Document of

The World Bank

FOR OFFICIAL USE ONLY

Reprt No. 7114-UNI

STAFF APPRAISAL REPORT

NIGERIA

PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

September 23, 1988

Africa Region, Western Africa DepartmentIndustry and Energy Operations Division

This document has a restricted distribution and may be used by recipients only in the performance oft v * , I t- -

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CURRENCY AND EQUIVALENT UNITS

Currency Unit - Naira (Y)

On September 26, 1986, Nigeria adopted a flexible exchange rate policy andintroduced a second-tier foreign exchange market (SFEH) comprising an auction andinterbank market. On July 2, 1987, SPEH and the official (i.e., first-tier) rateswere merged. All foreign exchange transactions now take place at market-determined exchange rates. The foreign exchange market (FEH) is a combination ofan auction (fortnightly) on the basis of the Dutch system, and a dealer marketwhich operates in response to supply and demand. The FEK rate in the auction ofJuly 7, 1988 was US$1 - N4.47. A rate of US$1 - t14.00 has been used for projectanalysis.

US$1 - M4.00NMl US$0.25

WEIGHTS AND MEASURES

Metric System

GLOSSARY OF ABBREVIATIONS

ASCON - Administrative Staff Collogo of t4ASSI - Nig,-ria Association of Small ScaloNiger! Industriallets

CIRD - Center for Industrial Research and NBCI - Nigerian Bank for Comerce andD-velopment Industry

CUD - Center for Management Development NGO(s) - Non-governmental organization(s)CBN - Central Bank of Nigeria NIDB - Nigorian Industrial DevelopmentCUB - Continental Merchant Bank BankDUBS - Durham University Business School NISER - Nigorian Institute of Social andEDP(s) - Entrepreneurship Development Economic Research

Program(s) NMB - Nigerian Morchant BankELAN - Equipment Leasing Association of ODA - Overseas Development Agency, UK

Nigeria PB(s) - Participating banksFBN - First Bank of Nigeria PCC - Project Coordination ComitteeFEM - Foreign Exchange Market PRODA - Project Development AgencyFGN - Federal Government of Nigeria SFEM - Second-Tier Foreign ExchangeFIIRO - Federal Institute of Industrial Market

Research, Oshodi SME(s) - Small and medium scaleFMI - Federal Ministry of Industries enterprise(s)IBWA - International Bank for West Africa SSE(s) - Small scale enterprise(s)ICON - ICON Merchant Bankers SSID(s)- Sinl! Scale Industry Divisions,IDC(s) - Industrial Development Center(s) State Ministries of Industry andITF - Industrial Training Fund CommerceILO - International Labor Organization WFYP - Work for Yourself ProgramIMB - International Merchant Bank USA - United Bank for AfricaMAN - Manufacturers Association of Nigeria UBN - Union Bank of NigeriaMGA(s) - Mutual guarantee association(s) UNDP - United Nations DevelopmentNAL - NAL Merchant Bank Program

FISCAL YEAR

January 1 to December 31

FM ONVDCUL U Y

NIGERIA

PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOP ENT PROJECT

TABLE OF CONTENTS

Pane No.

LOAN AND PROJECT SUMMARY ...... .............................. iii

I. INTRODUCTION ............................................. 1

II. THE CETTING ............................................. 1

A. The Economic Environment ........................... 1B. The Manufacturing Sector ..... .................... 3

1. Past Performance .............................. 32. Recent Reforms ................................ 43. Impact of the Industrial Sector Reforms

and Prospects ............................... 6C. The Small and Medium Scale Enterprise (SME) Sector . 7

1. Sectoral Context. 72. Government Policies and Support Programs 83. Prospects and Constraints .11

D. The Financial Sector .11

1. The Institutional Setting .112. Financial Policy Framework .133. Development Constraints .15

E. Government Objectives and the Role of SMEs . .18F. Bank Assistance .19

1. Past Ban!, Involvement .19

2. Bank Role *n the Sector .20

III. THE PROJECT .20

A. Project Rationale and Objectives . .20B. Project Description . .21

1. Line cf Credit Component .222. Pilot Financial Restructuring Component 223. Pilot Mutualist Credit Guarantee Scheme 23

4. Equipment Leasing Component .235. Technical Assistance Component .23

C. Project Cost and Financing Plan . .25

D. Credit Demand .. 25

IV. PRINCIPAL FEATURES OF THE LOAN . .27

A. The Loan and Institutional Arrangements .27

B. Eligible Financial Intermediaries .29

This Report was prepared by Surendra Agarwal (Task Manager), Kaikhosrou

Framji, Willem van Eeghen (Western Africa Department). Tu Dinh and Stephen

Berkman (Africa Technical Department) and N. Gangaram and Leila Webster(Consultants). Eleanor George provided word processing assistance and Iaidu

Hewawasam provided se retarial support in preparation of the Report.

This document has a restricted distribution and may be used by fecipients only in the performanceof their offcial duties. Its contents may no;t otherwise be disclosed without World Banks authorization.

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Paxe No.

C. Eligible Beneficiaries and Subprojects .... ......... 29D. Subloan Processing and Administration .... .......... 32E. Onlending Terms and Conditions ..... ................ 34F. Project ImplementatioL Arrangements and Schedule ... 35G. Procurement ........................................ 36H. Allocation and Disbursement of Bank Loan .... ....... 37I. Monitoring ......... ................................ 38J. Accounting, Auditing, and Reporting Requirements ... 38

V. PROJECT BENEFITS AND RISKS .............................. 39

VI. AGREEMENTS AND UNDERSTANDINGS REACHED ANDRECOMMENDATIONS ......... ............................. 41

ANNEXES

2-1 Index of Manufacturin, Production by Selected Products, 1980-19862-2 Results of a Small Scale Industry Survey, 19832-3 Institutions Providing Investment Promotion, Technical Assistance and

Lxtension Services to SMEs2-4 Industrial Development Centers(IDCs)2-5 Entrepreneurship Development2-6 Equipment Leasing2-7 Monetary Aggregates2-3 Suzmmary Financial Statements of Selected Commercial Banks2-9 Summary Financial Statements of Selected Merchant Banks2-10 Sunmmary Financial Statements of NBCI2-11 Selected Interest Rates2-12 Sectoral Distribution of Credit2-13 Characteristics of Subprojects under the Small- and Medium-Scale

Industry Project (Loan 2376-UNI)

3-1 Pilot Mutualist Credit Guarantee Scheme3-2 Sunmary and Estimated Costs for the Technical Assistance Program

4-1 Eligibility Criteria for Participating Banks4-2 Guidelines for the Financial Restructuring Component4-3 Key Indicators for Project Implementation and Reporting Requirements4-4 Procurement Arrangements4-5 Bank Loan Allocation and Disbursments4-6 Estimated Disbursement Schedule for Bank Loan

6 Selected Documents and Data Available in the Project File

MAP

IBRD No. 20709

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NIGZRIA

PRIVATE SMALL AND MEDIUY ENTERPRISE DEVELOPMENT PROJECT

Loan and Proiect Summara

Borrower: Federal Republic of Nigeria

Beneficiaries: Central Bank of Nigeria (CBN), participating banks (Pbs),Federal Ministry of Industries (FMl), Nigerian Bank forCommerce and Industry (NBCI), and mall and medium scaleenterprises (SMEs) in the private productive sectors andservice activities.

Amount: US$270 million equivalent

Terms: Twenty years, including a five-year grace period, at theBank's standard variable interest rate.

OnlendingTerms: The Government will: (a) pass on US$268.2 million equivalent

to CBN as follows--US$265.7 million for onlending to SMEsthrough eligible PBs, and US$2.5 millicn for technicalassistance; (b) onlend US$1 million to NBCI forstrengthening its operations at the same terms andconditions as are applicable to the Bank loan; and (c)retain US$0.8 million for technical assistance to PHI. TheCBN would onlend the loan proceeds (US$265.7 million) toeligible PBs in naira terms at a variable rate, equal to theprevailing CBN rediscount rate (currently 12.752 p.a.), anda commitment fee of 0.751, with an amortization schedulereflecting the aggregate subloans made by the PBs. Thefinal onlending rates to beneficiary enterprises would bevariable and determined by the PBs. The CBN would retainabout one percentage point of the spread on the Bank loan tocover its administrative cost and pay the remaining amountto the Government. The foreign exchange risk would be borneby the Government (for a fee implicit in the differentialbetween the onlending rate to the PBs and the interest rateon the Bank loan). Subloans under the line of credit andfinancial restructuring components would have a maturity upto 12 years, including up to a 3-year grace period.Subloans under the mutualist credit guarantee scheme wouldhave a maturity up to 5 years, including up to a one-yeargrace period. The PBs would be allowed to write leasesunder the equipment leasing component for up to 10 years,including up to a 2-year grace period. Subloans under thePilot Stw'dies Facility would have a maturity up to 3 years,including up to a one-year grace period.

ProjectDescription: The principal objective of the Project is to stimulate

productive activity in line with Nigeria's resourceendowments, and generate a sustained supply response inprivate, productive SMEs in the context of the new policy

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environment and the ongoing adjustment process. The Projectwould, in this way, help in the resumption of growth andefficient employment generation. The Project consists of(a) an apex line of credit to finance fixed assets andworking capital needs of SHEs; (b) a pilot program ofcorporate restructuring of viable SHEs which are currentlyin financial difficulties; tc) a pilot mutualist creditguarantee scheme for microenterprise lending, incollaboration vith selected non-governmental organizations(NGOs); (d) an equipment leasing component to provide analternative and flexible source of long-term financing toSMEs; and (e) an integrated package of technical assistancefor SHEs (Pilot Studies Facility to finance on loan termsthe consultancy costs for feasibility studies and othertechnical assistance), for CBN (strengthening of the SMEApex Unit, training for PBs in project analysis andpreparation of restructuring workouts, implementation designof the mutualist credit guarantee scheme, studies onequipment leasing and the mutual investment funds, andmonitoring the economic and social impact ofsubprojects--tracer studies), for FMI (improvements in theEntrepreneurship Development Programs, studies onsubcontracting, technology development and industrialestates, and training), and for NBCI to strengthen itsoperations in the areas of appraisal, supervision, portfoliomanagement, leasing and merchant banking.

ProiectBenefits andRisks: The integrated package of institutional and financial

measures under the Project would foster a stronger privatesector. The Project would strengthen and improve thecompetitiveness of existing SMEs, and help establish viablenew projects. It would also help generate new employment,maintain employment in existing viable enterprises, and thuspartially alleviate the social cost of the adjustmentprocess, and thereby enhance its sustainability. Theequipment leasing and pilot financial restructuringcomponents, pilot mutualist credit guarantee scheme formicroenterprises, and studies on the establishment of amutual investment fund, and the development of an appro-priate policy and regulatory framework for equipment leasingwould improve the quality and range of financial servicesavailable to the SME sector. The Pilot Studies Facilitywould help SMEs and entrepreneurs obtain consultancyservices of their choice and make the provision oftechnical assistance demand driven, with the involvement ofthe private sector and the banking system. Provision oftechnical assistance to and training for CBN, PBs, FMI andNBCI would enhance their capacity for developing andimplementing SME support programs more effectively.

A major risk of the loan is the possible reluctance of thebanking system to engage in term financing for SMEs,perceived generally as more risky thani traditional

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comuercial financing, and this could result in a slowdisbursement of the loan. This risk has been minimized asthe PBs will be free to determine the final onlending ratesto beneficiary enterprises. Another risk is that delays inthe resumption of economic growth and high interest ratesmay dampen investment demand. This risk is mitigated inpart by the overall size of the credit components which arebased on conservative demnd *stimates. Moreoor, thi PilotStudies Facility would help generate a significant pipelineof bankable SHE subprojects, and the participation of theentire banking system with extensive branch networks wouldextend the outreach of the Project in all parts of thecountry, which would further mitigate this risk. The pilotfinancial restructuring component and the pilot mutvalistcredit guarantee scheme could also encounter a difficultstart-up because of their newness. To minimize this risk,the amounts allocated to these components are relativelysmall, and the Project includes technical assistance for thepreparation of restructuring workouts. Finally, in view ofthe multi-component nature of the Project, and the pastexperience of weak project implementation in Nigeria, thereis always the risk of clogged paper work which may slow downproject implementation. To mitigate this risk, the Projectrelies largely on the banking system which is more efficientthan Government departments or agencies. The SME Apex Unitin CBN, however, would have mainly an administrative rolefor the credit components. The Project also includestechnical assistance to the SME Apex Unit.

Estimated Cost: a/Local Foreign Total--USS million equivalent---

Line of Credit 107.7 200.0 307.7Pilot Financial Restructuring 30.0 20.0 50.0Pilot Mutualist Credit GuaranteeScheme 2.7 2.8 5.5

Equipment Leasing 5.3 30.0 35.3Technical Assistance 6.7 4.9 11.6Unallocated - 5.7 5.7

Total 152.4 263.4 415.8

a/ Net of taxes and duties.

Financing Plan:

World Bank 6.6 263.4 270.0SMEs 79.7 - 79.7Participating Banks 66.1 - 66.1

Total 152.4 263.4 415.8

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Ystimatzd Disbursements: a/

IBRD FY 89 90 91 92 93 94 95 96

------------------US$ million equivalent-----------------

Annual 0 27.0 45.9 43.2 54.0 51.3 29.7 18.9Cualative 0 27.0 72.9 116.1 170.1 221.4 251.1 270.0

a/ Based on the standard, actual disbursement profile for IDE projectsAfrica Region-wide.

Economic Rateof Return: Subprojects with costs above US$200,000 would be required

to have financial rates of return (FRRs) after tax of atleast 121, and those with costs above US$1 million would berequired to also have economic rates of return (ERRs) of atleast 122; payback periods for leased equipment would beless than 6 years.

NIGERIA

PRIVATE SHALL AND MEDIUH ENTERPRISE DEVELOPMENT PROJECT

I. INTRODUCTION

1.01 The Federal Government of Nigeria (the Government, FGN) hasrequested a Bank loan of US$270 million for a Private Small and MediumEnterprise Development Project (the Project) consisting of an integratedpackage of financial support programs, investment promotion, technicalassistance and extension services for small and medium scale enterprises(SMEs). In July 1986, with the support of a Trade Policy and ExportDevelopment Loan (2758-UNI), the Government launched an ambitious andfar-reaching structural adjustment program to promote economic efficiencyand long-term growth through stabilization policies designed to restorebalance of payments and price stability. The introduction of amarket-determined exchange rate and the liberalization of trade are themost important measures of the Government's adjustment program. TheGovernment has now placed a high priority on developing a nationwideprogram to assist private sector SMEs. The Government believes thatprivate sector SME development is an important vehicle to 3timulateproductive activity and generate a sustained supply response, thusencouraging the resumption of growth and efficient employment generation inline with Nigeria's resource endowments and within the ongoing adjustmentprocess.

1.02 The Project would provide a broad and integrated package offinancial and technical assistance services to productive micro-, small-and medium-size enterprises in the private sector. It includes fivecomponents: (a) credit to SMEs (the Line of Credit Component); (b) supportfor restructuring viable enterprises which are currently in financialdifficulties (the Pilot Financial Restructuring Component); (c) credit tomicroenterprises through selected non-governmental organizations--NGOs (thePilot Mutualist Credit Guarantee Scheme); (d) a leasing program to improveaccess of SMEs to long-term financing (the Equipment Leasing Component);(e) technical assistance program to: improve extension services to SMEsthrough direct involvement of the private sector and the banking system;strengthen credit delivery systems; expand channels of credit; and conductstudies to improve the policy framework for SME development (the TechnicalAssistance Component).

1.03 The Project will require total financing of about US$416 millionequivalent, including US$263.4 million in foreign exchange. The proposedBank loan of US$270 million will cover 65Z of the total financing required(1002 of the total foreign exchange and about 4Z of the local costs).

II. THE SETTING

A. The Economic Environment

2.01 Nigeria, with a population of 103 million, has high potential fordiversified development. The country has considerable mineral wealth;

petroleum accounts for 142 of total GDP and about 90? of exports. It aLaohas vast rese..-7es of natural gas, little of which is being exploited atpresent. The agriculture sector, with cocoa, oil palm, rubber, and cottonas the principal cash crops, employs about three quarters of the laborforce and accounts for 402 of GDP. Agriculture is primarily based onemall-scale farming, and productivity is generally low. The manufacturingsector accounts for about 102 of total GDP and employment. Servicesaccount for ver 25Z of GDP. In terms of many socioeconomic indicators,Nigeria is close to the rest of Sub-Saharan Africa. With the recent dropin oil prices and the subsequent sharp depreciation of the naira since1986, the GNP per capita is expected to be about US$280 in 1988 and US$235in 1989.

2.02 Buoyant oil revenues in the 1970s provided the basis for largeincreases in government expenditures designed to expand infrastructure andnon-oil productive capacity. But, with some important exceptions, e.g.,expansion in transport and educational opportunities, much of the publicspending was on economically inefficient projects. Agriculture exportswere particularly hard hit since the exchange rate was allowed toappreciate substantially. When oil revenucs collapsed in the early 1980Q,the Government responded slowly. Foreign exchange reserves were run downand external payments arrears piled up. When austerity measures were takenbelatedly in 1984, non-oil GDP fell sharply. The inefficiencies that haddeveloped during the period of strong oil revenues multiplied, as importrestrictions and other administrative controls were tightened in an attemptto contain the growing balance of payment crisis.

2.03 On coming to power in August 1985, the new Government declaredits intent to move from mausterity alone to austerity with structuraladjustment. The commitment to reform intensified with the sharp fall inoil export earnings in early 1986. The Government adopted an ambitiousstructural adjustment program covering the period from July 1986 to June1988. The World Bank supported the program (Loan 2758-UNI). The mainfeatures of the new macroeconomic program were: (a) the establishment of amarket-determined exchange rate; (b) the dismantling of the previous systemof import licensing, removal of the majority of import bans, and reductionin tariffs; (c) the removal of ex-factory price controls; (d) a package ofexport incentive measures including simplification of procedures andabolition of the agricultural commodity boards; (e) a tight monetary policyand gradual liberalization of financial markets leading to the abolitioa ofinterest rate ceilings in August 1987; (f) moves to restore equilibrium inpublic finances; and (g) restraints on and rationalization of federalcapital expenditures to generate resources required by the private sectorfor growth. The Government has announced its decision for theprivatization and comercialization of some 135 parastatals, whichconstitute the bulk of the public enterprises of commercial nature, andappointed a technical committee to handle this program. The publicinvestment program and the regulatory environment for private investmentare also currently under review.

2.04 The impact of the structural adjustment program, which has beenin operation for over 18 months, has been to favor exporters over producersof import substitutes with little value added, and to emphasize growth ofdomestic resource-based and intermediate goods industries. However, theprogram has not yet produced the economic growth that had been hoped for.

Preliminary estimates suggest a modest recovery in the urban economy in1987, with manufacturing output rising by 42 in real terms. But despitethese gains, overall GDP is estimated to have fallen by almost 52 in realterms during 1987. Over 502 of GDP derives from crude oil production andagriculture, both of which suffered large declines last year. A key aspectof the austerity period preceding the adjustment program was the rise inunemployment to more than 10T in urban areas. In response to theadjustment program, however, a return migrrtion of workers from urban torural areas has begun to take place as workers take advantage of betterrural employment opportunities. Even so, the unemployment problem hasworsened, as employment needs to rise by 32 pa. simply to keep pace withlabor force growth. The urban and rural unemployment reached 12? and 62 inSeptember 1987, respectively. The Government thus faces a serious problemof unemployment that exceeds 45? among urban-based secondary schoolleavers. The high level of unemployment, together with the populationgrowth rate of 3.3? p.a., is increasing the pressure on the Government toencourage the development of labor-intensive productive activities,including SMEs.

