IMPACT OF LOAN FACILITY ON SMALL AND MEDIUM SCALE ENTERPRISE DEVELOPMENT

1.1 Introduction

Small and Medium enterprises are the catalyst for economic growth in most economies. Small firms marketing practices have been assessed in the context of existing models based on large firm practices. A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower. Loan lending is the principal business activity for most commercial banks. The loan portfolio is typically the largest asset and the predominate source of revenue. As such, it is one of the greatest sources of risk to a bank’s safety and soundness. Whether due to lax credit standards, poor portfolio risk management, or weakness in the economy, loan portfolio problems have historically been the major cause of bank losses and failures.

As a prelude to other parts of this study, this chapter will discuss the background upon which this study was initiated, the statement of problems that led to this study, the Aim and Objectives of the study. Others are Significance of the study, Scope of work, Research hypothesis and questions, Limitations of the Study and Definition of technical terms.

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1.2 Background of Study

In Nigeria, available data from the Registrar General Department indicates that 90% of companies registered are micro, small and medium enterprises (Mensah, 2004). This target group has been identified as the catalyst for economic growth of the country as they are a major source of income and employment to many Nigeriaians. According to Mensah (2004) Small enterprises employ between 6 and 29 employees with fixed assets of $100 Thousand with Medium enterprises employing between 30 and 99 employees with fixed assets of up to $1 Million, Hallberg (2001) put forward that SMEs account for majority of firms in an economy and a significant share of employment. Like other countries of the world, SMEs in Nigeria have the tendency to serve as sources of livelihood to the poor, create employment opportunities, generate income and contribute immensely to economic growth. Small firms are the engines for economic development of several developed countries such as the US and Japan (Hallberg, 2001).

Mensah (2004) states that a major barrier to rapid development of the SME sector is a shortage of both debt and equity financing. However Mensah (2004) postulate that equity shortage occurs because Equity investors seek highest return consistent with the risk of the investment and since SME investments are difficult to evaluate, their investments take time to mature and among others major institutional investors such as insurance companies are not allowed to invest in private SMEs. Hence there are many who believe that the single most important factor constraining the growth of the SME sector is the lack of finance.

However, these possibilities are difficult for SMEs since most of them do not always meet the return expectations. They thereby become less attractive for this group of investors. Other alternatives to financing are private placements and corporate bonds. Unfortunately, these types of financing are too expensive for SMEs or have limited resources. Therefore bank loans seem to be an appropriate way to finance SMEs’ capital requirements and seem to be an appropriate way. As a result, SMEs prefer most frequently debt funding by bank loans. The bank financing is tremendously attractive and seems to be realistic and a more reliable source to SMEs.

Similarly, Mensah (2004) states that recently, as banks and other financial institutions have sought to broaden their loan portfolio, SMEs have become an increasingly attractive customer group. Traditionally, however, financial institutions in Nigeria have been cautious with lending to SME groups because of high default rates and risks associated with the sector. Few banks have therefore developed an explicit policy for SME target groups taking the particular requirements and needs into consideration, an example is the development of customized financial products and appropriate credit management systems.

Only few banks have SME specific loan products, and many of these are donor funded. Since SMEs are scarcely finance by equity due to risk in its operation amongst others, the last resort is thus debt financing and this is usually financed by financial institutions through the granting of loans. Debt financing according to Ayadi et al (2009) continues to be the primary source of financing for SMEs in Europe, much more important than venture capital. This implies, for one thing, that an efficient functioning of credit markets is of utmost importance for SMEs − and the economy at large − to thrive. This problem seems to be particularly severe in transition economies, whose catching-up may suffer from continued wide-spread exclusion of SMEs from external bank finance. Of recent, there has been an increase in the recognition of the role played by small firms in national economies. Their contribution to job creation and poverty alleviation has been recognized by several governments of developing countries to the extent that they now include them in their development plans.

SMEs are often relatively new and lack a consistent track record of profitability that would demonstrate the capability to repay a loan. In addition, many SMEs lack assets that could be used as collateral. SMEs are also more prone to financial distress and failure. Commercial banks, because of these factors, consider lending to SMEs a high risk. Therefore, commercial banks often deny loans or offer loans to SMEs at higher rates of interest to accommodate the perceived high credit risk of SMEs according to Coleman and Cohn (2001). The inaccessibility of debt finance to SMEs can further be attributed to information asymmetry. Rwelamila et al. (2004) indicates that this arises when one party to a transaction has better information than the other.

