1.1 Background to the Study

Since Nigeria attained independence in 1960, considerable efforts have been directed towards industrial development. The initial efforts were government-led through the vehicle of large industry, but lately, emphasis has shifted to Small and Medium Scale Enterprises (SMEs) following the lessons learnt from the success of SMEs in the economic growth of Asian countries (Ojo, 2003). Thus, the recent industrial development drive in Nigeria has focused on sustainable development through small business development. Prior to this time, particularly judging from the objectives of the past National Development Plans, 1962-68, 1970-75, 1976-80 and 1981-85, emphasis had been on government-led industrialization, hinged on import-substitution strategy.

Since 1986, government had reduced its role as the major driving force of the economy through the process of economic liberalization entrenched in the IMF pill of Structural Adjustment Programme. Emphasis, therefore, has shifted from large-scale industries to small and medium- scale industries, which have the potentials for developing domestic linkages for rapid and sustainable industrial development. Attention was focused on the organized private sector to spearhead subsequent industrialization programmes. The incentives given to encourage increased participation in these sectors were directed at solving and/or alleviating the problems encountered by industrialists in the country, thereby giving them opportunity to increase their contribution to the Gross Domestic Product (GDP).

The contribution of Micro, Small & Medium Enterprises (MSMEs) to economic growth and sustainable development is globally acknowledged (CBN, 2004). There is an increasing recognition of its pivotal role in employment generation, income redistribution and wealth creation (NISER, 2004). The micro, small and medium enterprises (MSMEs) represent about 87 per cent of all firms operating in Nigeria (USAID, 2005). Non-farm micro, small and medium enterprises account for over 25 per cent of total employment and 20 percent of the GDP (SMEDAN, 2007) compared to the cases of countries like Indonesia, Thailand and India where Micro, Small and Medium Enterprises (MSMEs) contribute almost 40 percent of the GDP (IFC, 2002).

Whilst MSMEs are an important part of the business landscape in any country, they are faced with significant challenges that inhibit their ability to function and contribute optimally to the economic development of many African countries. The position in Nigeria is not different from this generalized position (NIPC, 2009).

Realizing the importance of small businesses as the engine of growth in the Nigerian economy, the government took some steps towards addressing the conditions that hinder their growth and survival. However, as argued by Ojo (2003), all these SME assistance programmes have failed to promote the development of SMEs. This was echoed by Yumkella (2003) who observes that all these programmes could not achieve their expected goals due largely to abuses, poor project evaluation and monitoring as well as moral hazards involved in using public funds for the purpose of promoting private sector enterprises. Thus, when compared with other developing countries, Variyam and Kraybill (1994) observed that many programmes for assisting small businesses implemented in many Sub-Saharan African (SSA) countries through cooperative services, mutual aid groups, business planning, product and market development, and the adoption of technology, failed to realize sustained growth and development in these small enterprises. Among the reasons given were that the small-sized enterprises are quite vulnerable to economic failure arising from problems related to business and managerial skills, access to finance and macroeconomic policy.

Despite MSME's important contributions to economic growth, small enterprises are plagued by many problems including stagnation and failure in most sub-Saharan African countries (Bekele, 2008). In Nigeria, the problem is not limited to lack of long-term financing and inadequate management skills and entrepreneurial capacity alone, but also, includes the combined effect of low market access, poor information flow, discriminatory legislation, poor access to land, weak linkage among different segments of the operations in the sector, weak operating capacities in terms of skills, knowledge and attitudes, as well as lack of infrastructure and an unfavourable economic climate.

Lack of access to finance has been identified as one of the major constraints to small business growth (Owualah, 1999; Carpenter, 2001; Anyawu, 2003; Lawson, 2007). The reason is that provision of financial services is an important means for mobilizing resources for more productive use (Watson and Everett, 1999). The extent to which small enterprises can access fund determines the extent to which small firms can save and accumulate their own capital for further investment (Hossain, 1988), but small business enterprises in Nigeria find it difficult to gain access to formal financial institutions such as commercial banks for funds. The inability of the MSEs to meet the conditionalities of the formal financial institutions for loan consideration provided a platform for attempt by informal institutions to fill the gap usually based on informal social networks; this is what gave birth to micro-financing. In many countries, people have relied on the mutually supportive and benefit-sharing nature of the social networking of these sectors for the fulfilment of economic, social and cultural needs and the improvement of quality of life (Portes, 1998). Networks based on social capital exist in developed as well as developing countries including Nigeria.

