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Banks are the most important example of a class of institutions called financial intermediaries, firms that extend credit to borrowers using funds raised from savers. However, credit is not an end in itself; it is a means to an end. The ultimate goal is to affect productivity. For both developing and developed countries, micro, small and medium scale enterprises (MSMEs) play important roles in the process of industrialization and economic growth. Thus, this paper set out to empirically evaluate the effect of deposit money banks’ credit on the performance of MSMEs in Nigeria with the aid of a vector autoregression and error correction mechanism (ECM) technique. Results of the empirical investigation confirmed credit has a positive effect on GDP of MSMEs in Nigeria as the coefficient of CAM (credit to MSMEs) was positive (1.0569) and significant at one percent level. It is therefore recommended that every effort should be made to improve access to credit by MSMEs so that they can play their potential roles of employment generation and wealth creation and move the majority of the entrepreneurs out of poverty 1. Introduction

Economic development is a process whereby an economy’s real national income increases over a long period of time. The term economic development also refers to achievement by poor countries of higher levels of real per capita income and of improved conditions of living for their people. Maintaining development is a problem for rich countries, but accelerating development is an even more pressing matter for poor countries (Ojo, 2010). The role of finance in economic development is widely acknowledged in literature. It is argued that financial intermediation through the banking system play a pivotal role in economic development by affecting the allocation of savings, thereby improving productivity, technical change and the rate of economic growth (Sanusi, 2011).

For both developing and developed countries, micro, small and medium scale firms play important roles in the process of industrialization and economic growth. Apart from increasing per capita income and output, MSMEs create employment opportunities, enhance regional economic balance through industrial dispersal and generally promote effective resource utilization considered critical to engineering economic development and growth (Sule, 1986; Udechukwu, 2003). Micro, small and medium enterprises (MSMEs) are companies whose headcount or turnover falls below certain limits. The definitions change over time and depend, to a large extent, on a country’s level of development. Thus, what is considered small in a developed country like the USA could actually be classified as large in a developing country like Nigeria. However, the definition of MSMEs in Nigeria as contained in the National Policy on Micro, Small and Medium Enterprises (SMEDAN, 2007) is adopted in this study (Table 1), because it is in line with the definition in other developing countries like Indonesia (Timberg, 2000) as well as in the European Union (EU) (European Commission, 2007).

* Okoruwa and Ikpi are staff of the Department of Agricultural Economics, University of Ibadan, Ibadan, Nigeria, while Evbuomwan is a retired staff of the Central Bank of Nigeria, Lagos and currently a Ph.D student in the Department of Agricultural Economics, University of Ibadan, Ibadan, Nigeria.


Size Category


Assets (N million)

(excluding land and buildings)


Micro enterprises

Less than 10

Less than 5


Small enterprises

10 -49

5 to less than 50


Medium enterprises

50 -199

50 – less than 500

Source: Small and Medium Enterprises Development Agency of Nigeria(SMEDAN), Abuja, 2007.

The National Policy document states that, where there exist a conflict in classification between employment and assets criteria (for example, if an enterprise has assets worth seven million naira (N7m) but employs 7 persons), the employment-based classification will take precedence and the enterprise would be regarded as micro (SMEDAN, 2007). This is because employment-based classification tends to be relatively more stable definition, given that inflationary pressures may compromise the asset-based definition.

1.1Problem Statement

In Nigeria today, incidence of poverty is still very high. According to the World Bank, in 2010, 68 percent of total Nigerian population was said to be living on less than $1.25 per day compared with 18.1percent in Indonesia. In the same vein, per capita income has not fared better. It was as low as US$1,180 in 2010 compared with US$2,500 in Indonesia (World Bank, 2012). The reason for evolving several credit schemes in the past was to accelerate economic development in the country through the MSMEs. Since the MSMEs represent over 90 percent of the agricultural and industrial sectors in terms of the number of enterprises and account for about 50 percent of Nigeria’s GDP together with the MSMEs in the other sectors of the economy, the acceleration of their growth and development will certainly have a positive spill over effect on the whole economy. This has not been the case because of their lack of access to adequate finance.

Credit-constrained groups, namely, micro, small and medium enterprises traditionally risk-appraised by lenders as the ‘’lower end’’ of the credit market often face discrimination from formal credit purveyors resulting in stringent credit rationing and high risk-premium charges, if even they secure credit. The repressive circumstance derive from their incapacity to pledge the traditional favoured securities such as; mortgages, land, sterling shares or other ‘’gilt-edges’’ to back up credit proposals (CBN/CeRAM, 2007). This is why specialized financing schemes and funds have been evolved over the years in Nigeria like in other developing countries.


