Document of The World Bank

FOR OFFICIAL USE ONLY

Report No.: 19973-UNI

Financing Nigeria’s Rural Micro and Small-Scale Enterprises

May 11, 2000

MAIN REPORT

Rural Development 2 Africa Region

CURRENCY EQUIVALENTS

Currency Unit = Naira (N) US$1.00 = N105.0 (as of May 11, 2000) N1 = 100 Kobo

ABBREVIATIONS AND ACRONYMS

ACGSF Agricultural Credit Guarantee Scheme Fund AfDB African Development Bank ADPs Agricultural Development Projects CBN Central Bank of Nigeria CDAs Community Development Associations CGAP Consultative Group to Assist the Poorest DFI Development Finance Institution EBRD European Bank for Reconstruction and Development ECOWAS Economic Community of West Africa EDF European Development Fund EIB European Investment Bank ESW Economic and Sector Work ESSD Environmentally and Socially Sustainable Development FACU Federal Agricultural Coordinating Unit FEAP Family Economic Advancement Program FGN Federal Government of Nigeria FMBN Federal Mortgage Bank of Nigeria GAAP Generally Accepted Accounting Principles GDP Gross Domestic Product IBRD International Bank for Reconstruction and Development IFAD International Fund for Agricultural Development MIS Management Information System NACB Nigeria Agricultural and Cooperative Bank NAIC Nigeria Agricultural Insurance Corporation NBCI Nigeria Bank for Commerce and Industry NBCB National Board for Community Banks NBFI Non-Bank Financial Institution NEB Nigeria Education Bank NEXIM Nigeria Export-Import Bank NGO Non-Governmental Organization NIDB Nigeria Industrial Development Bank PBN People’s Bank of Nigeria RBP Rural Banking Program RFI Rural Financial Institution RFM Rural Financial Market ROSCAs Rotating Saving and Credit Associations SAP Structural Adjustment Program SDI Subsidy Dependence Index UBN Union Bank of Nigeria UDB Urban Development Bank

This Economic and Sector Work (ESW) is prepared by a study team comprising Sidi Jammeh (Team Leader, AFTR2); Stephanie Charitonenko (Lead Consultant); Ayo Adeniyi of the Federal Agricultural Coordinating Unit (FACU), Nigeria; James Akinwumi, Professor of Agricultural Economics at the University of Ibadan, Nigeria. Contributions were also made by Sam Eremie, Dele Ilebani, Esther Walabai, and Foluso Okunmadewa (AFMNG), and our ESW partners in Nigeria. The peer reviewers for this paper are Carlos Cuevas and William F. Steel (AFTP1); and Jacob Yaron (RDV). Joseph Baah-Dwomoh (Sector Manager, AFTR2) is providing quality assurance support. As this is a work in progress, please do not cite or quote. However, comments are welcome and can be sent to Sidi Jammeh at SJammeh@worldbank.org.

Financing Nigeria’s Rural Micro And Small-Scale Enterprises

TABLE OF CONTENTS

Page No.

EXECUTIVE SUMMARY ............................................................................................ i-x Chapter 1. INTRODUCTION ........................................................................................1

A. Background ......................................................................................................................1 B. Objectives and Methodology............................................................................................1 C. Data Sources.....................................................................................................................2 D. Organization of this Report..............................................................................................3

Chapter 2. COUNTRY CONTEXT ...............................................................................4

A. Macroeconomic Indicators and Performance...................................................................4 B. Banking System Structure ................................................................................................5 C. Rural Financial Markets ...................................................................................................6

Chapter 3. POLICY, LEGAL, AND REGULATORY ENVIRONMENT ................9

A. Summary of Banking System Policies, Programs, and Reforms .....................................9 B. Macro and Sectoral Policy Environment........................................................................10

(a) Maximum Interest Rate Ceilings and Spreads ....................................................10 (b) Effective Taxation of Agriculture ........................................................................11 (c) Investments in Infrastructure and Human Services ............................................12

C. Legal and Regulatory Framework..................................................................................12 (a) Regulation and Supervision of NBFIs.................................................................13 (b) Creation, Perfection, and Enforcement of Security Interests .............................14

Chapter 4. MAJOR RURAL FINANCE INSTITUTIONS .......................................15

A. Nigeria Agricultural and Cooperative Bank...................................................................15 (a) Ownership and Governance ...............................................................................15 (b) Mission and Services...........................................................................................16 (c) Performance........................................................................................................18 (d) Constraints..........................................................................................................20 (e) Recommendations ...............................................................................................22

B. People’s Bank of Nigeria ...............................................................................................23 (a) Ownership and Governance ...............................................................................23 (b) Mission and Services...........................................................................................24 (c) Performance........................................................................................................25 (d) Constraints..........................................................................................................26 (e) Recommendations ...............................................................................................28

C. Rural Support Programs .................................................................................................29 (a) Family Economic Advancement Program ..........................................................29 (b) Agricultural Credit Guarantee Scheme Fund .....................................................30 (c) Nigeria Agricultural Insurance Corporation ......................................................33

Page No. D. Informal Rural Finance Providers ...................................................................................35

(a) Trade and Input Supply Financing .....................................................................35 (b) Cooperative Societies..........................................................................................36 (c) Non-Governmental Organizations ......................................................................38 (d) Esusus, Family and Friends, and Moneylenders ................................................39

Chapter 5. RECOMMENDATIONS ...........................................................................41

A. Creating an Enabling Macro and Sectoral Policy Environment.....................................41 B. Improving the Legal and Regulatory Framework ..........................................................42 C. Building the Institutional Capacity of Rural Finance Providers.....................................42 D. Encouraging Banking System Linkages ........................................................................43 E. Next Steps.......................................................................................................................44

REFERENCES.................................................................................................................47 BOXES Box 1.1: Eight Pillars of Urban-Biased Policies ...........................................................................2 Box 1.2: Key Performance Indicators for Rural Finance Institutions ...........................................2 Box 2.1: Interest Rate Structure ....................................................................................................5 Box 2.2: Banking Service Outlets in Rural Areas.........................................................................6 Box 2.3: Banking System Institutions...........................................................................................6 Box 3.1: Important Policy Reforms Affecting the Banking System, 1996 - 1998......................10 Box 3.2: FGN Rationale for Cheap Credit and Empirical Evidence...........................................11 Box 3.3: Institutional Development in Nigeria’s Financial Sector .............................................13 Box 4.1: NACB’s Foreign Funding Sources...............................................................................16 Box 4.2: NACB’s Loan Products................................................................................................17 Box 4.3: NACB’s Investments....................................................................................................17 Box 4.4: NACB’s Lending Terms...............................................................................................18 Box 4.5: NACB’s Loans and Advances......................................................................................18 Box 4.6: NACB’s Financial Highlights ......................................................................................19 Box 4.7: NACB’s Foreign Exchange Rate Problems..................................................................21 Box 4.8: PBN’s Mission Statement.............................................................................................24 Box 4.9: PBN’s Financial Highlights..........................................................................................26 Box 4.10: PBN’s Loan Approval Process .....................................................................................27 Box 4.11: PBN’s Average Loan Processing Period ......................................................................27 Box 4.12: ACGSF Loan Repayment by Number and Volume .....................................................31 Box 4.13: Deposit Mobilization through the ACGSF’s Self-Help Group Program......................32 Box 4.14: Commercial Bank Branches in Rural Areas.................................................................32 Box 4.15: The National Agricultural Insurance Committee .........................................................34 Box 4.16: The Bauchi State Cooperative Financing Agency Limited ..........................................38 Box 4.17: Distribution of Occupational Groups by Sources of Informal Credit...........................40

ANNEXES Annex 1. Executive Summary of “Nigeria: Rural Finance Issues Paper” ...................................49 Annex 2. Description of NACB’s Specialized Project Lending Products ...................................50 Annex 3. Description of PBN’s Proposed Loan and Savings Products .......................................51

Financing Nigeria’s Rural Micro and Small-Scale Enterprises

EXECUTIVE SUMMARY

Background 1. The rural sector is central to Nigeria’s development strategy and agriculture continues to play a key role in rural growth. Empirical evidence suggests that financial markets in Nigeria are fragmented and inadequate to meet the rural demand for financial services. The absence of efficiently operating rural financial markets has become a serious constraint on sustainable rural development. Efficient and cost-effective financial services are essential elements of an environment that supports entrepreneurship, innovation, and production to develop and flourish. Households need access to safe savings facilities. In addition, farm and off-farm entrepreneurs need timely access to appropriately designed financial services to take advantage of market and investment opportunities. 2. To date, the Government of Nigeria has taken the “traditional” supply-led approach to the provision of agricultural credit. The underlying premise has been that there is market failure.1 Under such a premise, the “free” market cannot be relied upon to supply adequate credit to “weaker” economic agents in the rural economy. As a result, the solution has been the establishment of government policies and programs to ensure the adequate transfer of “cheap” credit to smallholder farmers. With little or no regard to the nature of the demand for financial services and with exclusive emphasis on agricultural credit over rural financial intermediation2, the government-sponsored programs have not achieved their objectives of sustained poverty reduction and rural development. Indeed, most of the government-sponsored agricultural credit programs have become huge liabilities to the government, with large loan losses and limited outreach.

Introduction to the Study and Report

3. The micro and rural finance institutions (RFIs) operating in the rural areas of Nigeria are complex, given the wide variety of state, collective, and private decision-making groups that influence their operations and use their services. Description and analysis of the rural financial markets is also complicated by the rapid and substantial changes in economic policies in Nigeria over the last two years and the necessity of key RFIs to change as a result. This study examines the environment for the development of rural financial markets in Nigeria, including an analysis of: (a) the main policies, laws, and regulations affecting the public and private delivery of financial services to rural micro and small-scale, farm and off-farm enterprises; and (b) the operation and performance of major formal and informal RFIs in terms of their outreach and

1 World Bank (1994). 2 Two government-sponsored institutions, which have been operating since 1990, are exceptions to this.

The People’s Bank of Nigeria (PBN) and the Community Banks (CBs) provide rural financial intermediation (by offering both deposit and loan products) to on-farm and off-farm enterprises. Indeed, although over 70 percent of the client base of both PBN and the CBs is rural, both intermediaries operate in urban areas as well.

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sustainability. It also highlights critical issues and recommends key policy and institutional changes to enhance the efficiency of rural financial market operations. 4. This report presents the findings of Phase II of a two-part study, which has focused on the issues raised in the paragraph above (Annex 1). It has been prepared in coordination with a Financial Sector Review, which has assumed responsibility for analyzing the Community Bank system. Although the Community Banks were introduced in Phase I of this study, only basic data on the system has been updated in this report and readers interested in learning more about the Community Banks are encouraged to refer to the (March 2000) Financial Sector Review. The information contained in this report is expected to inform the development of a vision for a privately-oriented financial system to serve rural micro and small-scale entrepreneurs in the context of a possible rural financial market development program, based on private enterprise and competition in all possible markets. The Macro and Sectoral Policy Environment 5. Economic development plans in many developing countries have historically been characterized by policies that were implemented in pursuit of accelerated industrial development. Nigeria is no exception. While the Government has made impressive policy improvements toward creating an enabling environment for rural financial market development, several ill-designed policies and programs remain, and as a result of these, the vast majority of rural micro and small-scale entrepreneurs still do not have access to adequate credit, savings, and insurance services. The most important of these policies are: (a) the continued funding of a plethora of public micro and rural finance institutions and support programs, with overlapping mandates and unsustainable designs, such as the mandatory charging of concessional lending interest rates by several state-sponsored credit providers; and (b) the inadequate investment in physical and institutional infrastructure, as well as in basic social services in rural areas. Each of these is described in further detail below. 6. The several and identical programs that the Federal Government of Nigeria (FGN) has promoted over the last twenty years, notably the development finance institutions, agriculture development and poverty reduction programs (especially the ACGSF and FEAP), and specialized financial institutions (in particular, the PBN and the Community Banks), need to be rationalized and consolidated. Perhaps the most damaging of these programs is the directed, subsidized credit disbursement through FEAP, which effectively “crowds out” any privately-based micro or rural financial service provision. 7. Although as of June 1999, interest rates are deregulated for licensed commercial and merchant banks, several of the DFIs are still subject to interest rate ceilings. Such interest rate restrictions are inconsistent with general financial sector policies of interest rate deregulation and in particular they constrain the flow of financial resources to the less privileged rural sector. In fact, the Central Bank of Nigeria (CBN) itself has previously agreed that, “The under-pricing of credit…creates excess demand for cheap funds, which have to be administratively managed via a rationing system, which is itself, costly and ineffective…” (World Bank, 1994). 8. There are clearly good intentions behind setting lending interest rates so low, but it ignores the really difficult decision that policy makers considering similar programs all over the world have had to cope with. The “Cruel Dilemma” describes whether, subject to unavoidable budget constraints, to allow more people to solve what may be their binding constraint to income production/poverty alleviation, that is, obtaining access to formal credit or, rather to use the scarce public resources to subsidize relatively few, rationed producers in the real good sector through artificially low lending interest rates. Once it is agreed that the objective is to expand

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access to credit, the choice becomes clear. Any subsidization of lending interest rates would have to come at the expense of poor people, who have often been found eager to pay higher interest rates for timely and reliable financial services, but who would be deprived from having access to such services, as the funds allocated for such an objective would be wasted instead on subsidized lending interest rates that could benefit only fewer clients. With respect to the “Cruel Dilemma”, it appears that FGN policies still pay tribute to the old paradigm, as if relatively few agricultural producers deserve to benefit from cheap credit, and as if the rural financial market is not considered to become an integral part of the overall financial system. 9. Rural infrastructure and human development remains weak compared to the relatively more developed urban areas. Deficiencies in rural infrastructure, including roads, electricity, and water supply increase per unit transaction costs of providing rural financial services and reduce returns on private rural investments in the real goods sector, and therefore, pose a serious constraint on rural financial market development. In addition, human development services in rural areas remain weak, especially in the areas of education and health. For instance, as of 1995, 63 percent of the urban population versus 26 percent of the rural population had access to safe water (expressed as a percentage of the population with access). Access to roads and electricity follows a similar pattern.3 Also as of 1995, 33 percent of males and 53 percent of females were pre-literate, with literacy rates dramatically decreased in predominantly rural States of Sokoto (84 percent), Jigawa (88 percent), Yobe and Taraba (89 percent).4 Inadequate physical and institutional infrastructure have inhibited the establishment and growth of rural enterprises and the development of rural financial markets. For example, infrastructure deficiencies have contributed to preventing the timely sale of marketable agricultural surpluses and, hence have kept farmgate prices low and lessened incentives to increase production. The availability of appropriate infrastructure and human services need to be increased if financing of the rural sector is ever to be provided on a cost-effective and sustainable basis. The Legal and Regulatory Framework 10. The legal and regulatory framework of the Nigerian RFIs remains weak due to political and technical reasons. For instance, although both the People’s Bank and the Community Banks have undergone organizational restructuring over the last five years, they still continue to be plagued by political influence and limited institutional capacity. In addition, the regulation and supervision standards to which most RFIs are subject have changed over the last two years, and are still in the process of being clarified for the CBN and the institutions that have recently come under its regulation and supervision. These issues continue to translate into poor management practices and weak accountability at the financial institution level. Both the technical capacity of RFIs and the CBN’s regulatory and supervisory framework need to be strengthened before the flow of financial services to the rural areas can be sustainably increased. The most pressing legal and regulatory issues, namely the needed strengthening of the CBN’s capacity to supervise and enforce prudential regulations on the RFIs that have recently come under its supervision and the required enhancement of property rights and framework for secured transactions, are described below.

3 World Bank (1992) estimated that about 70 percent of Nigeria rural road network was in “poor” or “very

poor” condition, with only 5 percent in “good” condition. With 1.1 kilometer of road per 1,000 population, Nigeria’s rural road density is one of the lowest in Sub-Saharan Africa, compared to Cameroon (6.5), Cote d’Ivoire (4.8), and Ghana (2.3). Due in part to Nigeria’s low rural road density, post-harvest losses have been estimated as quite high, ranging between 20 percent in the semi-arid/arid north and 30 percent in the humid forest zones in the south (World Bank, 1994).

4 World Bank (1998) and Federal Office of Statistics (1997).

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11. Given the wide geographic and functional dispersion of the financial institutions now under the regulatory and supervisory responsibility of the CBN and the central bank’s limited physical and human resources, the regulatory and supervisory framework needs to be reviewed and strengthened during the transition period to appropriately account for the various activities of non-bank financial institutions (NBFIs).5 The activities of the NBFIs, especially the DFIs need to be streamlined, with most of the functions being housed in two to three institutions. Although this report focuses on one of the main DFIs, the NACB, and the PBN, as a major specialized financial institution, the Financial Sector Review being prepared in close coordination with this report is addressing recommended enhancements in the regulation and supervision of the other NBFIs. 12. The FGN is the only institution with the ability to create an environment in which a wider range of assets (tangible or intangible) can be used as collateral for financial transactions. In particular, Nigeria’s current system for creating, perfecting, and enforcing security interests has serious weaknesses, which need to be addressed. This inadequate system negatively affects the costs of credit transactions, the characteristics of credit contracts, and the degree of access by rural micro and small-scale entrepreneurs to financial services. Suitable reforms would include: (a) introducing a new law of secured transactions, which would allow effective use of movable assets, including equipment, inventory, receivables, and consumer goods as collateral; (b) improving the efficiency of public registries, permitting lenders to record pledges of land and housing, and provide quick access to information about existing liens; and (c) introducing a mechanism for expeditious recovery of collateral, including foreclosure of mortgage loans. Restructuring public registries and an improved legal framework are necessary conditions for well-functioning rural financial markets. Major Rural Finance Institutions 13. The main formal and informal financial institutions serving Nigeria’s rural sector are reviewed in Chapter 4. The types of RFIs discussed include one of the DFIs, NACB; one of the specialized banks, PBN (with the Community Banks [CBs] being covered in the parallel Financial Sector Review); three of the rural support programs, FEAP, ACGSF, and NAIC; and three categories of informal rural finance providers, cooperative societies; NGOs; esusus, family and friends, and moneylenders. In addition, this report reviews the scale and scope of trade and input supply financing being carried out by the formal and informal sectors. 14. These semi-formal rural finance providers and support programs have generally had only limited outreach to date and most of the formal and semi-formal institutions are unsustainable as currently designed. A few have recently made great strides toward increasing their outreach, namely PBN, the CBs, and NAIC; nevertheless, all RFIs continue to be severely hampered by existing policies, inadequate funding in relation to their mandates, and lack of technical expertise in banking. To date, the main three RFIs – NACB, PBN, and the CBs have only managed to reach less than ten percent of the rural households. Each of these RFIs is further analyzed in Chapter 4 in terms of their ownership and management, mission and services, performance, and constraints. However, specific options and recommendations for each institution to consider so that they may better contribute to rural financial market development in the future are shared below.

5 The NBFIs referred to in this report include: (a) the seven development finance institutions (NACB,

NIDB, FMBN, NBCI, NEXIM, NEB, and UDB); (b) the two major specialized financial institutions (PBN and the Community Banks); (c) licensed finance companies; (d) primary mortgage institutions; and (e) discount houses.

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15. Based on the findings of a 1994 World Bank study, a 1994 FAO report, and additional survey data gathered as part of the preparation of this report, it has been found that the informal sector continued to provide the bulk of rural dweller’s credit needs (mainly working capital). The three most important sources of rural credit are ROSCAs (40 percent), family (30 percent), and friends; commercial banks come a distant fourth, with only 11 percent of the sample sourcing credit from them. Trade and input supply financing has been found to be widely practiced by these and other informal groups, but despite the well-adapted operations of informal rural finance providers, the total amount of financial services provided by these institutions has not been sufficient to satisfy the rural demand for credit, which is both seasonal and short term in nature. Moreover, by extending loans with an average maturity of three months, the informal sector has not been involved in the provision of medium to long-term credit for term investment in long-gestation crops, livestock, agro-processing, or small-scale irrigation development activities. In addition, informal rural finance providers have not had the technical capacity for assessing the financial viability of projects. Hence, informal rural sector lending, even for short-term loans, has been restricted to traditional activities, whose financial viability has been established over the years. Thus, informal rural lenders have generally tended to rule out financing of new activities, about which they have had little or no knowledge – a typical risk-averse behavior – thereby limiting the provision of rural loans. Recommendations and Next Steps 16. The main recommendations of the study are related to the need to improve the macroeconomic and sectoral policy environment to promote rural financial markets, enhancing the legal and regulatory framework governing the operation of RFIs, building the institutional capacity of the main formal and informal rural finance providers, and the development of the supporting linkage between the formal and informal sectors of the banking system. General recommendations and suggested next steps to forming a holistic rural financial market development strategy and action plan are also included below.