The reluctance of formal financial institutions to introduce innovative ways of providing meaningful financial assistance to the MSEs is attributed to lack of competition among financial service providers, in the sense that none of financial service providers came up with an innovative way of financing small businesses. In order to enhance the flow of financial services to the MSME subsector, Government had, in the past, initiated a series of programmes and policies targeted at the MSMEs. Notable among such programmes were the establishment of Industrial Development Centres across the country (1960-70), the Small Scale Industries Credit Guarantee Scheme (SSICS) 1971, specialized financial schemes through development financial institutions such as the Nigerian Industrial Development Bank (NIDB) 1964, Nigerian Bank for Commerce and Industry (NBCI) 1973, and the National Economic Recovery Fund (NERFUND) 1989. All of these institutions merged to form the Bank of Industry (BOI) in 2000. In the same year, Government also merged the Nigeria Agricultural Cooperative Bank (NACB), the People's Bank of Nigeria (PBN) and Family Economic Advancement Programme (FEAP) to form the Nigerian Agricultural Cooperative and Rural Development Bank Limited (NACRDB). The Bank was set up to enhance the provision of finance to the agricultural and rural sector. Government also facilitated and guaranteed external finance by the World Bank (including the SME I and SME II loan scheme) in 1989, and established the National Directorate of Employment (NDE) in 1986.

In 2003, the Small and Medium Enterprise Development Agency of Nigeria (SMEDAN), an umbrella agency to coordinate the development of the SME sector was established. In the same year, the National Credit Guarantee Scheme for SMEs to facilitate its access to credit without stringent collateral requirements was reorganised and the Entrepreneurship Development Programme was revived. In terms of financing, an innovative form of financing that is peculiar to Nigeria came in the form of intervention from the deposit-money banks. The deposit money banks through its representatives, 'the Banker's Committee', at its 246th meeting held on December 21, 1999. The deposit-money banks agreed to set aside 10% of their profit before tax (PBT) annually for equity investment in small and medium scale industries. The scheme aimed, among other things, to assist the establishment of new, viable SMI projects; thereby stimulating economic growth, and development of local technology, promoting indigenous entrepreneurship and generating employment. Timing of investment exit was fixed at minimum of three years, that is, banks shall remain equity partners in the business enterprises for a minimum of three years after which they may exit anytime. By the end of 2001, the amount set aside under the scheme was in excess of six billion naira, which then rose to over N13 billion and N41.4 billion by the end of 2002 and 2005 respectively.

The modality for the implementation of the fund is such that the fund set aside is to be invested within 18 months in the first instance and 12 months thereafter. After the grace period, the CBN is required to debit the banks that fail to invest the fund set aside and invest same in treasury bills for 6 months. Thereafter, the un-invested fund would be bidded for by successful investors under the scheme. The fund set aside by the banks under the scheme decreased from N41.4 billion in 2005 to N38.2billion in 2006. This was as a result of N2.5billion and N25.3 million set aside from failed banks and liquidated banks respectively, which were netted out after the bank consolidation exercise. Actual investment during the period grew from N12 billion in December 2005 to N17 billion in 2006, representing only 29.1 percent of the total fund set aside. In 2007, total amount set aside decreased further to N37.4 billion, while total investment stood at N21.1 billion representing 56 percent of the total sum set aside. The number of projects that benefitted from the scheme also increased to 302 projects in 2007, from 248 in 2006 (CBN, 2007).