B. The Manufacturing Sector

1. Past Performance

2.05 With buoyant oil revenues and heavy public investments, themanufacturinAg sector grew rapidly at an average rate of about 122 p.a.betveen 1973 and 1982, compared with a growth of 3.7Z p.a. in overall GDP.Share of manufacturing in GDP thus rose from 42 in 1973 to a peak of 10.31in 1982. Between 1982 and 1986, however, real output of the manufacturingsector declined sharply in every year except in 1985. At the end of 1986,its share in GDP was about 9.72. Although data on the relative shares ofcapital versus labor are not available, it is clear that the manufacturingsector has become relatively more capital intensive: while its share inGDP more than doubled, the industrial sector as a whole now employs aboutthe same share of the total labor force as it did in 1973, i.e., about10.8?. Although, the general business environment in Nigeria has alwaysbeen strongly private sector oriented, the Government policies have greatlyinfluenced industrial development. The Government has undertaken, as inother oil economies, most of the country's investment in large basicindustries considered beyond the capacity of the private sector. Theimplementation of the indigenization decrees in the early 1970s led to adivestiture of foreign equity holdings and substantial Nigerian privatecapital were diverted into acquisition of exisa:ing assets. Publicinvestment in manufacturing thus grew more rap. dly than private investment,and the public sector dominated manufacturing investment. This wasfocussed principally on intermediate and capital goods industries--iron andsteel, pulp and paper, petroleum refineries and chemicals, cement, vehicleassembly, and sugar refining--with the aim of stimulating the developmentof a more diversified and integrated industrial base. Most of theseprojects suffered from inadequate project design, high initial projectcosts, cost overruns and excess capacity once completed.

2.06 Private sector decisions on investment and production patternshave been affected by the industrial incentives policies pursued. In the1970s, accelerated inflation and the appreciation of the naira contributedto a significant decline in competitiveness of domestic industry. With the

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rapid deterioration in the balance of payments situation since 1981,tariffs were increased, quantitative controls were extended to a widerrange of imports, and import licensing and the allocation of foreignexchange were introduced. The protective import regime, used to insulatedomestic industries from foreign competition, encouraged the growth ofimport-based consumer goods and assembly industries with little domesticvalue added. The indastrial sector has suffered badly from the cutbacks inimported raw matbrials and spare parts over the past few years (Annex 2-1).Manufactured exports based on 2gro-processing, about 101 of exports in1970, have all but disappeared. Equally important, industrial productivityand competitiveness have been affected adversely by bottlenecks inindustrial infrastructure and the unavailability of skilled manpower.There have been widespread plant closures, extensive retrenchment of theindustrial workforce, and a substantial overall drop in manufacturingcapacity utilization to an estimated 30-402 and even lower levels incertain major inditstries. Enterprise profitability has, therefore,dropped and many firms are heavily indebted.

2.07 Manufacturing activity is essentially aimed at the domesticmarket, and is mainly concentrated in the large urban centers of Lagos,Kano and Kaduna. Among the wide range of manufactured goods are cottontextiles, soft drinks and beer, refined petroleum products, soap anddetergents, cement, paper products, chemicals and paints, plastic andrubber goods, wood products, metal products, and locally assembled trucksand automobiles. Consumer goods industries dominate the sector with 752 ofthe value added and 702 of the employment. The food, beverages and tobaccosubsector is the largest in terms of value added (32Z) and employment(20Z), followed by textiles and apparel accounting for 152 of the valueadded and 182 of the employment. The intermediate goods industriesaccounted for about 182 of the value added and 23Z of employment in 1984compared with 292 and 242, respectively, in 1971/72. The capital goodsindustries, after a very substantial increase from less than 1Z of thevalue added in 1971/72 to 222 in 1980, now represent a modest 7X of themanufacturlng value added. Most of the decline in capital goods industryis due to poor performance of the heavily import dependent vehicle assemblyplants. The manufacturing sector is estimated to be on average about 552dependent on imported raw materials.

2. Recent Reforms

2.08 Besides the ambitious trade policy reforms adopted in 1986 (para2.03), further reforms in the area of trade policy and to improve theclimate for private investment and rationalize the public investmentprogram are to be supported under the proposed Trade Investment and PolicyLoan.

2.09 Incentive System. The most important step in the adjustmentprogram has been the shift to a market-determined exchange rate. InSeptember 1986, the second-tier foreign exchange market (SFEM) comprisingan auction and interbank market was established. In July 1987, SFEM andthe official (i.e., first-tier) rates were merged, and all foreign exchangetransactions now take place at market-determined exchange rates. Theforeign exchange market (FEM) is a combination of an auction for foreignexchange (fortnightly on the basis of the Dutch auction system), and adealer market which operates in response to supply and demand. The

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exchange rate in the auction of July 7, 1988 was N4.47 to the US dollarcompared with N1.6 to the US dollar on September 26, 1986. Foreignexchange is reaching the produc.ive sectors, with industrial raw materialsand capital goods absorbing over 702 of auction funds, compared with some602 of official allocations in the pre-SPEM period. Until recently, theforeign exchange market had been working well. However, in the last fewmonths, downward pressure on the exchange rate has sharply increased thedifferential between the exchange rates on the auction, where there hasbeen a small depreciation, and the interbank market, where the rate hasbeen free to respond to market pressures.

2.10 With the realignment of the exchange rate, the import licensingsystem was abolished, and the majority of import bans were removed. TheGovernment also abolished the 30? import surcharge, and, in October 1986,implemented interim revisions in import duty and excise schedules whichreduced the average trade-weighted tariff rate from 332 to 25Z, with mostrates falling in the range of 10 to 30Z. A comprehensive tariff review toformulate proposals for a more permanent, lower and uniform structure oftariffs and excise duty was completed in December 1987. To avoid imposingundue hardships on existing enterprises from a sudden change in tariffs,and to provide producers and consumers with a longer policy time horizonwithin which to make decisions, the niew tariff schedule is to be phasedover a period of 7 years. The Goverrm.ent has also transferred the dutyassessment and collection functions from the Customs and Excise Departmentto the banking system. The overall tariff structure is a significantimprovement in terms of providing a more certain policy environment withinwhich to make decisions and appropriate signals to investors on efficientresource allocation. Yet, there are significant anomalies in the structureof protection. The Government has established a Tariff Review Board toreview the tariff structure, correct anomalies and improve the structure ofprotection. In conjunction with the exchange rate liberalization,ex-factory price controls on manufactured goods were also abolished inSeptember 1986 to enable producers to operate profitably at import pricesbased on the market-determined exchange rate.

2.11 Export Promotion. Since January 1986, the Government has taken aseries of measures to promote export development. The most powerful newincentive to exporters is the unrestricted access to the foreign exchangemarket for realizing their export earnings and meeting their importrequirements. Non-oil exporters now have 10OZ retention rights. Tofurther encourage non-oil exports, the Government has (a) abolished allexport prohibitions and export licensing requirements; (b) simplifiedexport procedures; (c) abolished six agricultural commodity boards andtheir monopoly export powers; (d) introduced a rediscounting/refinancingfacility for exporters; (e) approved a duty drawback/suspension scheme; and(f) prepared a decree for the reorganization of the Nigerian ExportPromotion Council into an autonomous body with strong private sectorparticipation and strengthened export promotion capabilities.

2.12 Business ReRulations. To improve the business climate forprivate investment, the Government reduced the corporate tax rate from 452to 40? in January 1987, and granted tax free dividends for 3 years oncapital imported between 1987 and 1992. As part of the 1988 budget, theGovernment has exempted investment incomes from dividends, interest androyalties from income taxes beyond the present 15? withholding tax, and

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allowed an additional 5Z initial capital allowance for plant and machineryfor manufacturing and agriculture production. In addition, both existingand new small enterprises with turnover of not more than 3500,000 will nowbe subject to a lower tax rate of 202 for a period of 3 years. Investorswill also benefit from the proposed establishment of the IndustrialDevelopment Coordinating Committee (IDCC) as a one-stop investmentfacilitating and promotional body. In addition, the Nigerian EnterprisePromotion Decree is under review to expand the range of activities in whichforeign ownership is permitted. The overall statement of the Government'spolicy on the role of the private sector will be included in a fBlueprinton Industrial Policy' to be issued shortly.

3. Impact of the Industrial Sector Reforms and Prospects

2.13 Available data suggests some recovery of activity in themanufacturing sector since the start of the adjustment program. Thus,while the index of manufacturing output fell by 52 in volume terms in 1986,estimates point to an increase by about 42 in 1987. At the same time,employment in manufacturing has fallen by about 52 since the opening ofSFEM, reflecting major rationalization exercise in many subsectors.Performance of industry has also been affected by weak aggregate demand dueto the loss in real income in the short-term following the structuraladjustment program. Surveys show that branches of industry with largedomestic value added have benefitted over assembly type of activities whichare heavily import dependent with low value added. Subsectors such astextiles, wood furniture, tanneries, food products, cosmetics and cementseem to be doing well. On the other hand, assembly operations (e.g., motorvehicles) are in trouble due to a combination of lack of demand, escalationof costs due to the sharp devaluation of the naira, and an inability tocompete with imports. Firms now have easier access to foreign exchange forimports of raw materials and spare parts and can plan their operationsproperly. Capacity utilization is, however, down due to lack of effectivedemand, unlike in the past when the supply shortages of raw materials andspare parts kept the capacity utilization low. According to a survey ofthe Manufacturers Association of Nigeria (MAN), there was an increase inaverage capacity utilization from 302 in 1986 to 372 in 1987, with widevariations among the subsectors. Most of the firms in agro-industries,beer, textiles, chemicals, operated at 402 capacity utilization or more,while firms in bakery products, electronics and motor vehicle assemblyoperations operated at levels below 202. Dependence on foreign sourced rawmaterials dropped from 622 in 1986 to 542 in 1987.

2.14 There is now considerable evidence of new interest in exportingas a result of the shift in relative prices through the adjustment in theexchange rate. Besides the increase in the traditional agriculturalexports (cocoa, rubber, palm produce, etc.), interviews with firms suggestthat new potential markets (Europe and ECOWAS countries) are being exploredfor exports of manufactured goods. Exports of items such as cosmetics,plastic shoes, palm kernel cakes, and textiles are already picking up. Inaddition, products such as tires, industrial adhesives, tiles andfiberglass boat shells are being added to the export list.

2.15 Overall, while the recent reforms will help generate new growthopportunities, they will force many enterprises to improve theircompetitiveness through restructuring, including phasing out those

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activities which were kept artificially profitable in the past by anexcessively protective incentive system. Some enterprises are likely toremain unviable and may have to close down. Others vill have to reorienttheir activities through modernization investments, rationalization ofproduction processes, introduction of new technologiee and other reductionsin operating costs (including adjustments in the workforce). Maintenanceof existing assets was neglected in the past because of difficulties inobtaining foreign exchange for imports of spare parts and components.According to the survey by MAN, about two-thirds of the investments byfirms in the first half of 1987 were for plant changes, modifications andreplacements to improve efficiency. In the near term, manufacturing growthis, therefore, dependent to a large extent on the availability of importedraw materials, spare parts and components. Host of the new investments inthe near term are expected to be pursued by smaller, domestic resourcebased enterprises.

2.16 The exchange rate adjustment and accompanying tradeliberalization measures have led to far-reaching changes in the incentivesystem for industry. These, combined with an improved climate for theprivate sector, should help create over the medium- to long-term a bettermanufacturing sector which is consistent with Nigeria's resource endowmentsand comparative advantage. Nigeria's endowment of supply factors (adiversified agricultural and mineral resource base), demand factors (thelarge domestic market with over 100 million peopla), and catalytic factors(a sizeable and dynamic cadre of indigenous entrepreneurs) is favorable tooverall growth. Moreover, more than three-fourths of Nigeria's populationlives in rural areas and its participation and share in the market forexisting goods has been peripheral. Increases in rural incomes under thenew policy reforms should help bring this large segment of the populationinto the market for industrial goods. The policy reforms should emphasizegrowth of domestic resource-based and intermediate goods industries.Subsectors with good potential for growth include food and beveragessubsectors, agro-based non-food industries (textiles, leather products,rubber and rubber products, and wood products), industrial raw materialsand intermediate inputs (glucose and starches from crops, tires and tubesfrom rubber, and paints from petrochemicals), chemicals and buildingmaterials. Considering the sharp decline in manufacturing output over thepast five years and hence a low base, a growth rate approaching 8Z p.a.through 1995 is feasible.

C. The Small and Medium Scale Enterprise (SME) Sector

1. Sectoral Context

2.17 Various definitions of SMEs are used in Nigeria. Since 1985,NBCI has defined small scale enterprises (SSEs) as firms with assets(including working capital but excluding land) not exceeding N750,000 (orabout US$850,000 equivalent at that time). The Nigerian IndustrialDevelopment Bank (NIDB) defines medium scale enterprises as firms withproject costs between NO.75 and N3 million (or US$0.85 and US$3.4 millionin 1985 dollars). Since 1979, the CBN has defined SSEs as enterprises withan annual turnover of less than N500,000. With rapid inflation in theearly 1980s and devaluation of the naira, these definitions are no longerrelevant. For the purpose of the Project, enterprises with fixed assets(excluding land) plus investment under the Project not exceeding N10

million in constant 1988 prices (or US$2.5 million equivalent) will beeligible for financing. Recent statistical data indicating the number ofSMEs and relative importance in each sector are not available. Preliminaryestimates around 1980 placed the number of smaller enterprises employingfever than 10 workers at about 125,000. There are 'ndicaticns that theseSSEs account for about 702 of industrial employment, and 10-152 of themanufacturing output.

2.18 The most recent survey of smaller enterprises was conducted in1984 by the Nigerian Institute of Social and Economic Research (NISER). Itcovered 2,696 firms with a maximum capital of N150,000 (or US$200,000equivalent at that time) and with less than 50 employees (Annex 2-2).Textile and wearing apparel, food and beverages, furniture making, footwearand leather products, rubber and plastic products, basic metal andfabricated metal products for construction industry, and motor vehicle andother repair activities comprise the predominant small enterprises (86Z ofthe total number of SSEs in the sample). In terms of value added andemployment, wearing apparel, food and beverages, furniture, metal productsfor construction industry, and repair activities are the most important,accounting for 802 of the value added and 72Z of the employment in thesample. According to the survey, the average number of employees in a firmwas five, and 902 of firms were sole proprietorships. While about 352 ofthe managers did not attend any school and more than 752 possessed onlyprimary education, about three-fourths of the managers had workingexperience of five or more years, and about 88Z had received more than twoyears apprenticeship. They are also intensive users of domestic rawmaterials which accounted for about 602 of the total cost of materials.

2. Government Policies and Support Programs

2.19 The Government has long recognized the need to foster thedevelopment of small scale industries so as to stimulate employment,mobilize local resources, reduce migration from rural to urban areas, anddisperse industrial enterprises more evenly within the country. Theseobjectives were to be achieved through the provision of special financialan" technical assistance to SSEs. The focal point for all policiesaffecting SSEs is the Small Scale Industries Division (SSID) of the FederalMinistry of Industries (FMI); each State Ministry of Industry and Commercealso has its own SSID. The Industrial Development Centers (IDCs) under FMIand staffed by federal civil servants provide technical and managementassistance to SSEs. There are also a number of other public and privatesector agencies invc'ved in the provision of technical assistance andextension services to SMEs.

2.20 Financial Assistance. A Small Scale Industries Credit Scheme wasestablished by the Federal Goveniment in the mid-1960s. Loan managementcommittees, at the state level consisting of state civil servants,representatives of the IDCs and branch managers of local disbursing banks,were to administer the scheme. Due to political considerations in creditallocation and the lack of budgetary funds, the scheme was unsuccessful andis no longer active. In 1973, the Government established NBCI as aspecialized development bank and has relied exclusively on it to channelfunds to SMEs. During 1982-86, NBCI approved 122 projects with a totalloan amount of N85.1 million with an average loan size of N0.7 million.While NBCI's projects cover all sectors of industry, 362 of the loans in

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number (and 472 in amount) were for food and beverage industries. NBCIhas also received a line of credit from the Bank under the Small- andMedium-Scale Industry Project--Loan 2376-UNI (paras 2.45 to 2.46). Tochannel resources to SSEs, the CBN requires commercial and merchant banksto direct at least 16Z of their annual loans and advances to smallenterprises (paras 2.32 and 2.33). However, banks have never met thetarget because of the perceived high risk of lending to SSEs. TheGovernment also launched a job creation loan guarantee fund in 1987,administered by the National Directorate of Employment in the FederalMinistry of Employment. Labor and Productivity, for lending to unemployedgraduates for establishing small businesses.

2.21 Extension Services and Technical Assistance. There are a largenumber of both public and private sector agencies involved in providingnon-financial support services to SMEs (Annex 2-3). FMI maintains anetwork of IDCs in various states to provide extension services. FMI isalso responsible for the Industrial Training Fund (ITF), an autonomousagency that collects and disburses a training tax levy on businesses with25 or more employees. ITF maintains a network of area offices to providetraining for the employees of enterprises that participate in the Fund.The SSIDs in some states have also provided limited extension services.Over the years, an increasing number of other government-supportedinstitutions have become actively involved in providing extension services(preparation of feasibility studies, management and technical advisoryservices and training) to the SME sector. These include the AdministrativeStaff College of Nigeria (ASCON), Centre for Management Development (CMD),Center for Industrial Research and Development (CIRD, Obafemi AwolowoUniversity), Federal ID,titute for Industrial Research, Oshodi (FIIRO),Project Development Agency (PRODA) and NISER. There are also variousprivate sector groups and associations such as the Nigerian Association ofSmall Scale Industrialists (NASSI), the Nigerian Council for ManagementDevelopment, the Nigerian Employers Consultative Association, MAN, and theNational Association of Chambers of Commerce, Industry, Mining, andAgriculture, who disseminate information and/or conduct training programson management, product selection, manufacturing, marketing, and othertopics of interest to SMEs. In addition, there are over two hundredprivate firms (mostly located in the Lagos area and other major cities)that provide consulting services to SMEs covering a range of ranagerial,financial, and technical specialties. In sum, there is a sufficient numberof eristing institutions and agencies to provide support to the SME sector.

2.22 The Government's efforts to strengthen extension services to SMEshave been supported by significant external assistance, used mainly forstrengthening IDCs operated by FMI (Annex 2-4). However, IDCs have notperformed satisfactorily because of continued shortages of operating funds,vehicles and training equipment. Under Loan 2376-UN1, a project componentwas included to support and strengthen (a) NBCI through technicalassistance and staff training to improve its project appraisal and lendingoperations; and (b) the delivery of extension services to SMEs throughtraining for staff of FMI, state ministries of Industry and Commerce, IDCs,and other relevant government supported institutions (e.g., ASCON). Whiletechnical assistance to NBCI has been implemented satisfactorily, progressin implementing the extension services subcomponent has been delayed andhas shown mixed results. During project implementation, the technicalassistance component was, therefore, modified to provide equipment for

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selected IDCs, and to shift the emphasis in training from courses to workattachments for the IDC staff. About 300 persons have been trainedin-country, and some have received training overseas. including training oftrainers for the Entrepreneurship Development Programs (para 2.24), andwork attachments. Fcllwing long delays, the in-country work attachmentprograms are now being organized. The Government' s objective remains tofully *quip and strengthen IDCs in each state as soon as possible. But inview of the resource constraints and to reduce dependence on public sectorfinancing, there is, however, a need tos (a) concentrate efforts first onthose IDCs which offer the best prospects for success; (b) make IDCs moreautonomous in their day-to-day operations, and allow them to operate assoei-private institutions; and (c) allow them to charge fees for servicesof coomercial nature (e.g., the preparation of feasibility studies). FMIis at present formulating a plan of action for rationalizing the IDCnetwork, and considering the establishment of an umbrella agency foroverall coordination of existing agencies responsible for the delivery ofextension services, and to act as a referral agency for SMEs. The umbrellaagency may also be assigned the responsibility for operations of the IDCnetwork, and the establishment and management of industrial estates.However, it would be desirable to limit functions of the umbrella agency tothe coordination and referral roles only so as to keep it small, avoidduplication and unnecessary use of scarce Government resources.

