or negative rate of growth of real per

capital income, grossly unequal income distribution, low investment rates and scarce capital and political and economic instability (Lebell et al, 1974). This gives a vivid picture of Nigeria‘s industrial landscape which like any less developed country, is littered with many micro, small and medium enterprises. They are expected to provide the driving force for the industrialization and overall development of the Nigerian economy. This explains the increasing policy attention accorded the SMEs in addition to the fact that they play significant roles in meeting some basic economic and industrial developmental objectives. Few among the significant roles played by

the SMEs are as follows: First, the SMEs provide the training ground for the development and growth of indigenous entrepreneurs (Kilby, 1988). Casson (1982) opines that by acting as a seedbed or nursery, usually for the indigenous population, they serve as vehicles for the

propagation and diffusion of innovative ideas for far reaching dimensions. They are more flexible and can easily adapt to changes in the external environment. A second social contribution of SMEs according to Owualah (1987) is the transformation of traditional industry. In both developed and developing countries, the traditional sector has served and continues to serve as the springboard for launching into a vibrant modern sector. Thus a fledging SMEs sector

can be a means of achieving a smooth transition from the traditional to the modern industrial sector (United Nations, 1984). Third, SMEs due to their labor intensively and usage of low-level technology are able to garner and use the widely available local labor supply. This is consistent with the nation‘s income distribution objectives (Steel and Takigi, 1983). Also, it is opined that SMEs create more jobs per unit of energy consumed than large scale ones (Vankataraman, 1984). Fourth, SMEs assist in the dispersal of economic activities through encouraging the development and modernization of these activities outside the major metropolitan areas. Thus, they are able to stem the tide of rural-urban drift. Another economic role of the SMEs is their

ability to mobilize financial resources, which would otherwise be idle or untapped by the formal financial sector (Central Bank of Nigeria, 1985). Fifth, SMEs facilitate the conservation of foreign exchange and the development of the scarce resources of management in developing countries. This is mainly due to their size or scale of operations and unsophisticated management structure. A high percentage of the profit of SMEs, most of which are locally owned is known to be ploughed back to ensure a higher rate of future

growth (Committee of Inquiry on Small Firms, 1971) Also, Kamaluddin (1982) opined that the SMEs provide the desired linkage effects, especially agro-industrial linkages. It is pertinent to highlight the contributions of SMEs to the economic of some countries and also, that of Nigeria. A study carried out by the Small Business Research Unit in the United Kingdom between the periods 1982-1988, showed that SMEs created between 8000,000 and 1,000,000 new jobs. Also, Gibb (1996) opined that small and micro enterprises were by far the most common form of enterprises in Europe and constitute over 98 percent of all registered companies. In Japan, the

industrial strength of the nation is premised on SMEs. They employ more than 82 percent of the total labor force and account for more than 50 percent of the total manufacturing value added. In Nigeria, Kasimu (1998) opined that the SMEs have through NIDB assisted projects created more than 300,000 jobs and through the Nigeria Agricultural and Co-operative Bank (NACB), created more than 700,000 jobs.

CHARACTERISTICS OF MICROCREDIT

As earlier explained according to CBN (2012), and Mabogunje (2011), that micro credit is about providing financial services to the poor who are traditionally not served by the conventional or formal financial institutions. The following features distinguish microfinance from formal financial products or services; The smallest of loans advanced and or savings collected, The absence of asset based collateral, that is, the use of social collateral (such as character, cash flow) as against physical assets, Simplicity of operations, that is, there are simplicity and flexibility in the process and procedures unless which microfinance operates, Targeted at those who are not being served by the formal financial service providers, Access to repeat and larger loans based on repayment performance, Streamlined disbursement and monitoring

