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Can Development Bank of Nigeria be a game changer? 18 May 2017

After enduring three years of delays to its operational take-off, the Development Bank of Nigeria (DBN) was finally awarded licence by the Central Bank of Nigeria in March to operate as a development finance institution (DFI). One of the biggest challenges hindering rapid economic transformation in Nigeria is lack of access to financing by small and medium scale enterprises (SMEs). Micro businesses hardly have access to the formal credit market. But with the licensing of the DBN, the Micro, Small and Medium Scale Enterprises (MSME) sector is about to witness a financing boost.  
    
The birth of the DBN comes in the long line of DFIs that have been established and are operating in Nigeria. A motley of state-sponsored DFIs have been operating in Nigeria for decades. These include Bank of Agriculture, Bank of Industry, Federal Mortgage Bank of Nigeria, The Infrastructure Bank, and Nigerian Export-Import Bank.

The performances of these institutions, decent as they may have been in recent years, could excite cynicism about the licensing of yet another DFI in the country. However, there are reasons to suggest the DBN could be a game changer in Africa's biggest economy. The Development Bank of Nigeria can, indeed, play a pivotal role in transforming the real sector of the economy, which mostly consists of MSMEs.

Perhaps the biggest pointer to the DBN's catalytic potential is its mandate to lend to MSMEs, defined by size and not limited to one specific sector. The Bank of Industry lends mostly to businesses in the industrial sector. The Bank of Agriculture provides financing exclusively to agro-allied companies, while the Nigerian Export-Import Bank funds the development of export-oriented businesses. Even with the various mandates, some sectors are not specifically covered by any DFI. At best, coverage in the emergent subsectors in entertainment, and the fintechs, are after-thoughts. But the DBN has been designed to lend across all sectors of the economy.

The admittance of micro businesses under the financing interest of the Development Bank of Nigeria is remarkable because that sector operates informally. Therefore, bringing formal financing to the sector will help accelerate the formalisation of the businesses.

With this broad mandate, the DBN has over 37 million MSMEs to serve, going by SMEDAN/NBS 2013 survey. There are challenges – including credit risk – to serving this huge market. However, it is pertinent to point out that, according to the Development Bank of South Africa (DBSA), one of the main elements that must be present for a development bank to succeed is a flexible mandate that correctly positions it within the environment. This explains the successes of the broadly-mandated DFIs in the emerging markets, of which Brazil's BNDES serves as a model for the DBN.

The size, institutional knowledge and diversity of the DBN's funding sources prime it for success. Unlike the other Nigerian DFIs, which took off with seed capital provided by the federal government, 100 percent of DBN's initial share capital of $1.3 billion will come from long-term loans from international DFIs. The World Bank is providing $500 million; the African Development Bank, $450 million; KfW, the German development bank, $200 million; and the French Development Agency, $130 million. The DBN is also finalising agreements with the European Investment Bank (EIB) for more funding.

This funding structure has two key implications, compared with government funding of the other DFIs. One implication is financial sustainability. The other is stronger corporate governance as a result of meritocratic management. The DBN will start its operations with substantial funding. And given the experience of the funders in development internationally, a degree of scalability of funding for the DBN – especially on positive performance – is assured.

Part of the reasons the older DFIs in Nigeria have under-performed is that appointment to their Boards and management is mainly political. Notwithstanding the competence of such appointees, their tenure is not always sacrosanct, ironically for the same political reason. The DBN may be an exception now, because of its international stakeholders. One sign of this was the recent appointment of highly qualified and experienced financial experts to the Board and management of the Bank. This will influence the performance of the credit portfolio of the Bank.

Inadequate governance and risk management have contributed to the underperformance of the local DFIs. Being state-sponsored credit funds, local DFIs are usually susceptible to nepotism and cronyism. In fact, there have been cases where relatives and friends of the supervising government officials receive credit support while better-qualified businesses are left out. The DBN would most likely be spared this risky lending practice.

However, there are downside risks to the outlook of the Development Bank of Nigeria. A major risk frontier is its operational performance. While the Bank may be willing to lend, it may find that a lot of the MSME businesses are not creditworthy, strictly from the standpoint of financial viability and operational scalability.

It is often believed that a lot of Nigerian SMEs underperform because they lack access to credit. But a counter-narrative has also for a long time been that the poor structuring of the businesses and inadequate record-keeping are also key challenges for their continuity and growth. Where loanable funds are available, a lot of the projects put forward are not “bankable.” Indeed, most SMEs operate without a business plan. It is unlikely the DBN will overlook the associated credit risk. This may, therefore, limit the credit coverage of the new DFI.    

The fortunes of Nigerian businesses are quite correlated to the country's economic cycle, which feeds from the global commodity super-cycles. As has been the case in the past, the oil price shock of late 2015 and significant part of 2016 has badly eroded consumption amongst Nigeria's middle and lower classes. The economy contracted throughout 2016.

Non-performing loans of Nigerian banks generally rise during the oil-price-induced economic downturns. For instance, the NPLs of the commercial banks, which had stayed well under five percent before last year, has risen to seven percent on average, according to data provided by the CBN.

Other environmental factors may inhibit the acceleration of credit supply by the Development Bank of Nigeria. These factors would include lack of electricity supply, incidence of taxation, shortage of technical knowhow, bureaucratic bottlenecks in completing business registration and obtaining permits, as well as inconsistent government policies. Together, these and other encumbrances make the country one of the toughest places on earth to do business. The DBN will also face competition from the older DFIs in several sectors.  

Irrespective of these factors, the DBN can deliver on its mandate, taking a long-term view of its prospects. The current administration is determined to improve the ease of doing business in Nigeria. The economy is set to return to growth. With both government policies and private resources committed to the diversification of the economy, growth is expect to be more resilient, going forward.

Financial performances of the older DFIs have improved over the last years, as the economy – in particular the financial services sector – becomes more sophisticated. The DFIs have tried to mirror the financial performances of the commercial banks. Bank of Industry, currently Nigeria's leading development bank, reported that its pre-tax profit rose by 232 percent year-on-year to N47.23 billion in 2015, while operating income rose 161 percent year-on-year to N70.77 billion during the same period.

The pursuit of development impact is not incompatible with attaining positive financial bottomline. The BNDES achieved 21 percent return on equity in 2010. For the DBN, the expectation is that it will also boost the agenda of Sustainability in Nigeria, as it pursues financial, social and environment returns on its investments.

There has not been so many instances in Nigeria where a new institution comes with enormous potential to transform the economy. The DBN, based on its mandate, structure, and funding sources is highly likely to achieve transformative impacts in the Nigerian DFI space in terms of access to credit for the MSME sector.