2.23 It is not proposed to allocate any further technical assistancefunds to support the IDC network under the Project for t)e followingreasonst (a) sufficient funds are available under Loan 2376-UNI forstrengthening the IDC network and training; (b) UNDP has planned additionalassistance for IDCs; and (c) there is a need to increase the role of theprivate sector in the delivery of extension services so as to make theirdelivery demand driven, and enhance competition and efficiency. TheProject, however, includes the establishment of a Pilot Studies Facility tofinance entrepreneurs' costs related to consultants' services of theirchoice for the preparation of feasibility studies and other technicalassistance services. Training to SMEs in simple business skills (e.g.,bookkeeping, accounting and cash flow projections) will also be providedwith full cost recovery features (paras 3.09 and 3.10). The Bank ispreparing an Industrial Manpower Training Project, to be implemented by ITFin FMI, which will focus on increasing the quality and quantity ofon-the-job training with special emphasis on industrial and infrastructuremaintenance skills, and improving the delivery of training services to theindustrial sector.

2.24 Entrepreneurship Development. The Government has placed a highpriority on introducing entrepreneur identification and developmentprograms as an effective means of facilitating the establishment and growthof SSEs. Programs for identification, training, and development ofentrepreneurs can be effective components of a strategy to develop firstgeneration local entrepreneurs and assist them in the establishment ofsmall scale projects. Two separate entrepreneurship development programshave been developed and tested in Nigeria: the EntrepreneurshipDevelopment Program (EDP) based on a model developed by theEntrepreneurship Development Institute of India (EDII), and the Work forYourself Program (WFYP) based on a program developed by the DurhamUniversity Business School (UK) with ILO assistance. The EDP program ispromoted by NBCI, while the WFYP program is under the auspices of FMI in

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collaboration with ASCON. Based on experience to date, NBCI and FMI arenow planning to implement their programs in a coordinated mJn'ier on anationwide basis (Annex 2-5). The Project includes assistance for periodicreviews of these programs by experts to assess their overall effectivenessand recomend necessary changes (para 3.12).

2.25 Other Programs. Lack of access to adequate infrastructure (e.g.,pover, roads and water) is a major constraint to the growth of industry inNigeria, particularly SHEs. The Government plans to establish industrialestates in every state under the Fifth Five-Year Plan (1989-1993).However, there is a need to involve the private sector to ensure cost andmanagement efficiencies, to reduce the burden on scarce Governmentresources, and to make the establishment of industrial estates demanddriven. The Project would, therefore, support a study to evaluatealternatives for implementing an industrial estates program on a commercialbasis with private sector participation (para 3.12). Nigeria has longrecognized the importance of technological development forindustrialization. There are a number of universities and specializedresearch agencies such as FIIRO, CIRD and PRODA which can meet thetechnological needs of industry. But SMEs face two main problems: lack ofinformation on the industrial production technologies available, and theneed to build up their technical capacity to assess, choose, acquire, andadapt technological knowledge. The UNDP is providing assistance to FIIROin developing a national industrial information center which would supplyinformation on industrial production technologies, and establish links withindustrial information networks at the national, regional and internationallevels. The Project would support a technology development study toformulate mechanisms for encouraging linkages between SMEs and researchinstitutions, and enhancing technical capabilities of the manufacturingsector in research and development (para 3.12).

3. Prospects and Constraints

2.26 Given the revised macroeconomic policy environment, and theGovernment's interest in SHE development (para 2.41), prospects for SMEgrowth are good. Growth in agriculture would increase the supply ofdomestic raw materials for SMEs such as food processing, raise ruralincome and expand the markets for small industries. Removal of interestrate ceilings will give SMEs better access to institutional credit (para2.31). Realistic exchange rate and an open trade policy favor more use ofdomestic raw materials, and enhance prospects for SMEs which use domesticraw materials more intensively than larger enterprises. Under the neweconomic policies, prospects for subcontracting have also improved aslarger enterprises are now forced to look for their irputs locally.Currently binding constraints for SME development are shortages of equityfunds and term credit on suitable terms, especially for smallerenterprises, and technical assistance (i.e., preparation of feasibilitystudies which meet requirements of banks).

D. The Financial Sector

1. The Institutional Setting

2.27 The financial system of Nigeria consists of (a) CBN; (b) 33commercial banks with 1,407 branches; (c) 15 merchant banks with 31

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branches; (d) five specialized financial institutions of the FederalGovernment; (e) some twenty regional development finance companies; (f)insurance companies; and (g) the securities market. Under theindigenization decree of 1976, 60Z of the equity of banks must be held bythe Government or private Nigerian interests. Although activities of themerchant banks have grown rapidly in recent years, commercial banks reainthe largest financial intermediaries both in terms of their assets, andnetwork. Their share in the combined assets (148 billion) of thecommercial banks and merchant banks was 82Z in 1986. Among the commercialbanks, 3 banks 1/ account for about 40Z of the assets and the number ofbranches. The number of commercial bank branches in Nigeria has grownrapidly in recent years under the impetus of the CBN's rural bankingprogram which started in 1977. About 445 rural branches were opened duringthe first and second phases of the program (1977-83), and 51 out of theplanned 300 branches have been opened under the third phase (August1985-July 1989). Merchant banks are essentially wholesale banks, servingthe needs of corporate and institutional clients, and are governed byregulations similar to those for commercial banks. They may engage in thesame scope of activities as a commercial bank except for the acceptance ofindividual checking accounts. They also engage in equipment leasingservices which have grown rapidly in recent years (Annex 2-6). Out of the15 merchant banks, five banks 2/ accounted in 1986 for 45Z of the totalassets and 54Z of the total loans and advances by the merchant banks.

2.28 The Government supported specialized financial institutions of theFederal Government include NBCI, NIDB, Nigerian Agricultural andCooperative Bank, Federal Mortgage Bank of Nigeria, and the Federal SavingsBank of Nigeria. Among these, NBCI provides financing (both term loans andequity) for SMEs and also undertakes merchant banking operations; NIDBprovides both term loans and equity financing for relatively largerindustrial projects. Although NBCI and NIDB have thus far been the majorsources of long-term lending to the industrial sector, their combined loansaccounted for only 3.5Z of the total outstanding credit from the commercialand merchant banks at the end of 1986. Under the 1988 budget, theGovernment announced its decision to establish a National EconomicReconstruction Fund to refinance credit to SMEs in manufacturing,agro-allied industries and ancillary service activities on a nationwidebasis through participating commercial and merchants banks. Regulationsfor establishing the fund and its operations are under preparation.

2.29 In terms of the ratio of broad money (M2 ) to GDP, the financialsystem more than doubled from 16Z to 361 between 1972 and 1986 (Annex 2-7).Despite this measure of growth, there has not been a real expansion infinancial intermediation between savers and investors. Much of themonetary growth took place after the increase in oil prices, initially inthe form of an increase in foreign assets and later because of increased

1/ First Bank of Nigeria (FBN), Union Bank of Nigeria (UBN), and UnitedBank for Africa (UBA).

2/ Continental Merchant Bank (CMB), ICON Merchant Bankers (ICON), NALMerchant Bankers (NAL), Nigerian Merchant Bank (NMB), andInternational Merchant Bank (IMB).

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goverinnt borrowing. The array of financial assets available to themajority of savers is still limited to money, defined to include time andsavings deposits The Federal and state governments play a dominant rolein financial intermediation. They borrow actively from the financialsystm, and participate extensively in the ownership of many banks. TheFederal and state governments own most of the indigenous co=mercial banks.The Federal Government also has a controlling interest in the four largestcoamercial banks as well as in the most Important *wrchant banks. Thelargest co=ercial and merchant banks are free of Government interventionexcept for the appointmnts of managing directors, and they operate on acoaercial basis. Suamry financial statements of the four largestco ercial banks, five largest merchant banks 3/ and NBCI are given inAnnexes 2-8. 2-9 and 2-10; all have expressed strong interest in activeparticipation in the Project.

2. Financial Policy Framework

2.30 The Government's financial policies were previously embodied inguidelines for credit allocations to priority sectors and subsidizedinterest rates for these sectors. However, the special low interest ratesmade commercial lending to the priority sectors unprofitable, and thesectoral guidelines for credit allocation have not been generally met withbanks preferring to pay the penalties for shortfalls from these sectoraltargets. With the structural adjustment program, the Government hasadopted a more market-oriented approach and Nigeria is undergoing a rapidliberalization of the financial system. The number of priority sectors forspecial credit allocations has been progressively reduced, with only threepriority sectors remaining, e.g., agriculture, manufacturing and smallscale enterprises. Special interest rates have also been eliminated, andrecently ceilings on all interest rates have been removed. The Governmenthas decided to establish a Nigerian Deposit Insurance Corporation in 1988to protect depositors against bank failures and thereby enhance confidencein the banking system. These are major steps in both the mobilization ofsavings and efficient allocation of financial resources.

2.31 Interest Rates. The structure and levels of interest rates inthe formal financial system were controlled until recently by CBN throughstrict guidelines issued annually (Annex 2-11). Real interest rates havebeen negative in most years since the first oil boom in 1973/74, and theywere driven sharply lower during 1983 and 1984, as inflation increased inthese years to 23S and 402, respectively. With the marked slowdown ofinflation to 5.5Z in 1985, real interest rates became positive for thefirst time. The negative real interest rates discouraged real savings,discriminated against small and underprivileged borrowers in the allocationof credit, and resulted in a misallocation of resources and the flight ofcapital. The low interest rate policy is likely to have also encouragedthe use of capital intensive technology. In October 1986, CBN began toliberalize the interest rate policy: time deposit rates were allowed to benegotiated between the banks and savers, the maximum lending rate was

3/ Commercial banks: FBN, UBA, UBN, and the International Bank for WestAfrica (IBWA); merchant banks: CMB, ICON, NAL, NMB and IMB.

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increased by 2 points to 15, and the differential between preferred andnon-preferred sectors was eliminated. Following these measures and thewithdraval of deposits by CBN from banks related to external paymentarrears to mop up excess liquidity, banks embarked on aggressive campaignsfor deposits, offering competitive and attractive rates to depositors. Thepace of financial policy liberalization increased in 1987. All ceilings onlending and deposit rates were eliminated as of August 1987, and thediscount and treasury bill rates were increased by 4 percentage points from111 to 15? and from 102 to 142, respectively. The discount and treasurybill rates were, however, reduced as of December 29, 1987, by 2.25percentage points to 12.75Z and 11.752, respectively, to stimulate growthof the economy, particularly investment. Savings and time deposit rates ofmajor banks are now about 13-15, and lending rates are about 16-18S. Therate of inflation was less than 102 in 1987, but it is projected to beabout 202 in 1988 reflecting increases for staple food products early inthe year and adjustments in public sector prices as well as the impact ofhigher import prices from the devaluation of the naira. As a result, boththe deposit and lending rates are negative in real terms at this time.Beyond 1988, however, the rate of inflation is forecast to decline to about15? in 1989, and 10? p.a. thereafter. The elimination of ceilings oninterest rates should allow banks to compete for funds more aggressivelyand should allow the market to equate the demand for credit with thesupply.

2.32 Credit Policies. The CBN regulates the activities of thecommetcial and merchant banks through annual ceilings on the expansion ofloans and advances, and complex and rigid sectoral credit allocationcriteria which specify minimum shares for preferred sectors. Annual creditceilings have been reduced since 1983 in line with the restrictive monetarypolicy in response to deterioration in the balance of payments andexcessive demand pressures. Penalt.es for noncompliance of ceilings wereraised substantially in August 1987. The ceiling on the growth of banks'credit to the private sector was, however, raised for 1988 from 7.4Z fixedfor the last three quarters of 1987 to 12.5Z so as to stimulate economicgrowth. Until recently, the economy was divided into some 18 sectors/subsectors for the purpose of credit allocation. For example, commercialbanks in 1983 were required to allocate a minimum of 1OZ of their loans andadvances every month to agricultural production, a minimum of 36? tomanufacturing, a maximum of 102 for domestic trade, and so on. Bothcommercial and merchant banks were required to extend 16? of total creditto small scale Nigerian enterprises with turnover not exceeding M500,000.Loans and advances by a rural branch were to be at least 30Z (increased to40? in 1985 and 452 in 1988) of deposits mobilized by it in that area. Inaddition, banks are required to maintain minimum cash and liquidity ratios.The above sectoral guidelines were so complex and rigid that the banks wereunable to comply with the stipulated targets. The actual sectoraldistribution of credit is shown in Annex 2-12. As for loans to small scaleenterprises, the prescribed target of 162 has never been met, though it hasincreased from a low. of 1.6Z in 1980 to 92 and 3.1? in 1986 for commercialand merchant banks, respectively.

2.33 In an effort to allow banks somewhat greater flexibility indetermining composition of their loan portfolios, the number of categorieswas reduced from the previous 18 to only 3 in 1987--agriculture,manufacturing, and small scale enterprises. Furthermore, for the

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requirement of extending a minimum of 162 of total credit to SSEs, the sizedefinition of firms was modified for merchant banks in 1988. SSEs formerchant banks are now defined as firms with fixed assets below NZ millionor turnover below N5 million.

3. Development Constraints

2.34 Resource Mobilization. The recent liberalization of interestrates together with the tighter liquidity situation in the banking systemhas led to higher financial savings in naira assets than in the past andfavored a repatriation of capital from abroad. The rural branch bankingpolicy, while succesaful in increasing the number of branch banks, has beenperceived to be costly by the banks. The selection and allocation of sitesfor rural branches to the banks by CBN based on rec.auendation of the stategovernments, and the requirement that a significant share (45X beginning1988) of the deposits generated in each rural branch be relent by the samebranch have meant that the rural branches have not become an integral partof the planning and operations of the banks. There is, therefore, a needto reduce the cost of the branch program by integrating it into the overallbanking system (e.g., allowing the banks to select sites, and relaxing theobligation to lend 45% of each branch deposits in the same area). Therange and type of financial instruments available are also important forincreased savings mobilization. The opportunities available to individualsavers in Nigeria are limited largely tCz savings deposits with commercialbanks and cooperatives. Past policies discouraged the banks to activelyseek deposits. This has been largely corrected by the elimination ofceilings on all interest rates. But the credit expansion targets are setfor each individual bank separately and are not sufficiently marketoriented to encourage banks to attract new savings.

2.35 Lack of Term Financing. The current restructuring of theeconomy is predicated upon the entry of new firms and new investments inareas which have become or are potentially attractive under the newcost-price structure. These private investors will need financing, bothdomestic and external, to expand production. One of the major weaknessesof the Nigerian financial system has been its inability to generate asufficient amount of long-term financing mainly as a result of ceilings oninterest rates. Parastatals have obtained long-term financing from theGovernment through equity participation and direct borrowing, but privatebusinesses have raised little funding through capital markets, relyingmostly on their internal funds and on borrowings from financialinstitutions. However, because of low levels of term financing, this hasmeant for the most part short-term loans and overdrafts. Commercial bankswhich provide about 802 of the formal non-CBN bank credit tend to operateat the short-end of the market; only 122 of their maturities in 1986 werelonger than 3 years and 802 were below 12 months. Part of the explanationlies in the short-term nature of their deposits (602 of their deposits in1986 were demand and savings deposits). The merchant banks, who because oftheir efficiency attract wholesale term deposits from corporate andinstitutional investors (742 of their deposits in 1986 were time deposits),extend about 402 of their loans for over 3 years, and about 202 between oneand three years (1986). However, through continuous roll-overs andrenewals, the banks in effect supply more long-term finance to many oftheir creditworthy customers than their portfolios actually show. Thebanks seem to prefer this type of long-term lending to avoid illiquidity

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and the risk of interest rate changes, and to increase their operationalflexibility. With the total deregulation of interest rates, the banksshould now be able to mobilize longer-term deposits by offering higherinterest rates which in turn would provide an appropriate ba:, forlong-term lending.

2.36 The past policy of ceilings on interest rates and complexsectoral credit allocation criteria in practice made financial systembiased in favor of large industrial and coamercial borrowers againstcertain priority sectors, mostly small enterprises and small farmers.Lending to these sectors is associated with relatively higher unit costs ofadministering the small loans and has higher perceived risks, apart fromthe lack of collateral and guarantees. The previous interest rate controlsthus prevented banks from recovering their costs on these loans. NBCI,which is a major source of long-tprm finance to SMIs, represents only 22 ofthe total outstanding credit from commercial banks for productive sectors.There is, therefore, a need to tackle effectively and quickly the seriousproblem of credit availability to SMEs, if the employment and productionpotential of these enterprises made possible by the recent economic reformsis to be realized. While the liberalization of interest rates is a majorstep toward improving the efficiency of the allocation of credit, there isa need to strengthen the legal system for collecting on bad loans, reviewthe collateral base for credit, and promote the development ofnon-governmental mutualist credit guarantee schemes (para 3.06).

2.37 Financial Stability of Banks and Portfolio Management. The mostimportant structural issue facing the banking system is its stability.Manufacturing enterprises have gone through a series of severe shocks andmany firms are in financial distress: (a) prior to recent economicreforms, due to the scarcity of foreign exchange and import license system,many enterprises operated at low levels of capacity utilization since theycould not import adequate raw materials; (b) many heavily import dependentprojects with little value added, which were viable under the previouspolicy regime, are unlikely to be viable under the new price system and mayhave to be closed down; (c) the capacity utilization of many enterprises islow due to the still weak demand and slow economic recovery; and (d) therehave been large foreign exchange losses on long-term loans denominated inforeign currency, and those arising out of the trade arrears. As a result,banks are faced with potentially high arrears in their portfolios. Thereis no uniform policy on the accrual of interest on overdue and doubtfulloans, and it is possible that income is overstated in some banks, asdoubtful debts are rolled aver. According to a recent study, the range ofthe ratio of provisions to loans!and advances in 24 commercial banks was 02to 27Z (9 banks had ratios above 15Z and 5 banks between 10 and 152), andin 12 merchant banks was 02 to 182 (one bank had a ratio of 182, and 4banks had ratios between 5 and 11Z). These wide discrepancies aredisturbing. The CBN has the power to require that additional provisions bemade for doubtful loans and it has disallowed the distribution of dividendsby 9 banks in 1986 that had inadequate provisions. Disallowing dividendsmay not, however, be strong enough a sanction for state owned barks whoseowners (state governments) may not be interested in receiving dividends.The two development banks (NBCI and NIDB) are also facing serious portfolioproblems. As of June 1987, about 602 of NBCI's portfolio was in arrears,and 422 of these arrears were more than 18 months overdue. In the case ofNIDB, while only about 32Z of its portfolio, as of September 1987, was in

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arrears, its borrowers are likely to face serious difficulties in servicingtheir increased debt as they bear the foreign exchange risk.

2.38 Control of capital adequacy of the banks is also deficient. TheCBN requires that loans and advances by a bank may not be more than 12times its capital. This rule, however, does not take into account theother types of risk assets such as leasing, acceptances and guarantees.While the high reported profits of the banks in recent years and theprudeece of most banks have reduced the debt to equity ratios of commercialbanks from 44:1 in 1980 to 30:1 in 1986, and of merchant banks from 52:1 in1982 to 44:1 in 1986 (not counting the off-balance sheet items), there arewide variations among the banks. The latest published balance sheets of 9commercial banks showed a range of debt to equity ratio from 20:1 to 44:l,and of 4 merchant banks from 19:1 to 32:1. There is a need to subject thebanks to stronger regulatory pressure to classify their portfoliosproperly, work out their non-performing assets, make up the provisionshortfall, and strengthen their capital base. A strong regulatoryenforcement will also require strengthening of CBN staff in bankingsupervision. Simultaneously, there is a need to put in place a mechanismto assist viable corporate enterprises which are financially distressed inrestructuring their operations to improve profitability.

