EFFECT OF BANK CONSOLIDATION ON PERFORMANCE OF SMALL AND MEDIUM SCALE ENTERPRISES IN NIGERIA

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ABSTRACT

The central tenet of banking sector consolidation was to develop a strong, reliable and diversified banking sector that is capable of playing effective developmental roles in the economy, such as funding of small and medium scale enterprises and becoming a competent and competitive player in the African regional and global financial system. In essence, the reform was expected to create big banks by increasing bank capital base through the capital market and/or mergers and

acquisitions. The bank consolidation in Nigeria has generated raging debates on different frontiers such as; the effect of the consolidation on the financial crisis; the desirability of universal banking; and on whether more capital could translate to banking system stability among others. One area that has received little or no attention among scholars and policy makers is the effect of the consolidation on the lending and performance of small and Medium Scale Enterprises (SMEs)

in Nigeria. Specifically, SMEs are generally perceived as a catalyst for economic and development, given that the economy draws its strength from strong internal dynamics rooted in its large population, resilient SMEs, large and vibrant informal sector. A priori, the emergence of bigger banks is expected to translate into more lending to SMEs. However, some scholars have argued that as small banks transformed to become bigger banks, they tend to lose their existing

bonding relationship with smaller customers such as SMEs. They supported this postulation by arguing that bigger banks will have strong preference for high profile investment with higher returns, while displaying strong bias against credits to SMEs. While each of these groups has propounded theories to support their positions, empirical study that reconciles these theories with reality is non-extent. It was against this background that the main objective of this study was to

investigate the effect of pre and post bank consolidation on the performance of SMEs in Nigeria.

The specific objectives of the study therefore were to examine the impact of bank consolidation on number of registered SMEs, growth and access to fund for SMEs in Nigeria. This study adopted the ex-post facto design and time series data from 1991-2012 (22years) for pre and post consolidation era were collated from Nigerian Corporate Affairs Commission database, Central Bank of Nigeria Statistical Bulletin and Small and Medium Scale Enterprises Development

Agency of Nigeria database. The Ordinary Least Square (OLS) regression was used to estimate the three hypotheses formulated for the study. The result emanating from this study indicates that Bank consolidation had positive and non-significant impact on number of registered SMEs in pre consolidation era in Nigeria while it was found to have positive and significant impact on survival of SMEs in post consolidation era in Nigeria. Also Bank Consolidation had positive and

significant impact on growth of SMEs in both pre and post consolidation banking era in Nigeria and lastly Bank consolidation have negative and non-significant impact on bank lending to SMEs in pre consolidation banking era in Nigeria but was positive and non-significant on banking lending to SMEs in post consolidation banking era in Nigeria. The study, thus, concludes that the consolidation exercise in 2005 was a welcome development aim at enhancing the growth of

SMEs. We therefore, recommend among others that government should make policies that will strengthen and boost access to funds for small and medium scale enterprises. This will ensure continual survival and growth of SMEs which have been adjoined as the engine room for economic growth and development of nations.