The CBN found the reasons for the slow pace in utilization of the SMIEIS fund to include: the desire of the Banks to acquire controlling shares in the funded enterprises and the entrepreneurs' resistance to submit control; inability of the banks to adapt equity investment which is quite different from what the banks are familiar with in credit appraisal and management, and lack of proper structure for effective administration of the scheme when it took off among other factors. Responding to the findings, the Bankers' Committee took a policy decision to extend funding under the scheme to all business activities including even non-industrial enterprises, except for general commerce and financial services. The name of the scheme was changed from SMIEIS to Small and Medium Enterprises Equity Investment Scheme (SMEEIS) to reflect the expanded focus. Also, the limit of banks' equity investment in a single enterprise was increased from N200 million to N500 million, making room for medium size industries.

Despite all these efforts, the contribution of SMEs in the industrial sector to the Nation's GDP was estimated to be 37% compared to other countries like India, Japan and Sri Lanka and Thailand where SMEs contributed 40%, 52% 55% and 47.5% respectively to the GDP in 2003, (UNCTAD, 2003), hence the need for alternative funding window. In 2005, the Federal Government of Nigeria adopted microfinance as the main financing window for micro, small and medium enterprises in Nigeria. The Microfinance Policy Regulatory and Supervisory Framework (MPRSF) was launched in 2005. The policy, among other things, addresses the problem of lack of access to credit by small business operators who do not have access to regular bank credits. It is also meant to strengthen the weak capacity of such entrepreneurs, and raise the capital base of microfinance institutions. The objective of the microfinance policy is to make financial services accessible to a large segment of the potentially productive Nigerian population, which have had little or no access to financial services and empower them to contribute to economic development of the country.

The microfinance arrangement makes it possible for MSEs to secure credit from Microfinance Banks (MFBs) and other Microfinance Institutions (MFIs) on more liberal terms. It is on this platform that we intend to examine the impact of microfinance on small business growth, survival, as well as business performance of MSEs operators.

1.2 Statement of Research Problems

Majority of the micro and small enterprises (MSEs) in Nigeria are still at a low level of development, especially in terms of number of jobs, wealth and value creation. This is because 65% of the active population, who are majorly entrepreneurs, remain unserved by the formal financial institutions. The microfinance institutions available in the country prior to 2005 were not able to adequately address the gap in terms of credit, savings and other financial services. As reported by the CBN, the share of micro credit as a percentage of total credit was 0.9%, while its contribution to GDP was a mere 0.2% (CBN, 2005). The CBN in 2005 identified the unwillingness of conventional banks to support micro-enterprises, paucity of loanable funds, absence of support institutions in the sector, as well as weak institutional and managerial capacity of existing microfinance institutions among other reasons as the major reasons for the failure of past microfinance initiatives in the country. To address the situation, the Microfinance Policy, Regulatory and Supervisory Framework (MPRSF) for Nigeria was launched by CBN in 2005 to provide sustainable financial services to micro entrepreneurs. This initiated an important turning point in the microfinance industry with the establishment of the Microfinance Bank (MFB) as an institutional vehicle for privately owned, deposit taking Microfinance Institutions (MFIs). The framework is designed to unite the best of the NGO credit organizations, and new MFI initiatives under a common legal, regulatory and supervisory regime. Five years down the line, though microfinance has proven to be one of the ways of bridging the resource gap created in the Nigerian economy, there are still some undesirable problems experienced against its proper execution. The lack of documentation of the practice of microfinancing in Nigeria has made it difficult to formulate supportive programmes for the growth of the sector.

Despite the potential importance of MSMEs in any economy, high mortality rate among established MSMEs is a matter of major concern in developing economies. International Finance Corporation (IFC) reported in 2002 that only 2 out of every 10 newly established businesses survive up to the fifth year in Nigeria. The report was corroborated by Small and Medium Enterprise Development Agency of Nigeria (SMEDAN) that only 15% of newly established businesses survive the first five years in Nigeria. This is a pointer to the fact that there is a problem. The indispensable role of finance to the growth and survival of MSMEs and the adoption of microfinance as the main source of financing MSMEs in Nigeria therefore makes it imperative to study the extent to which microfinance can enhance small business survival.