2.39 Capital Markets. In recent years, merchant banks have becomemajor operators in Nigeria's capital markets offering a wide range offinancial services, including conventional investment banking typeservices. Insurance companies, pension funds and other specialistlong-term institutions are also beginning to play a role in themobilization and deployment of longer-term financial resources. In thepast, however, most financing from institutions has been in the form ofdebt, with only NBCI and NIDB providing a limited supply of equity. Of thetotal combined term investments outstanding for these two institutions atthe end of 1986 of N660 million for example, less than 13Z had been in theform of equity. The pension funds and insurance companies, traditionalproviders of equity finance, are underdeveloped. Nigeria has a young butfairly active stock exchange and a functional Securities and ExchangeCommission. The market capitalization at the end of 1986 was sizeable atabout N7 billion (US$2.1 billion), including N3.2 billion in 57 Governmentstocks and about N3 billion in 9) equities. There has, however, hardlybeen any growth in the number of equities listed (99 in 1986 versus 90 in1980). A second-tier securities exchange set up in April 1986 to inducesmaller Nigerian companies to list on the Stock Exchange has so farattracted only five new issues as of June 1987. The inefficient pricingarrangements in which the Securities and Exchange Commission solelydetermines the pricing of securities, and other administrative arrangementshave also inhibited capital market development. Adequate sources of equityand quasi equity are necessary for the expansion of the small and mediumscale entrepreneurial sector, and for the restructuring of existingenterprises in financial difficulties including mergers, acquisitions andother financial engineering possibilities. The Government has, therefore,decided under the 1988 budget to allow the commercial and merchant banks totake equity position in corporate enterprises, and the CBN is preparingnecessary amendments to the Banking Decree. The equity position by a bankin enterprises is to be limited to lOZ of its paid up capital plus reservesin any one enterprise, and to one-third of its paid up capital plusreserves in all enterprises.

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2.40 Further liberalization of the local securities markets,development of a regulatory framework for new financial instruments (e.g.,mutual funds), implementation of the Government's privatization program,and upgrading the technical capability of the Stock Exchange are necessaryto help develop the capital market. A more detailed analysis of the aboveissues is currently underway, and the proposed Financial Sector Policy Loanwill support reforms in the financial sector.

E. Government Obiectives and the Role of SHEs

2.41 Government Obiectives. The Government has assigned a highpriority to industrial development in the growth and diversification of theeconomy away from oil. The medium-term industrial strategy is to reduceimport dependence by accelerating the development and utilization of localtechnology, raw materials, and intermediate inputs through expansion ofprivate sector production and non-oil exports. The Government has alreadyundertaken a far-reaching program of reforms to rationalize the incentivesystem and encourage the private sector (paras 2.08-2.12). Yet, it willtake some time for the recent reforms to work through the system, for theshift and reallocation of resources to take place, and thus forrestructuring of the country's industrial structure. In view of thecontinued austerity and the serious unemployment problem, the Governmentfeels the urgent need to simultaneously combine growth promoting policiesand programs with the ongoing adjustment process. In this context, theGovernment considers private sector SME development as a positive endeavorto stimulate broad-based productive activity, generate a sustained supplyresponse, and to partially mitigate the social cost of adjustment.

2.42 Role of SMEs. Private sector SME development would contribute toNigeria's adjustment Process in several ways. They are complementary toand have significant linkages with the agricultural sector. SMEs promotebroad based agricultural development through the localized adaptation andmanufacture of simple farm equipment which increases productivitv. Theytend to be regionally more evenly distributed than larger industries whichare concentrated in the urban areas. Since SMEs employ generally largenumber of workers, they can become a major source of income, particularlyin small towns and rural areas. With the radical shifts in relative priceswhich have already taken place, SME development should also help establishlinkages with larger industries through subcontracting.

2.43 SMEs, in general, tend to be relatively efficient users ofresources compared with larger enterprises. They are more labor intensive,require less foreign exchange, and are intensive users of domestic rawmaterials. SMEs make the greatest contribution to developing an industrialtradition over time by providing a seed-bed, at the grass-roots level, todevelop entrepreneurial capabilities, management skills, and technologicalinfusion. In addition, they generally have small investment requirements,q-tick paybacks, and more flexibility. SMEs can adapt better and quickly toa changing environment. They also offer a unique opportunity fordeveloping the potential and active participation of women entrepreneurs inproductive activities for the overall economic and social development ofthe country.

2.44 The Government's emphasis on private sector SME development is,therefore, sound and represents an appropriate strategy for pursuing

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longer-term growth in the context of the ongoing adjustment process.However, efficient and sustained growth of SMEs will require an integratedpackage of assistance including measures to: (a) foster entrepreneurialcapacity; (b) develop an innovative institutionai support system withactive participation of the private sector for delivery of promotion,technical assistance and extension services; and (c) provide credit inconformity with market mechanisms for financing rehabilitation and workingcapital needs of existing enterprises as well as new investments by SHEM.The proposed Project would assist the Government in these efforts.

F. Bank Assistance

1. Past Bank Involvement

2.45 The Bank has so far made six loans to Nigeria's industrialsector. Five of these were DFC operations; 'o, TDans were channelledthrough NIDB, and one loan through NBCI. Ttc lati. ;t of these were theFourth NIDB Project approved in Hay 1983 (Lo&n t229-UNI, US$120 million)for financing relatively larger industries, and t'se Small- and Medium-ScaleIndustry Project channelled through NBCI, approved in January 1984 (Loan2376-UNI, US$41 million). The sixth loan was for the Industry TechnicalAssistance Project approved in September 1985 (Loan 2618-UNI). Inaddition, the Bank has assisted Nigeria with a quick disbursing TradePolicy and Export Development Loan (2758-UNI) in support of the structuraladjustment program.

2.46 While the fourth line of credit to NIDB and the line of credit toNBCI are almost fully committed, implementation of these two loans had notbeen smooth. Both NIDB and NBCI have large arrears in their portfoliossimilar to most development banks in West Africa. The high private sectorloan arrears are the result in part of the country's past macroeconomicproblems (para 2.37). In addition, both NIDB and NBCI face significantinstitutional weaknesses and are in need of strengthening their internalprocedures. To remedy the situation, comprehensive action programs havebeen discussed with NIDB and NBCI and agreed upon whose implementationbegan in 1987. These rehabilitation programs call for: (a) priority to oegiven to the management of existing portfolios; (b) a detailedaccount-by-account review of problem projects and formulations of remedialmeasures; (c) assigning priority for rehabilitation of existing clients;(d) improvements in appraisal, supervision, collection and other internalprocedures; (e) financing of working capital needs of viable enterprises toimprove their capacity utilization; (f) review of accounting procedures andmaking realistic provisions for bad loans; (g) changes in interest ratepolicy to bring them in line with the market; (h) managerial andorganizational improvements; (i) tightened control over operating costs;and (j) restoration of an adequate equity base. However, it will takesome time before any significant improvements are felt in the financialsituation of both intermediaries. Under Loan 2376-UNI, NBCI receivedtechnical assistance for institution building under a twinning arrangement,but it did not renew the consultants' contract when it expired in December1987. The proposed Project includes technical assistance for furtherstrengthening of the operations of NBCI in the areas of appraisal,supervision, portfolio management, equipment leasing and merchant banking(para 3.13). A summary analysis of subprojects financed by NBCI under Loan2376-UNI is given in Annex 2-13.

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2. Bank Role in the Sector

2.47 Bank strategy for Nigeria is two-fold: (a) support for theGovernment's broad policy initiatives to restructure the economy throughadjustment loans; and (b) sector lending to facilitate the resumption ofgrowth in productive sectors in line with Nigeria's comparative advantage.Within this strategy, the proposed Trade and Investment Policy Loanprovides support for continuation of the core program of structuraladjustment of Nigeria's economy, establishment of a favorable climate forprivate investment, and rationalization of the public expenditure programto ensure that it leads to a resumption of growth. It will be followed bya Financial Sector Policy Loan to support reforms in the financial sector,particularly efficient mobilization and allocation of savings.

2.48 lank assistance under the proposed Project would complement theGovernment's policy reforms by enabling private entrepreneurs (SME.) in theproductive and service sectors to restructure, expand businesses to becomemore competitive, and help establish new enterprises consistent withNigeria's resource endowments. To minimize the wpain of transition* ofmoving from a highly protected environment to one which is internationallycompetitive, there is a need to provide scarce long-term investmentresources to the private sector SMEs. In departure from the Bank's pastapproach of lending to the industrial sector through single intermediaries(NIDB and NBCI), it would involve the commercial banks (which haveextensive branch networks) and merchant banks in providing long-termfinancing to SMEs and thereby enhance the efficiency and competitiveness aswell as extend outreach of the credit delivery system. The proposedProject would also improve the quality and range of financial servicesavailable to the SME sector (e.g., the financial restructuring andequipment leasing components and the mutualist credit guarantee scheme formicroenterprise lending). It would link private entrepreneurs, banks andsources of technical assistance and extension services, and thereby makethe delivery of extension services to SHEs demand driven and moreresponsive to local entrepreneurial initiatives and the requirements of thebanking system. The Project would make maximum use of existinginstitutions and the relatively large consulting industry in the deliveryof technical support services to SMEs. Future Bank assistance forNigeria's industry would support a well-balanced and integrated developmentof the sector focussing on industrial restructuring of viable corporateenterprises, efficient import substitution and, in the medium-term, onnon-oil exports, based on ongoing sector work and policy dialogue with theGovernment.

III. THE PROJECT

A. Proiect Rationale and Obiectives

3.01 Proiect Rationale. The Project is an integral part of Bankassistance to Nigeria for structural adjustment of its economy. To sustainthe recent reforms, there is a need to combine the ongoing adjustmentprocess with growth promoting programs to facilitate a sustained supplyresponse and generate efficient employment in the private productive and

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service sectors. Now that an appropriate incentive system is largely inplace, the economy is gradually starting to respond to the dramatic changesin relative prices and direct growth oriented programs can bear fruit. Asnoted earlier, SMEs will play an important role in the resumption ofgrowth: they are flexible, generate employment at low investment costswith quick paybacks, have higher levels of domestic value added than thelarger firms and provide the seed-bed for the development of entrepre-neurial and industrial capabilities. They are traditionally dispersed inthe country and have the potential to establish productive linkages withthe rejuvenated agricultural sector. Moreover larger industries will shiftdemand away from imported toward domestically produced inputs as thesegradually become available, thus contributing to the development oflinkages with SMEs. With the removal of ceilings on interest rates, themain impediment for lending to SHEs has been removed. Yet, it will takesome time for the liberalization measures to work through the system, andthere are a number of market imperfections which discriminate against SMEs,including poor access to information, high transaction costs, andinadequate collaterals. Banks have to overcome their reluctance to lend tosmaller and relatively new enterprises which have only recently becomeprofitable. There is a shortage of term resources and working capital.There is also a need to strengthen the institutional support system forSMEs. The proposed Project would address these bottlenecks, and providecredit for the private sector at large for the overall development of theSME sector.

3.02 Proiect Objectives. The Project is designed to: (a) supportexisting enterprises restructure and modernize their operations inmaintaining their comparative advantage, and to regain competitivenessunder the new incentive system; (b) help establish a new generation ofviable investments in the private productive sectors and serviceactivities; and (c) improve the quality and range of financial andextension services available to SMEs. Specifically, the Project is aimedat: (i) enabling private small and medium entrepreneurs to become morecompetitive by investing in the rehabilitation and expansion of theirexisting units, and establishment of new enterprises; (ii) revivingproduction and improving viability of selected overleveraged firms throughestablishing an institutional and financial framework to plan, implement,and support restructuring programs; (iii) supporting a program ofassistance to microenterprises; (iv) providing an alternative and moreflexible source of long-term finance to SMEs through equipment leasing; (v)supporting the Entrepreneurship Development Programs; (vi) sponsoring thedelivery of technical support services that are more demand driven andresponsive to the needs of the private sector; and (vii) improving thepolicy and institutional support framework for SME development.

B. Proiect Description

3.03 In line with the above objectives, the proposed Project includesfive financial and technical assistance components: (a) line of credit;(b) pilot financial restructuring; (c) pilot mutualist credit guaranteescheme for microenterprises; (d) equipment leasing; and (e) technicalassistance. These are described briefly below. The main features of theonlending arrangements are given in Chapter IV.

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1. Line of Credit Component

3.04 The line of credit component (US$200 million) 41 will helpfinance, through the banking system, fixed investments (plant andmachinery, related civil works, consultancy services, and training) andworking capital needs of existing as well as new private sector SMEs. Forproject purposes, SHEs are defined as firms with fixed assets (excludingland) plus investment under the Project (asset size) not exceeding 310million in constant 1988 prices or US$2.5 million equivalent (para 4.09).In order to benefit smaller enterprises with asset size below U5 million inconstant 1988 prices or US$1.25 million equivalent, US$100 million of thetotal line of credit would be earmarked for financing such SMEs, includingUS$25 million for financing free standing working capital needs (ravmaterials, spare parts and components). These would include SMEs to beestablished by entrepreneurs who have successfully completed theEntrepreneurship Development Programs (para 2.24). The remaining US$100million of the total line of credit component would finance larger SMEswith existing fixed assets (excluding land) plus investment under theProject between N5 million and N10 million (or between US$1.25 million andUS$2.5 million), including US$25 million for financing free standingworking capital needs. Provision of financing for free standing workingcapital is particularly critical under prevailing circumstances toencourage more efficient utilization of existing capacity and maintenanceof employment in SMEs.

2. Pilot Financial Restructuring Component

3.05 The pilot restructuring component (US$20 million) will help meetthe long-term restructuring needs of selected enterprises that arepotentially viable and have good prospects, but currently suffer from aweak financial position. Based on satisfactory restructuring workoutsprepared by the eligible SMEs, the component would offer comprehensivefinancial packages including refinancing and/or rescheduling of existingdebts including capitalization of interest, swaps of debt into equityand/or quasi equity instruments, and injection of new money for freshworking capital and fixed assets. Up to US$1.0 million of the credit fundscould be applied to finance consultancy services for the preparation ofabove restructuring workouts. The Project would also provide technicalassistance to help develop the institutional capacity and associated skillsin the banks for enterprise restructuring (para 3.11). As part of therestructuring exercise, the banks will consider partial write-offs (e.g..accumulated penalty fees, charges, etc.) as well as conversion of existingdebt to equity and/or quasi equity. Efforts would also be made to attractother interested investors to take equity positions in the restructuredfirms. The Bank loan proceeds would finance fresh working capital (rawmaterials, spare parts and components), new fixed assets (mainly toeliminate physical bottlenecks) and technical assistance (consultancyservices, training) needs of the restructured companies.

4/ Figures in parentheses refer to the Bank loan amounts for respectivecomponents of the Project.

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3. Pilot Mutualist Credit Guarantee Scheme

3.06 The pilot mutualist credit guarantee scheme (US$5 million) willprovide access to institutional credit for fixed asset investment andworking capital needs (raw materials and spare parts) of microenterpriseswho, because of their small size and lack of collateral, are generallyunable to borrow through the normal banking channels. All eligibleparticipating banks (PBs) would have access to funds under the scheme. ThePBs would finance eligible subloans submitted by microenterprises, andguaranteed by the selected NGOs such as MAN, NASSI, etc. (Annex 3-1).Because of the newness of this concept in Nigeria, the Project would alsoprovide technical assistance for a study to be completed by March 31, 1989,to formulate detailed implementation arrangements for the scheme and toidentify other NGOs that could suitably participate in the program (para3.11).

4. Equipment Leasing Component

3.07 The equipment leasing component (US$30 million) will provide analternative and flexible source of long-term financing to SMEs which areunder-capitalized and lack adequate collateral. It will finance theleasing of equipment by SMEs through eligible PBs. An integral part of thefinancial support for leasing would be technical assistance for a study tobe completed by June 30, 1989, to develop an appropriate regulatory andpolicy framework for the leasing industry in Nigeria (para 3.11).

5. Technical Assistance Component

3.08 The technical assistance component (US$9.3 million) accounts forabout 3.4Z of the loan. A detailed description of the technical assistanceprogram and breakdown of costs are given in Annex 3-2. Project support(consultant services, training and equipment) for technical assistancewould cover four main areas as summarized below. The Project is expectedto finance in total an estimated 385 and 1,200 man-months of foreign andlocal consultancy services, respectively.

3.09 Assistance (U'$5 million) to SMEs and Entrepreneurs: It isrecognized that entrepreneurs are often in need of consulting services to(a) undertake studies, in particular prefeasibility or implementationstudies, to develop their initial project ideas; and (b) obtain technicalservices and management counselling for the acquisition of technologicalknow-how, and for solving operational problems. Experience in Nigeria andelsewhere has shown that studies and assistance provided by state-supportedpromotion agencies generally have lacked credibility and had difficultyfinding acceptance by the banks from whom financing was requested. InNigeria, there are a large number of private consulting firms and otheragencies whose services could be contracted usefully by local entrepreneursat various stages of project preparation and implementation (para 2.21).However, the cost of private consulting services is likely to be tooonerous for many small entrepreneurs. Therefore, a Pilot Studies Facility(US$5 million) will be established in CBN to provide financing to SMEs andentrepreneurs through the PBs on loan terms for costs related toconsultants' services. SMEs eligible for financing under the StudiesFacility will be those with existing assets not exceeding N#o million inconstant 1988 prices. For potential new enterprises, the estimated cost of

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the subproject would not exceed 310 million in constant 1988 prices. Theproposed loan will finance up to 70Z of the consultants' costs but themaxijm, financing from the Studies Facility for any one SME or entrepreneurwill be k15,000 (or US$3,750 equivalent) in constant 1988 prices. Subloansunder this component vill have maturities of up to 3 years, including graceperiods of up to 1 year. Apart from benefitting entrepreneurs, the fundwould help develop the nascent consulting industry in Nigeria. Anassurance has been obtained that CBN will establish the Pilot StudiesFacility by December 31, 1988, with procedures and conditions acceptable tothe Bank. The issuance of a circular by CBN to the banking system,satisfactory to the Bank, outlining the conditions and procedures forassistance to SMEs and entrepreneurs under the Studies Facility will be acondition of loan effectiveness. The signing of a participation agreementbetween the CBN and the concerned PB will be a condition of disbursementunder this component.

3.10 The Project would also support training for SMEs in simplebusiness skills, including bookkeeping, accounting and cash flowprojections with full cost recovery from SMEs. The training will beprovided by existing training institutions and consultants withcoordination from FKI.

3.11 Assistance (US$2.5 million) for CBN to: (a) supplement staffskills with an outside expert to build technical and institutionalcapabilities of the SME Apex Unit in CBN (para 4.02) for administration ofthe apex line of credit and other SME credit programs; (b) improveexpertise of staff of the PBs in project appraisal, supervision andmonitoring; (c) train staff of the PBs in the preparation and evaluationof workouts related to financial restructuring of enterprises; (d)formulate detailed procedures for implementation of the mutualist creditguarantee scheme as well as identify other NGOs besides MhAN and NASSI forparticipation in the program; (e) undertake a study to develop anappropriate regulatory and policy framework for equipment leasing; (f)conduct a study for the proposed establishment of a Mutual Investment Fundfor holding a portfolio of shares and bonds in corporate enterprises,particularly those involving restructuring, to be subscribed byinstitutional and individual investors; (g) monitor regularly the economicand social impact of the SHE subprojects financed under the Bank loan(tracer studies) (para 4.34); and (h) undertake further policy and projectpreparation work in the industrial and financial sectors (CBN, US$1million).