Creating an Enabling Policy Environment

17. While improvements have been made in the policies and laws of Nigeria, especially since 1996, there are still many challenges which need to be met in order to create an environment that is supportive of the development of rural financial markets. Key to building an enabling environment are maintenance of a stable and growing economy as well as improvements in the legal and regulatory framework to improve property rights and enhance the capacity of CBN to effectively supervise and enforce prudential guidelines on several of the RFIs which have recently come under its jurisdiction. In addition, a rationalization and restructuring of several government-sponsored development finance institutions is necessary for the development of rural financial markets. 18. Sound Macroeconomic Policies. Above all, the development of rural financial markets requires sound monetary and fiscal policies which result in macroeconomic stability with low and stable inflation. Extra-budgetary expenditures must also be minimized to ensure price stability. Consistent and rational economic policies foster investor and consumer confidence and encourage the development of rural financial markets. 19. Investment in Rural Infrastructure and Human Services. More resources from FGN budget allocations need to be directed to the rural sector, consistent with the need to invest adequately in rural infrastructure and human services, especially in the areas of providing safe drinking water, roads, electricity, telephone service, health, and education. Structural adjustment policies and deregulation programs, in the late 1980s and early 1990s, have left Nigeria’s agricultural sector

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largely deregulated; however, the years of austere fiscal policies accompanying adjustment and deregulation diminished the pool of funds available to be invested in rural services. Nevertheless, the creation of off-farm jobs hinges on the existence of essential supporting infrastructure and a pool of well-educated workers. In addition, improvements in on-farm productivity and profitability depend on the quality and density of rural infrastructure and investments in agricultural crop research and post harvest handling technologies. Both are necessary for rural financial market development and depend on adequate rural investment in infrastructure and human services. 20. Rationalization/Consolidation of FGN Rural Development Programs. The numerous microfinance programs that the FGN has promoted over the last twenty years need to be rationalized and consolidated. At present, the missions of many programs overlap. Perhaps the most damaging of these programs is the directed, subsidized credit disbursement through FEAP, which effectively “crowds out” any privately-based micro or rural financial service provision. 21. Promoting Private Risk Management. As the FGN lessens its emphasis on state-supported, supply-led interventions in rural financial markets, private risk management mechanisms must accommodate the risks formerly assumed by the government. The FGN should build off the successes achieved in the last several years through NAIC in this regard. NAIC’s operations have become widely recognized throughout West Africa as being innovative and developing best practices and the organization deserves a more in-depth study to discern where further efficiencies in the system might be found. Depending on the results of a more in-depth analysis and institutional development plan, the NAIC might be a good candidate to receive a one time injection of further funds to increase its share capital and make it a good candidate for privatization, provided it would keep the majority of its business oriented toward its core operations – meeting the insurance needs of Nigeria’s rural farm and off-farm enterprises.

Enhancing the Legal and Regulatory Framework

22. General areas of action regarding the legal and regulatory framework include: (a) adapting regulation and supervision to the growth of NBFIs; (b) promoting self-regulation of NBFIs; (c) provision of deposit insurance to specialized financial institutions; and (d) enhancing property rights in terms of recognizing non-traditional forms of collateral and promoting credit bureaus and rating agencies. In this section, we raise these issues as recommended areas of further research over a longer-term. No specific recommendations are provided here. The Next Steps matrix at the end of this section appropriately notes each of the issues raised below for further review and analysis over the longer term. 23. Adapting to the Growth of NBFIs – Appropriate Regulation and Supervision. The regulatory and supervisory framework needs to be reviewed and need to be strengthened to embrace the recently expanded activities of NBFIs. The legislation that governs the entry, capital adequacy, legal lending limits, risk classification standards should be adapted to the specialized operations of informal NBFIs that mobilize deposits. Furthermore, there is a need to harmonize and coordinate the efforts of apex organizations to maintain sustainable growth patterns in the informal system. 24. Adapting to the Growth of NBFIs – Effective Deposit Insurance. Another dimension to the issue of providing adequate protection to the investing public, particularly individuals, collective investment institutions, and contractual savings institutions, from mismanagement, is to instill confidence in the system, and ensure capital market stability by providing effective deposit insurance. The regulatory framework should clearly delineate the rights and obligation of parties engaging in financial transactions, and assure adequate disclosure, transparency, and protection

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for small and relatively unsophisticated depositors and investors. This is especially an issue with the large numbers of depositors in NBFIs such as the PBN and the Community Banks. Determining what form effective deposit insurance should take (for example, traditional deposit insurance or other, more indirect mechanisms such as an apex stabilization fund to instill depositor confidence and effectively safeguard funds), however, merits further review. 25. Clearly Defining Property Rights. Property rights need to be more clearly defined. Small agricultural producers in Nigeria tend not to hold secure title to land they own and farm. The absence of clear and legally-recognized ownership or access contributes to under-investment and unsustainable exploitation of the natural resource base. Farmers without title to land are unlikely to invest in productivity-enhancing technologies and to adopt soil and water conservation practices. These issues particularly affect women’s access to adequate micro and rural financial services. Ill-defined property rights also inhibit lending for long gestation crops without real collateral.

Building the Institutional Capacity of the Main RFIs

26. Several common issues affect each of the rural finance providers examined in this report. The scarcity of skilled banking professionals, which is a generic problem of the banking industry affects the main rural finance providers as well. Poor managerial and technical skills of both the formal and informal financial institutions are major bottlenecks to efficient rural financial intermediation. In addition, the maintenance of concessional interest rates by many of the RFIs continues to generate inadequate returns to cover costs and has generally led to severe liquidity constraints for the rural financial system. A rationalization of the plethora of state-sponsored RFIs and support programs is badly needed, and the restructuring of most of the institutions will be a necessary condition for the development of Nigeria’s rural financial markets. The Financial Sector Review being prepared in coordination with this report contains recommendations to combine the seven DFIs into two or three institutions. Recommendations regarding the Community Bank system have also been reserved for the Financial Sector Report. The one DFI analyzed here, NACB, is recommended to undergo substantial restructuring and revitalization, so that it may restructure its balance sheet and adjust its operating policies and procedures to be on a path to financial self-sustainability. The PBN, as in the case of NACB, should also undergo dramatic restructuring. Specific recommendations which address these concerns follow. 27. NACB: This institution has the largest branch network of any commercial bank or DFI, and is second only to the Community Banks in terms of the total number of rural outlets. Regarding overall country coverage, NACB has the greatest geographic representation and the best coverage of major agricultural centers in the rural areas. In addition to the extensive physical network, NACB also has substantial investment in human capital. The total number of its staff as at April 14, 1999 was 1,660. This number comprised 33 management staff, 508 senior staff, and 1,119 junior staff. The number of staff at headquarters was 432, while 1,228 were in the field. The organization benefits from over 25 years of accumulated wealth of experience in smallholder finance. Although many staff have left and low morale is a lingering problem, most of the remaining staff are dedicated professionals and are hopeful that the organization will change for the better, with adjustments in NACB’s operating policies and procedures. The staff who have been there the longest appear to be technically competent, well-experienced professionals in rural lending. 28. Perhaps most importantly, NACB’s senior management are aware of international best practices in rural finance, including the provision of micro and small-scale financial services, and are eager to adapt these to the context of Nigeria. There is widespread support in the organization

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for dramatically changing the operating policies and procedures to overcome the constraints identified above. 29. Provided NACB successfully undergoes a significant and widespread restructuring and revitalization process, this DFI would merit further recapitalization and restructuring of its debt burden. Critical elements of such a restructuring program would include: (a) balance sheet restructuring and adjusting the products and services offered; (b) changing the mission to emphasize financial self-sustainability; (c) appointing a new Board of Directors and instituting appropriate staff incentive systems to ensure appropriate governance; (d) introducing incentive systems for clients; (e) training in micro and rural finance institution management, operations, and lending technologies; and (f) improving the quality of its management information systems and reporting. Each of these areas is discussed in more detail in Chapter 4. 30. PBN. As recommended for NACB, PBN should also embark upon a substantial restructuring program so that it can be positioned to the a path towards financial self-sustainability in the near term. PBN’s on-lending of funds from FEAP should cease immediately, as it competes with PBN’s own loan products and creates the image of PBN as a cheap, short-term government credit disbursement center instead of a long-term financial service provider. Essential elements of PBN’s restructuring program would include areas similar to those described for the NACB above and are described further in Chapter 4.

Encouraging Banking System Linkages

31. In order to develop deeper, more efficient and complete markets, competitive forces have to be allowed to be in play. In Nigeria, competition in rural financial markets is largely absent. The predominant actors are state-owned, specialized financial institutions, credit granting NGOs, and informal financial suppliers. The clientele of each is segmented. The terms and conditions for each typical provider varies significantly. Financial costs are lowest for the state-owned institutions but the transaction costs are the highest. The reverse is true for the informal lenders. Part of the solution entails expansion of financial service provision along a sustainable path by NACB and the PBN. By virtue of being close to their clients, each of these institutions intermediates between community-based, informal groups and the formal financial sector with less processing time and expense than commercial banks. Strengthening these RFIs would facilitate banking system linkages. Another part of the solution requires building and strengthening trade and input supplier financiers and other informal providers of rural financial services. These intermediaries have a potentially significant role to play in the development of supplier finance and other inter-linked contracts. Specifically, improving the regulation and supervision of cooperatives that provide financial services, coupled with expansion of a properly established cooperative financial structure, along the lines of the Bauchi State Cooperative Financing Agency Limited as discussed in Chapter 4, could provide an excellent linkage between the formal and informal financial sectors.

Next Steps

32. The options and recommendations provided in the last section have been summarized below in matrix form. The recommendations fall under short, medium, and long-term priorities. The findings of this report, along with the prioritized recommendations, will enrich the Bank’s dialogue on financial sector issues with the FGN, as well as lead to the development of a vision for a privately-oriented financial system to serve rural micro and small-scale entrepreneurs in the context of a possible rural financial market development program, based on private enterprise and competition in all possible markets.

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33. This study has attempted to provide a holistic treatment of the major issues affecting the constitution and performance of rural financial markets serving micro and small-scale enterprises in Nigeria. As such, it exposes several important complex areas that require further, more focused analysis to appropriately address them. Specifically, more detailed qualitative and quantitative analyses of NACB, PBN, NAIC, and ACGSF need to be carried out in the context of working papers geared toward redefining their mandates and developing institutional development plans for each, where warranted. Two additional working papers would further sharpen the analysis and refine the recommendations of this report. The first would be focused on: 1) macro issues specifically related to the “Eight Pillars of Urban-Biased Policies” traditionally found to hamper the development of rural financial markets in many developing countries; and 2) the comparative advantages, if any, Nigerian farmers have in their production in import substitution or export crops. The second would more concretely address the issue of trade financing as a potentially important mechanism through which to substantially improve the performance of rural financial markets. Finally, a demand and supply analysis of the number and types of “constrained borrowers”, similar to previous studies carried out in El Salvador, Mexico, and Romania would complement the findings of this report and facilitate the production of any warranted institutional development plans for NACB, PBN, NAIC, or ACGSF. 34. As part of this ESW, the Bank is co-sponsoring a three-day sub-regional conference on micro and rural finance to be held in September, 2000 in Abuja, Nigeria. This conference is being closely coordinated and co-sponsored with the Central Bank of Nigeria, the Ford Foundation, USAID, DFID, IFAD, UNDP, and several other major stakeholders, including microfinance institutions operating in Nigeria and the West Africa Region. The objectives of the conference are to: validate the findings of this study, exchange views on “best practices” in rural microfinace and building consensus on the way forward. The outcome of this stakeholder meeting is expected to prepare the way for preparing an operation to support the implementation of the recommendations of this study.

Recommendations Priority Matrix

Issue(s) Problem(s) and Empirical

Evidence Recommendation(s)

Immediate Recommendations Rationalizing the plethora of similar government programs.

Several of the DFIs, the PBN, and FEAP have overlapping mandates and program designs with varying degrees of unsustainability, requiring large amounts of continued state support.

Consolidate the seven DFIs into two to three institutions, streamlining their mandates, restructure NACB and the PBN as part of this rationalization process, and phase out FEAP. Restructure the ACGSF to increase its outreach and operating efficiency.

Recommendations for the Short-Term

Promoting better rural risk management.

As the FGN decreases its emphasis on state-supported, supply-led interventions in rural financial markets, private risk management mechanisms must accommodate the risks formerly assumed by the government.

Develop an institutional development plan for NAIC to become a privatized insurance provider while keeping its focus on insuring rural farm and off-farm enterprises on a commercial basis.

Recommendations for the Medium-Term Developing formal - informal financial sector linkages.

The predominant actors are state-owned, specialized financial institutions, credit- granting NGOs, and informal financial suppliers, with the clientele of each being segmented and relatively unconnected to the formal financial system.

Restructure NACB and PBN so that they can operate along a sustainable growth path, and build on their existing strength in intermediating between community-based, informal groups and the formal financial sector with less processing time and expense than commercial banks. Strengthen linkages between the formal financial sector and trade and input supplier financiers and other informal providers of rural financial services, as they have a potentially significant role to play in the development of inter-linked contracts.

Recommendations for the Long-Term Ensuring macroeconomic stability.

Large fiscal deficits and extra-budgetary expenditures can lead to rising inflation, undermining the ability of financial institutions to set appropriate interest rate policies and extend loan maturates.

Adopt a combination of sound fiscal and monetary policies to keep inflation low and controlled, minimize policy reversals and avoid contradictory policies across Ministries and between the Federal and State levels of government.

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Issue(s) Problem(s) and Empirical

Evidence

Recommendation(s)

Recommendations for the Long-Term, cont’d.

Increasing provision of adequate infrastructure and human services.

Inadequate infrastructure and human services inhibit the growth of farm and off-farm enterprises, depressing demand for financial services and the development of efficient rural financial markets.

Shift additional resources to provide adequate rural infrastructure (roads, electricity, water) and human services (health and education), where these necessities are relatively underdeveloped compared to urban areas.

Enhancing the regulatory and supervisory framework for NBFIs

The recently expanded activities of NBFIs necessitates a review of the legal and regulatory structures affecting them to ensure confidence in the financial sector and protect depositor funds

Review the legal and regulatory framework governing the operations of the main NBFIs and develop appropriate supervision based on international best practices

Improving property rights.

The absence of clear and legally-recognized ownership or access contributes to under-investment and unsustainable exploitation of the natural resource base.

Suitable reforms would include: (a) introducing a new law of secured transactions, which would allow effective use of movable assets, including equipment, inventory, receivables, and consumer goods as collateral; (b) improving the efficiency of public registries, permitting lenders to record pledges of land and housing, and provide quick access to information about existing liens; and (c) introducing a mechanism for expeditious recovery of collateral.

Chapter 1. INTRODUCTION

A. Background

1.1 Rural financial institutions (RFIs) in Nigeria are complex, given the wide variety of state, collective, and private decision-making groups which influence their operations and use their services. Description and analysis of the rural financial markets is also complicated by the rapid and substantial changes in economic policies in Nigeria over the last two years and, as a result, the need for some of the key RFIs to change. This study examines the environment for the development of rural financial markets in Nigeria, including an analysis of: (a) the main policies, laws, and regulations affecting the public and private delivery of financial services to rural micro and small-scale, farm and off-farm enterprises; and (b) the operation and performance of major formal and informal RFIs in terms of their outreach and sustainability. It also highlights critical issues and recommends key policy and institutional changes to enhance the efficiency of rural financial market operations. 1.2 This report presents the findings of Phase II of a two-part study, which has focused on the issues raised in the paragraph above (also, see Annex 1). It has been prepared in coordination with a Financial Sector Review, which has assumed, as part of its coverage, responsibility for analyzing the Community Bank system. The contents of this report would contribute to the development of a vision for a privately-oriented financial system to serve rural micro and small-scale entrepreneurs in the context of a possible rural financial market development program, based on private enterprise and competition in all possible markets.

B. Objectives and Methodology

1.3 This study seeks to enrich the dialogue between the Federal Government of Nigeria (FGN) and the World Bank on developing a strategy to increase the outreach and sustainability of RFIs. The main objective of this report is to deepen our understanding of the workings of rural financial markets in Nigeria and of those factors which are likely to influence their future performance. Specifically, the report highlights critical macro and sectoral policies as well as laws and regulations affecting rural financial market development and recommends critical policy changes to encourage efficiency in rural financial markets as part of an integrated approach to rural development. The analysis of policies and laws is guided by the “Eight Pillars of Urban-Biased Policies” (Yaron, 1992), which serve as a convenient checklist, on the grounds that international experience has identified a common set of urban-biased policies as commonly inhibiting the development of rural financial markets (Box 1.1).In addition, this report assesses the main providers of formal and informal financial services, using the key performance indicators of outreach and sustainability (Box 1.2).6 Based on these analyses, several recommendations are made in order to strengthen the capacity of RFIs to provide more appropriate and sustainable financial services to rural micro and small-scale rural enterprises.

6 One of the first publications to propose the use of outreach and sustainability as key performance

indicators was Yaron (1992). Since then, these two primary assessment criteria have become generally accepted and widely used in the field of microfinance.

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Box 1.1: Eight Pillars of Urban-Biased Policies 1. Overvalued exchange rates. 2. Low, controlled, and seasonally invariant prices of agricultural products. 3. High effective rates of protection for domestic industry, the outputs of which are used as

agricultural inputs. 4. Disproportionately high budgetary allocations for urban, rather than rural infrastructure (roads,

electricity, and water supply.) 5. Disproportionately high investment in human resources in urban, rather than rural areas (health

and education.) 6. Usury laws that rule out the small, risky, and high-cost loans typical in rural areas. 7. Underdeveloped legal and regulatory provisions regarding land titling and collateral for typical

rural assets (land, crops, and farm implements) relative to urban assets (cars, homes, and other durables.)

8. Excessive taxes on agricultural exports. Source: Yaron, Benjamin, and Piprek (1997). Box 1.2: Key Performance Indicators for Rural Finance Institutions The key performance indicators for rural finance intermediaries are based on CGAP’s appraisal format, which is used to assess primarily microfinance intermediaries from four perspectives: (1) institutional factors (such as legal structure, ownership, management, and information systems); (2) the market and services provided; (3) strategic objectives; and (4) financial performance. The ten key outreach and financial performance indicators are listed below. Each represents a summary of more detailed areas of financial analysis. All the indicators should be based on audited balance sheets and income statements that conform to GAAP. • Number of voluntary consumer deposit accounts and outstanding loans. • Total volume of voluntary consumer deposits and outstanding loans. • Average voluntary consumer deposit amount and loan balance per client. • Loan loss rate. • Delinquency rate (loan portfolio at risk over 30 days). • Administrative efficiency. • Operational self-sufficiency. • Adjusted return on average assets. • Subsidy dependence index. • Total voluntary consumer deposits as a percentage of the total outstanding loan portfolio. • Total commercial liabilities as a percentage of the outstanding loan portfolio. Source: Adapted from Fruman and Goldberg (1997).

C. Data Sources

1.4. This report draws from a wide variety of published and unpublished data sources. These include policy and strategy papers prepared by several agencies of the FGN, apex and individual rural finance institutions in Nigeria, and Nigerian academicians. In addition, relevant data and analysis from the published and unpublished financial reports of several private and public rural finance institutions in Nigeria have been used.

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D. Organization of the Report

1.5 Chapter 2 summarizes the country context, including macroeconomic indicators relevant to rural financial market operations, the financial sector structure, and the main institutions providing rural financial services. Chapter 3 reviews recent financial sector reforms and analyzes what elements of the policy and legal framework are likely to inhibit or promote the development of rural financial markets. Chapter 4 examines the structure and functions of the main RFIs and assesses their performance. Chapter 5 offers several recommendations on how to create an enabling environment for RFIs and build the institutional capacity of the main providers of rural financial services. The Annexes contain key background documents used in the production of this report, and financial and operational highlights of the RFIs studied.

