This article was produced on behalf of FINT, a Nigerian peer-to-peer lending platform, as Stears explores marketplace lending in Nigeria.
How do banks decide if they should lend money to Nigerians?
The first thing they do is look at the alternatives; if they can park their money in risk-free treasury bills at 25% for a year, they are less likely to entertain any loan requests.
After that, they should be thinking about how likely it is the person will repay their money (with interest). While there is no way of knowing this for certain, there is information that can help you figure this out. Information like previous debt the person has taken and their criminal record.
This is particularly relevant when they are considering multiple loan requests. If the information suggests that person A is a crook, they probably aren’t going to lend him any money. If information suggests that person B is trust-worthy but has a very risky business idea, then they lend them the money at a high interest rate.
So, information about the prospective borrower is crucial for determining if they want to lend to them, and at what rate.
Nigerian banks have no reliable way of finding or verifying this information about prospective borrowers. And without that kind of information, they can’t differentiate between safe and risky borrowers. As a result, they impose a risk premium—they charge an interest rate so high that they would be comfortable even if all the borrowers were scoundrels.
This story isn’t an abstract one; it plays out every day in the Nigerian economy. Nigeria’s base interest rate is 13.5%, but individuals and businesses taking out loans can be charged a rate thrice as high. Many people ask why Nigerian banks don’t lend to individuals and small businesses, but the reason is simple: they don’t know them. They don’t know if they are trustworthy or not; they don’t know if their businesses are on the verge of collapse or a breakthrough; they don’t know if they are taking out this loan to finance another; they don’t know if they are creditworthy.
When banks know their customers, they can put them in different groups and charge them accordingly. For example, the Central Bank of Nigeria (CBN) reported a prime lending rate for manufacturing companies (the interest rate for the most creditworthy borrowers) of 15% for one Tier 1 bank. The maximum lending rate for that industry in the same bank is 29.5%.
Nigeria does not have credit histories
When banks don’t have useful information on their customers, they either refuse to lend to them or charge them a very high interest rate. But most Nigerians cannot afford the interest rates available. Take that 29.5%: a five year loan worth ₦10 million would mean that the borrower repays ₦24.75 million in total.
How do we escape this trap?
In more developed economies, they use credit histories to tailor interest rates to different borrowers. Credit histories are built on information such as how you handled your previous debts (credit card debt, student loans, etc.), bill payments (phone bills, cable bills, etc.), as well as public information like court records.
In the United States, they have the FICO score which assigns a number between 300 and 850. The average FICO score in the U.S. is about 704, and the subprime category is around the upper 500s range.
There are variations of the FICO score in Nigeria. FINT, a peer-to-peer (P2P) lender, assigns a risk rating called the FINT score for each borrower on its platform, and the score changes depending on the loan request and the borrower’s credit history. Such innovative credit ratings are not transferable, but provide the building blocks for financial data infrastructure in Nigeria.
Credit histories give banks the information they need to determine their creditworthiness and charge you accordingly. Without them, the credit mechanism malfunctions, and this comes at a steep economic price.
Credit growth drives economic growth
Whether an individual can get a decently-priced loan may seem like a private matter, but it affects the whole economy as credit is a powerful engine of economic growth. For example, credit drives investment, which has powered many economic booms—like China’s—and enables entrepreneurship. Given that SMEs account for over 80% of Nigerian jobs, their capacity to raise money to grow is critical to the health and development of the economy.
The effect of credit expansion on the economy is a relatively universal one. This paper by the International Monetary Fund found a significant positive effect of private and corporate credit growth in emerging markets. Likewise, this paper by the CBN found a significant positive effect of private sector credit on GDP.
Nigeria’s private sector credit as a percentage of GDP was estimated at 14% by the World Bank in 2017. In contrast, private sector credit was equivalent to 13% of GDP in Ghana, 29% of GDP in Kenya, 50% of GDP in India, and 66% of GDP in South Africa.
How to solve a problem like information
There are ways out of this problem, and Nigeria has set the foundations for some of them. A minor one is the passage of the Secured Transactions in Movable Assets Act in 2017, which allows people to register their movable assets (vehicles, equipment, farm products, etc.) on a national database and take out loans against them. Recently, the Central Bank Governor revealed that the registry has just ₦400 billion worth of assets, indicating that a lot more work needs to be done to maximise its potential.
A more robust solution is the use of credit bureaus. A credit bureau is an institution that aggregates the information used to build credit histories, so they are arguably the most important piece for bridging the information gap. Nigeria currently has three registered credit bureaus in the country, and they got a shot in the arm when the National Assembly passed the Credit Reporting Act in 2017.
FINT, the P2P lender mentioned above, works with XDS, one of the three Nigerian credit bureaux, to strengthen their risk assessment framework. The new law gives credit bureaus the needed legal backing, as well as provides a framework for credit reporting and licensing credit bureaus, outlines processes for information sharing, and obligates the bureaux to update information regularly.
These two new pieces of legislation are yet to translate to reality, and Nigeria’s credit market still suffers from asymmetric information. One policy that should address it—if well implemented—is the Bank Verification Number (BVN). When people have a unique ID they use for all financial transactions, it becomes a lot easier to track their economic behaviour and build credit histories. Unfortunately, the BVN exercise has been a timid one, and so far, only 38 million of 75 million active bank accounts are linked to a BVN.
Whether it’s BVN or the mythical National Identity Number (NIN), Nigeria needs a national database of its citizens that we can use as the foundation for building individual credit ratings. Without that, our credit markets will remain dysfunctional, and a significant subset of Nigerians will remain financially excluded.