3.12 Assistance (US$0.8 million) for FMI to: (a) assist in periodicreviews by outside experts of the nationwide Entrepreneurship DevelopmentPrograms to assess their overall effectiveness and recommend necessarychanges; (b) carry out a study for developing linkages between SMEs andlarger enterprises through subcontracting; (c) conduct subsector surveysand develop industry profiles; (d) undertake a technology development studyon encouraging linkages between SMEs and research institutions, andupgrading the technical capabilities of the manufacturing sector withparticular emphasis on SMEs; (e) conduct a study to evaluate thealternatives of implementing an industrial estates program on a commercialbasis with private sector participation to help SMEs overcome difficultiesof access to infrastructure facilities, and the eventual development of

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pilot/demonstration industrial estates within high priority areas; and (f)enhance the capacity of FHI to formulate policies for SHE development.

3.13 Assistance for NBCI (US$l million) co strengthen its operationsin the areas of appraisal, supervision, portfolio management, equipmentleasing and merchant banking. The consultants will be recruited byFebruary 28, 1989.

3.14 In view of the pilot nature of the financial restructuringcomponent, the mutualist credit guarantee scheme and the Pilot StudiesFacility for SMEs, an unallocated amount of US$5.7 million is proposedwhich could subsequently be allocated by the Bank to any component based onexperience during project implementation.

C. Proiect Cost and Financing Plan

3.15 The estimated project cost and financing plan are summarized inthe table on the following page. A detailed breakdown of the costs for thetechnical assistance component is given in Annex 3-2. Total project costis estimated at about US$416 million equivalent, including US$263.4 million(63Z) in foreign exchange. The proposed Bank loan of US$270 million wouldfinance 65Z of the total project costs (100Z of foreign exchangerequirements, and 4Z of the local costs). About US$146 million equivalentof the project costs would be financed by the beneficiary enterprises inequity and the share of technical assistanca costs, and the PBs from theirown resources.

D. Credit Demand

3.16 In Nigeria, there is no reliable data available on capitalformation by subsectors, and on new credits granted as distinct fromoutstanding credits. The target group for the proposed Project (e.g.,private sector enterprises with fixed assets not exceeding US$2.5 millionequivalent and operating in a broad spectrum of economic activities)differs significantly from SMEs as presently defined in Nigeria (para2.17). It is, therefore, difficult to relate precisely the proposed loanamount to the potential demand for credit. However, the proposed amount ofUS$200 million for the line of credit component represents (a) roughly 4Zof the Nigerian banking system's total outstanding credit to the privatesector as of end-1986 (N17.4 billion or US$5.2 billion equivalent); (b)about 12Z of the outstanding loans and advances of the commercial andmerchant banks to the manufacturing sector as of end-1986 (N5.5 billion orUS$1,645 million equivalent); (c) about 281 of the estimated new credit in1986 (N2.4 billion or US$710 million equivalent) to enterprises withassets below 12 million (or US$0.5 million equivalent); 5/ and (d) about11Z of the foreign exchange auctioned through SFEM/FEH between October 1986and October 1987 intended for imports of machinery, raw materials, sparesand components by the industrial sector (US$1.9 billion). The NBCIpipeline as of November 1987 included some 158 projects requiring aggregate

5/ Source: CBN, Annual Report and Economic and Financial Review, 1986;Report prepared by the Nigeria Merchant Bank, NMB (Project File).

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Proiect Cost and Financing

X of Z ofComponents Local Foresin Total Subtotal Total

------US$ million------

Line of CreditWorld Bank - 200.0 200.0 655SHE (Equity) 76.9 - 76.9 25Participating Banks 30.8 - 30.8 10

Subtotal 107.7 200.0 307.7 100 74

Pilot Financial RestructuringWorld Bank - 20.0 20.0 40Participating Banks 30.0 - 30.0 60

Subtotal 30.0 20.0 50.0 100 12

Pilot Mutualist CreditGuarantee Scheme

World Bank 2.2 2.8 5.0 90Microenterprises (Equity) 0.5 _ 0.5 10

Subtotal 2.7 2.8 5.5 100 1

Equipment LeasingWorld Bank - 30.0 30.0 85Participating Banks 5.3 - 5.3 15

Subtotal 5.3 30.0 35.3 100 9

Technical AssistanceWorld Bank 4.4 4.9 9.3 80SMEs 2.3 - 2.3 20

Subtotal 6.7 4.9 11.6 100 3

Unallocated (World Bank) 5.7 5.7 100 1

Total Project Cost 152.4 263.4 415.8 100=.,- ==z== t=m===s

Summary Financing PlanWorld Bank 6.6 263.4 270.0 64.9SMEs 79.7 - 79.7 19.2Participating Banks 66.1 - 66.1 15.9

Total Financing 152.4 263.4 415.8 100.0===== ==-M=

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financing of N193 million or US$48 million equivalent, and the NAL pipelineas of mid-1987 included some 50 projects requiring aggregate financing ofN139 million or US$35 million equivalent. Loan commitments by NBCI in 1987for SHE projects with assets below MS million under Loan 2376-UNI wereabout US$21 million for some 90 projects. Given that NBC1 and NAL accountfor a very small portion of SME lending in Nigeria, the overall pipeline ofthe Nigerian banking system and hence credit demand are significantlylarger. In addition, the ongoing nationwide Entrepreneurship DevelopmentPrograms (para 2.24) are expected to result in some 500 new SSEs each yQarEven if only one-half of these projects were to materialize, the creditdemand for such new SSEs alone would amount to about US$35 millionannually. The Pilot Studies Facility (para 3.09) would also help generatea significant pipeline of bankable SHE subprojects, and participation ofthe entire banking system with extensive branch networks would extend theoutreach of the Project in all parts of the country. The proposed amountof US$200 million for the line of credit comprises: (i) US$75 million forcredit for fixed investments and associated permanent working capital needsof both existing and new smaller SMEs, e.g. enterprises with assets belowUS$1.25 million; (ii) US$75 million for fixed investments and associatedpermanent working capital needs of larger SMEs with assets between US$1.25million and US$2.5 million; and (iii) US$50 million for financing of freestanding working capital needs of existing SMEs. In view of the above, theline of credit is expected to be committed quickly, well within the 45months assumed for the purposes of the project implementation schedule(para 4.26).

3.17 As for equipment leasing, the annual value of leased assets hasincreased from N24 million or US$35 million equivalent in 1982 to N110million or US$81 million equivalent in 1986 (Annex 2-8). The averageannual growth rate of assets acquired for lease during 1982-86 was thus 23?(calculated on the basis of data expressed in US dollar terms). Given theunder-capitalization of SMEs, their lack of collateral and the scarcity ofalternative sources of term financing, prospects for continued significantgrowth of the leasing industry are promising. For example, the NAL whichhad a 2.7? market share in 1986 based on leased assets acquired at originalcost, received applications for lease financing in the amount of N28million (or US$7 million equivalent) from enterprises with assets below N6million during January-September 1987. The proposed amount of US$30million for the equipment leasing component is, therefore, expected to becommitted quickly well within the 45 months assumed for the purposes of theproject implementation schedule. The loan amounts allocated to the pilotfinancial restructuring and the pilot mutualist credit guarantee schemecomponents are relatively small at US$20 million and US$5 million,respectively.

IV. PRINCIPAL FEATURES OF THE LOAN

A. The Loan and Institutional Arrangements

4.01 The proposed Bank loan of US$270 million will be made to theFederal Government of Nigeria at the Bank's standard variable rate for 20years, including 5 years of grace with a commitment fee of 0.75Z. of thetotal loan proceeds, the Government will (a) pass on US$268.2 million

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equivalent to CBN for: the line of credit (US$200 million); pilotfinancial restructuring component (US$20 million); pilot mutualist creditguarantee scheme (US$5 million); equipment leasing component (US$30million); pilot studies facility for S4Es and entrepreneurs (US$5 million);technical assistance for the SME Apex Unit and PBs (US$1.5 million);further policy and future project preparation work in the industrial andfinancial sectors (US$1 million); and an unallocated amount of US$5.7million in view of the pilot nature of several components, and which couldbe allocated by the Bank to any project component based on experienceduring project implementation (para 3.14); (b) onlend US$1 millionequivalent to NBCI for strengthening of its operations at the same termsand conditions as are applicable to the Bank loan, and under an agreementacceptable to the Bank (the NBCI agreement); and (c) retain the remainingloan amount of US$0.8 million equivalent for technical assistance to FMIfor SHE related studies. The amount of US$268.2 million to CBN will bepassed on by the Government under a subsidiary administration agreement onterms and conditions acceptable to the Bank (para 4.03). A ProjectAgreement will be signed between the Bank and CBN. The signing of anagreement between the Government and NBCI under terms and conditionssatisfactory to the Bank will be a condition of disbursement under thetechnical assistance to NBCI component.

4.02 In departure from the Bank's past approach of lending to theNigerian industrial sector through single financial intermediaries, NIDBand NBCI (para 2.45), funds under this loan would be made available to thebanking system as a whole under an apex arrangement. This approach wouldenhance competition among the banks and extend credit availability to allviable SHEs/entrepreneurs on a nationwide basis. A SME Apex Unit has beenestablished in CBN to administer the line of credit, the financialrestructuring component, the mutualist credit guarantee scheme, theenuipment leasing component, and the pilot studies facility on behalf ofthe Government. In view of its extensive involvement in regulating thefinancial sector (regulation and supervision of the banking system, creditpolicies, etc.), CBN is the most suitable institution to play that role.To avoid undue delays in the operation of the credit lines (processing offinancing proposals and disbursements), the SME Apex Unit was set up as asmall, separate, largely autonomous entity within CBN, reporting directlyto the Deputy Governor for Monetary and Banking Policy. It will mainlyperform the role of a disbursing agent with additional administrative tasksincluding the monitoring of overall implementation of the SME creditcomponents by the participating banks (PBs)--eligibility criteria,procedures for procurement, disbursements, and repayments, etc. The Unitwill be staffed initially with a Unit Manager with extensive experience inadministration, development and general banking, and accounting, two otherprofessional staff, and support staff as required. The Project wouldprovide technical assistance, i.e., experts to help organize the systemsand procedures and provide on-the-job training, equipment includingmicrocomputers, and training. Arrangements satisfactcry to the Bank forthe employment of consultants for the SME Apex Unit will be a condition ofloan effectiveness. More staff will be added as the need arises.

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4.03 Assurances have been obtained from the Government on theonlending arrangements as well as on the eligibility criteria for financialintermediaries, beneficiary enterprises and subprojects, subloan processingand administration, and onlending terme and conditions as described in thefollowing paragraphs. The signing of a subsidiary administration agreementbetween the Government and CbN defining the functions and responsibilitiesof the latter, and on terms and conditions acceptable to the Bank will be acondition of loan effectiveness. A circular outlining the conditions andprocedures for the utilization of the four credit lines and the pilotstudies facility, including a standard participation agreement to beentered into between CBN and PBs will be prepared by CBN, in consultationwith the Bank; its issuance will be a condition of loan effectiveness.

S. Eligible Financial Intermediaries

4.04 In order to reach a broad spectrum of private enterprises on anationwide basis, the loan will be made available to all sound banks whicharet (a) ln complian 'e with the CBN's creditworthiness criteria and otherterms and conditions satisfactory to the Bank (Annex 4-1); (b) interestedin term lending and project financing; and (c) willing to adhere to thespecific guidelines uwider the Project. Financial intermediaries which arenot in compliance with the CBN's regulations temporarily may be givenaccess to the credit lines provided they are in the process of implementinga restructuring program acceptable to CBN and the Bank. The PBs will bearthe full credit risk on subprojects and studies financed by them, and beresponsible for their appraisal and supervision.

4.05 As for the mutualist credit guarantee scheme for lending tomicroenterprises, it is expected that a significant part of the funds wouldbe channelled through NBCI because of its extensive past experience inlending to small scale enterprises (SSEs). All PBs will, however, beeligible for participation in the scheme. Since commercial banks are notat present allowed to engage in equipment leasing in Nigeria, only eligiblemerchant banks and NBCI would participate in the equipment leasingcomponent.

4.06 Prior to drawing on the Bank loan funds under the line ofcredit, financial restructuring, mutualist credit guarantee scheme, andequipment leasing components, and the pilot studies facility, each PB wouldbe required to sign a participation agreement with CBN on terms andconditions satisfactory to the Bank. The signing of at least three suchparticipation agreements for the line of credit component will be acondition of loan effectiveness. Adoption by CBN of detailedimplementation procedures, satisfactory to the Bank, will be a condition ofdisbursement under the mutualist credit guarantee scheme.

C. Eligible Beneficiaries and Subprojects

4.07 General. With the exception of subsistence agriculture, realestate, commerce, finance and insurance, hotels and construction, allprivate sector SMEs which operate in any economic sector (includingmanufacturing, agro-allied industries, mining, quarrying, industrialsupport services, equipment leasing and other ancillary service activities)and are 10O Nigerian-owned will be eligible for financing. In the case ofnew manufacturing enterprises under the line of credit component, the share

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of locally sourced raw materials of the total raw materials would have tobe at least 40Z with the objective of reaching 60Z by September 1992. TheProject would finance rehabilitation, expansion, and energy savinginvestments of existing enterprises as well as the establishment of newenterprises in the following general categories: (a) fixed assets(machinery, equipment, factory buildings and related civil works, know-howand consultancy services, and training); (b) permanent working capital(initial stocks or increases in stocks of raw materials, spare parts andcomponents); (c) free-standing working capital (raw materials, spare partsand components) to expand capacity utilization of existing firms; and (d)consultancy services for technical assistance and training during bothsubproject implementation and operations. In view of the need to improvethe capital structure of Nigerian enterprises which are generallyunder-capitalized, proceeds of the line of credit and the financialrestructuring components could also be used by the PBs to finance theirequity and quasi equity investments (e.g., convertible debentures andpreferred, non-voting shares) in corporate enterprises (para 2.39).

4.08 Subprojects eligible for financing under the Project would haveto be technically, financially and economically sound demonstrating goodpotential for adjusting to or operating under the new incentive system. Anevaluation of market potential as well as technical and managerial capacityof enterprises would have to be carried out. PBs would also mal-e anassessment of the environmental aspects of all subprojects to ensure thatthey do not have a negative impact on the environment.

4.09 The line of credit, financial restructuring and equipment leasingcomponents would support enterprises with assets, defined as existing fixedassets (excluding land) plus investment under the Project, not exceedingN10 million in constant 1988 prices (or US$2.5 million equivalent). Theseceilings would enable the Project to assist not only SMEs as conventionallydefined in Nigeria (para 2.17), but also provide access to long-termforeign exchange resources for private sector enterprises at large. Hostenterprises are currently in urgent need of credit to improve theircapacity utilization and adjust to the new policy regime throughrehabilitation, modernization and expansion of capacity, including changesin manufacturing processes to shift from imported to local raw materials.An additional benefit of a broader reach is the maintenanca of employmentin existing viable or potentially viable enterprises. For the purpose ofthe mutualist credit guarantee scheme, the beneficiary microenterpriseswould be defined as those with existing iixed assets (excluding land) pluscost of the subproject of up to N400,000 in constant 1988 prices (orUS$100,000 equivalent). Specific eligibility criteria for beneficiaryenterprises and subprojects under various components of the Project aredescribed in the following paragraphs.

4.10 The Line of Credit. Eligible beneficiaries should befinancially sound, able to contribute at least 25Z of the subproject costin equity and from internally generated cash. During subprojectimplementation and for five years after start-up of operations,beneficiaries shall maintain a long-term debt to equity ratio of not morethan 3:1, a curr¢nt ratio of at least 1.2, and a debt service coverageratio of at least 1.4. The PBs would be expected to finance from their ownresources about 10? of the subproject cost to ensure their commitment; thiscontribution can be made within or outside the subloans themselves, or in

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the form of equity/quasi eqi!ity financing. The PBs would analyze therepayment capacity of the enterprises for all subprojects.

4.11 While the methodology for subproject appraisal by the PBs woulddepend on the subproject size, their appraisal will include the calculationof the financial rates of return (FURs) for all subprojects vith costs overNO.8 million in constant 1988 price. (US$200,000 equivalent). Calculationof the economic rates of return (ERRs) would also be required forsubprojects with costs over U4 million in constant 1988 prices (US$1million equivalent). FRR (after tax) and ERR each would have to be atleast 122 in constant prices. For subprojects with costs below N0.8million, only a cash flow analysis of the enterprise would be undertaken.Maximum financing from the Bank loan would be 702 of the subproject costfor eligible enterprises. Maximum subloan with loan proceeds for freestanding working capital would be N2 million in constant 1988 prices (orUS$0.5 million equivalent). Financing for free standing working capital(raw materials, spare parts and components), with loan proceeds, should beincremental, resulting from a plan to increase utilization of installedproduction capacity. To ensure that the Project will benefit a reasonablylarge number of beneficiary enterprises, the overall maximum outstandingamount of financing to any individual firm or a group of relatedenterprises with loan proceeds would be N7 million in constant 1988 prices(or US$1.75 million equivalent).

4.12 The Pilot Financial RestructurinR Component. While the precisefinancial arrangements and terms of the restructuring would have to beestablished on a case-by-case basis, the following broad investmentguidelines would be followed (Annex 4-2). In general, eligible enterpriseswould have to be potentially viable but have tight debt service ratios dueto overindebtedness. The equity participation by the banks in arestructured enterprise would be such so as to maintain at all times aminority equity participation. The Bank loan funds would be used tofinance only increases in working capital (raw materials, spare parts andcomponents) and fixed assets (mainly for removing physical bottlenecks inthe plants), consultancy services, and training. The cost of preparationof the restructuring workouts by the enterprises would also be eligible forBank financing. The subprojects would be financed only if theirincremental FRR (after tax) and ERR exceed 122 in constant prices. Todetermine if a restructuring package ie viable, on the basis of reasonableassumptions, the proposed workout strategy should enable the company toservice its debt adequately while maintaining a sufficient level ofliquidity. Criteria to be used would include debt service coverage ratiosof not less than 1.0 in every year of the subproject, averaging not lessthan 1.2 during the entire period with the projected current ratios of notless than 1.2 at any time. The Bank loan would finance up to 1002 of theeligible cost of the subproject. The overall maximum outstanding amount offinancing to any individual enterprise or a group of related enterpriseswith loan proceeds would be N7 miliion in constant 1988 prices (or US$1.75million equivalent).

4.13 The Pilot Mutualist Credit Guarantee Scheme. Eligiblebeneficiaries should be members in good standing with their respectivemutual guarantee associations (MGAs) such as MAN and NASSI. In view of thesmall size of the subloans (maximum of N100,000 or US$25,000), simplifiedappraisal procedures will be adopted by the PBs, e.g., the cash flow

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analysis. The MGAs will have to satisfy themselves with the creditworthi-ness of their members, business outlook, and prospects for repayment ofsubloans, and provide a full guarantee on subloans extended by the PBs.Most subloans are expected to be used for financing expansion,rehabilitation, and working capital needs of existing enterprises. TheBank loan would finance 10OZ of the subloans.

4.14 The Eauirment Leasing Component. The financing for equipmentleased by an enterprise under the Project would be extended only tofinancially and economically viable enterprises as demonstrated throughsimple payback period tests with a maximum payback period of up to 6 years,calculated on the basis of the installed cost of the equipment and theestimated annual net cash flow generated from the equipment. Emphasiswould also be placed on the lessee's creditworthiness, ability to servicethe lease payments, and the quality of management. All industrial andbusiness equipment and machinery, energy conservation equipment to improveenergy efficiency in the industrial sector, and related costs of transport,handling, insurance and installation costs would be eligible for financing.The PBs would be expected to finance from their own resources about 15Z ofthe leased assets. Maximum lease amount financed from loan proceeds wouldthus be 85Z of the cost of the leased equipment. No individual lease withloan proceeds under the Project will exceed N2.5 million in constant 1988prices (or US$625,000 equivalent). The overall maximum book value ofleased equipment with loan proceeds and outstanding, to any individual firmor a group of related firms would be N2.5 million in constant 1988 prices.