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Chapter 2. COUNTRY CONTEXT

A. Macroeconomic Indicators and Performance

2.1 The state of Nigerian economic development is dismal. Even the low 1997 GDP per capita of US$260 masks the depth of poverty in the country due to highly uneven income distribution. The economy remains dependent on the income generated by the capital intensive oil sector, which provides half of GDP, about 90% of foreign exchange earnings, and approximately 80% of budgetary revenues.7 Agriculture, on the other hand, only accounts for about one-third of GDP but it employs nearly two-thirds of the labor force, and about 90 percent of the rural population. In 1996, it was estimated that about 56 per cent of Nigeria’s total population of about 107 million (or about 60 million people) live below the poverty line and that about 24 percent (or 26 million) could be classified as “hard core” poor.8 It was also estimated that over 60 percent of rural dwellers live in poverty. Poverty in Nigeria is especially pronounced in the northern part of the country, with pockets of severe poverty in the riverine and remote Southern areas.9 2.2 Macroeconomic conditions, however, have markedly improved over the last three years, mainly due to restrictive fiscal and monetary policies pursued during the period 1994 - 1996. The most outstanding achievement is the sharp reduction in inflation from a peak of 72.5 percent in 1995 to 8.5 percent by 1997 and 9.8 percent in 1998. Real GDP growth was over 3 percent in 1996 and 1997, declining only slightly, to 2.4 percent growth in 1998. This has been accompanied by a transformation of the fiscal accounts from a deficit amounting to 15.4 percent of GDP in 1993 to modest surpluses for three consecutive years, 1995 – 1997. Monetary growth has also slowed considerably, from 54 percent in 1993 to 17 percent in 1997, due mainly to decreased claims on the FGN.10 2.3 The interest rate structure has also vastly improved in recent years and this has positive implications for the financial sector and the economy as a whole. While nominal Treasury bill and minimum rediscount rates were steady over the last five years, at about 12 percent and 14 percent, respectively, high inflation translated these into negative real interest rates until 1998 (Box 2.1). Although real saving deposit interest rates remain slightly negative (about negative two percent as of the end of September, 1998), the real Prime lending interest rate was positive for the first time in at least five years. This is due in part to the lifting of imposed maximum lending interest rates and spreads in 1996. This trend toward increasingly positive real interest rates provides incentives to mobilize savings and to increasingly lend funds.

7 The main source of these statistics is Central Bank of Nigeria (1998). 8 “Hard core” poor is a term used to refer to the bottom 50 percent of those living below the poverty line. 9 The statistics presented here are from the World Bank (1994) and Okunmadewa (1998). They are

consistent with the findings of earlier studies by the Nigerian Federal Office of Statistics in 1985 and 1992 as cited in Okunmadewa (1997).

10 Sources of these macroeconomic statistics include the International Monetary Fund (1998), and World Bank (1997 and 1999).

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Box 2.1: Interest Rate Structure As at year end, unless otherwise specified Percentages Nominal Interest Rates 1994 1995 1996 1997 1998 Discount Rate 13.50 13.50 13.50 13.50 13.50 Prime Lending Rate 20.20 20.20 19.10 18.40 18.90 Savings Deposit Rate 12.30 12.60 10.10 6.10 6.10 Spread (Len 7.90 7.60 9.00 12.30 12.80

ding – Deposit)

Average Annual Inflation 57.05 72.80 29.29 8.53 10.30 Real Interest Rates 1994 1995 1996 1997 1998 Discount Rate -27.73 -34.32 -12.21 4.57 2.90 Prime Lending Rate -23.46 -30.44 -7.88 9.09 7.80 Savings Deposit Rate -28.49 -34.84 -14.84 -2.24 -3.81 Spread (Lending – Deposit) 5.03 4.40 6.96 11.33 11.61 Sources: International Monetary Fund (1998), World Bank (1999), and the authors’ calculations.

B. Banking System Structure11

2.4 The banking system at the end of 1998 comprised 89 licensed (predominantly private, for-profit) commercial and merchant banks; 1,014 Community Banks (privately owned by community shareholders); the People’s Bank (government owned), with about 278 branches; and seven development finance institutions (DFIs), also government owned-- the Nigeria Agricultural and Cooperative Bank (NACB), the Nigeria Industrial Development Bank (NIDB), the Federal Mortgage Bank of Nigeria (FMBN), the Nigeria Bank for Commerce and Industry (NBCI), the Nigeria Export-Import Bank (NEXIM), and the Nigerian Education Bank (NEB) and the Urban Development Bank (UDB). As a result of the ongoing restructuring and rationalization of commercial banks, the number of commercial bank branches fell from 2,402 in 1996 to 2,330 in 1997. Of these branches, 1,715 (74 percent) were located overseas or in urban areas and 615 (26 percent) were located in rural areas (Box 2.2).12 Merchant bank offices numbered 147 but all were located in urban areas. With the growing distress in the community banking system, 353 community banks had their licenses withdrawn by the National Board for Community Banks (NBCB) in 1997, thus reducing the number of community banks from 1,368 in 1996 to 1,015 in 1997. The total number of banking offices in Nigeria, comprising community, commercial, and merchant banks was 3,492 at the end of 1997, down from 3,917 a year earlier. This contributed to increasing the average number of people per banking office (of these types) from 25,342 in 1996 to 29,137 in 1997. 2.5 Commercial banks remain the dominant providers of financial intermediation, steadily accounting for over 80 percent of total banking assets (Box 2.3), as well as over

11 Box 3.3 depicts the banking system within the overall financial sector structure, as well as changes in

both 1985 – 1997. 12 The main source of these statistics is Central Bank of Nigeria (1998).

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80 percent of total banking deposits and total loan and advances of the banking system.13 Merchant banks, which accept block deposits and provide mainly trade finance, account for virtually all of the remainder. Box 2.2: Banking Service Outlets in Rural Areas14 As at the end of 1998 (b) Total Outlets Rural Outlets b/a b/c Commercial Banks 2,330 615 26% 33% Merchant Banks 147 0 0% – NACB 379 379 100% 20% PBN 278 219 79% 12% Community Banks 1,014 710 70% 37% TOTAL 4,148 (a) 1,923 (c) 45% 100% Sources: Central Bank of Nigeria (1998), and published and unpublished financial reports of NACB, NBCB, and PBN (1999, 2000). Box 2.3: Banking System Institutions Total assets as at year end Figures rounded to nearest N billion

1994 1995 1996 1997 1998 Commercial Banks 295 385 459 579 NA Merchant Banks 62 80 90 119 NA NACB 6 6 6 5 5 Community Banks 4 5 5 5 5 PBN 0 0 1 1 2 TOTAL 367 476 561 709 NA Sources: Central Bank of Nigeria (1998), and published and unpublished financial reports of NACB, NBCB, and PBN (various years). 2.6 The Central Bank of Nigeria (CBN) is the primary regulatory and supervisory body for the banking system, and is responsible for protecting the integrity of the payment system. Its basic functions include the issuance of legal tender currency, maintenance and management of external reserves, promotion of monetary stability and sound financial structure, provision of banking services to banks and acts as banker and financial adviser to the government. In addition, there are three other supervisory agencies for the banking sector: the Nigeria Deposit Insurance Corporation (NDIC), which provides deposit insurance (mandatory for all licensed banks) and, in conjunction with the Central Bank, supervises the insured banks; the National Board for Community Banks (NBCB), which is responsible for overseeing the activities of the Community Banks; and the Federal Mortgage Bank of Nigeria (FMBN), which is responsible for the oversight of the primary mortgage institutions (World Bank, 1997).

13 Excluding the Central Bank of Nigeria. 14 “Outlets” include branches, representative offices, service units, etc. where financial transactions occur.

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C. Rural Financial Markets

2.7 Rural financial services are provided by both formal and informal financial institutions. The main formal providers include commercial banks, government-sponsored DFIs and rural sector support programs. The most common informal-sector providers, in descending order of importance, are self-help groups, including the rotating savings and credit associations (ROSCAs) locally referred to as “Adashis” or “Esusus” by most Nigerians; family and friends; moneylenders; moneykeepers or savings collectors; and some cooperative societies which provide access to credit.15 This section reviews the major financial institutions operating in the rural areas and examines the structure and overall performance of rural financial markets.

2.8 The operations of the commercial banks continue to be urban-biased and oligopolistic. Less than a third of the total commercial bank branches are located in rural areas and only four banks account for over half of the total rural branch network, receiving only limited competition for rural clients. As of the end of 1997, First Bank of Nigeria had 105 rural branches; Union Bank of Nigeria (UBN) had 91 rural branches, the United Bank for Africa had 86 rural branches; and Afribank had 43 rural branches.16 Micro and small-scale, farm and off-farm entrepreneurs have historically been underserved by the commercial banking system and no new evidence contradicts this pattern. Sectoral allocations of credit extension imposed on commercial banks by the FGN were lifted in 1998 and since then, although commercial banks are prohibited from outright closure of rural branches by the CBN, the trend appears to be de facto closure of rural branches with little new small-scale lending taking place despite presumed continuance of deposit services. The main reasons for this seem to be the perceived high risks associated with operating in the rural environment, coupled with low anticipated returns of providing financial services to rural micro and small-scale entrepreneurs, especially smallholder farmers; lack of adequate rural infrastructure, including roads, telephone service, water, and electricity; and the dearth of knowledge about new financial service provision technologies which commercial banks could use to overcome the relatively high costs of doing business in the rural sector. 2.9 The relative share of total financial intermediation by the government-sponsored DFIs and rural support programs providing credit has been extremely low.17 However, these account for almost the total rural financial services provided. A few RFIs have recently made great strides toward sustainably increasing financial service outreach, namely NACB, PBN, the CBs, and NAIC. Nevertheless, all RFIs continue to be severely hampered by existing policies, inadequate funding in relation to their mandates, and lack of technical expertise in banking. For example, when one compares Nigeria’s total rural population estimated to be about 70 million with even the most liberal outreach estimates for the main rural finance providers – NACB, PBN, and the CBs – at most a combined total of five million clients over the respective lives of the programs, it is clear that the rural sector remains extremely under-served.

15 These claims are based on survey results presented in World Bank (1994). 16 Data on the branches presence of commercial banks was gathered from the 1997 Annual Report of the

Central Bank of Nigeria (1998). 17 The combined financial assets of development banks, insurance companies, and other non-bank RFIs

were estimated at less than four percent of total financial assets in 1997 in a 1999 draft Financial Sector Note prepared by the World Bank.

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2.10 Based on the findings of a 1994 World Bank study, a 1994 FAO report, and additional survey data gathered as part of the preparation of this report, it has been found that the informal sector continued to provide the bulk of rural dweller’s credit needs (mainly working capital). The three most important sources of rural credit are ROSCAs (40 percent), family (30 percent), and friends; commercial banks come a distant fourth, with only 11 percent of the sample sourcing credit from them. Trade and input supply financing has been found to be widely practiced by informal groups, but despite the well-adapted operations of informal rural finance providers, the total amount of financial services provided by these institutions has not been sufficient to satisfy the rural demand for credit, which is both seasonal and short term in nature. Moreover, with an average maturity of three months, the informal sector does not appear to be interested in the provision of medium to long-term credit for term investment in long-gestation crops, livestock, agro-processing, or small-scale irrigation. In addition, informal rural finance providers have not had the technical capacity for assessing the financial viability of projects. Hence, even for short-term loans, informal rural sector lending has normally been restricted to traditional activities, whose financial viability has been established over the years. This both ruled out the financing of new activities, about which informal rural lenders had little or no knowledge and decreased the provision of rural loans.

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Chapter 3. POLICY, LEGAL, AND REGULATORY ENVIRONMENT

A. Summary of Banking System Policies, Programs, and Reforms

3.1 After experimentation with various development-oriented financial institutions in the former regions of the country during the period prior to independence in 1960, the modern form of DFIs started to emerge with the establishment of the Nigerian Industrial Development Bank (NIDB) in 1964 to promote investment and rapid industrialization. In the 1970s, three other major DFIs were established at the national level, apart from several state development agencies. These three DFIs comprise the Nigerian Agricultural and Cooperative Bank (NACB), established in 1973 to raise output and encourage adoption of new agricultural technologies; the Nigerian Bank for Commerce and Industry (NBCI), created in 1978 to promote small and medium-scale enterprises; and the Federal Mortgage Bank of Nigeria (FMBN), also begun in the late 1970s to fund housing development and promote mortgage institutions.18 3.2 In addition to the creation of these DFIs, several state-supported programs were introduced in the 1970s to promote rural banking. Perhaps most important among these was the Rural Banking Program (RBP) which began in 1977 and which was designed to extend banking services to the rural areas. The RBP was implemented in three phases under which commercial banks were mandated to open and operate specific numbers of rural branches. The first phase terminated in 1980, while the second and third phases ended in 1984 and 1989, respectively. The specific objectives of the program were to: (a) mobilize rural savings and financing productive activities in rural areas; (b) finance small-scale industries; (b) establish a banking culture in Nigeria’s rural population; and (d) facilitate agricultural and allied industries to attain self-sufficiency in food production.19 In 1977, when the program became operational, commercial banks had only 13 branches in rural areas.20 As at December 31, 1989, the total number of rural branches opened by commercial banks stood at 756. Since then, the commercial bank presence in rural areas has declined to about 615 branches at the end of 1997, with the remaining branches generally acting as deposit collection centers and most operating at a loss. The RBP was replaced by the community banking system, which was introduced in December, 1990.

3.3 Many other programs were introduced by the government in the 1970s to promote rural banking. Two of these deserve attention because of the large amount of resources allocated to them and the fact that they are still operating today. These are the Agricultural Credit Guarantee Scheme Fund (ACGSF), established in 1977 to guarantee 75 percent of the lending by banks to the rural areas; and the Nigerian Agricultural Insurance Company (NAIC), established in 1988 to provide insurance coverage to farmers and mandated insurance coverage on loans granted by banks to the agricultural sector. To complement the RBP which had been suspended in the wake of financial deregulation, the government established the People’s Bank of Nigeria and the Community Bank system in 1990. Initiated in late 1997, the most recent government sponsored program, designed in large part to supply credit to the rural areas, is the Family Economic Advancement Program (FEAP) of the Family Support Program.

18 Data on these early DFIs was gathered from the Central Bank of Nigeria (1997) and from Odu (1996). 19 Yahaya (1998), page 4. 20 Yahaya (1998), page 5.

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3.4 In addition to program promotion, several policies have been introduced over the years specifically to promote rural banking. In an effort to ensure unhindered expansion of banking services to rural areas and the transformation of the rural economy, the CBN waived the feasibility study requirement to support a bank’s application to establish a rural branch in 1977. In the 1980s, as part of Nigeria’s Structural Adjustment Program, the licensing of banks was liberalized to promote a more competitive banking environment and thereby encourage efficient service delivery by the banking system.21 The most notable recent policies are included in Box 3.1.

Box 3.1: Important Policy Reforms Affecting the Banking System, 1996 - 1998 • Sectoral credit allocations were abolished. • Interest rate ceilings and margins were abolished. • Minimum paid-up capital for all banks was raised to N500 million ($5.6 million). • Official announcement that all insolvent banks would have to be recapitalized by March 31,

1997 or be liquidated (although Presidential approval for this still not received as of May 25, 1999).

• The CBN Decree was amended to provide for a part-time chairman and board, and placement of the CBN under the (direct) authority of the Federal Ministry of Finance.

• The NDIC Decree was amended to give it clear authority for administration of distressed bank (having capital adequacy of three percent or less), once taken over by the CBN.

• Elimination of fertilizer subsidy. • Liberalization of exchange rates as of January 1, 1999. Sources: Central Bank of Nigeria (1997 and 1998).

B. Macro and Sectoral Policy Environment

3.5 Economic development plans have historically been characterized by policies that were implemented in pursuit of accelerated industrial development. Nigeria is no exception. Several of the “Eight Pillars of Urban-Biased Policies” introduced in Chapter 1 continue to hamper the development of the rural sector and the promotion of rural financial markets. Pillars related to macro and sectoral policies are discussed below while those related to the legal and regulatory framework are discussed in the following section. The FGN has made impressive policy improvements toward creating an enabling environment for rural financial market development. However, several crucial policy weaknesses remain and as a result of these, the vast majority of rural micro and small-scale entrepreneurs still have inadequate access to credit, savings, and insurance services.

(a) Maximum Interest Rate Ceilings and Spreads 3.6 Although as of June 1999, interest rates are deregulated for licensed commercial and merchant banks, several of the DFIs and specialized financial institutions like PBN are still subject to interest rate ceilings. Such interest rate restrictions are inconsistent with general financial sector policies of interest rate deregulation and constrain the flow of financial resources to the less privileged rural sector. In fact, the CBN itself has previously agreed that, “The under-pricing of credit…creates excess demand for cheap funds, which have to be administratively managed via a rationing system, which is itself,

21 Central Bank of Nigeria (1998).

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costly and ineffective…” (World Bank, 1994). Although this issue is addressed in greater detail in Chapter 4, further background on Nigeria’s rationale for “cheap credit” and the World Bank’s view on how subsidies can hurt or help is provided in Box 3.2 below. Box 3.2: FGN Rationale for Cheap Credit and Empirical Evidence World Bank (1994) noted, “Practically every communiqué issued at the National Council of Agriculture meetings has reiterated the need to target subsidized credit to rural Nigeria. In all the discussions the rationale for the intervention has been market failure: that the free market cannot be relied upon to allocate adequate credit to smallholder agriculture, given: a) the high risks associated with rain-fed agriculture; b) lenders’ high transaction costs associated with administering credit to widely scattered small-sized loans; and c) the ‘high’ costs, to rural dwellers, of borrowing from both moneylenders and the Community Banks. Some State governments also see subsidized and targeted credit…as the only means by which equitable distribution of income to other rural economy can be assured.” Nigeria has a long history of using subsidized credit as part of its rural development and poverty alleviation programs and this targeting of cheap funds is still being carried out in several state-sponsored DFIs (details of which are provide in Chapter 4). However, as has been the case with most subsidized programs around the world and in Nigeria, subsidized credit has failed to reach the intended beneficiaries (namely low-income rural dwellers in general and smallholder farmers in particular) for several reasons, which can be grouped in two general categories – equity and efficiency. The equity arguments essentially state that greater breadth and depth of market coverage can be attained by lending at unsubsidized interest rates. Efficiency concerns are that funds can be allocated to the most productive uses when risk-adjusted lending interest rates reflect the opportunity cost of funds. Not less important, the objective is to provide access to credit, not just to subsidize farmers. This is not to say that subsidies never are helpful to development goals. Below is a convenient summary of “Where Subsidies Can Help and Where They Can Hurt. Social Microfinance Institution Financial Social Services Intermediation Building Intermediation Expanding access Developing training Developing sustainable Sustainable to services such in accounting and microfinance institutions. delivery of credit as health and management skills. and saving services. literacy training. _______________________________Form of Subsidy_________________________________ Subsidy from Long-term subsidy Time-bound subsidy No subsidy. Government “Infant industry” “Infant industry” approach development approach to develop approach to develop financially budget. local level human sustainable financial institutions. resources and Define measurable “outputs” that institutional capacity. may justify subsidization and

allow monitoring.

Sources: World Bank (1994); Yaron, Benjamin, and Piprek (1997); and Fruman and Goldberg (1997). 3.7 There are clearly good intentions behind setting lending interest rates so low, but it ignores the really difficult decision that policy makers considering similar programs all

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over the world have had to cope with. The “Cruel Dilemma” describes whether, subject to unavoidable budget constraints, to allow more people to solve what may be their binding constraint to income production/poverty alleviation, that is, obtaining access to formal credit or, rather to use the scarce public resources to subsidize relatively few, rationed producers in the real good sector through artificially low lending interest rates. Once it is agreed that the objective is to expand access to credit, the choice becomes clear. Any subsidization of lending interest rates would have to come at the expense of poor people, who have often been found eager to pay higher interest rates for timely and reliable financial services, but who would be deprived from having access to such services, as the funds allocated for such an objective would be wasted instead on subsidized lending interest rates that could benefit only fewer clients. With respect to the “Cruel Dilemma”, it appears that FGN policies still pay tribute to the old paradigm, as if relatively few agricultural producers deserve to benefit from cheap credit, and as if the rural financial market is not considered to become an integral part of the overall financial system. (b) Effective Taxation of Agriculture 3.8 The Export Prohibition Act of 1989 imposes heavy penalties on the exportation of specified food crops and their processed forms. This severely curtails income generation potential of agricultural producers of these crops. It may also lead to smuggling of these crops such that revenues are neither reflected in GDP, nor subject to taxation. In addition, the Export of Nigerian Produce Act was intended to maintain grade and quality standards for exported goods. However, the power reserved for the Minister of Agriculture to grant exclusive licenses to acquire produce for export and to specify territories to which exports can be exported is restrictive. These Acts are inconsistent with recent policies toward trade liberalization.22

(c) Investments in Infrastructure and Human Services 3.9 The FGN has historically favored urban areas in the provision of infrastructure and human services. For instance, as of 1995, 63 percent of the urban population versus 26 percent of the rural population had access to water (expressed as a percentage of the population with access). Also, while 80 percent of water resources in urban areas are safe for drinking (i.e., treated), only 39 percent of the sources in rural areas are safe (World Bank, 1998). In the communications sector, about 80 percent of the total telephone lines are concentrated in the Lagos area, while the rest of the country must make do with the remaining 20 percent. In the rural areas, having a working telephone is still widely considered a luxury. Access to roads and electricity follow a similar pattern.23 3.10 The same goes for investments in human resource development such as education and health. As of 1995, 33 percent of males and 53 percent of females were pre-literate, with literacy

22 These Acts were cited in a summary of discussions with Deputy Director, Real Sector Division, CBN,

May 11, 1999. 23 World Bank (1992) estimated that only about 70 percent of Nigeria rural road network was in poor or

very poor condition, with only 5 percent in good condition. With 1.1 kilometer of road per 1,000 population, Nigeria’s rural road density is one of the lowest in Sub-Saharan Africa, compared to Cameroon (6.5), Cote d’Ivoire (4.8), and Ghana (2.3). Due in part to Nigeria’s low rural road density, post-harvest losses have been estimated as quite high, ranging between 20 percent in the semi-arid/arid north and 30 percent in the humid forest zones in the south (World Bank, 1994).