THE CONSTRAINTS OF SMALL AND MEDIUM SCALE BUSINESS ENTERPRISES

The economic history of industrial countries points to the obvious fact that surest to an industrial revolution is through small and medium scale enterprise. We have also come to know the obvious importance of SMEs and their contributions to the national economy. Experience has shown that when given proper attention SMEs contributed to the national development unfortunately, despite the importance of small and medium scale enterprise in the economy of

the nation, the sector is still having some constraints. Following these constraints therefore, many eminent and ordinary people writing on this issue have been quoted in various circumstances concerning these constraints and their corresponding solutions.i. Lack of Fund: One of the main constraints is lack of fund, writing on this Moh, (1991) stated that; “there is hardly any doubt that the core of the constraints in the business sector is one with a financial coloration. Most of the sector problems in the areas of production, marketing and indeed general management can be resolved by a financial solution. Therefore, capital is critical for the efficient organization of all productive activities. He continued that although various institutions that are presumably supposed to provide credit to the small business sector exist such as the bank, ministry of industries loan scheme, World Bank small business loan, NBCI etc, their impact has remained largely minimal. Unlike large enterprise, lending to small business is thought to be inherently a more risky understanding principally due to the following: lack of Adequate Data Base and Track Record, Insufficient collateral, Relative high cost of administering and monitoring small loan portfolios, High rate of default. In practice, it would appear that banks prefer to pay stipulated fines rather than comply with Central bank of Nigeria provisions. Indeed access to loans SMES is really difficult especially in these days. In support of the above view, Ovuorie (1995:9) in his article “coping with small size business” noted that: “small scale businesses in Nigeria have very little or no access to loanable funds. Lending institutions conspicuously; everybody wants to do business with millionaire. It is not surprising therefore that SMES operators end up in the ugly trap under investment. This leads to very low returns on capital which in turn leads to the premature death of the business. Writing on the same view Jarret, 1977) in this book noted that: “the dilemma of the less developed countries is that it can provide only very limited capital income of its people is so low, since this is the case, there is a corresponding limitation upon capital investment and this in turn means that productivity and therefore income remains low” This is main reason why for so long par countries have remained poor, they are in the grip of economic situation which is very difficult indeed to change. Writing on the same view Callaway (1975) a study of 225 businesses in Kaduna observed that, the majority of the entrepreneurs mentioned capital shortages as the greatest obstacle to their business expansion. In his contribution, Shanon, (1977) in book underdeveloped Area” a book of reading and reach stated that: “The business man’s lack of capital makes him dependent on his supplier for credit; and upon his

customers, and his financier is one person, his position deteriorates to one compete dependence” Uzowulu, (1987), mentioned difficulties in obtaining local and foreign finance for the big projects as one of the major problems of SMEs. Marsha (1986) in his articles “self Reliance and small enterprises” stated that “the problem of finances is characteristics of small scale industries in both the developed and the developing countries. Indeed virtually all the other problems confronting small scale industries emanate from lack of finance. “Dr. Masha also observed that small scale enterprise often lack knowledge

of the right sources of finance for investment and working capital. In addition, institutional sources of funds are often unwilling to provide facilities for these enterprises. This made the SMEs to fact the perennial problem of shortage of working capital which hinders their ability to produce efficiently. The result is that many SMEs have to depend on alternative sources of capital in the form of family savings or borrowing from middlemen and money lenders where interest rate, collaterals and terms of repayment are much more exacting than those of the normal banking institutions.

Lack of Infrastructural Facilities:

Inadequate provision of essential services such as telecommunication, access roads, electricity and water supply constitutes one of the greatest constraints to SMEs development. Most SMEs resorts to private provisioning of these at great expense. A World Bank study (1989) estimated that cost accounted for 15-20 percent of the cost of establishing a manufacturing enterprise in Nigeria. Contemporary evidence has shown that the relative burden of the private provisioning of infrastructural facilities is such heavier on SMEs than on large scale enterprise.

High Rate Enterprise Mortality:

The incidence of inadequate working capital, which constraints productive capacities of the SMEs as well as absence of succession plan in the event of the death of the proprietor, leads in many cases to frequently early demise of SMEs. Moreover, the persistence of unstable macroeconomic environment, arising mainly from fiscal policy excesses has other smothered many SMEs. iv. Financial Indiscipline: Some SMEs proprietors deliberately divert loans obtained for project support to ostentatious, expenditure. Others refuse to pay back as and when due. The interest and the principal; because of political involvement and the misconceived notion of

sharing the so called national cake. (Chibundu, 2006).

Lack of Experience and Training:

Another serious problem is lack of experience and training. Many apparently successful business owners often neglect the need for experience and training. they rely on their skills and talent, completely ignoring the need for experience in accounting, personnel, advertising, budgeting, purchasing and other aspects of management.