TABLE OF CONTENTS

Title Page

Declaration

Approval Page

Dedication

Acknowledgments

Abstract

Table of Contents

List of Tables

List of Figures

Chapter One - Introduction

11 Background of the Study

12 Statement of the Problem

13 Objectives of the Study

14 Research Questions

15 Research Hypotheses

16 Scope of the Study

17 Significance of the Study

References

Chapter Two - Review of Related Literature

21 Theoretical Framework

211 Overview of the Role of the Banking Industry

212 Theoretical Basis for Banking Industry Consolidation

213 Theoretical Rationale for Banking System Consolidation

214 Strategies for Banking Sector Consolidation

215 Issues and Challenges Associated with Bank Consolidation

216 Post-Consolidation Challenges and Issues

22 Empirical Review

221 Small and Medium Scale Enterprises in Nigeria: A Brief Review

222 Problems of Small and Medium Scale Enterprises

223 Financing Options for Small and Medium Enterprises in Nigeria

224 Small and Medium Scale Enterprises and Poverty

225 Small and Medium Enterprises and Economic Growth

226 Small Business Lending and SMEs

227 Mergers and Acquisition and Small Scales Business Lending

228 Determinants of Mergers and Acquisitions and SMEs Lending

229 Relationship Lending and Financing of SMEs

2210 History of Banking Sector Reforms in Nigeria

23 Summary of Review

References

Chapter Three - Research Methodology

31 Research Design

32 Nature and Sources of Data

33 Model Specification

34 Explanatory Variables

341 Independent Variable

3 42 Dependent Variables

343 Control Variables

35 Techniques of Analysis

References

Chapter Four - Presentation of Data and Analysis of Result

41 Presentation and Analysis of Data

42 Test of Hypotheses

421 Test of Hypothesis One

421 Test of Hypothesis Two

421 Test of Hypothesis Three

43 Implications of Results

References

Chapter Five - Summary of Findings, Conclusion and Recommendations

51 Summary of Findings

52 Conclusion

53 Recommendations

54 Contribution to Further Studies

References

Bibliography

Appendix Assets Base of Registered SMEs in Nigeria

LIST OF TABLES

Table 41 Pre-Consolidation Shareholder's Fund of Banks and Number of SMEs

Table 42 Post Consolidation Shareholder's Fund of Banks and Number of SMEs

Table 43 Pre-Consolidation Shareholder's Fund of Banks and Growth of SMEs in Nigeria

Table 44 Post-Consolidation Shareholder's Fund of Banks and Growth of SMEs in Nigeria

Table 45 Pre-Consolidation Shareholder's Fund of Banks and Bank lending to SMEs

Table 46 Post-Consolidation Shareholder's Fund of SMEs and Bank lending to SMEs

Table 47 Pre-Consolidation of Absolute Values of the Controlled Variables

Table 48 Pre-Consolidation of Absolute Values of the Controlled Variables

Table 49: Result Regression of Hypothesis One (Pre Consolidation)

Table 410: Result Regression of Hypothesis One (Post Consolidation)

Table 411: Result Regression of Hypothesis Two (Pre Consolidation)

Table 412: Result Regression of Hypothesis Two (Post Consolidation)

Table 413: Result Regression of Hypothesis Three (Pre Consolidation)

Table 414: Result Regression of Hypothesis Three (Post Consolidation)

LIST OF FIGURES

Figure 41 Pre-Consolidation Shareholder's Fund of banks and Number of SMEs

Figure 42 Post Consolidation Shareholder's Fund of Banks and Number of SMEs

Figure 43 Pre-Consolidation Shareholder's Fund of Banks and Growth of SMEs in Nigeria

Figure 44 Post-Consolidation Shareholder's Fund of Banks and Growth of SMEs in Nigeria

Figure 45 Pre-Consolidation Shareholder's Fund of Banks and Bank lending to SMEs

Figure 46 Post-Consolidation Shareholder's Fund of SMEs and Bank lending to SMEs

Figure 47 Pre Consolidation of Deposit Money Bank Prime Lending Rate

Figure 48 Post Consolidation of Deposit Money Bank Prime Lending Rate

CHAPTER ONE

INTRODUCTION

11 BACKGROUND OF THE STUDY

Small and Medium Enterprises (SMEs) are argued to be an instrument of economic growth and

development Thus, Fatai (2010), states that in Nigeria where the private sector is not well

developed, SMEs are assumed to play prominent role in employment generation and facilitation

of economic recovery and national development He maintains that the growing recognition of the

role of SMEs may have influence the decision of World Bank Group to commit roughly $24

billion on SME, as core element in its strategy to foster economic growth, employment generation

and poverty alleviation

While the importance of small and medium enterprises has not been in doubt, unfortunately

classifying businesses and organizations into large and medium scale is subjective and depends on

different value parameters These parameters follow different criteria such as employment, total

assets or total investment The definitions of small and medium enterprises vary in different

economies but the underlying concept is the same Ayyagari etal (2003) and Buckley (1988)

contend that the "definition of small and medium scale enterprises varies according to context,

author and country"

In the case of Nigeria, hardly do we have a clear-cut definition that distinguishes small and

medium scale enterprises The first attempt to define SMEs in Nigeria was by the Central Bank of

Nigeria in its monetary policies circular No 22 of 1988, where SMEs was defined as those

enterprises with annual turnover not exceeding 500,000 naira Similarly, in 1990, the Federal

Government of Nigeria defined small scale enterprises for the purpose of commercial bank loans

as those enterprises whose annual turnover does not exceed 500,000 thousand naira and for

merchant bank loan, those enterprises with capital investment not exceeding 2million naira

(excluding the cost of land)

In 1993, the definition of SMEs was reviewed by the Federal Government, which increased their

total asset to five million as a result of the introduction of the Second Tier Foreign Exchange

Market (SFEM), and the spiral inflation fuelled by the Structural Adjustment Programme