D. Subloan Processing and Administration

4.15 The commercial risk of the subloans/investments lies with thePBs. They would be responsible for the appraisal of subprojects. Thefirst three financing proposals (i.e., appraisal reports) from each PB, foreach financing component under the Project, will be sent to the Bank(through the SME Apex Unit) for review prior to approval. On the basis ofthis review and of its assessment of the appraisal standards of the PBconcerned, the Bank will establish an appropriate free limit for a subloan,investment and lease financing for each intermediary. Thereafter, the PBswould be allowed to extend financing under the Bank loan for eligiblesubprojects up to the free limit. The PBs' compliance of the eligibilitycriteria for free limit subprojects will be monitored by independentauditors during annual audits of the PBs' project accounts (para 4.35).Subprojects above the free limit will be sent by the SME Apex Unit, afterverification of their eligibility and within two weeks of their receipt, tothe Bank for its review and approval. The levels of free limits will bekept under review by the Bank, and will be adjusted as necessary duringproject implementation. It is expected that, on average, not more than 20Zof the total number of subloans would require Bank review prior toapproval. The PBs' submissions for subprojects to the SME Apex Unit wouldbe in accordance with the Bank's normal standards for IDF subprojects. ThePBs will be fully responsible for the supervision and monitoring ofsubprojects both during and afteL implementation. The PBs will alsoprepare and submit to the SME Apex Unit a brief subproject completionreport within six months of physical completion of the subproject,comparing performance with appraisal estimates. The CBN will holdinitially two orientation seminars and two follow-up seminars for the staffof the PBs to familiarize them with the procedures of subloan processing

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and administration. The CBN will also advertise the Project regulerly toensure that SMEs are aware of these sources of finance.

4.16 For subprojects above the free limit, the submission by the PBs(through the SME Apex Unit) for the Bank's approval would include: (a) adescription of the beneficiary and an appraisal of the subproject,including its technical, economic and financial viability and environmentalaspects carried out in accordance with guidelines satisfactory to the Bank;(b) the proposed terms and conditions of the subloan, equity investment orleasing operation as applicable; (c) in respect of a restructuringsubproject, a restructuring plan, satisfactory to the Bank, including ananalysis of the managerial, marketing, production and financial aspects ofthe enterprise; (d) a list of goods and services to be financed out ofproceeds of the Bank loan; (e) the method of procurement of the goods andservices; and (f) such other information as the Bank may reasonablyrequest.

4.17 Business Advisory Services. The importance of integratingbusiness advice with the provision of credit by the banks to smallerborrowers has been underscored by the experience of many developingcountries including those in Africa. In Nigeria, the merchant banksprovide some business advisory services to their corporate clients. ThePBs, particularly the commercial banks would, therefore, be encouraged(although this would not be financed under the Project) to provide businessadvisory services to SME clients as an integral part of project financing,thus complementing technical and managerial assistance from otherinstitutions. By establishing such services, the PBs would assist theirclients in managing their enterprises more efficiently. The staff of thebusiness advisory units would act as financial diagnosticians, assistingclients with specific problems that may arise from time to time, andhelping them obtain more specialized professional services from outside asand when required. Specifically, business advisory services are needed inthe following areas: (a) accounting, budgeting, management of cash,finance, credit and insurance; (b) marketing, purchasing and inventorycontrol; (c) plant and equipment maintenance; (d) company registration,organization and statutory requirements, and office and personnelmanagement; and (e) taxation and legal obligations. The PBs will levyappropriate charges for such services. The Government would approach theCommonwealth Fund for Technical Cooperation for such assistance.

4.18 Training in Proiect Appraisal. In addition to NBCI, merchantbanks and most commercial banks are considered to have adequate expertisein financial and creditworthiness analysis as well as technical appraisalswith assistance from specialized consultants as necessary. On the otherhand, with the exception of NBCI, they are unfamiliar with economicanalysis. In order to fully familiarize the staff of prospective PBs withproject appraisal, particularly economic analysis, as well as supervisionand monitoring procedures, the Project would finance a series of trainingseminars and follow-up case study workshops under the coordination of theSME Apex Unit. Appropriate standard formats to be used by the PBs forproject appraisal of various sizes of subprojects will also be prepared.

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E. Onlendina Terms and Conditions

4.19 The CBN would make funds available (on behalf of the Government)to the PBs at a variable rate, equal to the prevailing CBN rediscount rate.The rate will be adjusted whenever there is a change in the rediscountrate. The final onlending rates to beneficiary enterprises will bedetermined by the PBs and will be variable. The PBs will adjust the finalonlending rates in accordance with changes in the rediscount rate. Basedon the current rediscount rate of 12.752 and lending rates of about 16 to182. spreads to the PBs are likely to range between 3.25 and 5.252 vhichshould be adequate to cover their administrative costs and lending risks,and to provide a reasonable profit. The onlending rates tomicroenterprises under the mutualist credit guarantee scheme will also bevariable and market-based; the sharing of the spread among the PBs, MGAsand the MGAs' mutualist credit guarantee funds (to expand their borrowingcapacity and cover losses from defaults) will be determined in consultationwith tVe Bank on the basis of findings of the study for this component(para 3.11). The PBs will pay to the CBN a commitment fee of 0.752 on theundisbursed committed amounts, which they will pass on to the finalbeneficiaries. Assuming an inflation rate of about 152 for 1989 and 102thereafter, the onlending rates are expected to be positive in real terms.The SME Apex Unit will monitor the experience of onlendiiig rates andspreads during project implementation, and as appropriate the matter ofonlending rates will be reviewed with the Bank (para 4.23).

4.20 In accordance with the above arrangements, subloans will bedenominated in naira terms, and the FEM rate prevailing on the date ofdisbursements out of the loan will be used to convert the foreign currencyinto naira equivalent. The Government will, therefore, bear the foreignexchange risk for a fee implicit in the differential between the CBN'sonlending rate to the PBs (currently 12.752) and the interest rate on theBank loan (currently 7.592). Out of the interest payments due from thePBs, the CBN would keep an annual administration fee (about 12 of thesubloan amounts outstanding) to cover its expenses for administering theProject, and it would pay to the Government (Federal Ministry of Financeand Economic Development) the remaining spread on Bank funds according to aschedule corresponding to receipts of interest payments due to it from thePBs.

4.21 Subloans under the line of credit and financial restructuringcomponents for fixed assets and free-standing working capital would havematurities up to 12 years and 3 years, respectively, including graceperiods of up to 3 years and one year, respectively. Subloans forpreparation of the restructuring workouts under the financial restructuringcomponent, and studies under the pilot studies facility will havematurities up to 3 years, including grace periods of up to one year.Subloans for fixed assets and free standing working capital under themutualist credit guarantee scheme would have maturities of up to 5 and 2years, respectively, including grace periods of up to 12 months and 6months, respectively. The PBs would be allowed to write leases under theequipment leasing component for up to 10 years, including up to 2 yearsgrace. The above maturities are substantially longer than those of creditsextended by the banks in Nigeria at present. This s provide anincentive for banks as well as for enterprises to make use of the fundsunder the Project. For the PBs' equity and quasi equity investments under

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the line of credit and the financial restructuring components, a flexibledivestment policy satisfactory to the Bank would be adopted, with anaverage holding period of about six years. The divestment policy wouldinclude a buyback option for the enterprise owner to purchase the bank'sequity at its estimated market or predetermined value. The equityinvestments would be expected to yield an after tax return of 121 in realterms.

4.22 Repayments from the PBs to CBN for each subloan would be on thebasis of the fixed amortization schedule as given in the appraisal reportat the time of the subloan approval and financing by the SHE Apex Unit.Repayments of equity and quasi equity investments from the PBs to CBN wouldalso be on a fixed amortization schedule for a period of up to 10 years.However, the PBs will be required to pay immediately to CBN any prepaymentof subloans from the final beneficiaries or any divestiture of investmentsby it. Onlending to beneficiary enterprises by the PBs will be undersubloan, investment or lease agreements on terms and conditions satisfac-tory to the Bank. The funds repaid by the PBs to the CBN and not yet dueto the Bank will be deposited in a separate account, and will be used bythe Government to finance SHEs with objectives and financing arrangementsconsistent with those under the Project.

4.23 The level of commitment of resources to SMEs, eligibilitycriteria for the PBs, beneficiary enterprises and subprojects, ownership ofthe SMEs, sourcing of raw materials, and onlending terms and conditionsunder the Project will be reviewed at least annually to identify andimplement changes, if needed, to ensure the successful implementation ofthe Project.

F. Proiect Implementation Arrangements and Schedule

4.24 Proiect ManaRement. In view of the complexity of the Projectinvolving several components and institutions, the Government wouldestablish a high level Project Coordination Committee (PCC) to ensureeffective coordination of implementation of the overall Project. The PCCwill be presided over by the Federal Ministry of Finance and EconomicDevelopment, and will include the following other members: the head of theSME Apex Unit, one member each from CBN, FMI, NBCI, participatingcommercial banks, and participating merchant banks. It will reviewregularly the progress of the overall Project, closely monitorimplementation of the more experimental project aspects, and coordinatetimely action to remove any constraints affecting project implementation.The PCC will be assisted by the technical staff of the SME Apex Unit--whichwill perform as its Secretariat--for follow-up actions and to coordinatesubmission of regular progress reports on the overall Project to the Bank(Annex 4-3). The PCC will meet at least once every three months. Itsestablishment with membership and responsibilities acceptable to the Bankwill be a condition of loan effectiveness.

4.25 The SME credit components will be managed by the SME Apex Unitin accordance with the procedures described earlier in this Chapter.Subprojects will be prepared by enterprises with assistance, as necessary,from consultants. The PBs will be responsible for (a) ensuring that thesubprojects meet the eligibility criteria; (b) appraisal and supervision ofthe subprojects financed by them; and (c) reviewing implementation

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arrangements for subprojects. They will be required to submit to the CBNsemi-annual progress reports on their subprojects. The CBN would reviewthese reports and make available a summary to the Bank as part of itsregular reporting requirements. rne technical assistance component will beimplemented by eacks executing agency, e.g., CBN, FMI and NBCI. The PilotStudies Facility for technical support to SMEs will be administered by theSME Apex Unit in CBN and channelled through the PBs. Training workshops insimple business skills, including bookkeeping, accounting and cash flowprojections will be coordinated by FMI, and are expected to be deliveredthrough training institutions and local consultants.

4.26 Implementation Schedule. The funds under the SHE creditcomponents are expected to be committed over about 45 months--January1989-September 1992. The Project will finance subprojects approved by thePBs for free limit subloans, investments and leasing operations, and thosesubmitted by the SME Apex Unit to the Bank for approval until September 30,1992. Since subprojects will be for SMEs, they are expected to have amaximum implementation period of about 24 months, giving an overallimplementation period for the SHE credit components of about six years(i.e., September 30, 1994). All activities under the technical assistancecomponent except the studies to regularly monitor the economic and socialimpact of subprojects 'para 4.34) are expected to be completed by September1992. Key indicators for project implementation are given in Annex 4-3.However, based on the Bank's experience as reflected in the standardprofile for disbursement for the industrial development and financeprojects Bankwide, the overall Project is assumed conservatively to becompleted by September 30, 1995, implying a 7-year implementation period.

G. Procurement

4.27 Procurement arrangements are summarized in Annex 4-4. The SMEApex Unit would have the overall responsibility for ensuring that suitableprocurement procedures are followed by the PBs. Procurement procedures forgoods and services financed under the Project would follow standardpractice for Bank IDF type projects, and will be from sources eligibleunder the Bank guidelines. The PBs would have direct responsibility forensuring the competitiveness, in price and quality, of items procured andtheir suitability for the purpose intended. All bid packages of valueexceeding US$250,000 equivalent would be procured upon the basis ofcomparison of price quotations solicited from a list of three qualifiedsuppliers eligible under the Bank guidelines, and contracts will bereviewed by the PBs prior to award. For bid packages with values less thanUS$250,000 equivalent, the PBs would assure themselves that the mainsources of supply have been canvassed and that the purchasing is from themost advantageous sources. Procurement of vehicles and equipment under thetechnical assistance component (estimated to be less than US$300,000 intotal) would be upon the basis of comparison of price quotations solicitedfrom a list of three qualified suppliers eligible under the Bankguidelines. All appraisal reports of subprojects by the PBs will include alist of goods and services to be financed under the Bank loan, and themethods of procurement; appraisal reports of subprojects above the freelimit will be reviewed by the Bank prior to approval.

4.28 Consultants for technical services under the Pilot StudiesFacility, for which the maximum size of a contract is not expected to

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exceed US$5,000 equivalent, will be selected by the SMEs and entrepreneursthemselves; the PBs will be responsible for ensuring the quality ofservices, and that services are obtained from the most advantageous source.Consultants for technical- Itvices and training under the technicalassistance program financed with loan proceeds would be contracted inaccordance with the Bank's guidelines for the use of consultants. Much ofthe consultant services, studies, and technical assistance are, however, ofa nature and scope to allow the extensive use of Nigerian consultants andexperts. Those activities requiring the use of foreign firms and expertswould be linked with training programs in order to ensure the transfer ofknow-how. All consultancy contracts for studies and training under thetechnical assistance component would have terms of reference and consultantselection subject to the Bank's prior approval. However, due to manyshort-term assignments, terms of the negotiated contracts for consultantsand training below US$50,000 would be subject to post-approval review byBank supervision missions. To proceed with the establishment of the SMEApex Unit and the employment of consultants for technical assistanceactivities, the Bank loan will retroactively finance up to US$350,000 ofeligible expenditures incurred after June 1, 1988.

4.29 As noted above, all subproject appraisals by the PBs wouldinclude a discussion of procurement procedures used or to be followed,responses received, prices quoted and criteria for selection of goods andservices. As part of their normal supervision of subprojects, the PBswould review the procurement aspects to assure that procurement is fromeligible sources and for eligible goods, works and services, and thatadequate commercial practices have been followed. The PBs would berequired to maintain records of the procurement methods and documents andto monitor the utilization of subloan funds. PBs' compliance with theprocurement guidelines will be monitored by the SME Apex Unit, and reviewedselectively during supervision missions by the Bank.

H. Allocation and Disbursement of Bank Loan

4.30 The proposed allocation of the Bank loan and percent expendituresto be financed are given in Annex 4-5. To facilitate disbursements, twospecial accounts (revolving funds) will be established in US dollars inbanks acceptable to the Bank. The first special account will be in CBN andwould have an authorized allocation of US$15 million, equivalent to anaverage disbursement for about four months, for the SME credit componentsand technical assistance program administered by the CBN. The secondspecial account would be in a commercial bank and would have an authorizedallocation of US$100,000 for the technical assistance program administeredby FMI. The CBN would also be authorized to establish, out of its specialaccount and in a manner satisfactory to the Bank, sub-accounts in USdollars in the PBs to expedite disbursements. The handling of thesub-accounts by the PBs will be in accordance with the accounting controlsto be set up by CBN, and compliance of which will be monitored by CBN.Replenishment of withdrawals from the special account for advances tosub-accounts will be made only against supporting documentation fordisbursements out of sub-accounts by the PBs. These requirements wereagreed upon during negotiations, and would also be explained in thedisbursement letter.

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4.31 Disbursements will be against full documentation except fortraining, and contracts valued less than US$500,000 equivalent each, whichwould be against statements of expenditure (SOEs). Documents in support ofSOEs will be retained by the SME Apex Unit and KMI for their respectivecomponents, and made available to the Bank for review during supervisionmissions. Only expenditures made no more than 180 days prior to thereceipt by the Bank of information relating to a free limit subloan,in.-estment and leasing operation as applicable, or before receipt of therequest to the Bank for approval of subprojects above the free limit wouldbe eligible for reimbursement. This extension of the Bank's normal 90-daylimit under IDF projects is justified in view of the longer period requiredfor transactions under a two-tier credit system.

4.32 Documentation to be submitted by CBN to the Bank, prior to arequest for authorization to make withdrawals from the loan account orpayments out of the special account in respect of expenditures for asubproject on account of a free limit subloan, investment or leasingoperation as appropriate would include: (a) a summary description of thebeneficiary and of the appraisal of the subproject, including itstechnical, economic and financial viability and environmental aspects inaccordance with guidelines satisfactory of the Bank; (b) a list of goodsand services to be financed out of proceeds of the Bank loan; (c) themethod of procurement of the goods and services; and (d) terms andconditions of the subloan, investment or leasing operation as appropriate.

4.33 Disbursement Schedule. In accordance with the standarddisbursement profile for IDF loans and credits Africa Region-wide, the Bankloan is assumed to be disbursed according to a schedule given in Annex 4-6.The loan closing date will be March 31, 1996.

I. Monitoring

4.34 In order to monitor closely the economic and social impact of theSME subprojects financed under the Bank loan, the CBN will undertakeregular reviews (tracer studies based on end-use analysis) of thesubprojects on an ex-post basis, with a comparison of ex-ante appraisaldata and ex-post results. These reviews, financed under the Project (para3.11), will cover the effects of factors such as scale of operations, levelof technology, resource use, rural vs urban, employment generation,capital/labor and capital/output ratios, local value added, etc. Thefirst such review will cover the first two years of the Project and the CBNwill prepare and submit to the Bank a report by December 31, 1990.Thereafter, reviews will be undertaken every twelve months until the loanclosing date, and reports will be submitted to the Bank by December 31 ofthe relevant year. These reviews will help trace the impact of thesubprojects, and build up a comprehensive data base on SMEs. Theexperience gained should also contribute to improvements in the Governmentpolicies toward SME development.

J. Accounting. AuditinR. and Reporting Requirements

4.35 The CBN would maintain separate accounts and adequate recordsto reflect the project's operations and financial situation, as well asseparate accounts and adequate records related to the PBs in accordancewith sound accounting principles consistently applied. The FMI and NBCI

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would maintain separate accounts and adequate records in accordance withsound accounting practices to reflect operations in respect of theirtechnical assistance programs. The CBN, FMI and NBCI would have theirrespective project accounts, including withdrawals from the specialaccounts and withdrawals made on the basis of SOEs, audited by independentauditors acceptable to the Bank in accordance vith appropriate accountingprinciples consistently applied, and submit the audited accounts with theaudit reports to the Bank within six months after the end of each fiscalyear. The CBN will also submit to the Bank monthly reports upon thetransactions of the special account. The audit reports for the CBN, PMIand NBCI will include a separate opinion on whether satisfactory proceduresare in operation regarding the use of SOEs, and, in the case of CBN, also aseparate opinion on whether satisfactory procedures are in operationregarding the use of sub-accounts. The CBN will require the PBs to: (a)follow accounting and auditing procedures for their project accounts,including withdrawals from the sub-accounts, similar to those mentionedabove and submit the audited accounts with the audit reports to CBN withinsix months after the end of each fiscal year. The audited project accountsof the PBs would also include a statement by the auditors on the complianceby the PBs on the eligibility criteria of subprojects financed by them; (b,submit to CBN monthly reports upon the transactions of the sub-accounts;and (c) submit their audited financial statemeuLts to CBN; thisdocumentation will be reviewed on a selective basis by the Bank duringsupervision missions.