Again, many business failure results from situations where people go into business without previous experience, so farmers, civil servants, lorry drivers etc in the past entered into business because when they saw traders making money, they felt the business was very easy and

profitable profession. They were doomed to fail because they never had thorough preparation before launching their business. Writing on lack of experience, Dennis et al (1976) stated that: “The ultimate failure of business could be directly attributed to lack of experience in accounting, purchasing, advertising, budgeting, pricing and other aspects of management”. To support the above view, Onyemelukwe (1976) in his book titled “problems of industrial planning and management in Nigeria” stated that” it is well accepted that lack of necessary know how is the main cause of the slow rate of industrialization in Nigeria”.

Poor Location:

The location of a business plays a major role in overall performance.

Business local calls for a place that suits the particulars business to be located and certain factors are considered. When the choice of location is poorly made it will surely affect the activities of such business. It is for this reason that promoted Jorenem (1983:10) to state that: “A poor location is a serious handicap to any business. Often the reason for a venture’s shrinking sales has been attributed to the declining quality of the location”. He added that „for a manufaturi1ng enterprise finding the right location involves the selection of the region or town with low transport cost reasonable amount or relevant labour, power-supply, accessibility to suppliers and customers, and freedom from burden – some local regulation and taxation. To support the above view, Tootelian et al (1976) also observed that a “poor or mediocre location is a severe handicap to any business whether soap factory, advertising agency or piano store. He added that often the reason for a firm’s shrinking sales can be traced directory to the declining quality of the locative advert.

Marketing Constraints:

One of the unnoticed grave problems facing small scale entrepreneur is marketing of her products. The small scale businessman experiences tremendously difficulties finding the appropriate market for her products, and even when the market is there, the technique of identifying the proper distribution channels may be another set of problem, this made Jorenem (1983) to comment that: “Small business owners often don’t see the need for advertising or sales promotion. Most of them hardly go beyond erecting a signboard which merely indicates their location. Hardly do they realize that effective advertising wakes prospective customers to develop strong opinions on their products in particular and the firm in genera; the first concern of every business is to get and keep customers. The best products, equipments, facilities and personal avail nothing unless they stimulate sales. Few products are electrifying. However and rarely is the old myth true about a better mouse trap bringing the world to one’s door unless revolutionary inventions or service s are brought to the attention of the public, they have little chance of being sold. To build customer awareness and demand an organized and vigorous marketing Champaign is essential. A complete marketing strategy includes not only personal salesmanship, but also a saleable line of products or services, appropriate pricing, and a good business location.

Lack of Planning and Budgeting:

Without proper planning and budgeting any small scale business is bound to fold up after a year or two of operation. In Nigeria situation, most SMES do not make proper planning and budgeting of their scare resources. Most of them do not have any plan for the future; they give insufficient attention of planning. Take the case of civil

servants who jumped into business during the 1975 purge when they were dismissed from service. They are certainly not prepared for business and because of this many of them failed. Some are promoted to go into business in order to make a living to support the family when an attractive job is not at hand such business owners might lack the necessary managerial skills of planning and budgeting for business success. Writing of this, Alonge (1992) stated that; “The importance of proper planning and budgeting cannot be over emphasized. The experience of many thousands of small or newly started business attests to the need to understand and learn

now to perform these essential in the financial areas”. He added that “entrepreneurs may be excellent sales people and may be able to superbly market their products, but if they cannot properly plan and budget, their business will fail”.

General State of the Economy:

In the heat of ongoing economic recession the collapse of small scale enterprises has created considerable concern in Nigeria. According to Ifedi (1992) “recent surveys in Nigeria highlight various symptoms of business failure. Some of the factors mentioned derive from SAP. He added that companies may come across difficulties caused a downswing of an economic cycle or the ups and downs of business” On his own part, Boswell (1973) stated that; “General state of the economy is a key influence very broadly in years of economic „squeeze‟ and slowdown fewer new businesses seem to be set up, also the number of Bankruptcies and liquidations tends to be high. Conversely in boom years more firms enter the field and relatively few are forced out, as one world except”.