Ogechukwu (2006) opines that the changing dynamics in the economy has also prompted scholars

and practitioners to reclassify SMEs into micro and super-micro businesses, with a view to

providing adequate incentives and protection for the former In that context, any business or

enterprise below the upper limit of N250, 000 and whose annual turnover exceeds that of a

cottage industry currently put at N50, 000 per annum is a small scale industry

Furthermore, the National Directorate of Employment (NDE) concept of a small scale industry

has been fixed to a maximum of N35, 000 In other words, a business unit of not less than N35,

000 is characterized as a small scale business in Nigeria

The definition of small-scale enterprises (SSEs) in Nigeria has changed over the years not only in

consonance with the changing fortune of the country but also in accordance with the diversity of

the Small and Medium Enterprises Prior to 1992, different institutions in Nigeria adopted varying

definitions of small enterprises The institutions include the Central Bank of Nigeria (CBN),

Nigerian Bank for Commerce and Industry (NBCI), Centre for Industrial Research and

Development (CIRD), Nigerian Association of Small-Scale Industrialists (NASSI), Federal

Ministry of Industry (FMI) and the National Economic Reconstruction Fund (NERFUND)

However, in 1992, the issue of conflicting definition was resolved with the establishment of

National Council on Industry, which is now policy making organ for the sector in Nigeria Among

the conceptual issue that was resolved is whether Small-Scale Industry definition should include

all economic activities such as trading, buying and selling or whether it should be restricted to

productive industrial activities especially manufacturing Accordingly, a clear distinction was

made between small-scale enterprises consisting of trading, buying and selling activities and

small-scale industries engaged in manufacturing industry

This definition of SMEs may not be the same in other countries, but may be useful in developing

countries, because of the low capacity of these countries small scale industry

One of the factors militating against the development of SMEs in Nigeria is lack of funding This

is so because, SMEs in Nigeria depends on owners equity (personal savings), borrowings from

friends and relations, borrowing from government agencies (example; Small and Medium Scale

Equity Investment scheme), and borrowing from commercial banks Of all these funding sources, extensive studies have shown that the most reliable and effective source is the commercial bank

loan to SMEs The studies further argue that those small banks are more effective in financing

this sector and attribute this to relationship bonding The studies further argue that the size of a

bank influences the volume of funding to SMEs SMEs in Nigeria cannot access the capital

market because of the stringent listing requirement for the first and second tier markets However,

it is speculated that the recent banking reforms, through consolidation, might have affected the

effectiveness of banks in discharging this function

There are a number of potential benefits derivable from the lifting of geographic barriers to

competition in banking and the associated wave of consolidation These include, but are not

limited to, diversification, improved competition, and the elimination of entrenched inefficient or

self serving bank managers What is less clear is the effect of consolidation on the supply of credit

to businesses, particularly small businesses that depend on banks for external credit

A survey of small credit to small firms (Cole, Wolken, and Woodburn 1996), has established a

fairly strong link between size of banks and the supply of small business credit, with bigger banks

devoting less proportions of their assets to small business lending than smaller banks (Berger,

Kashyap, and Scalise 1995, Keeton 1995, Levonian and Soller 1995, Berger and Udell 1996, Peek

and Rosengren 1996, Strahan and Weston 1996) Small banks are considered primary sources of

credit for small businesses Unlike highly capitalized and publicly traded firms, which have

access to capital markets, small businesses rely strongly on banks for small business credit, partly

because of the challenges of accessing fund from the capital market These Small and Medium

Scale businesses often concentrate their borrowing at financial institutions, mostly small banks

with which they have long-term relationships, ie relationships that prove mutually beneficial to

both parties This relationship enables banks to collect information about the SME's ability to

repay such facility, thereby reducing the cost of providing credit facilities Small and Medium

Scale Enterprise in turn, enjoy better access to credit facilities and lower cost of borrowing

Small banks make more of these "mutual relationship loans" than do large banks, which are more

likely to make generic loans based on calculated financial ratios from the operating result of the

borrower and credit indices The banking industry which is considered as a major provider of fund to small and medium

enterprises has passed through several stages of regulatory frameworks to its present state and this

development could be categorized into five stages Okafor (2011) presented five clusters of

reform as (i) First (Independence) reforms cluster 1960 to 1996, The objective of this reform was

to establish indigenous Banking institutions that will pilot the economy of the newly independent