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rates dramatically decreased in predominantly rural States of Sokoto (84 percent), Jigawa (88 percent), Yobe and Taraba (89 percent).24 In most rural areas, most of the populace is left without a hospital/health center while many school children attend classes under trees, thatched roofs, or very dilapidated buildings. It has been estimated recently that about 62 percent of the population has no access to modern primary health care (Richard Frederick Associates, 1999).

C. Legal and Regulatory Framework

3.11 The legal and regulatory framework of the Nigerian RFIs remains weak due to political and technical reasons. For instance, although both the People’s Bank and the Community Banks have undergone organizational restructuring over the last five years, they still continue to be plagued by political influence and limited institutional capacity. In addition, the regulation and supervision standards to which most RFIs are subject have changed over the last two years, and are still in the process of being clarified for the CBN and the institutions that have recently come under its regulation and supervision. These issues continue to translate into poor management practices and weak accountability at the financial institution level. Both the technical capacity of RFIs, and the CBN’s regulatory and supervisory framework need to be strengthened before the flow of financial services to the rural areas can be sustainably increased. The most pressing legal and regulatory issues, namely the needed strengthening of the CBN’s capacity to supervise and enforce prudential regulations on the RFIs that have recently come under its supervision and the required enhancement of property rights and framework for secured transactions, are described below.

(a) Regulation and Supervision of NBFIs

3.12 During the 1990s, Nigeria’s financial system has undergone rapid expansion in the total number of institutions25 and in the scope of financial services offered, creating a need for major regulatory and supervisory reforms designed to promote a sounder system of financial intermediation (Box 3.3). The Banks and Other Financial Institutions (BOFI) Decree made in 1991 conferred on the CBN wide regulatory and supervisory powers over the conduct of monetary management and the activities of commercial banks and merchant banks, as well as non-bank financial institutions (NBFIs), such as finance companies, development banks, primary mortgage institutions, and discount houses. In addition, BOFI Decrees of 1997 and 1998 made the CBN responsible for regulating and supervising these entities, plus over 1,000 Community Banks and the PBN, along the prudential guidelines traditionally followed by commercial and merchant banks, irrespective of their charter. Box 3.3: Institutional Development in Nigeria’s Financial Sector As at end of year 1985 ~ 1990 ~ 1995 ~ 1997 Commercial Banks 28 58 64 64 Commercial Bank Branches 1,297 1,939 2,351 2,330 Merchant Banks 12 48 51 51 Merchant Bank Branches 26 74 149 147 Community Banks/Branches 0 1 1,355 1,015 People’s Bank Branches 0 147 275 278 24 World Bank (1998) and Federal Office of Statistics (1997). 25 Box 2.2 also contains summary information on the total assets of major rural finance institutions over the

last five years.

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Finance Companies 0 0 279 279 Insurance Companies 84 95 177 181 Primary Mortgage Institutions 0 0 280 115 Unit Trusts 0 1 9 9 Stockbrokerage Firms 19 80 162 164 Discount Houses 0 0 4 5 Source: Onyido (1998). 3.13 Given the wide geographic and functional dispersion of the financial entities now under the regulatory and supervisory responsibility of the CBN and the central bank’s limited physical and human resources, the regulatory and supervisory framework needs to be reviewed and strengthened during the transition period to adequately account for the various activities of non-bank financial institutions (NBFIs).26 The activities of the NBFIs, especially the DFIs need to be streamlined, with most of the functions housed in two to three institutions. Although this report focuses on one of the main DFIs, the NACB, and the PBN, as a major specialized financial institution, the Financial Sector Review being prepared in close coordination with this report is addressing recommended enhancements in the regulation and supervision of the other NBFIs.

(b) Creation, Perfection, and Enforcement of Security Interests

3.13 The FGN is the only institution with the ability to create an environment in which a wider range of assets (tangible or intangible) can be used as collateral for financial transactions. In particular, Nigeria’s current system for creating, perfecting, and enforcing security interests has serious weaknesses, which need to be addressed. This inadequate system negatively affects the costs of credit transactions, the characteristics of credit contracts, and the degree of access by rural micro and small-scale entrepreneurs to financial services. Suitable reforms would include: (a) introducing a new law of secured transactions, which would allow effective use of movable assets, including equipment, inventory, receivables, and consumer goods as collateral; (b) improving the efficiency of public registries, permitting lenders to record pledges of land and housing, and provide quick access to information about existing liens; and (c) introducing a mechanism for expeditious recovery of collateral, including foreclosure of mortgage loans. Restructuring public registries and an improved legal framework are necessary conditions for well-functioning rural financial markets.

26 The NBFIs referred to in this report include: (a) the seven development finance institutions (NACB,

NIDB, FMBN, NBCI, NEXIM, NEB, and UDB); (b) the two major specialized financial institutions (PBN and the Community Banks); (c) licensed finance companies; (d) primary mortgage institutions; and (e) discount houses.

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Chapter 4. MAJOR RURAL FINANCE INSTITUTIONS

4.1 This chapter presents an overview of the main formal and informal institutions providing financial services to the rural sector. The types of institutions covered include: one of the DFIs, NACB; one of the specialized banks, PBN (with the CBs being covered in the parallel Financial Sector Review); three of the rural support programs, FEAP, ACGSF, and NAIC; and three categories of informal rural finance providers, cooperative societies; NGOs; esusus, family and friends, and moneylenders. In addition, this report reviews the scale and scope of trade and input supply financing being carried out by the formal and informal sectors. 4.2 These semi-formal rural finance providers and support programs have generally had only limited outreach to date and most of the formal and semi-formal institutions are unsustainable as currently designed. A few have recently made great strides toward increasing their outreach, namely PBN, the CBs, and NAIC. However, all RFIs continue to be severely hampered by existing policies, inadequate funding in relation to their mandates, and lack of technical expertise in banking. To date, the main three RFIs – NACB, PBN, and the CBs have only managed to reach less than ten percent of the rural households. Each of these RFIs, with the notable exception of the CBs is further analyzed below in terms of their ownership and management, mission and services, performance, and constraints. These findings lead to specific recommendations for each institution on how they can better contribute to rural financial market development in the future. Analysis and recommendations regarding the CBs, however, are included in a Financial Sector Review, which has been prepared in close coordination with this study.

A. Nigeria Agricultural and Cooperative Bank27

(a) Ownership and Governance 4.3 NACB is a development finance institution established by the FGN on November 24, 1972 as a limited liability company to foster the growth of agriculture and development of the rural economy. Commencing operations on March 6, 1973 and wholly owned by the FGN, NACB’s shares are 60 percent subscribed to by the Federal Ministry of Finance and 40 percent owned by the CBN. 4.4 Management of NACB takes place through three directorates and seven departments. The Directorates cover Operations, Finance, and Services. The Departments comprise Operations, Finance, Services, Inspection, Research and Training, and Investment and Recovery. There is also a Legal and Company Secretary Department. Each Department is headed by a General Manager. The FGN appointed Boards of Directors for all parastatals, including NACB. However, these Boards were dissolved in August, 1994 and have not been reinstated as of June, 1999. 4.5 NACB’s management has very limited autonomy in that it cannot set its own lending interest rates and is prohibited from mobilizing consumer deposits. As such, it is completely dependent on continual grants and loans from the FGN and other loans from international development organizations. At inception, the Bank’s authorized share capital was N1 million. This was increased to N2 million in 1974 and N150 million in 1978. In order to broaden NACB’s financial base to meet the increasing demands for agricultural credit as well as to shore

27 This section draws from data and descriptions included in NACB (1998).

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up its absorptive capacity for foreign loans, the authorized share capital was increased to N500 million in 1988 and N1 billion in 1993. With the addition of FGN grants since 1995, total FGN funding of NACB has risen to N1.5 billion as of the end of 1998. The loans contracted from the FGN generally carry an interest rate of 7 percent, with a 25 year maturity and 15 year grace period. While this is the least expensive source of funds for the bank, it is unreliable and inadequate to sustain the high level of operations suggested by the bank’s mandate. For example, NACB management maintains that their records show that only N237 million has been received from the FGN since 1973. 4.6 Total foreign sources of funding for NACB are shown in Box 4.1. The single most important source of funds to NACB is the AfDB, which accounted for about 60 percent of the total funds available to the Bank over the last ten years. This is followed by the EIB/EDF with around 20 percent, while the FGN sources rank third, averaging about 10 percent. Other foreign funding sources (IBRD, IFAD, and ECOWAS) make up the rest. Box 4.1: NACB’s Foreign Funding Sources

N millions AfDB IBRD IFAD EIB/EDF ECOWAS TOTAL

1988 42.5 0.0 0.0 0.0 0.0 42.51989 529.0 7.6 0.0 0.0 0.0 536.61990 111.7 35.3 0.0 0.0 0.0 147.01991 137.9 14.6 2.1 65.4 0.0 220.01992 805.5 27.2 4.9 329.6 0.0 1,167.21993 939.8 15.5 33.9 550.4 3.6 1,543.21994 734.6 21.4 10.7 0.0 11.6 778.31995 42.8 0.0 71.0 0.0 5.5 119.31996 33.6 0.0 93.4 0.0 0.0 127.01997 22.0 0.0 1.3 94.2 31.1 148.61998 0.0 0.0 0.0 0.0 0.0 0.0

TOTAL 3,399.4 121.6 217.3 1,039.6 51.8 4,829.7 Avg. Interest

Rate (%) 7.83 6.00 4.00 5.20 4.75 -Source: Figures above are approximations based on NACB (1998).

(b) Mission and Services

4.7 NACB’s objectives are to: (a) promote agricultural production and rural development; (b) assist in the improvement of the income and quality of life of the rural population; and (c) improve the overall growth and development of the Nigerian economy, through the provision of financial support for the production, processing, and marketing of agricultural produce. These objectives are being achieved primarily through the provision of various types of agricultural credit facilities to the Nigerian farming community. The secondary role of the Bank relates to direct financial participation through equity investments in agricultural and agro-allied industries as well as the provision of guarantees for viable agro-based ventures to facilitate the raising of funds from both domestic and external sources. These secondary responsibilities; however, and NACB’s equity investments in particular, are incompatible with NACB’s banking operations and should be eliminated.

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Box 4.2: NACB’s Investments 1995 1996 1997 1998Total (Naira millions) 86.9 87.4 87.5 82.9 Approximate Percentage of Total

Risonpalm Limited Food Development Limited Aeronautical Industry Engineering and Project Mgt. Co. Ltd. Adapalm Limited National Poultry Production Company Limited Okomu Oil Palm Company, Plc. Nigerian Beverages Production Company Gaskiya Chemical Industry Limited Nigerian Animal Feeds Company Limited Akwa Palm Limited Madara Dairy Company Limited Nigeria National Fishing Limited NACB Consultancy and Finance Company Limited Savannah Sugar Limited

34.3% 23.5% 14.9% 9.7% 5.1% 5.1% 1.7% 1.4% 1.4% 1.1% 0.7% 0.4% 0.4% 0.2%

Source: NACB Annual Reports which were audited but not Board approved for1996, 1997, and 1998. 4.8 Although relatively small compared to total assets (only two percent in 1998), NACB’s investment portfolio deserves special focus because they are presented in the financial statements at cost and no provision has been made in case of any losses that might arise when the investments are realized. As such, this may pose some additional risk to NACB’s financial position as these investments do not appear to have had positive returns over the period 1995 – 1998 and may need to be written-off or at least provided against loss. 4.9 NACB’s credit facilities are extended to individuals, cooperative societies, farmers’ groups and corporate bodies, as well as the State and FGN agencies. Loans are extended to all agricultural enterprises and lending by major type of agricultural activity is broken down as follows (based on number of loans approved from program inception through June 1998): (a) general agricultural production and marketing (85 percent); (b) livestock, including poultry, cattle, etc. (14 percent); (c) fisheries (just less than 1 percent); and (d) all other, including tree crops, agro-processing, and loans for on-lending (almost 1 percent). Credit terms depend on the loan type, and there are basically three main loan products offered by NACB, namely: the Smallholder Loan (SHL); the large-scale or Investment Loan; and the On-Lending Loan. Essential components of each of these are presented in Box 4.2. 4.10 In addition to the lending programs described above, NACB offers several other products and services designed and funded by several development agencies to reach specific clients. Currently included in NACB’s portfolio are loans associated with: (a) the IFAD Artisanal Fisheries Development Project; (b) the ECOWAS Fund Artisanal Fish Production Project; (c) the World Bank’s Second Livestock Development Project; and (d) the ILO/NACB Revolving Fund Project. Each of these projects is described in Annex 2.

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Box 4.3: NACB’s Loan Products Smallholder Loans – This loan product was introduced in 1981to meet the credit needs of small-scale, resource poor farmers28 (generally cultivating less than 2 hectares) who do not possess the collateral usually required by commercial banks. In fact, no collateral is required. These loans primarily finance smallholder agricultural production. While the credit limit is N25,000 no tangible collateral is required for eligibility, except the provision of at least two acceptable guarantors. The maximum loan amount for this type of lending to cooperative societies only, is N5,000 times the number of members. In cases where no collateral is pledged, members are jointly guaranteed by the cooperative society. Maximum loan amounts are revised upwards depending on timely repayment of previous loans and client interest. This loan product carries a concessional interest rate, which as of 1998 was 15 percent per annum compared to the Prime lending interest rate in 1998 of 18.9 percent.. These loans account for about 30 percent of total umulative disbursements. c

Large-scale or Investment Loans – The loan product is designed for medium and large-scale farmers for agricultural production and marketing. The minimum loan size is N25,000 and in light of the relatively large loan amount, the provision of adequate collateral and an investment appraisal are needed. The maximum loan amount for an individual is N500,000. In contrast, there is no upper limit for this type of lending to corporate bodies, cooperative societies, and

overnment and its agencies. G Loans for On-Lending – These loans are an avenue to reach a greater number of farmers at the grassroots level. These loans involve the provision of wholesale credit to an acceptable institution or agency for on-lending to ultimate clients. The on-lending agents may include Government institutions, viable cooperative societies, or any other recognized apex credit organization. This program allows NACB to extend credit to an increased number of farmers at a lower cost, while the on-lending agency provides the requisite collateral and ensures loan effectiveness and timely repayment by the clients. Sources: NACB (1998) and published and unpublished financial reports of NACB (various years).

(c) Performance 4.11 Outreach. As at December 31, 1998, NACB had established 67 branches, seven zonal offices, and 206 representative offices located in all the State capitals and all the major agricultural production centers throughout Nigeria. This wide service network has allowed NACB to reach about 318,000 clients since inception (1973 – 1998). Over 80 percent of total loans disbursed have been to individuals and most of the remainder have been lending to corporate bodies. Of NACB’s cumulative number of clients through September 1999, the breakdown by major lending program is around 427,229 smallholder loans (97 percent of the total number), about 10,412 investment program loans (3 percent), and about 40 government loans (less than 1 percent). 4.12 Although the number of new loans extended has dramatically decreased since 1994 (for reasons discussed below), this pattern of lending almost exclusively to smallholders has been maintained over the last few years. Average new loan amounts per borrower were small at N12,007 ($133) in 1997 and N14,042 ($156) in 1998, representing about half the GDP per capita. About 25 percent of total lending is to women. Loan maturities are mainly short and medium

28 This group of farmers forms more than 80 percent of Nigeria’s farming population, and they are known

to produce the bulk of Nigeria’s food and fiber.

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term – of the loans disbursed in 1997 and 1998, 38% were for 12 months or less, 58% were for 12-36 months, and 4% were for over 36 months. Box 4.4: NACB’s Lending Terms As at December 31, 1998 Minimum Borrower Interest Rate Contribution Maximum Nominal Real Loan Maximum as a % of Loan Type Maturity (%) (%) (N) Collateral Loan Amount Smallholder 12 months 15 4 25,000 None 10 Artisanal Fisheries 2.5 years 20 9 250,000 per group None 15 Medium Scale (Marketing) 9 months 21 10 Varies with project Tangible 15 Medium Scale (Production) 3 years 19 8 Varies with project Tangible 15 Large Scale (Marketing) 9 months 21 10 Varies with project Tangible 15 Large Scale (Production) > 3 years 19 8 Varies with project Tangible 15 No maximum Sources: NACB (1998), and published and unpublished financial reports of NACB (various years). Box 4.5: NACB’s Loan Portfolio

AMOUNTS IN NAIRA (MILLIONS)

1996 1997 1998Outstanding Loan Portfolio 3,263 3,695 2,710Loans Disbursed 411 491 444Sources: NACB (1998 and 1999a) and CBN (1998) . 4.13 Sustainability. Between 1988 and 1993, NACB had net operating profits and high growth in its operations and financial base. Due mainly to high levels of foreign borrowing denominated in US dollars and European Currency Units (ECUs), and NACB’s almost complete assumption of the associated foreign exchange risk, the period of expansion was reversed with dramatic devaluation of the Naira and the onset of the maturity of off-shore loans. From 1993 to present, operations have remained stagnant at very low levels, with new lending not quite keeping pace with rolling off of old loans (Box 4.4). The negative effect of the foreign exchange fluctuations coupled with losses due to high cost of loan administration relative to the interest rate charged, resulted in the increase in net operating loss from N68.9 million in 1992 to N1.9 billion in 1998 (Boxes 4.5 and 4.6). In addition, NACB has significant losses associated with deposits placed with defunct commercial banks. This has led to negative earnings per share as well as negative equity. Similarly, negative returns on assets and negative operating cost ratios have been recorded in recent years.

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Box 4.6: NACB's Financial Highlights

Volumes expressed in millions of Naira 1996 1997 1998*

Total Assets 6,141.1 5,578.6 4,347.5 Cash 535.4 617.7 435.1 Investments 87.4 87.5 82.9 Net Loan Portfolio Outstanding 3,263.2 3,695.3 2,710.1 Fixed Assets 1,052.4 1,024.3 992.5 Other Assets 1,202.7 153.8 126.9

Liabilities 7,819.8 8,579.0 9,204.6 Total Consumer Deposits 0.0 0.0 0.0 Other Short-Term Liabilities 2,175.9 3,303.4 3,961.3 Othe Long-Term Liabilities 5,643.9 5,275.6 5,243.3

Equity Paid-up Share Capital 1,000.0 1,000.0 1,000.0 General Reserve (Retained) Earnings (1,651.7) (3,438.6) (5,300.9) FGN Subvention 350.0 500.0 505.0 Foreign Exchange Fluctuation Reserve (1,377.0) (1,061.8) (1,061.2)

Total Liabilities and Equity 6,141.1 5,578.6 4,347.5

Total Income 738.8 447.6 525.7 Total Interest/Fees on Loans 649.8 NA NA Other Income 89.0 NA NA

Total Expenses 891.3 2,234.5 2,388.0 Total Interest Expense 399.4 391.8 372.6 Staff Salaries and Benefits 448.4 423.8 418.1 Other Administrative Expenses 29.9 51.3 50.3 Foreign Exchange Losses 0.0 247.4 0.0 Loan Losses 13.6 1,120.2 1,547.0

Profit or (Loss) (152.5) (1,786.9) (1,862.3)Note: A convenient translation has been used for reporting the profits and losses, due to the unavailability of data which would have made inflation adjustment of NACB’s financial statements possible. Source: NACB (1999b). 4.14 NACB’s loan portfolio quality is also weak. Some loans have been on the books for 20 years, and several of the largest amounts that were lent to Federal and State government agencies are overdue. The bulk of this lending took place during 1980-1981, with overdue loans to the FGN guaranteed by the Federal Ministry of Water Resources amounting to over N2.1 billion. Although provisioning for loan losses has increased in recent years for consumer lending, from 10 percent in 1996 to 49 percent in 1998, NACB anticipated that planned application of CBN accounting rules may lead to additional provisioning and write-off requirements. This will further stress the current negative financial position of NACB. Generally, NACB maintains an average loan recovery rate of 65 percent, varying between 60 and 97 percent, depending on loan type. The highest loan repayment of over 90 percent comes from the ILO/NACB Women’s Loan program. Next, at about 85 percent repayment are the Smallholder Loans. The World Bank’s Livestock Development Loan program has repayment rates of about 75 percent, while the Investment Loan and IFAD and ECOWAS Fishery Loan program all have loan repayment of around 60 percent.

