Below is an Abstract and introduction from the full academic paper which can be accessed below.
Abstract:
In this paper, we explore the impact of creating a public sector nano, micro, small and medium enterprise (nMSME) grading system in Nigeria. Using insights from work with the Nigerian government, the first country in Africa to attempt to establish a public sector SME grading system, we showcase the potential economic benefits of the public sector model. We show that SMEs exposed to SME gradings can contribute as much as US$28 billion to the Nigerian economy over a 5-year period. This potential benefit can be used as a proxy for the potential impact that can be derived by other emerging market economies wanting to implement a similar model. Given the challenges faced by most private sector rating agencies focusing on SMEs, we propose a public sector model as an alternative solution. The public sector model has been successful in Europe, and the work completed within the Nigerian project highlights how the model can be calibrated to be effective within an emerging market setting. Subsequent survey evidence presented in the paper indicates that various stakeholders, including lenders and the nMSMEs fully support the creation of the public-sector rating agency.
Introduction
Small and Medium Enterprises (SMEs) or nano, Micro, Small, and Medium Enterprises (nMSMEs) are the pulse of many, if not all, economies around the world. Consistent with this, governments are constantly formulating policies and programs to support SMEs. For example, in the United States, the government actively supports and advocates for small businesses through the Small Business Administration (SBA), which connects entrepreneurs with lenders and funding to help them plan, start and grow their business.
“Economies like China which have thrived in recent times, have done so due to surges in the SME sector which have contributed significantly to economic growth and exports”
Mr Saveshen Pillay
Co-Author
In the United Kingdom, recognizing that long accounts payable days can impose financial strain on SMEs, the UK government enacted policy to pay its invoices from SMEs within five days and provided guidance that any companies with government contracts ensure prompt payment to their own suppliers. In Nigeria, the subject of this paper, the government, via its Small and Medium Enterprise Development Agency (SMEDAN), is constantly seeking ways to enhance the growth and sustainability of its nearly 40 million nMSMEs. In this paper, we highlight the government’s move to become the first African country to adopt a public sector nMSME credit grading system to enhance operational efficiency, create business opportunities, and enable access to financing for the nMSMEs.
A public sector nMSME credit grading system is a government-driven credit rating system with a singular focus on nMSMEs. The grading system is like a traditional credit rating system, which seeks to assess the creditworthiness of an entity. Yet, unlike the traditional credit rating system which focuses on likelihood of default and loss given default, the nMSME credit grading system does not necessarily emphasize these two metrics. Instead, the credit grading system can emphasize simple due diligence and operational assessments of an entity and thereby provide the entity’s credibility, highlight areas for improvements, and create opportunities for business engagements and access to financing. The involvement of the government ensures that the goal of the grading system is not to profit from providing the services, but rather to support the nMSMEs and drive economic growth in the country. The government not-for-profit approach also ensures that the credit gradings are available to a wide range of entities, something that the private sector fails to provide (Pillay and Sikochi, 2024).
France provides a well-documented example of a public sector rating system with significant economic benefits. Through Banque de France (Bank of France), France generates credit scores for over three hundred thousand entities, most of them SMEs, that are registered in the country. A growing body of research provides evidence that, thanks to these public sector credit scores, France boasts one of the lowest SME loan rejection rates amongst OECD countries, the lowest interest rates charged to SMEs, and the lowest collateral requirements for SME funding (OECD, 2022).
Our work indicates that Nigeria’s nMSMEs and economy are poised to accrue significant growth from a public sector nMSME grading system. Nigeria is the first African country to seek to introduce the public sector grading model, with the primary objective of opening-up business and export opportunities for its millions of nMSMEs, the largest number of nMSMEs in Africa and to create a significant boost to economic activity. Using economic performance data for Nigeria for the period covering 1980-2021, we first explore whether and how nMSME output contributes to the country’s economic output (i.e., Gross Domestic Product, or GDP) and then examine how the introduction of nMSME gradings can enhance the GDP over a given period. We project that nMSMEs exposed to NMSME gradings can incrementally contribute more than US$28 billion to Nigeria’s GDP over the period 2025-2030.
We also uncover important insights into other key success factors for the nMSME grading system to achieve its full potential in the Nigerian and potentially other African context. Notably, while the grading system is government-driven, its success depends on a host of external stakeholders including the nMSMEs themselves and principal capital market participants (e.g., banks). Are nMSMEs keen on having the government grading them? Will banks accept the government-sponsored gradings in making lending decisions? To address these and other related questions, we conducted surveys to engage the various stakeholders to gauge their views towards and willingness to support a government-sponsored grading agency. Overall, nearly 100 percent of the nMSMEs, financial institutions, and non-financial companies surveyed support the creation of a public-sector grading system. More tellingly, the same proportion of nMSMEs and most of the financial and non-financial companies state that they would be willing to pay a minimal fee or pay subscription fees for these gradings, respectively. This implies that key stakeholders view the gradings as a highly valued service.
In the remainder of the paper, we highlight these and many other insights we gained from advising the government of Nigeria as follows. Section 2 provides an overview of the SME/nMSME grading concept, the Nigerian economic environment, and existing research in SME credit ratings and the motivation for nMSMEs’ contribution to economic performance. Section 3 discusses our statistical approach and results to enumerating the contribution of nMSMEs in Nigeria to the country’s economic output. Section 4 highlights insights on survey evidence on key success factors of the nMSMEs grading system in Nigeria. Section 5 concludes.