Nigeria (ii) Second (indigenization) reform cluster 1970 to 1976 (iii) Third (Okigbo Committee)

reform cluster 1977 to 1985, (iv) Fourth (Structural Adjustment Programme) reform Cluster 1986

to 1990 (v) Fifth (Fourth Republic) reform cluster 2000-2010 Okafor (2011) further states that

each of the clusters represents some major and minor reforms that are directed at improving

banking service delivery in Nigeria

Nnanna (2006) states that the first stage from 1930 to 1959, was characterized by poorly

capitalized and unsupervised indigenous banks, leading to failure at their infancy He states that

the second stage was from 1960 to 1985 In this period, the Central Bank of Nigeria regulatory

policy framework was designed to ensure that only persons with good character and financial

strength were granted Banking License subject to prescribed minimum paid up capital

The development of this stage was based on the introduction of minimum paid up capital and

other requirements before the grant of banking licenses to operators He states also that the third

stage from 1986 to 2004 involved the post Structural Adjustment Programmes (SAPs) or the De-

control Regime during which the neo-liberal philosophy of free entry was over stretched and

Banking licenses were dispensed by the political authority on the basis of patronage A major

reform in the banking sector during the period was universal banking policy This policy was

responsible for the consolidation of merchant banks, commercial banks and exchange house into a

universal bank Therefore, one bank was required to perform all banking functions He states

further that the fourth stage of banking sector reform could be described as the era of

consolidation ie 2004 to 2008

The major emphasis of that period was on recapitalization and proactive regulation based on risk

focused supervision framework The fifth stage; he describes as the post consolidation era, where

the focus is to strengthen the banking sector through efficiency-driven policies The fourth stage, which was the consolidation era elicited interest both from the academic circle as well as from

operators in the Nigerian Banking industry more than the other eras (Nnanna 2006)

This frequent policy changes which the CBN introduces as a regulatory institution may have

affected the banking landscape in Nigeria, as a result, there have been several attempts both

within and outside Nigeria to examine the impact of these consolidation programmes on bank

performance In Nigeria and other economies, researchers have viewed banking sector

consolidation differently

Adeyemi (2006) examines the issues and challenges arising from the banking sector reform

programme in Nigeria He noted that since the consolidation programme was policy induced, the

18 months given for total compliance appeared inadequate, following the number of activities

required for consolidation to be successfully consummated, he however acknowledged that the

programme could lead to the emergence of a sound and efficient financial system that would

support the growth and development needs and aspirations of the Nigerian economy, to fully

harness the synergies and potentials of the consolidation programme He therefore, advocated for

proper handling of post consolidation challenges such as continuous flow of fund to small and

medium enterprises

Oladepo (2010) posits that the value gains that alleged to accrue to the large and growing wave of

consolidation activity have not been verified Thus leading the research community in quandary

on whether the industry has followed a path of massive restructuring or a misguided belief of

value gains of consolidation He stated that it is not clear whether the financial regulators and

operators are insincere to the public and shareholders about the effects of their activity on

shareholders' value and banking performance It is important to address this issue by reconciling

data with empirical reality of continued consolidation activity

Soludo (2004) states that one of the focus of the banking sector consolidation was to develop a

diversified, strong and reliable banking sector capable of playing active developmental roles in

the local economy including funding of SMEs and of being competent and competitive players in the African regional and global financial system It is argued that small banks are primary source

of credit for small and medium enterprises This is because these enterprises do not have access to

capital market where large funds can be sourced Their inability to access fund from the capital

market could make them to concentrate their borrowing from institutions with which they have

long term relationship ie relationship that prove mutually beneficial It is generally argued that

this relationship enables banks to collect information about the borrower's ability to repay, and

this could reduce the cost of providing credit

The need to empirically investigate the impact of bank consolidation on the performance of SMEs

in Nigeria motivates this study, since empirical studies on this issue, based on the researcher's

knowledge are inadequate

12 STATEMENT OF PROBLEM

Graig and Hardee (2006) posit that small and medium enterprises are the major sources of job

growth in any country It is generally argued that small and medium enterprises are characterized

by three principal features namely (i) relatively small principal (ii) absence of asset-based

collateral and (iii) simplicity of operations

The bulk of small and medium enterprise credit is said to come primarily from banks therefore

institutional changes through consolidation could have an adverse effect on small business credits

and the performance of SMEs (Gray abd Harde, 2006) This really has to be ascertained in the

Nigerian situation, hence the challenge or problem of this study For instance, government in past

have tried through several intervention schemes to promote funding to SMEs The schemes which

were designed to ensure continuous flow of fund to SMEs include; the Nigerian Agricultural and