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(d) Constraints

4.15 Lending Interest Rates. NACB is forced to maintain subsidized lending interest rate policies that provide the lowest rates to small borrowers (15 percent) and low rates (18 to 20 percent) to most other borrowers. These policies do not provide NACB adequate spreads to cover interest rate expense and administrative cost of bad debt risk. They also contribute to depressing loan repayment rates, since subsidized interest rates give the clients an impression that borrowing from NACB is one way to get their part of the “national cake” and that repayment will not be strongly enforced, if at all. 4.16 Loan Repayment. The past-due loans owed by FGN and State government agencies amounting to over N2.1 billion, need to either be repaid or written off, with such lending discontinued in the future. In terms of consumer lending, it would be prudent to build on the repayment successes of the Women’s and Smallholder loan products by expanding their current share of the total loan portfolio and decrease of relative share of the other loan types, which have experienced lower repayment rates. 4.17 Deposit Mobilization. NACB has effectively had to operate as half a bank since its inception, acting as a disbursement window for “cheap” agricultural credit rather than a true financial intermediary. By decree, NACB is prohibited to mobilize deposits and, therefore, has been denied a stable source of funds with which to carry out its mandates. The inability of the bank to mobilize deposits or access long-term market based funding sources has compelled the institution to rely exclusively on continued FGN recapitalization and foreign loans for funding its operations. Under the present framework, the issue of sourcing funds from the capital markets is also ruled out. 4.18 High Administrative Costs. The cost of loan administration per N1,000; was estimated by NACB in 1997 to be: (a) Small Holder = 163; (b) Artisanal Fisheries = 160; and (c) Women’s’ Groups = 150. Volume of lending in recent years has been very low. Higher volumes would probably reduce these administration costs. 4.19 Training. NACB has comprehensive physical and institutional infrastructure for staff training, complete with a Staff Training and Development Center including several offices, classrooms, and a library near its headquarters in Kaduna. As a result of rapid expansion and frequent changes in NACB’s operations during the 1980s, the Center became a full-fledged department in 1991. However, due to NACB’s poor financial performance in recent years, the Center was reduced to that of a unit, with limited scope of activities. The interrelated issues of NACB’s poor operating performance, the departing of technically proficient staff; and the sharp decline in use of the training facility, has left the institution with staff that are either generally poorly trained or of inadequate technical competencies. The Center is, however, poised to revitalizing its workforce, through intensive training; and if NACB were restructured, the Center could easily become an integral Department again for the training of new staff and retraining of existing employees.

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Box 4.7: NACB’s Foreign Exchange Rate Problems As at December 31, 1998, NACB was indebted to four international development organizations with loans denominated in US dollars and European Currency Units, totaling N4.898 billion. This amount almost quadrupled to N19.147 the next day, when the FGN changed the fixed value of the Naira to the dollar from 22 to 86, and adjusted NACB’s foreign debt in ECU to dollars. Accrued interest payable on these loans also increased from N454 million to N1,776. With the devaluation of the Naira in 1999, NACB’s debt obligation in Naira terms almost quadrupled, and effectively raised the interest rates payable on its foreign debt in Naira terms as high as 105 percent per annum. The loan from the ADB registered the highest foreign exchange loss. As at the end of 1998, $237.94 million has been drawn and the sum of $57.10 million has been repaid on principal, leaving a balance of $180.84 million outstanding. Drawing commenced in September 1988, when the Naira was N6.150 to US $1 and by 1993, when the official exchange rate was fixed at N22 to the dollar, the bulk of the sum had been drawn. Although NACB was allowed to repay its foreign loans at this exchange rate before January 1999, the bank still incurred enormous losses on foreign exchange fluctuations. Between January, 1993 and December, 1998, NACB had written off to the Profit and Loss Account a total of N1.070 billion, as losses due to exchange rate fluctuations on repayment of some of the installments due on the ADB loans. As at the end of 1998, there was a sum of N1.075 billion carried in the accounts as exchange rate fluctuation reserve waiting to be written off as the ADB loans were repaid. In summary, the foreign exchange loss at the end of 1998 was N2.145 and in 1999, NACB must have maintained a provision of N15.323 billion for foreign exchange losses assuming an exchange rate of N86 to the dollar. To compound a bad situation, the FGN has continued to devalue the Naira at relatively minor increments during 1999 and since 1993, NACB has had negative equity and suffered annual losses, even before considering the foreign exchange loss problems. Source: NACB (1999). 4.20 Management Information Systems (MIS). Several operations at the head office and at many zonal and branch offices have been computerized. NACB uses mostly customized software, including a Loan Administration System, a Funds Accounting System, a module of the Financial Management System, a Human Resources System, a General Ledger Data Entry System, and a Zonal Office MIS. Given this number of installed information systems plus an additional procurement of software that was planned since last year, it is evident that NACB’s MIS will be in need of some overhaul, so that hardware and software are appropriate and compatible throughout the organization. 4.21 Staff Incentives. The issue of appropriate remuneration for NACB staff in terms of salaries and other incentives has been raised over the years without tangible results. While NACB is a DFI, with mandates similar to NIDB, NBCI, FMBN, and UDB, available evidence indicates that the incentive package of its staff has remained the poorest in the industry. Herein lies the basis for the continued loss of competent staff and the low morale among the remaining employees. The general conditions of staff at NACB need to be improved so that competent personnel will be attracted and retained, and corruption of the system will be minimized.

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(e) Recommendations

4.22 NACB has the largest branch network of any commercial bank or development finance institution, and is second only to the Community Banks in terms of the total number of rural outlets. Regarding overall country coverage, NACB has the greatest geographic representation and the best coverage of major agricultural centers in the rural areas. In addition to the extensive physical network, NACB also has substantial investment in human capital. The total number of its staff as at April 14, 1999 was 1,660. This number comprised 33 management staff, 508 senior staff, and 1,119 junior staff. The number of staff at headquarters was 432, while 1,228 were in the field. The organization benefits from over 25 years of accumulated wealth of experience in smallholder finance. Although many staff have left and low morale is a lingering problem, most of the remaining staff are dedicated professionals and are hopeful that the organization will change for the better, with adjustments in NACB’s operating policies and procedures. The staff who have been there the longest appear to be technically competent, well-experienced professionals in rural lending. 4.23 Perhaps most importantly, NACB’s senior management are aware of international best practices in rural finance, including the provision of micro and small-scale financial services, and are eager to adapt these to the context of Nigeria. There is widespread support in the organization for dramatically changing the operating policies and procedures to overcome the constraints identified above. Provided NACB successfully undergoes a significant and widespread restructuring and revitalization process, this DFI would merit further recapitalization and restructuring of its debt burden. Critical elements of such a restructuring program are described below. 4.24 Balance Sheet Restructuring and Adjusting the Products and Services Offered. NACB’s balance sheet would need to be restructured with the objective to make it a creditworthy recipient of funds from non-governmental sources that expect to be repaid. NACB’s diverse loan products and number of service units would need to be rationalized. Loan products should be redesigned with increased interest rates that fully cover the financial and administrative costs involved with lending the funds as well as built-in client incentives to improve probability of repayment. NACB’s non-banking activities (especially its equity investments in agricultural and agro-allied industries as well as the provision of guarantees for agro-based ventures) should be carefully analyzed to see if it would they would be appropriate candidates for placement in a unit trust to be sold off through an IPO or private placement). It would be prudent to build on the repayment successes of the Women’s and Smallholder loan products by expanding their current share of the total loan portfolio and decrease of relative share of the other loan types, which have experienced lower repayment rates. 4.25 Change in Mission to Emphasize Movement Toward Financial Self-Sustainability. NACB’s mandate should be broadened from that of an agricultural bank to a rural bank, and its management should be given much greater autonomy to determine the operating policies and procedures with the aim of sustainably serving the greatest number of micro and small scale rural enterprises possible. 4.26 Appointing a New Board of Directors and Effecting Appropriate Governance. NACB should have a functioning Board of Directors made up of seven to ten experts in banking or corporate management, drawn mainly from the private sector. In addition, subject to the Board of Directors, NACB’s senior management needs full autonomy in terms of its setting operating policies and procedures, especially in the areas of interest rate policy, coupled with transparency and accountability. Adequate incentive systems for staff at all levels should be instituted, which

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link financial performance of NACB (based on a combination of loans disbursed, repayment rates, etc.) to cash or merit awards for staff. 4.27 Introducing Incentive Systems for Clients. In addition, NACB’s incentives systems for clients would need to be revised. Stepped lending (with access to greater loan amounts based on previous good repayment performance) and interest rate rebates based on full and timely loan repayment should be considered as means to increase demand for funds and enhance repayment performance. 4.28 Training in Micro and Rural Finance. Knowledge of best practices in rural finance institution management and operations needs to be strengthened throughout the organization. NACB has existing training infrastructure centrally located in Kaduna, which could be improved and made operational again with relatively little investment. An improved training center could serve as a hub for “training of trainers” for NACB itself as well as serve as a means for other income/fee generation by hosting rural and microfinance training for various target organizations, including the People’s Bank of Nigeria, the Community Banks, and various credit disbursing NGOs and cooperatives. 4.29 Improving Management Information Systems (MIS). Appropriate computer hardware and software need to be installed in the headquarters and throughout the branch network and adequate MIS needs to be put in place to provide accurate and timely management reporting and to support the effectiveness of client and staff incentive systems. B. People’s Bank of Nigeria29

(a) Ownership and Management 4.30 The FGN established the People’s Bank of Nigeria (PBN) in October 3, 1989 to improve access to financial services for hitherto excluded economic groups such as micro and small-scale enterprises in rural and urban areas and disadvantaged social groups, including women. PBN is a specialized bank, which is wholly owned by the FGN and subject to CBN regulation and supervision. However, its management is semi-autonomous, with the ability to determine most of its operating policies and procedures, except for lending and savings deposit interest rates. 4.31 Between October 1989 and January 1990, the Pilot Project of the Bank was tested in only a few States. Following the success of these pilots, the FGN approved the scaling up of the project from January 1990 to reach all the States in Nigeria. As operations were rapidly expanded; however, performance declined and the organization underwent a restructuring in August, 1995, which included the installation of a new senior management team. 4.32 PBN has a Board of Directors for the general guidance of the bank, and daily operations are headed by a Managing Director. General Managers for Operations and Finance report to the Managing Director. At each of the branches, PBN encourages the formation of a People’s Bank Community Relations Committee (PBCRC). This committee serves to get the host community more involved in the operation of the branch, with members drawn from local government councils, traditional rulers, religious leaders, market women, law enforcement agencies, and PBN customers. The responsibilities of the committees are to: (a) ensure the survival of the PBN

29 This section draws from data and descriptions included in PBN (1998a) and several unpublished papers

by PBN managers produced in 1998 and 1999.

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branch in their locality; (b) advise and monitor daily branch activity; (c) take steps to prevent fraud and mismanagement of funds in the branches; and (d) assist the branch in marketing and loan recovery. Through these committee’s, PBN effectively involves the community in program design and implementation.

(b) Mission and Services 4.33 The main objectives for the establishment of PBN were: (a) the extension of credit facilities to the less privileged members of the society who cannot normally benefit from the services of the conventional banks; (b) the acceptance of savings from customers and repayments together with any interest thereon; (c) provision of opportunities for self-employment for the vast unutilized and under-utilized manpower resources; (d) complement the efforts of the FGN in improving the productive base of the economy; and (e) inculcate banking habits at the grassroots level and reduce rural-urban migration. PBN’s mission statement is included in Box 4.7 below. Box 4.8: PBN’s Mission Statement “Our mission is to provide a people-centered and community-based microcredit services, employing the best technology, systems, and human resources to operate a transparent and accountable microcredit institution with the ultimate aim of the eradication of poverty through economic empowerment while adhering to the best practice code.” Source: PBN (1999). 4.34 Over the years, PBN has introduced several loan and deposit products as well as non-financial services to meet the needs of its numerous and diverse client base. 4.35 Loan Products. PBN has developed several small, quick, and easy to obtain loan products for individuals or groups of 7 – 10 persons, and has similar procedures guiding lending for: Projects (comprising 25 percent of total lending); Agriculture (20 percent); Women’s Cooperative Societies (20 percent); the Very Poor, Widowed, or Disabled (20 percent); and all Other loans to traders, artisans, etc. (15 percent). All loan applications, except the loans to the Very Poor, Widowed, or Disabled require a simple viability report. Loans exceeding N20,000 must be guaranteed by two guarantors while those under N20,000 require only one guarantor. Some savings is mandatory in the sense that the maximum loan amount to an individual or group is N250,000, subject to maintenance of a minimum deposit balance of one-third of the loan amount for at least six months before loan application. Loans of up to N3,000 can be extended irrespective of the minimum balance in the customer’s deposit account. Loans are generally for 12 months and carry a 20 percent service charge on the original loan amount. All agricultural loans above N5,000 must be insured with NAIC and the premium forms part of the service charge on the loan so as to ensure that the farmer takes the insurance coverage. 4.36 Deposit Products. Three deposit products have been offered over the last several years, while five new ones are under consideration by PBN management. PBN has cumulatively mobilized N10.3 billion since its inception to October, 1998 under its general savings mobilization program. All deposit products carry positive nominal interest rates, which since program inception, have ranged between three percent and eight percent, depending on deposit amount and liquidity. Savings equal to at least one-third of a loan amount, if there is one desired, is mandatory for six months before the date of loan application. The bank also offers a fixed deposit program, under which individuals are encouraged to make fixed deposits for periods ranging from three months to one year. PBN then invests these funds and repays the principal plus interest after the term expires. In addition, PBN has a Banking for Health savings program,

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which was started in collaboration with the World Health Organization and the Federal Ministry of Health. It helps clients save toward health-related emergencies. 4.37 New Deposit/Loan Products. PBN is also offering five new deposit/loan products: (a) the People’s Target Saving Scheme; (b) the Mutual Support Fund; (c) the People’s Adashi/Esusu Group Scheme; (d) the People’s Development Fund; and (e) the People’s Start-Up Loan Scheme. Each of these is described in Annex 3. 4.38 Non-Financial Services. Financial advisory services are also provided by PBN. In all the branches, the credit officer provides professional advice to enhance the loan application. These services are also available at the zonal offices of the bank. The financial advisory services provided by PBN staff give customers an opportunity to improve the operation of their micro and small-scale enterprises and enhance loan repayment.

(c) Performance 4.39 Outreach. As at December 31, 1998, PBN had established 219 rural branches and 60 urban branches, for a total of 279 branches spread throughout the country. This wide representation has allowed PBN to reach about 3.2 million customers, from inception through June 30, 1999. Although the target clients are the rural and urban poor, women account for about one-third of PBN’s total clients. Cumulative disbursed credit was N1.7 billion and cumulative savings mobilization was N10.3 billion. The categories of PBN loans disbursed, by percentage of the total amount, are: project loans, 25 percent; cooperative loans, 20 percent; agricultural loans, 20 percent; loans to the poorest, 20 percent; and other loans, 15 percent. PBN has estimated its current loan repayment rate (defined as total loans repaid as a percentage of total amounts fallen due) as 87 percent. PBN management estimates that 553,200 businesses have benefited from PBN’s financial services. 4.40 Sustainability. PBN has not been profitable since establishment and, even under the new management since 1995, does not appear to be headed in that direction. Although PBN has benefited from FGN cumulative subventions of about N2 billion, the system has not been able to generate enough interest and fee income from loans and investments to cover administrative and interest expenses. Indeed, as can be seen below, total loans outstanding as a percentage of total assets has been declining and by September 1998, only accounted for about 14 percent of total assets. Unless several operational changes are made, including shifting the assets mix and revising upward the interest rates charged on loans, PBN will maintain its reliance on FGN funding and will never attain financial self-sustainability. Financial highlights are presented in Box 4.8. Although deposit volume is about double the outstanding loan volume and loan repayment has been estimated by PBN to be 87 percent, these positive highlights are overshadowed by its current and anticipated continued large losses. PBN management also indicated that PriceWaterhouse Coopers has been employed to complete a thorough operational and administrative restructuring to accommodate the issues raised by the financial highlights presented here and other relevant studies.

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Box 4.9: PBN’s Financial Highlights Volumes expressed in thousands of Naira

1996 1997 1998*Total Assets 664 825.9 1579.7

Cash 11.2 10.7 17.4 Short-term investments 479.6 667.7 1286.7 Total Loans Outstanding 177.5 186.6 227.3 Less: Loan Loss Provisions (138.6) (154.9) (155.0) Net Portfolio Outstanding 38.9 31.7 72.3 Fixed Assets 74.9 55.7 131.6 Other Assets 59.4 60.1 71.7

Liabilities 371.7 415.3 1,021.7 Total Consumer Deposits 342.5 384.8 589.9 Other Short-Term Liabilities 29.2 30.5 31.8 Othe Long-Term Liabilities - FEAP Funds 0.0 0.0 400.0

Equity Donated Equity 1.6 1.6 1.4 Retained Earnings (228.7) (310.9) (385.6) FGN Subvention 601.7 676.7 837.2 Current Year Profit (Loss) (82.3) 43.2 104.9

Total Liabilities and Equity 664.0 825.9 1,579.6

Total Income 63.7 65.7 67.4 Total Interest/Fees on Loans 2.2 9.4 4.5 Other Oper. Income from Financial Services 4.2 0.0 10.5 Income from Investments 57.3 56.3 52.4

Total Expenses 228.7 243.2 162.6 Total Interest Paid on Deposits 28.3 23.2 9.3 Staff Salaries and Benefits 48.9 117.3 96.6 Other Administrative Expenses 127.8 86.3 56.7 Loan Losses 23.7 16.4 0.0

Profit or (Loss) (164.9) (177.5) (95.2) FGN Subvention 82.7 220.0 200.0

*1998 figures are as of September 30, 1998. Source: PBN (1999).

(d) Constraints

4.41 Lending Interest Rates. Although PBN does not charge an interest rate on loans, it captures revenues from loans by charging a 20 percent “service charge” on the amount lent. Given that this has been around the level of the Prime lending interest rate over the last five years and most of PBN’s loans are for 12 months or less, the service charge is commensurate with the commercial loan market rate. However, this fee income is not sufficient to cover the higher transaction costs of providing funds to smaller-scale, rural entrepreneurs. It is not clear to what extent PBN’s management has the autonomy or willingness to increase the fees charged on loans, but unless the bank adequately covers its costs, it will not be on the path to sustainability. 4.42 Computerization/MIS. Only a very limited set of activities are computerized, and each branch must keep track of its operations manually. This is obviously a major obstacle to

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expanding operations and it significantly hinders the bank’s ability to consolidate administrative and financial data, and react in a timely manner to market changes or accounting anomalies. As of April, 1999, PBN was searching for a MIS hardware and software package appropriate to its current and planned operations. Until such an MIS system is in place, operations will remain disjointed between the branches and between the branches and headquarters, and information flows will be relatively slow and inaccurate as well. These factors exacerbate PBN’s high administration and operation costs. 4.43 Loan Approval Process. Another area that contributes to excessive administration and operation costs is the laborious loan approval process. Although PBN’s procedures are transparent, the entire process from loan application to disbursement often takes an inordinate amount of time (Box 4.9). Box 4.10: PBN’s Loan Approval Process 1. The Branch Manager receives the application with the attached relevant documents from applicant. He/she checks to ensure the application has been properly completed and then passes it to the People’s Bank Community Relations Committee (PBCRC) for deliberation and recommendation. 2. The PBCRC confirms that applicant(s) belong to the target group, have genuine projects to execute, and are capable of repaying the loan. They also authenticate the guarantor(s) and then return the application to the Branch Manger with their approval. 3. The Branch Manager then passes the application to the Zonal Manager for onward transmission to the Secretary of the Head Office Credit Committee. 4. The Head Office Credit Committee scrutinizes the application and makes recommendation to the Executive Management for approval. At any point in this process, the loan application can be disapproved. Source: PBN (1998b). 4.44 A recent impact assessment that was performed on the PBN indicated the average period of processing loans and release of funds was about three months, for most major cities, as per Table 4.10 (Richard Frederick Associates, 1999). Box 4.11: PBN’s Average Loan Processing Period

Immediate One Week One Month Three Months Above Three Months

Lagos 8% 5% 11% 18% 12% Maiduguri 4% 2% 13% 11% 6% Minna 6% - 6% 39% 11% Abuja 16% - 11% 26% - Ibadan 20% 6% 17% 32% 4% Owerri 19% 5% 15% 20% - Kano 28% 6% 17% 20% - Benin 17% 1% 10% 26% 7% Source: PBN (1999). 4.45 Training. Although international best practices have been well adapted in several areas of operations, PBN could benefit from additional lessons learned in micro and small-scale financial service delivery. For example, several of the proposed products, especially the Mutual Support

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Fund, might pose further impediments to PBN’s achievement of sustainability if it is rolled out as currently designed. In addition to new loan and deposit product design, other areas of PBN that could benefit from international best practice experience (through appropriate staff training), include business development planning at the branch level, client and staff incentive systems, and management information systems.

