The financial sector limits, prices,
pools and trades all the risks involved in a transaction and provide incentives
for savers to invest by matching potential earnings with those risks. Empirical
research has shown that financial depth is generally associated with an
increase in GDP (Levine, 1997). In contrast, distorted financial markets with
high macroeconomic instability, direct government involvement and weak
regulations can have extremely adverse effects on industrial sector and on
economic growth in general. As a result, the focus of much recent work on the
financial sector has been on deepening and broadening financial markets in
developing countries and on improving financial sector regulation, supervision
and governance. The increasing participation of commercial banks has been one
of the most striking structural changes experienced by banking systems in
developing countries over the past decade.
In Nigeria the number of banks
stands at 24 due to the recent consolidation exercise. Common argument against
bank credit is that banks might tend to “cheery pick” the most profitable
customers, reducing financial risks and thus, affecting the overall
distribution of credit. In particular, the main area of concern is the
availability of credit to private investors and small firms. In many developing
countries, small firms account for a very significant share of total value
added and generate a large fraction of the total jobs in the economy.
Commercial banks are perceived as having a comparative advantage over other
credit institutions in small business credit. This role is likely to be more
important in less developed countries that are generally more heavily dependent
on bank financing. In Argentina for example, 79 percent of small industrial
firms have bank debt (Lorens, Van der Host, and Isusi, 1999). Moreover, small
firms tend to have exclusive dealings with a single bank with which they have a
strong relationship, given the paucity of information on the risk
characteristics of individual investors or small firms.
Therefore, access to
credit by private investors and small firms would be reduced if banks were to
neglect small firms and/or drive domestic micro-finance banks from the market,
destroying the information generated through bank-borrower relationship. A
number of recent studies have shown that commercial banks seems to improve
banking systems efficiency in the provision of credit to investors and
contribute to overall banking stability in developing countries (See
Dermirgue-Kunt, Levine, and Min (1998), Levine (1999), Barajas et al (2000). On
the other hand, the effect of bank credit on industrial sector in developing
countries especially in Nigeria remains largely unexplored. Olubiyo, S.O. and
Hill G.P (2003), examined the changes in bank credit to the farm sector before
and since the inception of the subsidized credit insurance in Nigeria, the
study also identified the pattern of bank credit to different agricultural
sub-sectors. The findings from the study suggested that there is the need for
the government to review its policy of underwriting loans as an instrument to
encourage increased bank credit to small-scale farmers.
Evidence from the United
States indicates that large and organizationally complex institutions find it
difficult to give credit to information opaque small and medium sized
enterprise (Berger and Udell (1995), Berger et al (1995); Keeton (1995),
Levonian and Soller (1995), Berger and Udell (1996), Peek and Rosengren (1996),
and Strahan and Weston (1996). These organizational diseconomies might explain
why a number of studies have found that commercial banks, which as shown by
Focarelli and Poozolo are typically large appear to allocate greater shares of
their credit to activities and sectors dominated by big investors or large
firms (Goldberg, 1992; Cho et al, 1987; and Clarke et al, 2000). While large
banks are unlikely to replicate the credit methods of small domestic micro
finances banks technological innovation could offer them an avenue for
increasing small firm’s credit. Mester (1997) argues that advances in credit
scoring methodologies, together with enhanced computer power and increased data
availability, are likely to change the nature of small business credit.
This
suggests that there could be a non-linear and in particular U-shaped relation
between bank size and credit to small firms, Mester, 1997) and Peek and
Rosengren (1998). The literature for the US also suggests that the type of bank
may affect credit patterns. For example, the evidence from the U.S. indicates
that de novo entrants seem to devote larger shares of their assets to small
firms than other banks (Goldberg and White, 1998. Deyoung et al, 1999 and
Jenkins (2000). Commercial bank entry through merger and acquisition might have
different effects on small firm credit. Some studies find that, merger and
acquisitions among small banks led to increased propensity to give credit to
small firms following their consolidation (Peek and Rosengren, 1998), Walraven,
1997), Strahan and Weston (1998), Berger et al (1998). However, when medium
sized and large banks are involved, a number of recent works have reached
conflicting conclusions. Keeton (1996) and Berger et al (1998) uncovered that
merger and acquisitions tend to result in a reduction in small firm credit when
large banks are involved, but Strahan and Welson (1998) found no significant
change in the ration of small firms credit to assets following large merger and
acquisitions.
There is however, very little literature that deals directly with
the implications of bank credit to investors and small-medium sized firms in
developing countries. Argentina is the only country for which we found such
studies. Belger and Rozenwureel (2000), indicate that bank participation in
Argentina is associated with a reduction of bank credit to medium sized firms
from around 20 to 16 percent of total credit between 1996 and 1998. In
contrast, Escude et al, (2001), found that despite their lower tendency to give
credit to small and medium sized firms, banks have increased both their
propensity and their market share of giving credit to the sector between 1998
and 2000. Finally, using a rich data set on Argentinean business sector in
December, 1998, Berger, Klapper, and Udell (2000), find that large banks and
foreign owned banks are less inclined to extend credit to smaller firms which
are likely to be informational opaque. Gien the paucity of research on the
impact of bank credit on industrial sector or access to credit and the
importance of this issue from a policy stand point, further investigation is
clearly warranted.