The impact of micro-financing majorly should be seen in the multiplication of MSEs across Nigeria. The survival of these MSEs should reflect in employment generation, engagement of available local resources, local technology utilization, improved standard of living and growing gross domestic product (GDP). However, despite MSEs representing about 87% of all firms operating in Nigeria (USAID, 2005), they only account for 10% of total manufacturing output, 25% of total employment in the productive sector and 37% of GDP (Investment Climate Assessment (ICA) survey, 2009). A common problem for the Nigerian small business sector is that, the high rates of formation of new businesses evidenced in Corporate Affairs Commission (CAC) annual report have not yet translated into comparable high rates of small firm growth. New firms are being started but few grow rapidly to become significant international competitors. For the great majority of micro and small enterprise in Nigeria long term growth remains uncertain and bleak. The question is how many of these small businesses are transforming from the subsistence level at start-up to the stage of maturity and later expansion where they will have to employ more hands? Total productive output is also low compared to other emerging economies like India, Sri Lanka and Thailand where SMEs contribute 40%, 55% and 47% respectively in 2002 into the productive sectors of the economy (UNCTAD, 2003).

It is not uncommon to find in many microfinance programmes non-financial services such as advisory services, managerial and technical training, weekly meetings and pre-loan training to mention only a few, rendered as support services to MSMEs. These services that are poorly provided in Nigeria are mostly very costly to deliver (McKernan, 2002), yet many microfinance programmes consider them an integral part of the success of their programmes. Though the contribution of such non-financial services is not in doubt, the extent of the contributions is yet to be ascertained in Nigeria.

1.3 Research Questions

The study attempts to answer the following research questions:

1. To what extent does micro financing enhance the survival of MSEs in Nigeria?

2. To what extent is the growth of small businesses influenced by the financing capacity of Microfinance Banks?

3. How does the injection of microfinance funds into small business operations affect the productivity of MSEs in Nigeria?

4. What role(s) does the incorporation of non-financial services of microfinance banks play in enhancing the business performance of MSEs in Nigeria?

5. What is the nature, mode of operation and process of micro financing in Nigeria?

1.4 Objectives of the Study

The aim of this study is to estimate the effects of microfinancing on business performance of MSEs in Nigeria.

The primary objectives are to:

1. assess the contributions of microfinancing to the survival of MSEs in Nigeria.

2. analyse the effects of microfinancing on MSE growth and expansion capacity in Nigeria.

3. ascertain the effects of microfinance on the productivity of MSEs operators in Nigeria.

4. examine the effects of non-financial services of microfinance institutions on MSEs business performance in Nigeria.

5. document the operations and processes of microfinancing activities in Nigeria.

1.5 Statement of Hypotheses

1. Ho - Microfinancing makes no significant contribution to the survival of MSEs in Nigeria.

2. Ho - Microfinancing does not have the capability to influence the expansion capacity of MSEs in Nigeria.

3. Ho - Microfinance has no significant effect on the level of productivity of MSEs in Nigeria.

4. Ho - The provision of non-financial services (training and advisory services) by micro finance institutions does not enhance the performance of MSEs in Nigeria.

1.6 Significance of the Study

A significant amount of empirical research has been carried out both within and outside the country on the relationship between microfinance and microenterprise development (See Kotir and Obeg-odom, 2009; Ogunrinola and Alege, 2007; Pronyk, Hargreaves and Morduch, 2007; Matouv, 2006; Khandker, 2005; Morduch and Haley, 2002). It has been observed from the literature, that most research works treated microfinance as a solution to poverty. To the best of our knowledge, the impact of microfinance on Micro and Small Enterprise survival and growth has not been empirically tested in the literature, especially in Nigeria. Most researchers in Nigeria have also not taken time to document the nature, mode of operation and processes involved in microfinancing. This study therefore becomes significant in filling this observed gap by testing empirically the impact of both the financial and non-financial services offered by Microfinance Banks on small business growth/survival and by examining the capability of Microfinance institutions in enhancing the expansion capacity of small businesses in Nigeria. The study also contributes to the literature on microfinance and small business survival.