4.36 PBs will be required to submit to CBN project progress reports atleast semi-annually within six weeks after the end of each semester. Basedon inputs from the PBs and its own analysis and review, the CBN willprepare a consolidated project progress report semi-annually on the overallProject except the technical assistance related to FMI, and submit it tothe Bank within two months after the end of each semester (Annex 4-3). TheCBN will prepare quarterly progress reports on the pilot components, i.e.,financial restructuring, mutualist credit guarantee scheme and the PilotStudies Facility for SMEs, and submit them to the Bank within six weeksafter the end of each quarter. The PBs will also be required to prepareand submit to CBN a brief completion report on each subproject within sixmonths after subproject completion; such reports will be made available tothe Bank for review during supervision. This would be in addition to anoverall completion report on the entire Project to be prepared within sixmonths after the loan closing date for the Project. FMI and NBCI willprepare and submit to the Bank semi-annual progress reports related totheir technical assistance programs under the Project within six weeksafter the end of each semester.

V. PROJECT BENEFITS AND RISKS

5.01 Proiect Berefits. The integrated package of institutional andfinancial support programs under the proposed Project would foster astronger private sector. The Project would provide critical support to theGovernment's efforts in stimulating productive activity and generating asustained supply response in the context of the new policy environment.Resumption of growth, maintenance of employment in existing and viableenterprises, and the generation of new employment are major Government

- 40 -

objectives to alleviate the social cost of the adjustment process andthereby enhance its sustainability. SMEs supported by the Project areexpected to be complementary to and have significant linkages with theagriculture sector and larger enterprises. They would thereby lead to ashift in the industrial structure consistent with Nigeria's resourceendowments and comparative advantage. SMEs should also make substantialcontribution to developing an industrial tradition over time by providing aseed-bed, at the grass-roots level, to help develop scarce entrepreneurialcapabilities, management skills, and technological infusion.

5.02 The Project would improve the quality and range of financialservices available to the SME sector. It would put in place an apexmechanism designed to foster active participation of the entire bankingsystem in term lending and SME financing. The line of credit componentwould also finance working capital to ensure more efficient utilization ofexisting assets and the maintenance of employment. The equipment leasingprogram would provide greater flexibility to SMEs, which generally haveless bankable collateral, insufficient asset and capital bases, and areunder-capitalized. The financial restructuring component would helprestructure selected overleveraged firms, which are potentially viable butare underutilizing installed capacity, and improve their profitability; itwould also serve to upgrade the financial engineering capability of theparticipating financial institutions. In addition to help salvageinvestment resources, this component should enable the preservation of'industrial capabilities" that have been built up through these firms atthe level of management and skilled labor, and help minimize the negativeemployment impact. The mutualist credit guarantee scheme should lead toinnovations in the financial system by involving NGOs in the delivery ofcredit, and particularly benefit low-income microenterprises who, becauseof their small size and lack of collateral, are generally unable to borrowthrough the normal banking channels. The entrepreneurship developmentprogram would assist in creating first geaeration local entrepreneurs andhelp establish small scale enterprises to generate productiveself-employment. The Pilot Studies Facility for technical assistance toSMEs with the involvement of the banking community is expected to make thedelivery of non-financial support services responsive to the needs of theprivate sector SMEs, as well as help develop the nascent local consultingindustry in Nigeria. The unquantifiable economic benefits of training aswell as technical assistance add to the attractiveness of the Project.

5.03 Proiect Risks. A major risk of the loan is the possiblereluctance of the banking system to engage in term financing for SMEs,perceived generally as more risky than traditicnal commercial financing,and this could result in a slow disbursement of the loan. This risk hasbeen minimized as the PBs will be free to determine the final onlendingrates to beneficiary enterprises. Another risk is that demand for newinvestments may be slow to materialize on account of the uncertainty overthe sustainability of the overall economic reforms, the pace of economicrecovery and high interest rates. It is expected that the Project willinitially finance mostly the rehabilitation, restructuring, expansion anddiversification of existirg enterprises. After the initial adjustment, andas the policy reforms are deepened, the revised incentive system should,however, provide a sustainable basis for the development of new investmentopportunities. The overall size of the credit components has been based onconservative demand estimates. Moreover, the Pilot Studies Facility for

- 41 -

studies would help generate a significant pipeline of bankable SMEsubprojects, and the participation of the entire banking system withextensive branch networks would extend the outreach of the Project in allparts of the country, which would further mitigate this risk. The pilotfinancial restructuring component and the pilot mutualist credit guarant ?scheme could also encounter a difficult start-up because of their newness.To minimize this risk, the amounts allocated to these components arerelatively mall, and the Project includes technical assistance for thepreparation of restructuring workouts. Finally, in view of themulti-component natare of the Project, and the past experience of weakproject implementation in Nigeria, there is always the risk of cloggedpaper work which may slow down project implementation. To mitigate thisrisk, the Project relies largely on the banking system which is moreefficient than Government departments or agencies. The SME Apex Unit inCBN, however, would have mainly an administrative role for the creditcomponents. The Project also includes technical assistance to the SME ApexUnit.

VI. AGREEMENTS AND UNDERSTANDINGS REACHED AND RECOMMENDATIONS

6.01 An SHE Apex Unit has been established in CBN to administer andmanage the Project with staff and responsibilities acceptable to the Bank(para 4.02).

6.02 During negotiations, the following major assurances andagreements have been obtained:

(a) the project financing plan (para 3.15), arrangements forchannelling the loan to the eligible PBs (paras 4.02 to 4.06) andthe eligibility criteria for beneficiary enterprises andsubprojects (paras 4.07 to 4.14);

(b) subloan processing and administration procedures (paras 4.15 and4.16);

(c) arrangements for training of banking staff in project appraisaland supervision (para 4.18);

(d) onlending terms and conditions (interest rates, spreads,maturities, and grace periods) (paras 4.19 to 4.23);

(e) the funds repaid by the PBs to the CBN but not yet due to theBank to be deposited in a separate account, and to be used tofinance SMEs with objectives and financing arrangementsconsistent with those under the Project (para 4.22);

(f) reviews at least once every year of the project progress with aview to identifying and making necessary changes for successfulimplementation of the Project (para 4.23);

(g) the procurement, disbursement, monitoring, accounting, auditingand reporting requirements (paras 4.27 to 4.36);

-42 -

(h) the establishment of the Pilot Studies Facility by December 31,1988, according to procedures and conditions acceptable to theBank, and arrangements for channelling funds to SMEs andentrepreneurs (para 3.09);

(i) the completion of a study by March 31. 1989, according to termsof reference satisfactory to the Bank, to formulate detailedimplementation arrangements for the mutualist credit guaranteescheme and to identify prospective NGOs (other than HAN andNASSI) for participation in the scheme (paras 3.06 and 3.11);

(j) the completion of a study by June 30, 1989, according to terms ofreference satisfactory to the Bank, to develop an appropriateregulatory and policy framework for equipment leasing, andimplementation of findings thereafter following exchange of viewswith the Bank (paras 3.07 and 3.11); and

(k) the other technical assistance activities (paras 3.10 to 3.13).

6.03 Conditions of loan effectiveness are:

(a) signing of the subsidiary administration agreement between theGovernment and CBN with terms and conditions satisfactory to theBank (para 4.03);

(b) arrangements satisfactory to the Bank for the employment ofconsultants to assist the SME Apex Unit in the administration andoperations of the SME credit components (para 4.02);

cc) the issuance by CBN of a circular to the banking system,satisfactory to the Bank, outlining the conditions and proceduresfor the utilization of funds by the PBs under the SME creditcomponents, and the Pilot Studies Facility (para 4.03);

(d) the signing of participation agreements between the CBN and atleast three PBs for the line of credit component with terms andconditions satisfactory to the Bank (para 4.06); and

(e) the establishment of a Project Coordination Committee (PCC). withmembership and responsibilities acceptable to the Bank (para4.24).

6.04 Specific conditions of disbursement are: (a) for each PBreceiving loan funds, signing of a participation agreement with the CBNoutlining the conditions and procedures satisfactory to the Bank forutilization of funds under the SME credit components and the Pilot StudiesFacility (paras 3.09 and 4.06); (b) for the mutualist credit guaranteescheme, the adoption by CBN of detailed implementation proceduressatisfactory to the Bank (para 4.06); and (c) for the technical ascistancecomponent for NBCI, signing of an agreement between the Government and NBCIunder terms and conditions satisfactory to the Bank (para 4.01).

6.05 On the basis of the above assurances and agreementsreached, the Project is suitable for a Bank loan of US$270 millionequivalent to the Federal Government of Nigeria at the Bank's standard

- 43 -

variable interest rate for twenty years, including a five-year grace periodand with a commitment fee of 0.75Z. The Government will pass on US$268.2million equivalent to CBN, and onlend US$1 million equivalent to NBCI underterm and condit.ins acceptable to the Bank.

AP4IESeptember 1988

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Index of Manufacturing Production by Selected Products, 1980-1986

(1972=100)

Soft Cotton Synthetic Refined Roofing Vehicle Soaps/

Drinks Beer Textiles Fabrics Paints Petroleum Cement Sheets Assembly Detergents

1980 514.0 604.8 257.3 n.a. n.a. 460.8 146.9 n.a. 2,808.2 449.5

1981 818.5 497.3 212.9 1,031.0 471.8 336,0 232.8 148.5 1,727.8 470.5

1982 1,006.0 509.3 258.5 1,175.0 474.3 353.4 272.8 243.3 5,463.3 467.0

1983 873.0 306.1 144.8 1,262.9 211.1 255.7 96.6 106.8 2,068.3 558.6

1984 921.6 419.4 103.9 639.1 243.1 251.7 60.9 113.2 689.3 334.1

1985 785.4 489.3 110.0 340.2 177.2 358.8 303.8 285.1 1,344.1 367.9

1986 644.1 587.3 73.5 646.2 149.5 338.3 285.1 350.1 687.8 247.!)

(Annual Percent Change)

1981 59.2 -17.8 -17.3 n.a. n.a. -27.1 85.9 n.a. -38.5 4.7

1982 22.9 2.4 21.4 14.0 0.5 5.2 17.2 63.8 216.2 -0.7

1983 -13.2 -39.9 -44.0 7.5 -55.5 -27.6 -65.0 -56.1 -62.1 19.6

1984 5.6 37.0 -28.2 -49.4 15.2 -1.6 -37.0 6.0 -66.7 -40.1

1985 -14.8 16.7 5.8 -46.8 -27.1 43.0 399.0 152.0 95.0 10.1

1986 -18.0 20.1 -33.2 89.9 -15.6 -5.7 -6.2 22.8 -48.8 -32.7

Source: Central Bank of Nigeria, various Annual Reports and Statement of Accounts.

AF41EDecember 1987

Nlt!A.ft lU11Y '2611 ND' KDIS EN16RP915E OEYtlOiN&T FHO*CT

_e__! .5e s-LsC-l Ind-t-. So,.na I98 I/

* .4 Na%.s6r.E.alo,"st. Cost of Imported . . S o, I. of

Nu.be, Outaut Yau Added Val. ND. of N. Nat."r,a1 Cae. tj, O Sol* ,. ye's .. ib in'

of Total S Shere Totl S Share Addad as 3 Pta4 * Shaee A. S of Total Ut, I ,o.at.oas P.e%..- of wsrh'ea the. 2 Years

F!! C'09D .cu) of Total '000 na- r-a) of Total of gLl* tk/ Ei gmtg of TtoL l Raw 0a to- a I is). A.&A kaM±aass h6sUh1.Ec.186

Non-Dosbl. Consos, Coods j1 Z.d 70l Ut 461 200 3 6 A 'd MM 0 7 39 56 A 2 4tl 9 a2 2 S S

Food, B-mraga. and Tobacco 293 17,036 11 1 5.656 5 4 33 2 2.440 19.9 27 3 64 2 " 7 70 0 4 64T..t.l. and W-1-.ng Apparl 80b 37,055 24 1 26.063 25 1 70 4 3.943 29 7 56 4 *5I S9 3 77 2 *1 7Foot.a., and Lather Prodct lSS 2.767 1.6 -602 -0 6 -21.6 292 2 2 36 4 5 7 36 41 2 92 4Prod.ct of R.bb., &,.d Pleatc 131 4.406 2.9 4,219 4 1 95.6 131 1 0 65 2 100 0 .3.2 1000Pape, and Paper P,od.cts 15 6,685 4.4 1,697 1 6 25.4 351 2 6 916 46.0 so9 * 9 37Potterj, Chna and Cli--... 12 122 0.1 -106 -0 1 -86.5 3 0 0 76 4 6 4 7 6t1 a

Paotols.. roducta 1 2 0.0 2 0 0 100.0 5 0 4 90W4

Others 23 2,770 1.5 1.333 13 46.1 51 0 4 16 9 n.7 7r 6 6.7 6 2

Droabl Consume, Cood a 31jl 2. 2149 21 AL LEA A L aS u 4 ELI ts

F-ftn,toa 311 13.220 .6 5.676 6 2 64.1 1*,OS 7.9 15. 67.2 67.6 6 66 IRd,0o 64 174 0.1 -39 0 -22.4 13 0.1 47.1 9 a 9.6 n O to 10.

Csn.,1 l4ou hold AePl,snces 14 45 0 -149 -0 1 -331.1 6 0 7 92.6 66.1 54 * 0U

OChibO 127 16.020 11.7 13,159 12 6 73.0 691 6.2 57. 1 6 J *1.2 76 4 95

C.t± Goods C ed 51 303 MA 4422 ft MA L_7 293 1 W 5J KLt S7L 2

86s.c Hatal Prodoct. 112 41.216 26 6 39,25 36 2 96.6 1.470 11. 9S 4 ".2 Pe G 76 4 66.

Febr,catod Natal Pod.cts ISO 3.625 2 4 -461 -0 5 -13.3 161 1.2 64.5 0 W. a 1 92 2

machnery and Eq..P.nt 62 12 0 0 -69 -0 1 -575.0 0 6 27 0 t4 * 5 6 9 6 96

Tlan.o-t 199 4.90 3 2 * .106 3 9 63 7 ISO 1.1 31.1 6.0 W 0 W 2 u.0Othe. 52 L 2 1 0 912 0 _ . 1 . 9 0A IS O li " MA

Total 2.606 153.166 100 0 104.122 100 0 6r 6 15.265 1000 40 57y a e s 76 of

=5........ : . -1g... $ =a

I/ lba-d un a ao..ay of 2.696 small scals f-aa -th loss tan 50 aloIaye and/or _..a o -aptal f oN I50.000 (or tJU207.345 *analant) n 1663 The aaar.. calg_aI .4 Me *.,. am. ba5 psson* Tb. a.rnsy d,d not nocluda any ,. produccng ,ot..d,t. good.

i/ Thb st Il ty .plnat,on for nago.t- .a(.as n Coss ca.s .s that tho f-r.. .c.rred losses The. data refer to 1962/d3 cond,t-oa hn the ane-w asn. d,ff.caltp Z

Sowerg 7osrda th. D-lop..nt of $-.l1-Sral Indt,,aa ,n N s. . gan Xnst,t of S.C.l and E -onoae aareh (NISfR). 1967

AF41t

t>co b., 1VO/

- 46 -

ANNEX 2-S

NIO£PtA - PRItVATE SMALL AND MEDIUM EiTERPRISE DEVELOPMENT PROJECT

Institutions Providing Investment Promotion. Technical Assistance and Extension Services to SNEs s

PrivateIDCe SSIDs CIRD ITF CiD PRODA FIIRO ASCON NASSI Consults.

Tehnicl assistance providedSelection of machinery X X X X XChoice of production technique X X X x X xChoice of raw materials X X X x xPlant layout X X X X X XInstallation of machinery X X x x xPlant maintenance A repair X X x xProduct design a prototype developmt. X X X X X xIndustry outlook surveys X X X XIdentif. of business opportunities X X X X XInvestment counselling X X X XPreparation of feasibility studies X X X X X X

Extension services providedResolution of operational problems X X XProduct Improvement X X XQuality control A standardization XDiversification and product mix X XIndustry information X x xMarket A markoting counaelling X X XFinancial counselling X X X XPeraonnel counselling X XCeneral management counselling X X X XOrganixation restructuring X X XInvestment promotion X X X

Training assistance providodEngineering X X X X XProduct-rolated(-.g.textilex) X X X X X XFinancial X X X X XGeneral management X X X X X XProduction management X X X X X XInventory control X X X XMarketing management X X X X X XProject identif.& formulation X X X X XGeneral entrepreneurial X X X XVocational A apprenticeship X

*/ IDCu: Industrial Developmnt Centers under the Federal Ministry of Industrios (FMI); SSIOs: Small ScaleIndustry Divisions of the state Ministries of Industry and Commerce; CIRD: Center for IndustrialResearch and Development, Obafemi Awolowo University; ITF: Industrial Training Fund under FMI; CUD:Center for Management Development; PRODA: Project Development Agency; FIIRO: Federal Institute ofIndustrial Research, Oshodi; ASCON: Administrative Staff College of Nigeria; and NASSI: NigeriaAssociation of Small Scale Industrialists.

AF4IEDOcember 1987

- 47 -

ANNEX 2-4Page 1 of 2

Industrial Development Centers (IDCs)

1. The purpose of the IDCs has been to provide small scaleentrepreneurs (SSEs) with a wide range of services including technicalassistance, extension services and training. The first IDC was created inOwerri in 1963. Subsequently two IDCs were established though not fullyequipped in Zaria in 1964 and in Osogbo in 1976. Recently, thirteen otherIDCs have been established formally and plans exist to create an additionalthree IDCs. FHI has allocated 36 million to equip the nineteen IDCs withmulti-purpose workshops. To date, however, only the zonal IDCs of Owerriand Zaria, and, to a lesser extent, Osogbo are functional and provideservices of significance to SSEs. Over the years these three IDCs havereceived substantial technical assistance funded by various bilateral andmultilateral donors including UNDP, World Bank, USAID, the Ford Foundation,the Governments of China and the Netherlands.

2. IDC operations have received considerable support from theGovernment. Total Federal Government expenditures during 1984-1987 on thethree functional IDCs alone amounted to approximatel; N4.5 million (US$4.8million equivalent). The IDC in Osogbo, for example, received 439man-months of expert assistance from UNDP (some US$3.3 million in UNDPsupport) over the 1975-1984 period. In view of these expenditures, IDCoperations as a whole have not been very efficient and have not yielded thedesired results. The less than satisfactory performance of IDCs to a largeextent is attributable to a number of factors including the lack ofnon-personnel operating funds. In fact, more than 90? of total recurrentexpenditures for IDCs was spent on personnel costs; on average about 66X ofIDC personnel are support staff.

3. It is therefore essential that a "success formula' for theexisting IDCs be found, before embarking on a full scale national IDCdevelopment program, so as to avoid the burden on public funding at a timewhen government expenditures must be carefully controlled. In addition, newinstitutions generate their own momentum, and are subsequently difficult toreorient or even dismantle should they prove to be unsuccessful. The FMIrecognizes the importance of making the IDCs of Zaria, Owerri and Osogbofully operational and expand only gradually the remaining IDC network.

4. In order to make the IDCs operationally and financially soundwhile simultaneously reducing their dependence on public funds, FHI isconsidering to allow the IDCs to charge fees for their services. The costrecovery features would also help identify the services for which there isan actual demand. Part of the inefficiency of IDCs is due to the fact thattheir responsibilities are very broad and have not been focusedsufficiently in the past. Service fees would also provide an incentive forIDCs to become responsive to actual needs as well as allow them toconcentrate on areas of their expertise.

- 48 -

ANNEX 2-4Page 2 of 2

5. Even with revenues from fees, IDCs would still not be fullyself-supporting in the short run, and some transitional financialassistance from the Federal Government would be required, which could bereduced gradually to, say, 201 of current levels over a period of fiveyears. It would also enhance competition particularly for services ofcommercial nature (e.g., the preparation of feasibility studies whichcan also be carried out by institutions such as NISER and CIRD, and privateconsultants), and thus help stimulate the emergence and further developmentof private institutions. However, many SHEs are unable to finance the costof such services. In such a case, the desirable approach is to directlyassist entrepreneurs in paying market fees for consultants' services. Theproposed Project will therefore support the establishment of a PilotStudies Facility to finance through the banking system the cost ofconsultancy services for SMEs and entrepreneurs; it would also encouragethe development of the Nigerian consultant industry.

