One of the greatest financial challenge for businesses and even the federal government of Nigeria is the high cost of credit in the country. Prime lending rate which is the rate at which banks lend to the most credit worthy customers has remained persistently high in Nigeria since the late 1980s. In fact, the last time Nigeria ever enjoyed a single digit prime lending rate was in 1985 when the lending rate was 9.25 percent (according to financial statistics collated from the Central Bank of Nigeria). 34 years on, prime lending interest rate has stubbornly remained in double digit, averaging 18.79 percent during the period (double its 1985 level) despite several contractional monetary policy efforts to reduce interest rate in Nigeria. Two key questions then arise from this issue, how important is a single digit interest rate in Nigeria and why has it been difficult to achieve since 1985? I attempt to answer both questions in this article.

The importance of a single digit interest rate

1. It could lead to rapid economic growth: The myth that only borrowers benefit from single digit interest rates is untrue. Indeed, single digit interest rates is desired by all financial markets’ stakeholders including borrowers, lenders and financial markets regulators. Single digit interest rate is considered healthy for economies around the world as it encourages borrowing for manufacturing and consumption. The lower the level of interest rate, the more producers will borrow from financial institutions to increase production of goods and services which leads to a faster growth in the national output. As economic growth quickens, the poverty level in a country typically declines. Asides increasing production on the supply side, low interest rate encourages borrowing by households for today’s consumption. Low level of interest rate can allow individuals take a loan to pay school fees, pay house rent, pay for hospital bills, buy a car, shop for loved ones and decide to pay in installments for items that they would not have ordinarily been able to afford without availability of cheap credit. Cheap credit encourages a debt financed consumption that typically drives economic growth. Little wonder, economic studies have shown that economic boom typically occurs in periods of low interest rate.

• It increases the value of financial assets and collateral: Investors also enjoy periods of low interest rate as the value of their assets typically rise rapidly during such periods through proper allocation of investments. Since the discount rate (interest rate) with which most financial assets including stocks and bonds is low, their worth and returns tend to be high. The reverse occurs when interest rate rises as the discount rate will also increase, thereby suppressing asset prices and leading to significant wealth loss for investors. Since assets are often used as collateral (for secured loans), lower interest rate could increase the value of the collateral and increase the amount of loan that can be assessed from a lender. Higher interest rate could cause this collateral to lose value and cause a panic in the financial market as collaterals may no longer be sufficiently valuable to secure the loan originally disbursed to the customer.

• It increases the amount of money you can access as loan from lenders at a given level of income: Since the interest on the loan is low, borrowers at the same level of income will be able to access more loans from lenders which can be invested in private businesses, acquisition of assets or for consumption. Any of these activities are positive for economic growth and the more money spent on them, the faster the economy will grow. However, if a borrower at the same level of income approached a lender to borrow funds in a double digit interest rate environment like we are currently experiencing in Nigeria, the borrower will not be able to access as much loans as he did when interest rate was lower because the interest payment is significantly higher and will prevent the borrower from easily covering repayment of loan principal and interest within the same agreed period using his fixed salary.

Why has single digit interest rate remained elusive after three decades?

For decades, a narrative from the Apex bank (i.e. Central Bank of Nigeria “CBN”) has been a mandate to make credit more affordable by reducing interest rate to single digit. While most Nigerians believe that the power to do so rests in the hands of the monetary authority and with one simple decision it could be done, the reality is that this decision is not as simple as many believe. Even though the monetary policy committee (a committee within the CBN that meets often to set interest rate for the country) have the power to make the decision to reduce the monetary policy rate (which is the anchor for all interest rate in the economy including treasury bill rate and prime lending rate) to single digit, there are restrictions to doing so because the country’s economic fundamentals currently does not support such low interest rate. Any attempt to do so forcibly will lead to financial instabilities that could bring our financial system grinding to a halt, thereby causing what could be the greatest economic disaster the economy has ever faced.

Essentially for the monetary policy committee to comfortably reduce interest rate to single digit, a single digit inflation rate must first be achieved. This is because interest rate is generally used by Apex Banks as a monetary policy tool to ensure price stability. If inflation rate is high, interest rate will be high not only to ensure that inflation declines (since they share a negative relationship) but to also ensure that suppliers of monies “investors” to the financial system get compensated above the rate of inflation. This compensation is referred to as real interest rate which makes investing in such an economy attractive. If real interest rate was to be negative such that the rate of inflation exceeded the prime lending rate in the country, banks will refuse to lend as there will be no real financial benefit to lending and this will starve the economy and customers of much needed credit required to survive and grow. This explains why anytime the National Bureau of Statistics announces that inflation is trending upwards in Nigeria, the expected monetary policy response from the CBN will be to adopt a contractionary monetary policy stance which includes increasing interest rate to bring down the rate of inflation and make investing and lending in the economy remain attractive.

Since we have now established that single digit interest rate is beneficial to most stakeholders in the financial system and that inflation is the single greatest influence of the direction of interest rate in a country, we must then turn our focus on inflation to understand why for three decades, interest rate in Nigeria has remained in double digit. In the last 34 years, average inflation rate was 19.69 percent, including 6 years when inflation level exceeded 40 percent. Single digit inflation rate in the country has been rare, occurring only 6 times in the last 3 and a half decades. If we agree that investors should earn a premium above inflation rate for taking investment risk and inflation has remained at double digit for 28 of the last 34 years, it should then be no surprise to Nigerians that lending interest rate in the country is persistently at double digit.

-Emeka Ucheaga.

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A young man once asked his Father, what must I do to be a successful entrepreneur? His Father looked at him and with a big smile on his face then beckoned on him to take a seat. As both men sat, his Father told him a parable.