(e) Recommendations

4.46 PBN has established 279 branches throughout the country and managed to build linkages with the informal financial sector to achieve significant outreach to about 3.2 million relatively poorer entrepreneurs since 1990. As PBN is currently designed, the organization is not on a path to financial self-sustainability and would need continued large FGN subventions to maintain operations. However, there is scope to significantly restructure the organization to put it on a sustainable growth path. PBN should be restructured to adjust its operating policies an procedures, so that it can reduce its reliance on FGN subventions and sustainably serve large numbers of Nigeria’s micro and small-scale entrepreneurs. In particular, PBN’s on-lending of funds from FEAP should cease immediately as it competes with PBN’s own loan products and creates the image of PBN as a cheap, short-term government credit disbursement center instead of a long-term microfinance service provider. 4.47 As was noted in the case of NACB, PBN’s senior management are aware of some of the international best practices in the provision of micro and small-scale financial services, and are eager to learn more about what has worked well elsewhere and adapt these modes of operation to the context of Nigeria. There is widespread support in the organization for dramatically changing the operating policies and procedures to overcome the constraints identified above. Provided PBN phases out its participation in the FEAP, PBN would be a prime candidate for a restructuring and revitalization program. Critical elements of such a program are described below. 4.48 Managerial Autonomy and Accountability. As a financial intermediary, PBN needs to be explicitly seen as operating independently from FGN control and interferrence. To this end, PBN should have a functioning Board of Directors made up of seven to ten experts in banking or corporate management drawn mainly from the private sector. In addition, subject to the Board of Directors, PBN’s management needs full autonomy in terms of its operating policies and procedures coupled with transparency and accountability. Incentive systems for staff at all levels need to be instituted, which would link financial performance of PBN (based on a combination of loans disbursed, repayment rates, etc.) with cash or merit awards for staff. 4.49 Rationalizing Branch Presence and the Products and Services Offered. Perhaps the most important factor that has contributed to PBN’s extraordinarily high administrative costs has been the institution’s push to expand its branch presence and staffing. PBN’s 279 branches, however, would need to be scrutinized on a case-by-case basis to determine if a sufficient market exists for the continued operation of each. In addition, PBN’s diverse loan and deposit products would need to be rationalized. As in the case of NACB, PBN’s loan products would need to be consolidated and redesigned with increased interest rates (referred to as service charges within PBN, for cultural reasons) that fully cover the financial and administrative costs involved with lending the funds as well as built-in client incentives to improve probability of repayment. In particular, the loan approval process needs to be streamlined to minimize related administrative expenses. The deposit products would need to be reviewed to ensure that they satisfy the main demand attributes of their target clients. The spread between the lending and deposit interest rates would need to be maintained wide enough to ensure that PBN is put on a path toward financial self-sustainability.

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4.50 Introducing Incentive Systems for Clients. As was recommended for NACB, PBN’s incentive systems for clients would also need to be revised. Stepped lending (with access to greater loan amounts based on previous good repayment performance) and interest rate rebates based on full and timely loan repayment should be considered as means to increase demand for funds and enhance repayment performance. 4.51 Training in Micro and Rural Finance. Knowledge of best practices in rural finance institution management and operations needs to be strengthened throughout the organization. In particular, management requires training in break-even analysis for branch rationalization. 4.52 Improving Management Information Systems (MIS). Appropriate computing hardware and software need to be installed in the headquarters and throughout the branch network and adequate MIS needs to be put in place to provide accurate and timely management reporting, and to support the effectiveness of client and staff incentive systems.

C. Rural Support Programs

(a) Family Economic Advancement Program 4.53 Established in 1994 by the former First Lady of Nigeria, FEAP is Nigeria’s newest and largest provider of credit to the rural sector The program began operations in November 1997 with several interrelated objectives: 1) poverty reduction through improving the standard of living of Nigerians and minimizing income disparities between the rich and the poor; 2) encouragement of design and manufacture of machinery and equipment locally so as to provide a solid foundation for industrialization; 3) encouragement of producers at ward levels to form cooperative societies; 4) reduction of rural-urban migration through the creation of employment opportunities at ward levels; 5) promotion of production and development consciousness through the utilization of available local resources; and 6) promotion of industrial development at every ward in the country.30 4.54 Major achievements of the program include establishing managing bodies at the national, State, local, and ward levels; and selecting six participating banks, two insurance companies, and a few NGOs and community-based organizations to assist in the monitoring of projects, loan disbursement, and recovery. The allocation of FEAP’s loanable funds is 40 percent to agriculture and 60 percent to non-agricultural cottage industries. FEAP’s most recent funding from the government totaled N 7.5 billion (US$ 94 million). As at the end of October 1998, a total of N4.2 billion ($46.3 million) was released for the activities of the program, which is N1.0 billion (20 percent) less than the N5.2 billion earmarked for it in the 1998 budget. Out of this, a total of N1.7 billion ($18.6 million), representing 40 percent of the total amount allocated so far released , has been disbursed as loans to over 3,000 projects. A total of N1.3 billion ($14.4 million) has been approved for about 10,000 cooperatives, but is still awaiting disbursement. Approval and disbursement were spread over the 600 out of the 774 local government areas of the Federation. 4.55 Loans are disbursed through six selected banks and disbursements are allocated to all States based on population and poverty incidence. Qualifications for loans include formation of cooperative societies based at the ward level and recognition of such groups through registration at the local government level. Such groups must save at least 10 percent of the amount they wish to borrow, and these savings must not be withdrawn until the loan is fully repaid. The

30 Aliyu (1998), page 6.

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participating banks, including PBN, are to provide counterpart funding of 30 percent of the funds allocated to them, while the loan losses are expected to be shared up to 25 percent by the banks. 4.56 FEAP’s mission and services; however, are at odds with one another. The most serious problems with the program’s design and implementation are: (a) lending at a subsidized interest rate of 10 percent through a program that is clearly government owned and operated for poverty reduction; (b) disbursing funds to cooperative societies with little to no attention paid to their track record or even the veracity of their registration; (c) paying no attention to mobilizing deposits as a means to achieve program sustainability; and (d) blending the functions and responsibilities for accounting, administration and training with lending services, which results in very weak staff accountability and lack of transparency in program expenditures. Given the huge (relative) allocation of funds to FEAP and its very weak program design and implementation, it is likely that the program will result in high expenditures with low loan repayment and little, if any, sustainable development impact. Recent significant anomalies regarding the authenticity of cooperatives applying for loans and the devastating effects the “crowding out” by FEAP of formerly small yet well-functioning rural credit cooperatives and other providers, strengthen this likelihood. It is, therefore, imperative that the FGN cease lending operations through FEAP immediately and redirect the funds to other, more promising endeavors like restructuring programs for NACB and the PBN.

(b) Agricultural Credit Guarantee Scheme Fund 4.57 Established in 1977 under CBN management with a capital base of N100 million31, funded by the FGN (60 percent) and the CBN (40 percent), the ACGSF began operations in 1978 to encourage banks to lend to agriculture by providing some form of guarantee against risks inherent in agricultural lending. In case of default, the lending bank is expected to exhaust all legal means of recovery, including realization of any security pledged for loans, before ACGSF pays 75 percent of guaranteed loans in default, net the amount realized by the bank from the disposal of security pledged by the farmer.

4.58 The maximum loan which can be guaranteed by the fund is N100,000 to individual farmers and N1 million to cooperative societies and other corporate bodies. The program provides coverage for all farming activities while a wide range of collateral is acceptable for loan. The securities which could be pledged for loans include a charge on land, movable properties of the borrower, life insurance policy, stocks and shares, personal guarantee, and other more traditional forms of security acceptable to commercial banks. As a result of the shift in emphasis to small-scale agricultural production in the middle of the 1980s, a waiver of tangible security was provided for small loans of N5,000 and below. For this category of borrowers, an introduction from a respected member of the community, usually a village head, would suffice. From the inception of the program in 1978 to 1986, borrowers under the program enjoyed concessional interest rates. Thereafter, loans under the program were granted at market interest rates, following the deregulation of the financial sector associated with the introduction of SAP.

4.59 In order to ensure that loans are used for the purposes for which they were intended and foster repayment, the CBN organizes courses on finance and accounts for agricultural Credit Officers, undertakes farm visits in connection with pre-guarantee appraisals and post-guarantee monitoring of projects, and investigates default claims. The CBN also holds regular meetings with farmers and officials of the participating banks, the Ministry of Agriculture, and the Agricultural Development Projects (ADPs) on the operations of the ACGSF. In order to provide incentives for efficient utilization of bank loans, farmers who benefit from loans under the 31 Of the N100 million in authorized capital, N85 million has been paid up.

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ACGSF, and achieve outstanding performance in output, loan repayment, and adoption of good husbandry practices, are annually presented with certificates of merit. The CBN introduced an award of a certificate to the best bank under the ACGSF in 1995.

4.60 Summary Statistics on Loans Guaranteed. The number and value of loans guaranteed under ACGSF between 1978 and 1998 stood at 267,144 and N1.97 billion, respectively, but there have been two distinct phases in the Fund.32 The first phase was the period of a sustained increase in activities during the first twelve years (1978-1989) of the ACGSF, referred to by ACGSF management as the “pre-deregulation period”, with the cumulative number and value of loans guaranteed reaching 34,518 and N129.3 million by 1989. The second phase was the eight year period, from 1990 through the end of 1997marked by a general decline, with guarantees declining to 17,840, with a value of N242.0 million (US$ 3.0 million). The decline in the number of guaranteed loans during the second phase could be attributed to the ACGSF’s concentration on the Self-Help Program.

Box 4.12: ACGSF Loan Repayment by Number and Volume

Phase I Sub-total

Phase II Sub-total

Total

1978 - 1988 1989 - 1998 1978 - 1998No. Guaranteed 57,024 210,120 267,144 No. Repaid 8,989 150,680 159,669 Percentage Repaid 16% 72% 60%

Volumes expressed in thousands of Naira Vol. Guaranteed 538 1,429 1,967 Vol. Repaid 65 964 1,029 Percentage Repaid 12% 67% 52% 4.61 Loans Guaranteed by Location, Purpose, Size, and Category of Borrower. Loans guaranteed by the ACGSF have been widely spread throughout the country. All States in the Federation have benefited from loans guaranteed under the program since its inception. In addition, the ACGSF has benefited borrowers for many different agricultural purposes. In general, the ACGSF has skewed lending to favor micro and small-scale agricultural borrowers, who have historically found it difficult to obtain adequate credit. 4.62 Analysis of Loans Guaranteed, Default Claims Settled and Outstanding. As at December 31, 1998 a total of 6,615 claims valued at N282.2 million had been filed with the ACGSF by the participating banks. Out of this, 2,463 claims amounting to N20.9 million (37 percent of the total number of claims and seven percent of the value) had been settled. Of the remainder, about 1,535 claims, valued at N42.4 million was repaid through intensive recovery efforts of ACGSF field officers. The balance of unsettled claims at the end of 1998, therefore, stood at 2,617 claims, valued at N223.9 million. Non-settlement of claims, however, has been cited by ACGSF management, as being mainly due to non-compliance with the settlement procedures by the banks. 4.63 The paid-up capital of the ACGSF in 1997 was N85.6 million (US$ 1.1 million), as in the previous year. Indeed, this has been the position since the Fund’s inception. However, earnings through investments of the Fund in the Nigerian Treasury Bills raised the Fund from N194.3 million at the end of 1990 to N407.8 million by June 1999. The number of participating banks has

32 Ogwuma (1998), pages 5-6.

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continued to decline from 29 in 1989 to only five33 by the end of 1997. One of the main reasons is that of the total claims submitted over the years, only about 40 percent have been settled by the Fund.

4.64 As mentioned above, activities under the ACGSF peaked in 1989, after which they started declining as a result of the high rate of default by the farmers and the inability of the CBN to honor its guarantee obligation. The Self-Help Groups Linkage Program was introduced in 1991 to arrest this downturn in the activities of the ACGSF. It was designed to introduce savings on the part of the borrowers as a pre-condition to lending. It encouraged the formation of new farming groups or the adoption of existing viable ones (either as registered cooperative societies or informal groups). The groups’ members come together to save an agreed sum of money on a regular basis, over a period of time, with a partner (participating) bank of their choice. The banks are expected to make loans available to the groups in multiples of their savings. The savings are expected to grow over a period of time and be able to serve as collateral for future loans. The self-help group loans are also guaranteed under the ACGSF.

4.65 This program is meant to facilitate a two-way flow of funds between the borrowers and the participating banks. It is also meant to assist group members to inculcate the habit of regular savings and to elicit their commitments to loan repayment. Accumulated savings also enhances the liquidity position of the participating banks and serves as security for the loans, thereby reducing the loss level of the lending banks in case of default. There is also, of course, the likelihood that the savings may grow eventually to a level that members could on-lend their own funds to their group members and earn interest that would have been paid to the bank. This is a step toward transformation from informal to formal institution with all the benefits derivable therefrom.

4.66 Since the SHG program became operational in 1992, considerable progress has been made in terms of savings mobilization.

Box 4.13: Deposit Mobilization through the ACGSF’s Self-Help Group Program 1994 1995 1996 1997 1998

No. of groups 185 340 313 626 1,083No. of members 647 9,339 8,999 11,784 15,340Savings Mobilized (N millions) 2.6 5.2 6.9 13.2 25.3 4.67 The number of banks participating in the ACGSF dropped from 31 in 1989 to only five in 1998. Key factors that contributed to this were the general distress in the banking industry in the early 1990s, brought about in large part by the general macroeconomic deregulation programs, especially the devaluation of the Naira. These factors added considerable pressure on the credit portfolios of the banks, which shifted to shorter-term lending.

33 The participating five banks comprised the Union Bank of Nigeria, First Bank of Nigeria, AfriBank of

Nigeria, Habib Nigeria Bank, and Bank of the North.

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Box 4.14: Commercial Bank Branches in Rural Areas as at December 31, 1998

Number Percentage of Total Branches Total Commercial Bank Branches 2,107 26% Commercial Bank Branches in Rural Areas 557 Percentage of Rural Branches

Banks Participating in the ACGSF 1 First Bank of Nigeria 106 19% 2 Union Bank of Nigeria 93 17% 3 Afribank 43 8% 4 Bank of the North 25 4% 5 Habib Bank Nigeria 10 2%

Sub-total 277 50%

4.68 Even though the number of participating banks has declined, the fact that the active lending banks under the ACGSF hold about 80 percent of the deposits in the industry is encouraging, This has compensated for the drop in the term of loans extended. The five banks together account for about half of the rural branches throughout the country. It is noteworthy, however, that if United Bank for Africa (with 88 rural branches) also participated in the ACGSF, total commercial bank rural branch coverage would be boosted from 50 percent to 70 percent.

(c) Nigeria Agricultural Insurance Corporation (NAIC) 4.69 NAIC was established in 1987 mainly to provide insurance coverage to farmers. Other specific objectives of the organization are: (a) to induce the provision of credit by financial institutions as insurance coverage is an added collateral; (b) to promote agricultural production by giving farmers confidence to accept new/modern innovations and inputs; and (c) to minimize or eliminate the need for ad-hoc government assistance during agricultural disasters.34 At inception, the program covered only two crops (rice and maize), two types of livestock (cattle and poultry), and some commercial businesses like farm buildings, machinery, and equipment. The coverage has now been expanded to include 21 crops, nine species of livestock, and 12 types of commercial businesses. As of June, 1999, NAIC’s efforts are being intensified to expand its coverage to fisheries, vegetables, and other horticultural products. Insurance contracts on crops and livestock have their premiums subsidized by the FGN at a rate of 50 percent; however, premiums on other types of contracts are not subsidized.

4.70 As of 1999, NAIC is Nigeria’s sole insurer of the nation’s agricultural produce and investments. NAIC has its headquarters in Abuja and has operational presence in all 36 States, with five zonal offices; and the plans are to further expand the number of field offices throughout the country. After a 1995 FAO consultation and subsequent revamping of NAIC’s business practices, the insurance provider posted a 1996 profit of N1.8 million (about US$20,000) after consistently registering losses for more than five years prior to this period. Profits in 1997 increased to N15.2 million ($169,000). Also in 1997, NAIC provided 59,932 insurance contracts totaling N7.7 million (US$ 96,000). From program inception to the end of 1998, 354,862 groups, cooperatives, and individuals were insured, the total sum insured was N22.87 billion, the total premium 34 Nigerian Agricultural Insurance Company (1998).

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earned was N448.80 million, the total claims paid was N104.39 million, and the total number of claimants paid was 8,391. NAIC does not receive recurrent funding support from the FGN, which is especially remarkable given NAIC’s scope and scale of operations.

4.71 NAIC has emerged in the last few years as a highly successful agricultural insurance provider in terms of its diverse products offerings and its profitability, and it serves as a model for other countries in West Africa (Box 4.14). It has, however, suffered setbacks resulting from the general economic downturn in the agricultural sector and the reduced lending to agriculture by financial institutions. Agricultural insurance, unlike conventional insurance, are especially capital- and logistics- sensitive. Whereas the latter may be more selective on areas within which to operate, NAIC is responsible for covering the entire nation, irrespective of profit potential. Specific areas requiring extra funding include: (a) increased transportation in terms of motorcycles, automobiles, and small boats for pre-insurance inspections, gestation period inspections, and loss inspections around the country; (b) enhanced communication systems between its 260 staff at its headquarters, zonal, branch, and liaison offices; and (c) publicity to increase the general public’s knowledge of insurance services and to market NAIC.

4.72 Given that agriculture employs over 90 percent of Nigeria’s rural population and that cultivation is mainly rain-fed, labor-intensive, and of low technology, NAIC, as Nigeria’s main agricultural insurer has a major role to play in accommodating risk. It is, therefore, recommended that further data collection and analysis of NAIC be carried out to determine if it is an appropriate candidate to be privatized and receive a one-time injection of further funds to: (a) help it increase its share capital from N5 million to the required minimum of N120 million for insurance companies, and expand its coverage at a sustainable rate of growth, from the one percent of the farming households it currently serves to the 50 percent of farmers it is mandated to serve; (b) further differentiate its services from the agricultural sub-sector to the rural sector; and (c) spend more time “fire preventing” rather than “fire fighting” by placing greater emphasis on extension services aimed at encouraging loss prevention or minimization techniques.

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Box 4.15: The National Agricultural Insurance Committee The National Agricultural Insurance Committee for Nigeria was formally established on October 28, 1997 with a total fund of about N250,000, in compliance with the resolution adopted at the AIO/UNCTAD seminars on Agricultural Insurance held in Mombassa, Kenya in November, 1996 and in Cairo, Egypt in May, 1997. The purpose of establishing the Committee was so that it would serve as a working group at the national level to determine the nature and scope of agricultural insurance and how it can be made more attractive to private insurance companies. The Committee also serves as a liaison between the AIO and other national committees at the sub-regional level, and is chaired by NAIC management. Membership of the Committee is made up of NAIC staff, insurance supervisory bodies, other insurance companies, and Federal and State government agricultural policy makers. At the inaugural meeting of the Committee, it was resolved that NAIC’s activities would be assessed with a view to determining progress made and identifying problem areas. NAIC’s evaluation was to facilitate objective discussion on how to improve other insurers involved in underwriting agricultural risks. Two sub-committees were formed to deal with the four major areas of the evaluation of NAIC: (a) the sub-committee on assessment of NAIC’s operations and their impact on the insured; and (b) the sub-committee on the assessment of the legal framework and funding. These sub-committees have since completed their assignments and the reports have been considered by the national Committee. The next work program for the Committee members includes: (a) an appraisal of NAIC; (b) data collection on the rural sector and the agricultural sub-sector; (c) an exploration of more generalized rural insurance services, including rural properties, micro and small-scale enterprises, personal risks, various agribusinesses, and marketing; and (d) staff training and development programs. The Committee members have been very enthusiastic about the potential of the Committee for popularizing agricultural insurance services and opening the market further for other private insurers. Further assistance in the form of funding, especially for organization of seminars, workshops, and the provision of computers and other working materials is recommended so that NAIC, through the Committee, can continue serving as a model for all the other West African countries. Source: NAIC (1999).

D. Informal Rural Finance Providers

(a) Trade and Input Supply Financing 4.73 Trade and input supply financing concerns the provision of funds for the purchase, handling, transportation, processing, storage, and selling of various commodities. It involves short-term funding to carry stocks of inputs and produce at various stages of production and marketing. Trade and input supply financing is widespread in Nigeria at the micro level in both rural and urban areas. Although reliable, consolidated data on total trade and input supply financing is unavailable, several of the largest commercial banks with the greatest rural branch presence indicated that as much as 40 percent of their total loan portfolio was devoted to commodity trade financing. In addition, specialized microfinance intermediaries such as the People’s Bank have indicated that their trade-related financing has grown rapidly, and now comprises about 20 percent of their total loan portfolio.