While financing is obviously not the only problem militating against the MSME sector, it is certainly the most formidable. Like any other investment in the real sector of the economy, investment in MSMEs is relatively bulky because of the need for fixed assets such as land, civil works, buildings, machinery and equipment and movable assets. Moreover, empirical studies (Udechukwu, 2003; NISER, 2005), show that the incidence of the extra outlays required to compensate for deficiencies in the supply of basic utilities is relatively heavier on MSMEs than large enterprises. While such extra investments have been shown to account for about 10 percent of the cost of machinery and equipment of large enterprises, they represent about 20 to 30 percent of that of MSMEs because of the absence of economies of scale.

Furthermore, due to the long gestation period of MSME investments in the real sector compared with trading activities, and other ancillary reasons, MSMEs have suffered bias by deposit money banks, which prefer to pay penalty rather than meet up the 20 percent target lending to small-scale enterprises (SSEs) following the then CBN credit guidelines in the direct monetary policy regime (CBN, Research Dept., 1995). This resulted in a drastic decline of SSEs lending after the abolition of the sectoral allocation in 1996 (CBN, Statistical Bulletin, 2009).

Statistics from the Central Bank of Nigeria also revealed that commercial banks’ loans to SSEs as a percentage of total credit dropped from 48.8 percent in 1992 to 17 percent in 1997, just one year after the abolition of the guidelines. By 2009, SSEs share of commercial banks’ total credit portfolio was a paltry 0.17 percent. Similarly, the ratio of SSEs loans to merchant banks’ total credit before the granting of universal banking license to deposit money banks in 2000/2001 declined from 31.2 percent in 1992 to 9.0 percent in 2000. According to Anyanwu (2003), the technical committee for the establishment of a national credit guarantee scheme for SMEs in its analysis, established that not more than 50 percent of aggregate effective demand for investment loans in the manufacturing sector were being met. This therefore necessitates further action aimed at enhancing the flow of financial resources to the MSMEs.

In Nigeria, after several years of debt (credit) financing, inadequate capital or lack of it is still believed within state planning circles and even among MSME owners themselves to be a major inhibiting factor for new and growing MSMEs. Specifically, it is argued that inadequate equity capital creates the need for debt financing which the MSMEs are ill-equipped to attract; and determines or influences their initial decisions concerning the acquisition of fixed assets, working capital requirements and even location (Owualah, 2002). To alleviate the shortcomings of the past schemes towards the financing of MSMEs in Nigeria, the Small and Medium Enterprises Equity Investment Scheme (SMEEIS) was conceived and put into operation from August 2001 with emphasis on banks providing equity financing rather than debt. From inception in 2001 to end December 2008, the cumulative sum set aside by banks under the SMEEIS was N42.0 billion. The sum of N28.2 billion or 67.1 percent of the sum was invested in 333 projects, out of which the real sector accounted for 205 projects, and the service-related sector, excluding trading, accounted for 128 projects (CBN, 2008). By the third quarter of 2008, the Bankers Committee took the decision that participation under SMEEIS be optional. After almost five decades of tinkering with various financing schemes for the MSMEs, it has become pertinent to carry out an empirical study on the effect of these funding initiatives on the performance of the MSMEs in Nigeria.

From the foregoing therefore, the major objective of this paper is to examine the effect of deposit money banks credit on the performance of MSMEs in Nigeria.

2. Theory, Conceptual Framework and Literature Review

2.1 Theory and Conceptual Framework

This study is built on the theory of economic growth and the fundamental role the financial system plays in the growth of the economy. All the funding schemes in the past were intended to stimulate economic growth and development, develop local technology and generate employment. Hence it is pertinent to review the theory of economic growth and development as basis for this study. The financial system plays a fundamental role in the growth and development of an economy, particularly by serving as the fulcrum for financial intermediation between the surplus and deficit units in the economy. For many years, theoretical discussions about the importance of credit development and the role that financial intermediaries play in economic growth have occupied a key position in the literature of developmental finance. Shaw (1973), stated that financial or credit development can foster economic growth by raising savings, improving efficiency of loan-able funds and promoting capital accumulation. Following the adoption of the Universal Banking System in Nigeria in January 2001, the dichotomy between the erstwhile commercial and merchant banks was removed, thus paving the way for banks to effectively play their intermediation role and provide level playing ground for operators in the banking industry. Consequently, the banks were able to pursue the business of receiving deposits, and the provision of finance, consultancy and advisory services unhindered (CBN Briefs, 2006-2007).

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