Co-operative Bank Ltd (NACB), the National Directorate of Employment (NDE), the Nigerian

Agricultural Insurance Corporation (NAIC), the Peoples Bank of Nigeria (PBN), the Community

Banks (CBs), the Family Economic Advancement programme (FEAP)

Despite these schemes, SMEs largely rely on commercial bank for fund However, the 2004/2005

bank consolidation is argued to have constrained the smooth flow of fund from commercial banks to SMEs in Nigeria Some studies have argued that consolidation of the banking industry will

have negative impact on the amount of credit available to small businesses Strahan and Weston

(1996) state that small banks are said to be major source of credits for small business outfit,

unlike large firms which have access to the capital market, small and medium enterprises rely

heavily on bank credit If small banks are increasingly acquired by large banks in the form of

consolidation, it may be strongly contended that it will have a negative effect on the availability

of credit to small and medium enterprises

Graig and Hardee (2004) examine the implication of consolidation on the amount of credit

available to small business They found that access to credit consolidation significantly reduced

banking credit to SMEs They argue that this can reduce the productivity of small businesses and

their overall contribution to the economy in terms of increasing employment creation and social

welfare The implication of lack of credit to small business is that these small businesses may be

increasingly turning to non-bank sources of finance to access credit However this source comes

with a cost to this class of business hence increasing the cost of production

However, these studies failed to investigate the impact of bank consolidation on the performance

of SMEs in Nigeria This is especially necessary, given that bank consolidation was aimed at

ensuring bank stability, promoting good corporate governance, establish mega banks and promote

bank lending to the private sector

13 OBJECTIVES OF THE STUDY

The main objective of this study is to assess impact the 2004/2005 bank consolidation on the

performance of SMEs in Nigeria Specific objectives of the study include:

(i) To determine the effect of pre and post bank consolidation on the number of registered

small and medium enterprises in Nigeria

(ii) To examine the impact of pre and post bank consolidation on the growth of small and

medium enterprises

(iii) To assess the contribution of pre and post bank consolidation Nigeria on lending to small

and medium enterprises in Nigeria

14 RESEARCH QUESTIONS

As a follow-up to the objective, this research seeks to provide answers to the following questions

(i) To what extent do pre and post bank consolidation affect the number of registered small and

medium enterprises in Nigeria

(ii) In which ways do pre and post bank consolidations affect the asset size of small and

medium enterprises in Nigeria?

(iii) How far do pre and post bank consolidation in Nigeria enhance lending to small and

medium enterprises?

15 RESEARCH HYPOTHESES

Based on the foregoing research questions, the following hypotheses are formulated

(i) Pre and post bank consolidations in Nigeria do not have significant and positive impact on

the number of registered small and medium enterprises

(ii) Pre and post bank consolidations of banks in Nigeria do not have significant effect on asset

size of small and medium enterprises in Nigeria

(iii) Pre and post bank consolidations do not have any significant contribution on lending to

small and medium enterprises in Nigeria

16 SCOPE OF THE STUDY

The scope of this study covers the period 1991 to 2012 To achieve the objectives of the study, the

period of the study was divided into two The first was from 1991-2005, fifteen years before and

during consolidation; and second, 2006-2012, seven years after consolidation The appeal of using

pre and post analysis is to aid the researcher compare the performance of SMEs before

consolidation with the trend at present, on the performance of small and medium enterprises in

Nigeria

17 SIGNIFICANCE OF THE STUDY

It is important to investigate this issue by reconciling data with empirical reality of consolidation

activity Therefore, this study will be significant to the following group of persons:

1 Management of Banks

The decision making authority in banks lies in the hands of managers Therefore, this research

will enable management to understand what must be done in order to act in the best interest of

shareholders in choosing expansion measures which will help the bank achieve an optimal

structure that will maximize shareholders' value

2 Investors and Potential Investors

The major beneficiaries of an enhanced performance of banks are shareholders otherwise called

investors or potential investors The choice of consolidation between banks ultimately affects

their role in lending to small and medium enterprises Therefore, this research will contribute

along with other similar literatures available in this area of finance in enhancing value

maximization on the effect of consolidation on the performance of small and medium enterprises

in Nigeria

3 The Academia

Essentially, this research intends to contribute significantly to the volume of literature available in

this area of finance In academics, the unknown is never exhausted, as the list of what we do not

know could go on forever Therefore, as a contribution in this area, recommendations about

consolidation and its effect on performances of SMEs in Nigeria will be studied Localizing the

research to the Nigerian environment is particularly important in this research

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