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(i) The Main Types of Trade and Input Supply Financing

4.74 Input Financing. With regard to food crops, small-scale traders, who scout around to purchase, assemble and bulk various items, often finance their purchases themselves or through contributions made by family or friends. When purchases increase in volume or value, small-scale traders often approach their informal thrift and savings associations for loans. However, the size of such loans depend on the amount deposited. For example, an individual may receive two or three times his/her deposit as a loan, which must be repaid with interest within six months to one year. 4.75 Trade Credit. The FGN has traditionally been heavily involved in the procurement of fertilizer. However, many individuals finance the purchase of their input requirements (notably herbicides, pesticides, seeds, and seedlings), through traders who buy inputs and collect multiples of products from the farmers to whom they may also supply the inputs. The final users may deposit money ahead of supply of the inputs, providing the traders part of the funds required for their input purchases. Agro-chemical companies selling herbicides and pesticides, such as Chemical and Allied Products Limited (CAPL) or Norvatis (previously Ceiba Geigy) also organize their own financing. Retailers usually purchase with cash, but when demand is low, the companies offer supplier credit to reliable distributors in order to maintain sales volumes and profit levels. 4.76 Supplier Financing. As soon as a buyer establishes his/her credibility, reliability, and regular payment profile, the suppliers of produce make available two or more times the quantity of produce that has been paid for. The buyer is then expected to pay back as soon as the sale is effected. For certain commodities, suppliers use this method to increase the volume of sales and stay competitive. 4.77 Cooperative Societies. Loans through cooperative societies are used to purchase commodities like palm oil for storage and resale, and grains, cowpeas, and other farm products for gradual sale. 4.78 Non-Government Organizations (NGOs). Some NGOs providing microfinance services, assist their clients with small loans for purchasing machinery and processing equipment such as cassava graters, palm oil presses, pepper grinders, and the like. In particular, the Farmers Development Union (FADU) and the Fadama Users Associations (FUAs) have been provided loans mainly for the purchase of pumps, hoses, and other inputs. 4.79 Licensed Buying Agents. There is a tradition of export commodity assemblers, such as licensed buying agents (LBAs) for cocoa and other major export crops (such as palm oil and kernel, rubber, cotton, cashews, hides and skins, etc.), approaching commercial banks for trade credit, which could total millions of Naira per loan. NEXIM has traditionally been approached by the commercial banks as a rediscounter or refinancier for the loans. The loan funds are then distributed to farmers as advances so that the farmers could sell their cocoa to the LBAs. Some of the loans are repaid within three or four months 4.80 Processing Credit. Processors such as feed millers, flour millers, and breweries, who must stockpile huge quantities of grains for gradual milling have traditionally borrowed from commercial banks up to as much as N 100 million. However, it has not been uncommon for the banks to provide only part of the loan amount requested, with the remaining amount covered by an overdraft, carrying a much higher interest rate. Financing may also be carried out by contractors who supply grains to feed or flour mills. Such arrangements include out-grower

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systems such as through the African Cotton Association (AFCOT), and the Nigerian Tobacco Company (NTC). These companies, for example, obtain substantial amounts of money for on-lending in supervised, out-grower input supply credit. 4.81 In virtually every part of Nigeria, people have used their personal savings and small loans from family and friends, as well as from informal associations, to carry out the buying and selling associated with commodities produced for domestic consumption or export. As profits have accrued to the traders, they have reinvested and expanded their businesses. Thus, the scale and scope of rural and microfinance to support input supply and trade is very large. Trade and input supply financing provides tremendous opportunity for financial intermediaries to extend loans and recover them with interest. The People’s Bank and the Community Banks have a very good opportunity to operate viable credit facilities in remote rural areas as long as they can incorporate incentives as part of the loan contract to encourage high recovery rates and to build positive attitudes among the smallholder clients who sometime tend to regard loans as their share of the “national cake”.

(b) Cooperative Societies

4.82 The cooperative movement has a long history in Nigeria, with the Cooperative Registrar of the colonial government established in 1935. Early activities of the Registrar and its subsidiary departments centered on the formation, guidance, and inspection by trained government officials. Since the new cooperative group leaders needed training in cooperative management, the government established cooperative training institutions, of which there are three Federal and several State colleges operating as of June 1999. The early cooperative societies were established to facilitate cocoa farming. Later on, these societies began providing financial intermediation between members. Eventually, multi-purpose cooperative societies were designed to simultaneously solve several of the problems facing members, namely input supply (including credit), farming, and marketing of farm produce. 4.83 At the peak of cooperative development in the early 1990s, Nigeria had more than 10,000 registered cooperative societies, with membership of about 2.5 million farm families and low-income urban households.35 According to the last population census figures (1991), the average number of persons per household in Nigeria was 4.8, hence, the total number of cooperative members would be around 12 million people. Most of these cooperatives were thrift and credit societies with an estimated total amount of savings deposits and share capital of N250 million. Some cooperatives were sufficiently liquid to become major stockholders of community banks.

(i) Structure of the Nigerian Cooperatives

4.84 The typical cooperative in Nigeria is three-tiered. There is a primary tier called a society, a secondary level called a union, and a third tier called an apex. There is a single apex in each State called a Federation, which brings together all cooperative unions in that State. Cooperatives are often organized by function, for example, the apex organization for all credit societies and unions in Nigeria is the National Association of Cooperative Credit Unions of Nigeria (NACCUN). There may also be unions for the producer cooperatives, such as Cooperative Produce Marketing Union (CPMU) or the Fishermen’s Cooperative Thrift and Credit Union (FCU), etc. There are also cooperative multipurpose societies and unions in most States.

(ii) Legal Status of Cooperatives 35 World Bank (1994) estimated the number of cooperatives to be 40,000 although the number registered

was only 17,000 at the time of the study.

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4.85 Like other businesses, cooperative societies, unions, and apex institutions are registered so that they become corporations that can sue or be sued. Registered cooperatives have access to government grants, as available, and to bank credit. They are also exempt from paying taxes, provided they keep strictly to transactions with their own members and meet certain rules, such as obeying basic cooperative laws, setting acceptable by-laws, demonstrating seriousness in working together, keeping accounts which are inspected and confirmed to be satisfactory. This inspection and audits are carried out by the Registrar of Cooperatives at the Federal and State levels. 4.86 The period of observation for primary societies was three years until 1979, when this was reduced to six months so as not to discourage hard working, enthusiastic groups. During the six months, government inspectors would be sent to ascertain the true nature of the cooperative. This can be contrasted to the case of FEAP “cooperatives”, whose members may hardly know each other, and can be registered often within two weeks of formation. There is widespread anecdotal evidence suggesting that the new groups received FEAP loans even when pre-existing, properly registered cooperative societies did not. This has caused many members of long-standing cooperatives to abandon their societies to join new groups.

(iii) Challenges and Opportunities

4.87 Cooperatives with a successful track record of prudent management and cohesive membership stand to play a major role in the development of rural financial markets in Nigeria and should be included in future development plans. An example of an exemplary cooperative is provided in Box 4.15. However, the effective use of cooperative institutions faces two significant challenges, namely, the need for coordination at the Federal level and improving the laws and regulations for cooperatives that provide financial services. 4.88 At the Federal level, cooperatives belong to two separate ministries – the Ministry of Agriculture, and the Ministry of Employment and Labor. Unclear mandates and coordination between the two ministries has impeded the design and implementation of various programs affecting cooperatives. While many cooperatives are close to farmers and rural people such that the largest number of cooperative societies are related to agriculture, the main urban cooperative societies revolve around workers, traders, and artisans. Both groups are vital, but there is a need to harmonize activities between the two ministries for progress in the cooperative movement at both ends. 4.89 Also, as in most other developing countries, a general law governing all types of cooperatives regulates the Nigerian cooperative system. This legal framework is largely inadequate for cooperatives that provide financial services. It does not formulate specific requirements for cooperatives that provide financial services, such as those required of licensed banks (for example, asset quality and capitalization measures). The legal and regulatory framework for cooperative groups providing financial services needs to be revised to assist their positive contribution in the development of rural financial markets. Strengthened regulation and supervision coupled with a properly established cooperative financial structure, along the lines of the Bauchi State Cooperative Financing Agency Limited highlighted in Box 4.13, could provide an excellent linkage between the formal and informal financial sectors, and thus help to improve financial intermediation in rural Nigeria.

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Box 4.16: The Bauchi State Cooperative Financing Agency Limited (BCFA) The Bauchi State Cooperative Financing Agency Limited came into existence in 1976, following the creation of Bauchi State. It was carved out of the old North Eastern State Cooperative Financing Agency Limited. The agency is an apex cooperative owned by over 3,000 registered primary cooperative societies scattered in all the local governments of Bauchi State. The major objectives of BCFA are: (a) to source and provide funds for the promotion of the agricultural activities of its members; (b) to engage in crop processing and marketing; (c) to carry out purchasing, selling, and distribution of farm inputs; and (d) to harness all available resources for the overall benefit of its members and to undertake any other activities that will promote the cooperative movement in the State.

Organization and management is clear and autonomous with little to no interference from government agencies. Overall guidance and daily operations are led by BCFA’s Board of Directors, a Management Committee, a General Manager, an Assistant General Manager, a Finance Manager, an Operations Manager, an Administrative and Training Manager, an Internal Auditor, and two Zonal Managers. Loans have generally been provided at a couple of percent over prevailing market interest rates to accommodate administrative costs over the cost of funds to the BCFA. Over the period 1976 to early 1994, the BCFA lent about N127 million to over 650,000 farmers. While the BCFA is not exclusively a rural financing organization, about 80 percent of its funding operations are used to finance rural dwellers. For the period 1997-1998, crop production loans were provided to 15,525 farmers totaling N17.4 million. Repayment rates have averaged over 90 percent consistently from inception. The last cattle fattening and mixed farming loans for which data was available showed 1994/95 volume of lending at N7 million, with loan repayments also averaging over 90 percent since program inception. Loan repayment rates are bolstered since repayment can be made in cash or in kind, in connection with BCFA’s produce marketing programs.

Sadly, with the introduction of FEAP subsidized credit at 10 percent, the mainstay of the BCFA’s activities has been wiped out. BCFA cannot compete with its costs of funds at almost double the interest rate that is being offered by FEAP. In addition, FEAP’s weak conditions of making credit available to any cooperative, regardless of duration of formation or performance, has seriously undermined what was a well-functioning set of about 3,000 registered cooperative societies in Bauchi State alone. Extrapolating the adverse effects that FEAP has had on the Bauchi State cooperative system to Nigeria’s other 30 States further supports the recommendation to the FGN to halt FEAP disbursement of subsidized credit immediately. Sources: BSCFA (1998) and the authors’ findings.

(c) Non-Governmental Organizations 4.90 In recent years, the number of NGOs providing credit has multiplied, partly as a result of programs sponsored by development organizations and donor agencies to support poverty alleviation and rural development. The mandate of most NGOs is to promote rural development and increase the standard of living of the poorer rural communities by providing credit and technical assistance. There are numerous NGOs whose outreach has been very limited – to under one thousand people each – in select areas of the country. There are at least 21 major NGOs operating in Nigeria with 17 of those providing microfinance services. However, even these have very limited outreach and most depend on continued donor support. For example, data for the three NGOs widely accepted as among the most successful in terms of scale and depth of microcredit delivery, indicates that their combined outreach as of 1998 was only to about 30,000 people, with total outstanding loans amounting to less than N100 million ($1.1 million).

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4.91 Although their outreach and scale of operations have been relatively small to date, like the cooperative societies, NGOs have managed to reach the poorest segments of the rural population, with average loan amounts per person of less than N5,000 ($56). As such, some NGOs which incorporate best practices, especially in relation to their lending interest rates and repayment experience, should be considered potentially valuable partners in any rural financial market development plans.

(d) Esusus, Family and Friends, and Moneylenders 4.92 A field survey and study were completed in 1994. Although the expanded operations of RFIs like the PBN and the CBs can be expected to have generally increased the supply of rural financial services, informal sector demand and supply are expected not to have changed significantly over the last five years. Highlights from the 1994 study’s findings, therefore, are presented here in lieu of a new survey and analysis of the informal sector. On the demand side, the study included results from direct interviews with five occupational groups across three culturally distinct communities in the Northern, South-Eastern, and South-Western zones of Nigeria. The occupations included farmers, artisans, market women, traders, and local manufacturers, with 100 persons in each group. Field surveys were also conducted on the supply side, with interviews of ten of each of the following types of informal financial service providers: esusus, moneylenders, money collectors, and friends and family members in the selected communities. 4.93 An FAO study completed at about the time of the 1994 World Bank study estimated that about 90 percent of the rural sector’s financial needs were satisfied by informal rural finance providers (World Bank, 1994). The Bank’s 1994 study identified various forms of informal financial operations in rural Nigeria. In general, informal finance operators were married, male dominated, and had secondary to college level education, except in esusu leadership, which was dominated by women (80 percent) with up to only high school education. The informal sector provided the bulk of rural dwellers’ credit needs (mainly working capital) for five active occupational groups, namely: farmers, artisans, market women, traders, and local manufacturers. In terms of the amount borrowed by rural dwellers, banks came a distant fourth behind esusus, family/friends, and moneylenders, in that order of importance (Box 4.14). Loan amounts ranged between N500 and N12,000 and averaged just over N5,000. In terms of preferences, moneylenders were the least preferred source of rural credit, implying that rural dwellers were “forced” to borrow from them because there were no “competitive” alternatives in times of need.

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Box 4.17: Distribution of Occupational Groups by Sources of Informal Credit Market Local All Source of Credit Farmers Artisans Women Traders Manufacturers Groups Banks 13.1 18.6 5.2 21.6 4.4 10.9 Moneylenders 4.0 11.4 1.0 9.5 8.8 5.7 Esusus 19.7 39.7 28.0 41.9 65.9 39.5 Family 38.2 22.3 56.1 16.2 5.5 30.1 Friends 25.0 8.0 9.7 10.8 15.4 13.9 Total 100.0 100.0 100.0 100.0 100.0 100.0 Source: World Bank, 1994. 4.94 About half the population of rural dwellers had a preference for keeping liquid cash as the most popular form of asset holding, followed by livestock and land, in that order. Furthermore, the preference to keep cash holdings outside the formal banking system was very strong, with only 20 percent of the rural populace indicating a preference for saving their surplus with banks; the remaining 80 percent preferred their homes, esusus, respected family members and/or friends for safe-keeping of cash. The negative real returns, and the low liquidity typically associated with keeping savings in banks probably accounted for much of the aversion. In addition, the banking crisis which was occurring at about the time of the study can be expected to have exacerbated the general unwillingness of rural dwellers to deposit excess funds in banks. 4.95 The two most frequently cited reasons for rural dwellers not patronizing the formal banking system were poor access and bureaucratic delays. The two factors augment borrower transaction costs, which were found to be significantly higher when they borrowed from banks, compared to borrowing from the informal sector. When interest rates were included, however, total financial costs involved in sourcing funds from informal lenders far outweighed the corresponding costs associated with borrowing from the formal banking system. This fact, notwithstanding, rural dwellers still patronized and showed preference for the informal sector, due to the high degree of certainty and flexibility in sourcing for, and repaying loans from informal lenders. Thus, the seasonal nature of demand for rural credit necessarily implied a high premium (by rural borrowers) on timely availability of loan funds; at the same time, the high risk of default and the excess demand for rural credit were the reasons for the high costs of funds charged by informal lenders (for example, the effective interest rate charged by moneylenders averaged about 100 percent on an annualized basis). 4.96 The high propensity to save, coupled with the low preference for saving surplus funds with the formal banking system implies a high potential for mobilization of rural savings by the formal sector. The main informal lenders that mobilize deposits are the esusus and the moneykeepers, while moneylenders are seldom involved in accepting deposits. In terms of volume and coverage, the savings collectors have the highest rates of savings mobilization. 4.97 The 1994 study concluded that despite the well-adapted operations of informal rural finance providers, the total amount of rural credit provided was not sufficient to satisfy the rural demand for credit, which is both seasonal and short term in nature. Moreover, with an average maturity of three months, the informal sector ruled out getting involved in the provision of the medium to long-term credit necessary for term investment in long-gestation crops, livestock, agro-processing, or small-scale irrigation. In addition, informal rural finance providers did not have the technical capacity for assessing the financial viability of projects. Hence, even for short-term loans, informal rural sector lending was normally restricted to traditional activities, whose financial viability were known and established over the years. This ruled out financing of new activities, about which informal rural lenders had little or no knowledge and, as a result, limited the provision of rural loans.

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Chapter 5. RECOMMENDATIONS 5.1 We have, in this report, reviewed the macro and sectoral policy environment as well as the legal and regulatory framework affecting rural financial markets, with a view to determining whether an enabling environment exists for the efficient functioning of these markets. In addition, we have also examined the major formal and informal rural finance providers to assess their performance and development needs. It is noted in this report that, while improvements have been made in the policy and laws of Nigeria, especially since 1996, there are still many policy and institutional challenges which need to be met in order to create an environment that is supportive of the development of rural financial markets. Key to building an enabling environment are maintenance of a stable and growing economy as well as improvements in the legal and regulatory framework, so that property rights are clear, and the CBN can effectively supervise and enforce prudential guidelines on several of the RFIs which have recently come under its jurisdiction. In addition, we would like to submit that a rationalization and restructuring of several government-sponsored development finance institutions is necessary for the development of rural financial markets. The main recommendations and suggested next steps to forming a holistic rural financial market development strategy and action plan are summarized below.

A. Creating an Enabling Macro and Sectoral Policy Environment

5.2 Sound Macroeconomic Policies. Above all, the development of rural financial markets requires sound monetary and fiscal policies which result in macroeconomic stability with low and stable inflation. Extra-budgetary expenditures must also be minimized to ensure price stability. Consistent and rational economic policies foster investor and consumer confidence and encourage the development of rural financial markets. 5.3 Investment in Rural Infrastructure and Human Services. FGN budget allocations need to be adjusted to invest adequately in rural infrastructure and human services, especially in the areas of providing safe drinking water, roads, electricity, telephone service, and health and education. Structural adjustment policies and deregulation programs in the late 1980s and early 1990s, have left Nigeria’s agricultural sector largely deregulated. However, the years of austere fiscal policies accompanying adjustment and deregulation diminished the pool of funds available to be invested in rural services. Nevertheless, the creation of non-farm jobs hinges on favorable infrastructure and a pool of well-educated workers. In addition, improvements in on-farm productivity and profitability depend on the quality and density of rural infrastructure and investments in agricultural crop research and post harvest handling technologies. Both are necessary for rural financial market development and depend on adequate rural investment in infrastructure and human services. 5.4 Rationalization/Consolidation of FGN Rural Development Programs. The numerous microfinance programs that the FGN has promoted over the last twenty years need to be rationalized and consolidated. At present, the missions of many programs overlap. Perhaps the most damaging of these programs is the directed, subsidized credit disbursement through FEAP, which effectively “crowds out” any privately-based micro or rural financial service provision.

5.5 Promoting Private Risk Management. As the FGN lessens its emphasis on state-supported, supply-led interventions in rural financial markets, private risk management mechanisms must accommodate the risks formerly assumed by the government. The FGN should build upon the successes achieved in the last several years through NAIC in this regard. NAIC’s operations have become widely recognized throughout West Africa as being innovative and developing best practices. This organization deserves a more in-depth study to discern where further efficiencies

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in the system might be found. Depending on the results of a more in-depth analysis and institutional development plan, the NAIC might be a good candidate to receive a one time injection of further funds to increase its share capital and make it a good candidate for privatization, provided it would keep the majority of its business oriented toward its core operations – meeting the insurance needs of Nigeria’s rural farm and off-farm enterprises.