Successive governments in Nigeria have always had a policy programme for SMEs, but most of the programmes have failed to achieve sustainable growth in the SMEs sub-sector. Most of the government assisted-programmes have themselves become failures. The findings of this study is expected to inform policy makers regarding the direction of further research into interventionist programmes for MSEs in Nigeria. The study is also of great importance to Microfinance Institutions, in the sense that it is expected to assist the microfinance institutions in assessing the effectiveness of their programmes and to know which variables contribute most to small business growth and survival. The study is expected to assist the microfinance institutions in their credit policy formulation strategies. For owners and managers of micro and small businesses, access to a study like this can aid their understanding of current challenges and reveal the essential factors that promote small business growth and survival and thus enable them to focus on the relevant ones in an attempt to enhance their growth and performance. The study is expected to help the government to validate or reject the choice of microfinance as the main source of financing MSEs in Nigeria and also suggest ways of improving the existing financing arrangements, if need be.

1.7 Scope of the study

The study provides insight into microfinance and small business survival and growth, as well as provides a measure of the effects of microfinancing on small business performance and productivity in Nigeria. It covers MSEs that have access to microfinance for a period of at least five years (2004 - 2008). The population for the study includes the clients of the selected Microfinance Banks, that is, the 169 Microfinance Banks in the South-West geopolitical zone that have obtained their final operating licenses as of the year 2009. These includes microfinance banks that metamorphosed from community Banks into MFBs in 2005. They are spread across both rural and urban areas of the South-West geographical zone. The microfinance clients are selected based on the following criteria:

1. The client that has stayed for a minimum of 5 years with the Microfinance Banks, i.e from the period 2004 to 2008.

2. The client operates/manages a small or micro business enterprise.

Five years is often used as a yardstick for survival by demographers (Alexander, Davern and Stevenson, 2010) to permit greater balancing of statistical power of test.

1.8 Limitation of the study

The main limitation of the study is the reliance on information supplied by micro and small business operators who normally do not want to make a full disclosure of their businesses to an unknown person for fear of being subjected to tax payment. In the same vein, most of the small business operators lack proper record keeping practices and do not adhere to standard book keeping and accounting procedures. Some of them do not have the necessary skills needed for sound book keeping, auditing and tax assessment; neither do they employ qualified personnel to undertake such tasks for them. The oath of secrecy between the bank and its customers is another area of constraint in this study. Factors such as economic environment, political instability and government policy on MSEs are considered to have strong effects on MSE performance but are not readily available and so constitute a constraint to the study. However, we rely on scientific methods to obtain the data and the analysis is based on superior analytical techniques, which we believe allow us to generalize our findings.

1.10 Definition of Terms

• Micro enterprise: Micro- enterprise is the informally organized business activity undertaken by entrepreneurs; excluding crop production by convention, employing less than ten people and having assets less than N5 million excluding land and building.

• Small enterprise: Small enterprise is any enterprise that employs between ten (10) to forty-nine (49) people and has asset worth (excluding land and building) between N5 million and N50 million.

• Medium enterprise: Medium enterprise is any enterprise that employs between fifty (50) and one hundred and ninety-nine (199) people and has assets worth (excluding land and building) between N50 million and N500 million (SMEDAN, 2007).

• Microfinance Banks: Microfinance Banks are licensed financial institutions meant to serve the un-served, but economically active clients in the rural and peri-urban areas by providing diversified, affordable and dependable financial services to the active poor, in a timely and competitive manner, which would enable them to undertake and develop long-term, sustainable entrepreneurial activities and mobilize savings for intermediation (CBN, 2005).

• Microfinance Institutions: Microfinance Institutions are organizations whose activities consist wholly or in significant part, of the provision of financial services to micro entrepreneurs.

• Microfinance: Microfinance denotes the provision of financial services adapted to the needs of low income people such as micro-entrepreneurs, especially the provision of small loans, acceptance of small savings deposits and simple payment services needed by micro-entrepreneurs and other poor people (USAID, 2005).

• Microcredit: Microcredit is commonly defined in terms of loan amount as a percentage of average per capita income (USAID, 2005). In the context of Nigeria, with a GDP per capita of N42,000 (about $300) in 2003, loans up to N50,000 (around $350) will be regarded as micro loans. GDP per capital (PPP U$) in 2007 was U$1,969 (UNDP - HD Report, 2009).

• Microsavings: Microsavings are defined as savings accounts with a balance of less than N8,400 (about $50), that is less than 20% of the average annual income per capita.