Unfavourable Government Policies:

Obliviously, there are some decrees and polices which the government imposes of SMEs which instead of aiding its growth, scare away investors. The government acts as a secondary and tertiary party through official control and administration of polices by its use of weapons such as tariffs, subsides, various taxes and other ordinance. These policies present obstacles to the development of private Nigeria centerpieces. Writing on this Ifedi (1992) stated that; “Government intervention can be disruptive such as price control, new taxes interest rates or under interference with market forces” Other reasons for business failure according to Ifedi include; bad corporate communication, ageing product arising from lack of innovation and inability to keep up with change in technology, bad luck in which a thriving firm suddenly fall in the face of a misfortune such as an accident or unforeseen tragic event, massive frauds in which managers misuse their positions to run down the SMEs tragic event, massive frauds in which managers misuse their position to run

down the SMEs they are supposed to build up, there are occasions in which the SMEs expand too fast and run short of cash, managers many lose control because the SMEs affairs becomes too complex for the information system, to cope with some SMEs should not have started in the first instance as there was no proper feasibility study or CHALLENGES OF MICROCREDIT IN NIGERIA

Microfinance is faced with the following challenges in the Nigeria financial system Ikechukwu (2012);

Firstly, MFBs have a greater number of active but poor and low income groups to extend their financial service to. According to CBN (2012), the average banking density in Nigeria is one financial institution outlet to 32,700 inhabitants in the urban area in Nigeria. It is 1:57,000 in the rural areas, that is, less than 2% of rural households have access to financial services.

Secondly, according to Anyanwu (2011), the funding of real sector activities, especially agricultural and manufacturing production, as well as other sectors that need funding to developing towards contributing to the growth of the MSMEs in Nigeria should be the main priority of the MFBs.

Thirdly, according to Anyanwu (2011), the issue of sustainability is crucial to the continuous operations of MFBs. Therefore, according to Oyejide (2011), the effort to make MFBs more variable should not end up by relegating the provision of efficient financial services to small enterprises and poor households to a separate and unequal existence. Rather, the goal/challenge should be to make efficient services available to all, even though their producers may vary quite

Widely market reassert.

2.2 THEORETICAL FRAMEWORK

Pecking order theory

The pecking order theory is one that was developed by Myers Sanders in 1984. It implies that the financing requirements of firms (usually SMEs) are catered for in a hierarchical order. The initial

source of funds is internally generated. As the amount of funds required is increased, the next source is via the use of debt. Further increase in the need of funds leads to sourcing for external equity. Thus there tends to be a negative relationship between profitability and external borrowing by small firms. This further implies that the debt equity mix of a firm should be heavily dependent on the hierarchical financing decisions over time.This theory thus maintains that businesses organizations always prefer to use internal funds. If it

is not available, the organization will prefer to use debt as an external source of fund before it considers equity financing. Therefore, by simply examining a firm’s debt equity mix, one can have a general understanding on the health of that organization. When managers issue new shares, the public believe that the managers have concluded that the firm is valued more than its actual worth and as such they want to quickly utilize the opportunity. This leads to the investors valuing these new stocks lower than before. The theory also implies that older firms should have more funds available to promote growth since they have had more opportunities to accumulate internally generated funds i.e retained earnings.Holmes and Kent (1991) found that SMEs observe strict adherence to the pecking order due to the fact that it is difficult for them to acquire externally generated finance. SMEs rely heavily on private markets thus limiting their financing sources. These restrictions on the type of finance available to SMEs coupled with the small firm‘s insistence on first using internal sources of capital (Holmes and Kent, 1991), creates a unique structure for small business.

Financial growth theory

This theory was developed by Berger and Udell (1998). According to them, as a business matures over the years, its financial obligations and financing options metamorphose having more information available to the public.According to them, firms that are smaller, younger and possess more ambiguous information must depend on initial internal funding, trade credit, or a type of financing called angel finance. (Angel finance is one that occurs when an individual or organization provides a limited amount of financial backing for a start up business with more favourable repayment plan). As the firm

grows, it qualifies for acquiring both venture capital and midterm loans as sources of both intermediate equity and intermediate debt respectively. Further aging of the firm makes it to become bigger and less informationally murky. This thus qualifies the firm to have access to both public equity and long term loans as sources of both long term equity and long term debtrespectively.The capital structure of SMEs is thus very different from that of bigger firms because SMEs rely more on informal financial market which limits the type of financing they are able to secure. The SMEs initial use of internal financing leads to a peculiar state of affairs whereby capital structure

decisions are heavily dependent on the limited financing options. Therefore, SMEs possess varying capital structures and are financed by various sources at different stages of their development (Berger and Udell, 1998).