There were two women, one with a degree from a reputable University named Zeo and another named Zara who didn’t go to the University but learnt the art of trading from her mother. Zeo and Zara set out to start-up businesses in their chosen fields. Zeo was a gifted Baker and set out to start a Bakery while Zara a very good cook set out to start a Restaurant. Before departing from home, Zeo was given some money by her parents and also obtained a loan from her best friend Zikora which was to be paid up in six months. Zara’s mother applied for a six month loan from her co-operative, sold some of her possessions and gave the money she had put together to her.

Zeo chose to situate the Bakery in an upscale neighbourhood where most of the residents appeared to live healthy lives as most of them were seen jogging very early in the morning every day. She got a space in a high street shopping mall and contracted a leading interior decoration company to help with the interior and exterior design of the Bakery she named “Zeo’s”. After finishing the interior and exterior design of the Bakery, Zeo set out to buy Bakery equipment’s only to realise that she had spent more than she should have on leasing and renovating/ upgrading the space where the Bakery was situated. Instead of buying new equipment’s, she resorted to buying fairly used equipment’s. With the money she had left, she had a launch party where she and her very excited friends sang, danced and posted pictures on social media all night.

Zara elected to open her restaurant close to a major bus terminal in a densely populated part of town where hundreds of people took the bus on a daily basis. Her Restaurant named after her, served local delicacies with the option to sit in and eat or take-away. She ensured her environment was always clean and made sure her sales girl was courteous to everyone who came to buy a meal. Her investment in acquiring assets for use in the restaurant was minimal as she bought only the basics with the mind-set that she will buy more equipment’s as the restaurant grew.

Both businesses started about the same time but three months into starting the Bakery, Zeo complained that her patronage was not as she envisaged. Her friends always came around and she was more than happy to give them pastries and bread every time they were leaving and even when they decided to buy, they bought on credit most of the time. Her oven started developing problems and she was unable to produce on some days. She had issues with the service charge at the shopping mall; the management of the mall wanted to collect service fees upfront for a three months period going forward. Zeo was distraught, everything seemed to be falling apart. She had not repaid her loan, no money, no customers, faulty equipment’s and increasing administrative overheads were her new reality.

Zara was having a different experience. Her native jollof rice was the rave of the moment as customers from within and outside her locality patronized her. She employed a “pay before service” philosophy. Her sales girl did the serving while she collected the money from the customer. She had repaid the monthly instalments on the loan her mother took on her behalf as and when due. Business was really good.

The young man appeared to be enjoying the story when his father asked him if he was able to extract any lessons from the parable. As he was about to respond, his father motioned towards him and continued speaking. “To become a successful entrepreneur, you need to understand the role of Assets, Liabilities and Equity in the business” he said. He went on to explain what he meant by Assets, Liabilities and Equity. The accounting equation (Assets= Liabilities+ Equity) truly sums it all. It suggests that assets can be acquired either through liabilities (debt) or equity or a combination of both. Assets can be referred to as resources controlled by a business from which future economic benefits are expected to flow to the business. “Future economic benefits” from that definition refer to the income generated by the business and it is safe to assume therefrom that cash will flow to the business. Liabilitieson the other hand can be described as a “present obligation, arising from past transactions which when settled or paid will lead to an outflow of economic benefit from the business’’. Equitycan be described as an “owners claim to a business’s net assets” and net assets refers to total assets less total liabilities. Equity is sometimes referred to as the cash or idea the owner of the business makes available to start up the business.

Assets can either be acquired by way of debt (loans, borrowings from family and friends) or Equity (personal savings, inheritance, funds from partners etc). One of the principal things done with loans or equity is the acquisition of assets (note that for a start-up, debt and/or equity can also be used for set-up costs). These assets are expected to generate income or enable income generation. It is this cash that is in turn used to settle expenses that maybe incurred during the course of business or liabilities as and when they fall due. Excess cash can also be used in acquiring new assets, used for growing the business or even paid out as dividend to the owners of the business.

Looking lost, the young man asked “Father, how does all this relate to your parable”? His Father answered with the following points

1. The monies obtained by Zeo from her parents and the proceeds from Zara’s mother’s possession were equity in the business. Every start-up business needs equity as it shows a level of belief in the business idea or as some will say skin in the game.
2. The six month loan Zeo took from Zikora and the loan Zara’s mum took on her behalf from the co-operative are Liabilities. These loans have cash flow implications as principal and interest will have to be repaid based on the terms of the loan. Start-ups and small businesses are encouraged to use more of equity at the start and when the business starts generating a regular cash flow pattern, they can consider taking debt by way of loans if and only where necessary.
3. Zeo and Zara used their debt and equity differently. While Zeo used her’s  for non-income generating assets leading to poor cash flows, Zara used hers wisely, spending wisely and being more deliberate about getting the proceeds of her sales.
4. To be a successful entrepreneur, you need more than talent. Zeo and Zara were gifted at what they did but the decision making required to manage a successful enterprise was evidently better with Zara.
5. Cash is the life-blood of any organization. Any business that is starved of cash will find it difficult to operate whether in the short, medium or long term. Cash is used to fund day to day operations of the business, repay loans, settle overheads, invest, acquire assets and at the right time pay dividends.
6. An understanding of your market and the interplay of product, price, promotion and place (4p’s of marketing) are as important as the talent, capital and passion any entrepreneur possesses.

The Father asked his Son, is there any other lesson you have learnt? The son replied heartily, “business thrives when friends and family pay for goods and services”.

• Post by Chukwuma Nwanze- Executive Director (Credit Direct Limited)

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