Against this background, the study investigates whether SMEs in developing countries can use debt and still remain solvent in this era of high interest rates. Furthermore, SMEs often pay interest premiums and a host of non-interest fees such as application and other transaction fees when borrowing from commercial banks. The cause of this is that SMEs are considered a high credit risk compared to large firms. This high cost of funds because of increased risk increases the costs of debt for small firms.

Therefore, in Kaura Local Government Area of Kaduna State where the research was carried out, the activities that was conducted is to know the impact of loan facility on small and medium scale enterprise development.

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1.3 Statement of Problems

Inferring from the above, SMEs serve as sources of livelihood to the poor, create employment opportunities, generate income and contribute to economic growth. There is also the potential of small firms to turn economies with negative growth into vibrant ones, not to mention the fact that most large companies usually start as small enterprises, so the ability of SMEs to develop and invest becomes crucial to any economy wishing to prosper.

From the argument above the only easier finance options for SMEs are loans (Debt financing) assess from financial institutions, thus it’s necessary to examine the impact of these loans on the performance of SMEs. Are they having negative or positive impact on their performance .this is worth investigating because majority of the businesses fall within the SME category especially in developing countries.

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1.4 Aim and Objectives of Study

The aim of the study is to investigate the impact of loan facility on small and medium scale enterprise development using Kaura Local Government Area in Kaduna State as a case study. In achieving this aim, the following specific objectives were laid out as follows:

1. To find out what SMEs classify as disadvantages and advantages of accessing loans.
2. To find out how loans provided by financial institutions are utilized by the SMEs.
3. To investigate whether loans to SMEs actually lead to increase in stated performance or otherwise.
4. To examine the factors inhibiting the development of loan facility on small and medium scale enterprise in Kaura Local Government Area

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1.5 Research Questions

The study came up with research questions so as to be able to ascertain the above stated objectives. The specific research questions for the study are stated below as follows:

• Do SME loans affect performance?
• Are there factors inhibiting the development of loan facility on SME in Kaura Local Government Area?
• How do SMEs utilize loans?
• What are the disadvantages and advantages of taking a Bank Facility?

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1.6 Research Hypothesis

In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.

Hypothesis One

• H0: There are no significant factors inhibiting the development of loan facility on small and medium scale enterprise in Kaura Local Government Area
• H1: There are significant factors inhibiting the development of loan facility on small and medium scale enterprise in Kaura Local Government Area

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1.7 Significance of Study

A research of this sort is necessary with respect to the fact that; worldwide, the SMEs have been accepted as the engine of economic growth and for promoting equitable development. Thus its leverage should be of great concern. Accessing finance has been identified as a key element for SMEs to succeed in their drive to build productive capacity, to compete, to create jobs and to contribute to poverty alleviation in developing countries.

Small business especially in Africa can rarely meet the conditions set by financial institutions, which see SMEs as a risk because of poor guarantees and lack of information about their ability to repay loans. Without finance, SMEs cannot acquire or absorb new technologies nor can they expand to compete in global markets or even strike business linkages with larger firms (UNCTAD, 2002).

This study will be of immense benefit to other researchers who intend to know more on this study and can also be used by non-researchers to build more on their research work. This study contributes to knowledge and could serve as a guide for other study.

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1.8 Scope of Study

The study focuses on the impact of loan facility on small and medium scale enterprise development using Kaura Local Government Area in Kaduna State as a case study.

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1.9 Limitations of the Study

During the course of this study, many things militated against its completion, some of which are:

1. Time Constraint: The time frame given to accomplish this project was very short due to school academic calendar and it was carried out under pressure which made the researcher not to implement some necessary features.
2. Research material: availability of research material is a major setback to the scope of the study.
3. Frequent power failure: This made the researcher append more money on fuel to ensure sustainable power.
4. Financial Constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

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1.10 Definition of Terms

Debt: An amount of money, a service, or an item of property that is owed to somebody

Loan: An amount of money given to somebody on the condition that it will be paid back later.

Lending: To allow a person or business to use a sum of money for a particular period of time, usually on condition that a charge interest is paid in return

Guarantor: Somebody who gives a guarantee, especially a formal promise to be responsible for somebody else’s debts or obligations.