Bank capital channel theory

This model implies that the lending behaviour of banks to SMEs is heavily dependent on capital adequacy requirement. Obamuyi (2007) showed that a change in interest rate can influence banks lending to SMEs through bank’s capital. This implies that increasing the value of interest rates raises the cost of banks’ external funding, but reduces banks’ profits and capital. The tendency is for the banks to reduce their supply of loans if the capital constraint becomes binding. On the other hand, the banks could also become more willing to lend during situations when the interest rate is favourable.

The Life cycle model

This model was developed by Weston and Brigham (1981). According to them, accelerated growth of a small firm could lead to the firm lacking capital. This was because, most of the time, small firms are created with just internal funds from the owners. As the firm grows, the amount of owners’ equity is no longer capable of sustaining it and the firm would have to resort to external sources of funds in order to survive. Thus, accelerated growth could result in illiquidity and thus the firm would have a decision to make between reducing its growth rate or becoming illiquid and sourcing for external funds. Therefore Weston and Brigham (1981) concluded by

showing that SMEs that grow in size are very likely to have an increase in its debt structure.

Contract Theory

According to Wikipedia (2015), this theory was first formally treated by Kenneth Arrow. It studies how economic actors construct contractual arrangements in the presence of asymmetric information. Information asymmetry arises when one of two parties engaged in a business transaction happens to have more or different information than the other. In such a situation, one party does not have adequate information about the other party resulting in inaccurate decision making. This circumstance leads to a potential adverse selection and moral hazard problems in the credit market. Adverse selection is a problem arising from asymmetric information which occurs prior to the transaction actually occurring. Here a lender may decide not to lend money even though the borrower has the ability to make loan repayments as expected, just because he does not have enough information about the borrower to aid in his decision making.On the other hand, moral hazard is a problem of asymmetric information that occurs posttransaction.The borrower might engage in activities that are unknown yet undesirable from the lender‘s point of view, and this makes it less likely that the loan will be paid back. For these reasons, formal financial institutions insist on collaterals as a prerequisite for providing loan money to SMEs. The disbursement of loan money without securing adequate collateral is considered too risky. Stigilitz and Weiss (1981) have opined that information asymmetry is a significant reason why SMEs find it difficult to acquire adequate loans. According to them, capital does not always flow to small firms because of adverse selection and moral hazard, two factors that are known to have a devastating negative impact on small enterprises.

2.3 EMPERICAL FRAMEWORK

Amin et al (2001) the consumption and income done for 229 households used to identify household that are poor and vulnerable from three microcredit institutions namely Grameen Bank, Bagladesh rural advancement committee (BRAC) and association for social advance (ASA). The findings revealed that though microcredit

programs are unsuccessful at reaching those who are in need of assistance (vulnerable poor) due to limitation of subsidized credit, still programs are successful in reaching the poor.

Mosley and Hulme (1998) in their work found that, most of micro credit institutions especially in developing countries targeted on low income earners due to the fact that most of them do not need very big amount of funds. And there is greater impact on household’s income of higher-income compared to those below poverty line who

were negatively affected. The loans were also used to maintain consumption level and working capital instead of being used for a fixed asserts investment and improved technology. Due to insufficient amount and time of repayment some argue that installments come from selling house properties and not from profits of business.

Pitt and Khandker (1998) argued that, microcredit’s roles in smoothing consumption. This is due to the fact that other factors considered remaining constant such as labour and capital, especially when credit finance increases also the results increases in employment. Whereas the increase in income can negatively affect labour supply and causes the decline in employment. Therefore, credit finance program increases opportunities of self-employment,

income and improve economic condition of poor households. Wages decreased as well as employment in the wage market also decreased. This may not happen if and only if the wage-employment gap was filled by a new employment from the previously unemployment and generation of additional employment for underemployed.