B. Improving the Legal and Regulatory Framework

5.6 General areas of action regarding the legal and regulatory framework include: (a) adapting regulation and supervision to the growth of NBFIs; (b) promoting self-regulation of NBFIs; (c) provision of deposit insurance to specialized financial institutions; and (d) enhancing property rights in terms of recognizing non-traditional forms of collateral and promoting credit bureaus and rating agencies. In this section, we raise these issues as recommended areas of further research over a longer-term. No specific recommendations are provided here. The Next Steps matrix at the end of this section appropriately notes each of the issues raised below for further review and analysis over the longer term. 5.7 Growth of NBFIs – Appropriate Regulation and Supervision. The regulatory and supervisory framework needs to be reviewed and need to be strengthened to embrace the recently expanded activities of NBFIs. The legislation that governs the entry, capital adequacy, legal lending limits, risk classification standards should be adapted to the specialized operations of informal NBFIs that mobilize deposits. Furthermore, there is a need to harmonize and coordinate the efforts of apex organizations to maintain sustainable growth patterns in the informal system. 5.8 Adapting to the Growth of NBFIs – Effective Deposit Insurance. Another dimension to the issue of providing adequate protection to the investing public, particularly individuals, collective investment institutions, and contractual savings institutions, from mismanagement, is to instill confidence in the system, and ensure capital market stability by providing effective deposit insurance. The regulatory framework should clearly delineate the rights and obligation of parties engaging in financial transactions, and assure adequate disclosure, transparency, and protection for small and relatively unsophisticated depositors and investors. This is especially an issue with the large numbers of depositors in NBFIs such as the PBN and the Community Banks. Determining what form effective deposit insurance should take (for example, traditional deposit insurance or other, more indirect mechanisms such as an apex stabilization fund to instill depositor confidence and effectively safeguard funds), however, merits further review. 5.9 Clearly Defining Property Rights. Property rights need to be more clearly defined. Small agricultural producers in Nigeria tend not to hold secure title to land they own and farm. The absence of clear and legally-recognized ownership or access contributes to under-investment and unsustainable exploitation of the natural resource base. Farmers without title to land are unlikely to invest in productivity-enhancing technologies and to adopt soil and water conservation practices. These issues particularly affect women’s access to adequate micro and rural financial services. Ill-defined property rights also inhibit lending for long gestation crops without real collateral. C. Building the Institutional Capacity of Rural Finance Providers

5.10 Several common issues affect each of the rural finance providers examined in this report. The lack of a critical mass of skilled banking professionals, which is a generic problem of the banking industry, affects the main rural finance providers as well. Poor managerial and technical skills of both the formal and informal financial institutions are major bottlenecks to efficient rural financial intermediation In addition, the maintenance of concessional interest rates by many of

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the RFIs continues to generate inadequate returns to cover costs and has generally led to severe liquidity constraints for the rural financial system. A rationalization of the plethora of state-sponsored RFIs and support programs is badly needed and the restructuring of most of the institutions will be a necessary condition for the development of Nigeria’s rural financial markets. Specific recommendations which address these concerns follow. 5.11 NACB. This institution has the largest branch network of any commercial bank or DFI, and is second only to the Community Banks in terms of the total number of rural outlets. Regarding overall country coverage, NACB has the greatest geographic representation and the best coverage of major agricultural centers in the rural areas. In addition to the extensive physical network, NACB also has substantial investment in human capital. The total number of its staff as at April 14, 1999 was 1,660. This number comprised 33 management staff, 508 senior staff, and 1,119 junior staff. The number of staff at headquarters was 432, while 1,228 were in the field. The organization benefits from over 25 years of accumulated wealth of experience in smallholder finance. Although many staff have left and low morale is a lingering problem, most of the remaining staff are dedicated professionals and are hopeful that the organization will change for the better, with adjustments in NACB’s operating policies and procedures. The staff who have been there the longest appear to be technically competent, well-experienced professionals in rural lending. 5.12 Perhaps most importantly, NACB’s senior management are aware of international best practices in rural finance, including the provision of micro and small-scale financial services, and are eager to adapt these to the context of Nigeria. There is widespread support in the organization for dramatically changing the operating policies and procedures to overcome the constraints identified above. 5.13 Provided NACB successfully undergoes a significant and widespread restructuring and revitalization process, this DFI would merit further recapitalization and restructuring of its debt burden. Critical elements of such a restructuring program would include: (a) balance sheet restructuring and adjusting the products and services offered; (b) changing the mission to emphasize financial self-sustainability; (c) appointing a new Board of Directors and instituting appropriate staff incentive systems to ensure appropriate governance; (d) introducing incentive systems for clients; (e) training in micro and rural finance institution management, operations, and lending technologies; and (f) improving the quality of its management information systems and reporting, as developed further in Chapter 4. 5.14 PBN. As recommended for NACB, PBN should also embark upon a substantial restructuring program so that it can be positioned to the a path towards financial self-sustainability in the near term. PBN’s on-lending of funds from FEAP should cease immediately, as it competes with PBN’s own loan products and creates the image of PBN as a cheap, short-term government credit disbursement center instead of a long-term financial service provider. Essential elements of PBN’s restructuring program would include areas similar to those described for the NACB above and was as elaborated on in Chapter 4.

D. Encouraging Banking System Linkages

5.15 In order to develop deeper, more efficient and complete markets, competitive forces have to be allowed to be in play. In Nigeria, competition in rural financial markets is largely absent. The predominant actors are state-owned, specialized financial institutions, credit granting NGOs, and informal financial suppliers. The clientele of each is segmented. The terms and conditions for each typical provider varies significantly. Financial costs are lowest for the state-owned institutions but the transaction costs are the highest. The reverse is true for the informal lenders.

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Part of the solution entails expansion of financial service provision along a sustainable path by NACB and the PBN. By virtue of being close to their clients, each of these institutions intermediates between community-based, informal groups and the formal financial sector with less processing time and expense than commercial banks. Strengthening these RFIs would facilitate banking system linkages. Another part of the solution requires building and strengthening trade and input supplier financiers and other informal providers of rural financial services. These intermediaries have a potentially significant role to play in the development of supplier finance and other inter-linked contracts. Specifically, improving the regulation and supervision of cooperatives that provide financial services, coupled with expansion of a properly established cooperative financial structure, along the lines of the Bauchi State Cooperative Financing Agency Limited, could provide an excellent linkage between the formal and informal financial sectors.

E. Next Steps

5.16 The options and recommendations provided in the last section have been summarized below in matrix form. The recommendations fall under short, medium, and long-term priorities. The findings of this report along with the prioritized recommendations will enrich the Bank’s dialogue on financial sector issues with the FGN, as well as lead to the development of a vision for a privately-oriented financial system to serve rural micro and small-scale entrepreneurs in the context of a possible rural financial market development program, based on private enterprise and competition in all possible markets. 5.17 This study has attempted to provide a holistic treatment of the major issues affecting the constitution and performance of rural financial markets serving micro and small-scale enterprises in Nigeria. As such, it exposes several important complex areas that require further, more focused analysis to appropriately address them. Specifically, more detailed qualitative and quantitative analyses of NACB, PBN, NAIC, and ACGSF need to be carried out in the context of working papers geared toward redefining their mandates and developing institutional development plans for each, where warranted. Two additional working papers would further sharpen the analysis and refine the recommendations of this report. The first would be focused on: 1) macro issues specifically related to the “Eight Pillars of Urban-Biased Policies” traditionally found to hamper the development of rural financial markets in many developing countries; and 2) the comparative advantages, if any, Nigerian farmers have in their production in import substitution or export crops. The second would more concretely address the issue of trade financing as a potentially important mechanism through which to substantially improve the performance of rural financial markets. Finally, a demand and supply analysis of the number and types of “constrained borrowers”, similar to previous studies carried out in El Salvador, Mexico, and Romania would complement the findings of this report and facilitate the production of any warranted institutional development plans for NACB, PBN, NAIC, or ACGSF. 5.18 As part of this ESW, the Bank is co-sponsoring a three-day sub-regional conference on micro and rural finance to be held in September, 2000 in Abuja, Nigeria. This conference is being closely coordinated and co-sponsored with the Central Bank of Nigeria, the Ford Foundation, USAID, DFID, IFAD, UNDP, and several other major stakeholders, including microfinance institutions operating in Nigeria and the West Africa Region. The objectives of the conference are to: validate the findings of this study, exchange views on “best practices” in rural microfinace and building consensus on the way forward. The outcome of this stakeholder meeting is expected to prepare the way for preparing an operation to support the implementation of the recommendations of this study.

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Recommendations Priority Matrix

Issue(s) Problem(s) and Empirical Evidence

Recommendation(s)

Immediate Recommendations Rationalizing the plethora of similar government programs.

Several of the DFIs, the PBN, and FEAP have overlapping mandates and program designs with varying degrees of unsustainability, requiring large amounts of continued state support.

Consolidate the seven DFIs into two to three institutions, streamlining their mandates, restructure NACB and the PBN as part of this rationalization process, and phase out FEAP. Restructure the ACGSF to increase its outreach and operating efficiency.

Recommendations for the Short-Term Promoting better rural risk management.

As the FGN decreases its emphasis on state-supported, supply-led interventions in rural financial markets, private risk management mechanisms must accommodate the risks formerly assumed by the government.

Develop an institutional development plan for NAIC to become a privatized insurance provider while keeping its focus on insuring rural farm and off-farm enterprises on a commercial basis.

Recommendations for the Medium-Term Developing formal - informal financial sector linkages.

The predominant actors are state-owned, specialized financial institutions, credit- granting NGOs, and informal financial suppliers, with the clientele of each being segmented and relatively unconnected to the formal financial system.

Restructure NACB and PBN so that they can operate along a sustainable growth path, and build on their existing strength in intermediating between community-based, informal groups and the formal financial sector with lower processing time and operating costs than commercial banks. Strengthen linkages between the formal financial sector and trade and input supplier financiers and other informal providers of rural financial services, as they have a potentially significant role to play in the development of inter-linked contracts.

Recommendations for the Long-Term Ensuring macroeconomic stability.

Large fiscal deficits and extra-budgetary expenditures can lead to rising inflation, undermining the ability of financial institutions to set appropriate interest rate policies and extend loan maturities.

Adopt a combination of sound fiscal and monetary policies to keep inflation low and controlled, minimize policy reversals and avoid contradictory policies across Ministries and between the Federal and State levels of government.

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Issue(s) Problem(s) and Empirical

Evidence

Recommendation(s)

Recommendations for the Long-Term, cont’d.

Increasing provision of adequate infrastructure and human services.

Inadequate infrastructure and human services inhibit the growth of farm and off-farm enterprises, depressing demand for financial services and the development of efficient rural financial markets.

Shift additional resources to provide adequate rural infrastructure (roads, electricity, water) and human services (health and education), where these necessities are relatively underdeveloped compared to urban areas.

Enhancing the regulatory and supervisory framework for NBFIs

The recently expanded activities of NBFIs necessitates a review of the legal and regulatory structures affecting them to ensure confidence in the financial sector and protect depositor funds

Review the legal and regulatory framework governing the operations of the main NBFIs and develop appropriate supervision based on international best practices

Improving property rights.

The absence of clear and legally-recognized land ownership or access/user rights contributes to under-investment and unsustainable exploitation of the natural resource base.

Suitable reforms would include: (a) introducing a new law of secured transactions, which would allow effective use of movable assets, including equipment, inventory, receivables, and consumer goods as collateral; (b) improving the efficiency of public registries, permitting lenders to record pledges of land and housing, and provide quick access to information about existing liens; and (c) introducing a mechanism for expeditious recovery of collateral.

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REFERENCES

CBN. Annual Report and Statement of Accounts for the Year Ended December 31, 1996. Lagos, Nigeria: Central Bank of Nigeria, 1997.

_____. Annual Report and Statement of Accounts for the Year Ended 31st December,

1997. Lagos, Nigeria: Central Bank of Nigeria, 1998. Aliyu, Abdullahi. 1998a. Press Briefing on the Disbursement of the First Batch of Loans

Under Family Economic Advancement Programme (FEAP). Lagos, Nigeria: Family Economic Advancement Programme.

_____. 1998b. “Small and Micro-Enterprises in the Alleviation of Poverty.” Paper

presented at the 1998 Technology Summit: Abuja, Nigeria, 1998. FAO and GTZ. Agricultural Finance Revisited: Why?. The first of a series of

publications under the heading “Agricultural Finance Revisited.” Rome, Italy: FAO.

Federal Office of Statistics. 1997. Major Social Indicators by Local Government Areas,

Nigeria: 1993/4. Nigeria: Federal Office of Statistics.

Fruman, Cecile and Mike Goldberg. 1997. Microfinance Practical Guide for World Bank Staff. Washington, D.C.: Sustainable Banking with the Poor and the Consultative Group to Assist the Poorest, World Bank.

NACB. 1999. “Impacts of Financial Technologies and Sources of Funds on the Performance of Rural Financial Institutions: A Case Study of the Nigerian Rural Financial Market and the Nigerian Agricultural Co-operative Bank (NACB) Limited.” Unpublished paper: Kaduna, Nigeria.

_____. 1999. Brochure. Kaduna, Nigeria: Nigerian Agricultural and Cooperative Bank Limited.

NBCB. 1999. “Eight Years of Community Banking: Nigeria.” Briefs on Community Banking Scheme in Nigeria. Nigerian Agricultural Co-operative Bank Limited: Abuja, Nigeria.

NAIC. 1998. Various audited and unaudited, and unpublished financial statements. Abuja, Nigeria: Nigerian Agricultural Insurance Corporation.

Ogwuma, P.A. 1998. Keynote Address at the 20th Anniversary of the Agricultural

Credit Guarantee Scheme Fund: Abuja, Nigeria. August, 1998. Okunmadewa, Foluso. 1997. “World Bank: Microcredit and Poverty Alleviation in

Nigeria.” Paper presented at the National Workshop on Microcredit as a Basis for Economic Empowerment organized by People’s Bank and UNDP: Abuja, Nigeria. June 1997.

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REFERENCES continued

_____. 1998. “Scope, Dimension, and Reduction of Poverty in Nigeria: Essence of

Microcredit.” Paper presented at the Seminar on NGOs and Financial Institutions organized by the Centre for Human Development: Lagos, Nigeria. August, 1998.

Olomola, Ade. 1992. “Interlinked Credit Transactions in the Nigerian Rural Credit

System.” Agriculture and Rural Development Department, Nigerian Institute of Social and Economic Research, Ibadan.

PBN. 1999. Unaudited financial data from PBN. Unpublished report: Abuja, Nigeria.

Soyibo, Adedoyin. 1996a. “Financial Linkage and Development in Sub-Saharan Africa: The Role of Formal Financial Institutions in Nigeria.” Working Paper 88. Regent’s Park, London: Overseas Development Institute.

_____. 1996b. “Financial Linkage and Development in Sub-Saharan Africa: The Role

of Informal Financial Institutions in Nigeria.” Working Paper 90. Regent’s Park, London: Overseas Development Institute.

World Bank. 1994. “The Nigerian Rural Financial System: Assessment and

Recommendations.” AF4AE Department of the World Bank: Washington, D.C. _____. 1997a. 9/9/97 Draft “Africa Region Strategy for Development of Micro and

Small Enterprise Finance.” World Bank: Washington, D.C. _____. 1997b. 1997. “A Review of the World Bank’s Micro-Finance Portfolio: FY91-

FY96.” CGAP: Washington, D.C. _____. 1998. “Nigeria: Country Strategy Paper and Work Program.” AFC12, World

Bank: Washington, D.C. _____. 1999. “Financial Sector White Cover BTOR.” World Bank. 1999 Yahaya, Alhaji. 1998. “Financial Institutions and Rural Finance: Role of Banks.” Paper

presented at a National Workshop to commemorate the 20th Anniversary of the Agricultural Credit Guarantee Scheme Fund: Abuja, Nigeria. August, 1998.

Yaron, Jacob; McDonald Benjamin; and Gerda Piprek. 1997. “Rural Finance: Issues,

Design, and Best Practices.” No. 14 of the Environmentally and Socially Sustainable Development Studies and Monographs Series, World Bank: Washington, D.C.

Yaron, Jacob. 1992. Successful Rural Finance Institutions. World Bank Discussion

Paper No. 150. Washington, D.C.: World Bank.

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Annex 1: Executive Summary of “Nigeria: Rural Finance Issues Paper” 1. The rural sector is central to Nigeria’s development strategy and agriculture continues to play a key role in rural growth. Preliminary empirical evidence suggests that rural financial markets in Nigeria are fragmented and inadequate to meet the demand for financial services. The absence of efficiently operating rural financial markets is becoming a serious constraint on sustainable rural development. Efficient and cost-effective financial services are essential elements of an environment that enables entrepreneurship, innovation, and production to develop and flourish. Households need access to safe savings facilities. In addition, farm and off-farm entrepreneurs need timely access to appropriately designed program of financial services to take advantage of market and investment opportunities. 2. Several factors are likely to hamper the development of rural financial markets in Nigeria, including: (a) urban-biased policies which undermine the emergence of profitable rural investment opportunities; (b) an inadequate legal and regulatory framework; (c) underdeveloped institutional and physical infrastructure; and (d)) government interventions which “crowd out” private financial service providers by allowing weak, government-supported financial institutions and support programs to lend at below-market interest rates with poor outreach to the target clients and low loan recovery. These issues would be properly examined in this Economic Sector Work (ESW) in two phases.

3. Phase I, will be devoted to the policy, legal and regulatory environment as well as the institutional issues affecting rural financial markets. Through policy and institutional analyses, we will identify key areas of the macroeconomic and sectoral policy environment as well as the legal and regulatory framework that need to be addressed in order to create an environment that is supportive of the development of rural financial markets, leading to specific recommendations on corrective measures and the likely constraints to implementing the desired changes. In addition, we will assess the institutional development needs of major formal and informal suppliers of rural finance. A White Cover Report on the outcome of this phase of the study would be produced by June 30, 1999.

4. Phase II of the ESW, proposed to begin July 1, 1999 and end by December 31, 1999, would estimate the cost-effectiveness of major government-sponsored rural finance institutions and support programs, using loan and cost recovery, and subsidy dependence indicators, as data permits. It would also include analysis of rural household/enterprise models to identify the income-generating activities of a sample of rural household enterprises by region, estimate their relative economic and financial rates of return, and determine their constraints and growth potential. This research would also provide an empirical basis to estimate the quantity and quality of demand for rural financial services. The information generated at the completion of this study would be helpful for developing a vision of an appropriate privately-oriented financial system to serve rural micro and small-scale entrepreneurs in the context of a possible rural finance development program based on private enterprise and competition in all possible markets.

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Annex 2: Description of NACB’s Specialized Project Lending Products 1. The IFAD project is being implemented in conjunction with the FGN through the Department of Fisheries, and the Ministries of Agriculture in several States in Nigeria. It involves a foreign loan of $15 million, out of which $8.5 million is earmarked for NACB to disburse for fishing and other income generating activities in the identified fishing villages. The loan has a maturity of 20 years and a grace period of 5 years at an interest rate of 4 percent. A maximum loan ceiling of N250,000 is made available to fishing groups of not more than 10 members each. The disbursement of loans under this program began in 1993 and until the end of 1998, the total amount disbursed was over N100 million with loan repayment of over N58 million, or about 60 percent.

2. Under the ECOWAS Project, a maximum loan amount of N150,000 is made available to individuals for fishing. The loan maturity is 15 years with a grace period of 3 years at an interest rate of 4.75 per annum. It is jointly implemented by NACB and several Federal and State governments. It was designed to provide credit to individuals for fishing. Disbursement to the end of 1998 was about N100 million, while only about N30 million has been recovered so far.

3. The World Bank-financed project is being jointly implemented by NACB and the National Livestock Project Department of the Federal Ministry of Agriculture. As at the end of 1998, about N 267 million has been disbursed under the program, with loan recovery at about 75 percent of the amount due. The FGN on-lends the funds it borrowed from the World Bank in local currency at an interest rate of 6 percent per year, with a maturity of 20 years.

4. For its project, the ILO provides a guarantee of 50 percent of all loans in default. The project finances income-generating activities in four villages as a model. It is being implemented using groups of women borrowers and relies on peer pressure for loan repayment. Total project disbursements to the end of 1998 were just over N500,000 and the recovery rate is 97 percent.

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Annex 3: Description of PBN’s Proposed Loan and Savings Products 1. In the People’s Target Saving Scheme, a customer opens an account with PBN after filling out a participating form, where the intended project is described and the amounts to be periodically deposited over the next six months or beyond are stated. At the expiration of this period, the customer automatically qualifies for six times the value of the amount saved, subject to a maximum of N250,000.

2. Through the Mutual Support Fund, philanthropists and corporations get an opportunity to contribute to poverty alleviation in Nigeria. It offers the poorest segment of society the opportunity to access cheap funds and enhance their economic well-being. Participants are drawn from the poorest of the poor, as determined by the respective saving accounts, which they are required to maintain for at least three months.

3. The People’s Adashi/Esusu Group Scheme has been developed by PBN to integrate the informal sector, including moneylenders and money keepers, into the bank’s microfinance program. It is aimed at bringing the huge, hitherto idle funds into the formal banking system. It is open to all, whether already a collector of funds or not. Participants are encouraged to save for at least three months before being eligible for up to three times their savings, subject to a maximum of N250,000

4. The People’s Development Fund is a product born out of PBN’s desire to increase the amount of loanable funds available to the bank and create avenues for philanthropists and corporations to meet their social responsibilities by encouraging them to invest in the ability of disadvantaged citizens to work their way out of poverty with dignity. Deposits must be for a minimum of one year and are paid an interest rate of three percent per year, if interest is desired by the depositor. Clients borrowing from these deposited funds must be PBN deposit clients as well. Sponsors can nominate or guarantee borrowers to access the funds.

5. The People’s Start-Up Loan Scheme is aimed at improving the economic status of the poor, who cannot raise any funds to start even the smallest business due to their extreme poverty. It provides the start-up credit to these people with very low monetary savings. Participants are expected to open a savings account with PBN with a minimum of N100 deposited for at least three months, and must be willing to become entrepreneurs.