6. In the areas where there is no effective competition with theprivate sector and there is apparent demand, direct support to IDCs wouldbe necessary (e.g. transfer of technical knowledge and the provision ofworkshop facilities for SSEs). Such direct support should, however, beprovided for those services which are actually needed by entrepreneurs.Again, charging fees is generally an effective mechanism for determiningthose services for which there is a demand.

7. Even with the supplementary support from the Government, IDCswould have to become independent, autonomous, flexible and operatebasically as semi-private institutions. The Government support to IDCsshould therefore be under a contract to IDCs for providing well-identifiedand quantifiable services against a fixed amount. Actual performance ofIDCs should be reviewed annually by FMI. Support to IDCs, to the extentpossible, would have to be predictable so that they can plan theiractivities accordingly. IDCs would thus have freedom in delivering theservices requested knowing that they will be evaluated only by theirresults. IDC management would have to be also allowed to rationalize theirexpenditures, determine their own personnel policy, including levels ofremuneration, set their own fees and decide which services to providebeyond those requested directly by the Government. IDCs should also beencouraged to respond to new needs or to drop services for which there isno demand or where they are unable to compete (in quality and price) withthe private sector.

8. The FMI is, at present, in the process of formulating a plan ofaction for rationalizing the IDC network as part of its overall program ofthe institutional support system for SMEs (e.g. umbrella agency).Meanwhile, support for IDCs (e.g. necessary equipment for the IDCs atOwerri, Zaria and Osogbo) is being provided under the ongoing Loan2376-UNI. The Bank is also coordinating assistance to IDCs with UNDP/UNIDO,who has about US$2 million earmarked for the strengthening of the IDCnetwork.

AF4IEJuly 1988

- 49 -ANNEX 2-5Page 1 of 4

NIGERIA - PRIVATE SMALT. AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Entrepreneurship Development

A. Backaround

1. The Federal Government of Nigeria has placed a high priority ondeveloping entrepreneurship development programs as an effective means offacilitating the establishment and growth of small scale enterprises(SSEs), and providing additional productive employment. Entrepreneurshipdevelopment programs, that include identification, training, anddevelopment of entrepreneurs, can be effective components of a strategy tocreate first generation local entrepreneurs and to encourage small andmicro-enterprises that will generate productive employment, income, andcapital formation. Such programs must be integrated with the otherinstitutional support systems for SSEs, especially technical assistance,extension services and credit delivery systems. Although the entrepreneur-ship development programs cannot be panaceas to the problems confrontingNigeria, they could serve as seedbeds at the grass roots level to sustainand deepen the development process. However, they have to be undertaken asa long term commitment to see a measurable impact.

2. Two separate entrepreneurship development programs have beendeveloped and tested: the Entrepreneurship Development Program (EDP) basedon a model developed by the Entrepreneurship Development Institute of India(EDII), and the Work For Yourself Program (WFYP) based on a programdeveloped by the Durham University Business School (UK) with ILOassistance. The EDP program is promoted by NBCI, while the WFYP program isunder the auspices of FMI in collaboration with ASCON. Based on experienceto date, NBCI and FHI are now planning to implement their programs on anationwide basis in a coordinated manner. The main features of bothprograms and their achievements to date are summarized below.

B. The Entrepreneurship Development Program (EDP)

3. The EDP program uses behavioral science techniques to selectentrepreneurs with high potential with the objective of reinforcing theirentrepreneurial orientation (using trainers/motivators) and assisting themin starting and managing their enterprises. The obiectives of the EDPprogram under NBCI, based on the methodology of EDII, are the following:(a) generation of productive self-employment through the establishment ofSSEs; (b) stimulation of indigenous entrepreneurship and harmonious growthof the industrial sector, mobilization of local resources, and reduction ofregional imbalances; (c) improvement in the performance of SSEs throughtraining and developing well-rounded entrepreneurs; (d) improvement in therelationship between SSEs and credit institutions; and (e) generating,stimulating and encouraging cultural and behavioral attitudes necessary forthe evolution of a healthy industrial culture. The EDP program of NBCI isopen to unemployed educated youths, retired/ retrenched public/privatepersonnel, traders, businessmen/women, technicians, and skilled workers whopossess basic entrepreneurial skills and are willing to work hard.

- 50 -ANNEX 2-5Page 2 of 4

4. The EDP Drocess involves the following main steps: (a)identifying and carefully selecting those who could be developed asentrepreneurs; (b) developing their entrepreneurial capabilities; (c)ensuring that each potential entrepreneur (trainee) prepares a viableproject suited to his/her capability, inclination and experience; (d)teaching them basic managerial skills; and (e) helping them to secureneeded financial, infrastructural and related assistance so that thebusiness venture materializes within the shortest time. Post-startupassistance to SSEs is to be provided by the extension service deliverysystem.

5. Progress to date. NBCI has developed its EDP program with theassistance of an EDP expert from the Industrial Development Bank of India(IDBI), financed under Loan 2376-UNI. A two-week EntrepreneurTrainers/Hotivators program was held in June 1987. The trainers/motivatorsare the key to the EDP process with the responsibility of starting with theidentification of potential entrepreneurs and leading to the establishmentof successful business ventures. They must not only train but motivate,counsel and support their entrepreneur-candidates. Their role is that ofmotivator, promoter, counsellor, manager and development officer rolledinto one. Following the trainers/motivators workshop, NBCI conducted anEDP program (July-September 1987) for entrepreneurs in the state of Lagos.The first step was a promotional campaign using local media to create anawareness of the EDP program among the target group (about 400 applicationforms were sold at a fee of N20 each). Out of the short-listed 90applicants, 30 candidates were selected using the EDII selection process(including 5 women) for training. The training program included 3 weeks ofclassroom work, 2 weeks of field work/project identification andformulation, and one week for evaluation of business plans. The classroomtraining focussed on information on entrepreneurship; the institutionalenvironment, i.e., identifying agencies and schemes assisting SSEs;procedures and formalities; business opportunities; business plans;implementation and management of enterprises; and guidance for fieldwork(market surveys, etc.) in preparation for project selection and formulationof the project proposal. The faculty included staff from NBCI, banks,IDCs, FPI, CMD, ASCON, CIRD, FIIRO, universities, and independentconsultants and successful entrepreneurs. Following the classroomtraining, participants carried out fieldwork to collect data forpreparation of their business plans under the guidance/supervision of theirtrainerslmotivators (one per five trainee entrepreneurs). Of the 30entrepreneurs, 28 completed their business plans and presented them to acounittee of selected trainers/motivators and other officials. The overallcost of the trainers/motivators (residential basis) and the EDP program(non-residential basis) was about N150,000. Two other EDP workshops areunderway in the Kano and Anambra states, and will be completed beforeend-1987. Efforts are being madc to reduce costs to about N100,000 perworkshop. NBCI has also received assistance (US$30,000) from the FordFoundation (US) for its EDP program.

6. To provide focus and to also monitor/coordinate EDP activities,NBCI has set up a separate EDP division within its Research and Development

- 51 -ANNEX 2-5Page 3 of 4

Department under an Executive Director. The Department is to be suitablystrengthened to carry out EDP programs annually on a nationwide basis ineach state either independently or in association with the Government,

j bebnks and other agencies.

C. Vorking For Yourself Program (WFYP)

7. The WFYP program was developed originally for ILO by the DurhamUniversity's Business School (DUBS, UK) to address the serious unemploymentproblem in the UK. The WFYP is based on four key *success* factorsnecessary for starting a business, i.e., motivation, idea, ability/skilland resources. It is expected that most of the people who intend to runtheir own businesses will normally have some of these 'success' factors invarying proportions. It is hardly likely that anyone has all these factorsoperating at optimal levels. An individual intending to start a businessshould therefore ascertain the relative importance of each factor to thescale and type of business planned and assess his/her strengths andweaknesses in relation to them. One of the main purposes of WFYP is tofacilitate this awareness. The key factors of 'success' can change anddevelop over time. Through the work of motivators, the WFYP programgradually helps to develop these factors in its participants as a part ofthe process of getting into business.

8. The materials used by DUBS for its WFYP have now been adapted forNigeria with ILO's assistance. A group of trainers/motivators were trainedin the use of adapted materials at DUBS and ASCON, with assistance from theBank (Loan 2376-UNI) and ODA through the British Council. A workshopsponsored by FMI and NBCI to test-run the WFYP materials, and the traininggiven to trainers in the use of such materials was held in Akure (OndoState) in March/April 1987. As with the EDP, the first step was apromotional campaign using local media to create an awareness of theprogram among the target group. Of the 510 applications received, about 60applicants were selected for a day of preliminary participation andinterviews. Of these, 26 participants were selected for the actual testrun of the WFYP program. The next step was a two-week classroom trainingto develop managerial skills and prepare the participants for the normalpitfalls encountered in the business world. Classroom training wasfollo-wed by two weeks of fieldwork to collect data/information forpreparation of their business plans. One trainer/motivator was assigned to5 participants to supervise and monitor progress in the preparation ofbusiness plans. Of the 26 participants, 25 completed their business plansand presented them to a panel of experts. Four more pilot workshops forthe WFYP program (Niger, Imo, Cross River and Plateau States) are expectedto be completed before end-1987.

9. FMI, in collaboration with ASCON and DUBS, has made somerefinements in the WFYP materials. It now plans to train moretrainers/motivators, and work towards holding annual WFYP courses in eachstate for about 25-30 selected would-be entrepreneurs on a nationwidebasis. Financing foreign costs of future expansions of the WFYP program(costs of the consultants (DUBS) and visits of Nigerians to the UK) is to

- 52 - ANNEX 2-5

Page 4 of 4

be provided by ODA (British Council). Related local costs are to becovered by FMI.

D. Proposed Assistance Under the Proiect

10. The continuation of the entrepreneurship development program.over the next several years, with further refinements over time, isexpected to yield significant benefits to Nigeria through the emergence ofa new class of entrepreneurs endowed with requisite entrepreneurialtraining and skills. SSEs established by them are expected generally to bebased on substantial use of domestic raw materials and labor intensivetechnologies that partially alleviate the current unemployment problem.Both programs share the same objectives and underlying philosophy thoughthere are some important variations in methodology and emphasis. Effortsare currently underway to coordinate the both programs with a view toencourage a degree of cross-fertilization.

11. The proposed Project would provide (a) technical assistance forannual reviews of the EDP and WFYP programs to assess their effectiveness(contents of the programs, relative emphasis on steps, process, delivery bytrainers/ motivators, impact assessment, etc.) and suggest modificationsneeded; and (b) financing for viable subprojects for establishing SSEs byentrepreneurs who have successfully completed the EDP/WFYP programs, underthe line of credit component of the Project.

AP4IEJuly 1988

- 53 -ANNEX 2-6Page 1 of 4

NIGERIA - PRIVATE SHALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Eauipment Leasing

1. Financial leasing is an important term-financing instrument whosedevelopment is particularly relevant in Nigeria where medium- and long-termfinancing has not yet developed adequately. Leasing can play an importantrole in encouraging capital formation by small- and medium-scale enter-prises (SMEs) in the country. The business community in Nigeria has nowbegun to encourage leasing as an alternative and a more flexeble source ofterm credit. Contribution of leasing to industrial finance has been modestdue primarily to constraints in the availability of long-term funds and itsrelatively recent development. With sufficient funds, however, leasingcould become a valuable source of industrial finance given the inherentadvantages of the lease instrument. The primary advantage of leasing isthat ownership of the asset remains with the lessor (lender); leasefinancing typically is unrelated to the size of the lessee's (borrower's)capital base, and relies principally on the lessee's cash flow to servicelease payments. Moreover, the schedule and size of lease payments can betailored to the specific needs of lessees. Therefore, leasing can offerenterprises, particularly SMEs with insufficient asset and capital bases tomeet the high collateral requirements of most other forms of long-termfinancing, greater access to capital and more flexible arrangements ofrepayment.

2. Leasing in Nigeria started in the early 19708 with some hire-purchase/leasing companies, but it is still at an early stage of develop-ment. The Nigerian leasing industry is dominated by approximately 10merchant banks and specialized leasing companies. In addition, somedevelopment finance institutions such as NBCI have recently startedleasing operations. Though small in total volume, the leasing industry'sgrowth over the last five years (1982-86) is impressive as shown in thetable below.

1982 1983 1984 1985 1986----in million nairas, end December----

Annual value of assets 23.7 16.1 45.8 97.0 109.9acquired for lease

Total assets on lease 60.9 75.2 100.3 159.4 206.7(at original cost)

Rentals received 13.1 17.6 23.5 30.9 36.4

Net book value of leased assets 36.2 42.9 63.9 73.2 123.2

Net book value of leased 4.92 5.OZ 6.32 8.22 8.52assets as a Z of loan portfolio

Memo Item:Annual value of assets 35.4 22.4 60.2 109.0 81.4acquired for lease(in USS million equivalent)

Source: Equipment Leasing Association of Nigeria (ELAN).

- 54 -

ANNEX 2-6Paae 2 of 4

Total assets on lease at cost have increased from N 61 million in 1982 toN 207 million in 1986, and the net book value of leased assets fromN 36 million to N 123 million, equivalent to about 8.5 of the loanportfolio of these institutions in 1986. A breakdown of total leasedassets, the net book values of leased assets, and assets acquired for leaseat original cost in 1985 and 1986 by the major lessors is given in thetable on the following page. Leasing institutions have focused ontransportation, manufacturing, construction and business equipment and, asexpected in an emerging leasing industry, they have concentrated on thelarger and less risky clients. Consequently, the volume of leasing to SHEsto date has been small though recent indications are that Nigerian lessorsare beginning to recognize the potential of the SHE sector.

3. The merchant banks have relied primarily on short term resourcesfor their lease financing operations and as a result the average duration,i.e., term to final maturity, of leases in Nigeria is 3-4 years. Aselsewhere in Africa and Asia, leasing to SMEs has been viewed as risky,particularly in times of illiquidity when enterprises find it difficult tomeet lease obligations. The cost of lease financing to SMEs is thereforefrequently higher than that for larger enterprises in Niigeria. Theavailability of long term funds for leasing operations and increasingcompetition among the lessors should, however, help bring down effectiverates for lease financing.

4. In Nigeria, there are no laws on equipment leasing norestablished definitions of what constitutes a true financial lease, anoperational lease or a conditional sale. However, most leasing operationscurrently undertaken could be classified as conditional sales given thatmost of them include some arrangements for transferring ownership of theleased asset to the lessee at the end of the lease term, normally at aprice below fair market value of the asset. In this sense, leasing istherefore governed largely by common law rules and, to some extent, by theCompanies Income Tax Act of 1979, which stipulates only the rules forcapital allowances that can be claimed for various assets.

5. A future comprehensive policy to regulate and promote the leasingindustry is currently under study by the Equipment Leasing Association ofNigeria (ELAN) which is drafting proposed leasing regulations forconsideration by the Government. The Nigerian leasing industry is stillevolving, despite its years of existence and the participation of reputableinternational companies as technical partners and affiliates. The industryis a growing and valuable source of term financing; there is now need foran appropriate regulatory framework to ensure sound industry standards andpractices, and to provide sufficiently attractive incentives to encourageand foster its development. The Government (CBN) will therefore carry outa study of the leasing industry which would focus on the development of anappropriate regulatory and policy framework for leasing, the legal andcontractual rights and remedies of both lessees and lessors, and other

iotal Liard st Nt Siok Valug of Leare Assets. and Ameeta Acai rid

for Lea" at Orininal Coat, 1985 and 196

(mmounte in million naira-, end-oc_mker)

Nat Sook

Value of Leaoe Aete Ma1ired forTotal Leased Aaeta Owned Hot Book Vnlue ft Leaed Ansets Assets se * of Lrnee at -ri--al C_

ount Oi J Tota I nt _ of Total J; Lmn_trfa Ii s Taal

1 13 LW LW 1 131 13 13 1W 1W W LW L

B.ntworth Finance Ltd. (BF) 23.0 2S.0 14.4 12.1 0.8 1.6 0.4 1.4 1.0 11.8 3.2 17.4 #1 2 16.

Continental Merchant Bank of 33.7 47.1 21.2 22.6 12.5 47.1 17.1 3l.3 27.0 15.6 S 1.5 40.9 0 .7 317.1Nigeria Ltd. (09d)

First City Merchant Sonk (FO) 18.2 23.4 6.8 11.8 12.1 t8.6 16.5 15.1 27.0 29.0 9.7 10.7 10.0 6.6

ICON 14.8 28.1 6.9 11.1 8.1 11.6 4.2 9.4 1.4 2.6 0.3 11.0 0.3 10.0

International Merchant Sank (INB) 15.0 28.2 9.4 11.2 1.5 15.6 2.1 12.6 0.6 1.6 S 1.0 164. 18.4 14.6

Merchant Banking Corp. (NC) 0.5 1.8 0.4 0.9 0.5 1.8 0.7 1.5 2.9 6.4 0.6 1.6 0.6 1.4

Nigerian Merchant Bank (NM) 38.4 36.8 20.9 17.6 17.3 16.3 2S.6 13.2 9.0 9.0 11.1 3.4 .11. 5.1

NAL Merchant Sank (NAL) 12.5 18.5 7.8 7.5 1215 - 17.1 0.1 5.7 8.5 12.5 3.C 12.9 2.7

Nigerian A_rican Merchant Bank (NANBL) 13.4 10.4 8.4 6.1 18.4 10.4 18.8 8.4 16.8 6.8 9.1 5.5 9.4 6.0

Nigerian Bank for Comoerce anJ Industry a s 04 s- 0.2 2 _-

(tI)

Total 159.4 206.7 100.0 100.0 78.2 128.2 100.0 100.0 6.2 3.8 97.0 1009. 100.0 130.0

- - - - -- - - -

Source Equipment Leasing Association of Nigeria (ELAN), and NBCI. l

0 1

- 56 -

ANNEX 2-6Page 4 of 4

matters such as the registration of lessor and tax incentives and theirimplications, as vell as the desirability of establishing a governing bodyfor the leasing industry. In addition, the study would assess the need forcomiercial banks, currently precluded from leasing, to be authorized toundertake lease financing. The study would take into account the workalready completed by ELAN in this area.

AP4IEJuly 1988

- 57 -

ANNEX 2-7

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Monetary Aggregates(in billions of nairas, end December)

1972 1980 1982 1983 1984 1985 1986

Foreign assets (net) 0.2 5.6 1.1 0.9 1.5 1.8 5.0

Credit to the economy 1.3 10.7 21.9 28.2 31.1 32.7 36.8

of which:Private sector 0.8 7.2 11.4 12.4 12.9 13.7 17.4Government sector 0.5 3.5 10.5 15.8 18.2 19.0 19.4

Other assets (net) -0.3 -1.9 -6.1 -9.7 .11.0 -10.7 -17.2

Honey and quasi money 1.2 14.4 16.9 19.4 21.6 23.8 24.6

of which:Money supply 0.7 9.2 10.1 11.3 12.2 13.3 13.1Quasi money 0.5 5.2 6.8 8.1 9.4 10.5 11.5

Memo Items:

Commercial bank creditto private sector 0.6 6.4 10.5 11.3 11.6 12.3 15.7

M2 /GDP (Z) 16 29 32 33 35 35 36

Source: CBN, various Annual Reports; and IFS for 1972 and 1980 data.

AF4IEOctober 1987

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Summary Financial Statements of Selected Comercial Banks

Income Statements(in million naira)

1?BN a/ UBA b/ UBN cl IRWA a/1985 1986 1986 1987 1985 1986 1985 1986

Interest Income 172.7 206.2 153.9 194.4 195.6 198.2 41.0 62.7Interest Expenses 183.6 194.9 182.9 236.9 124.7 134.6 36.9 55.4

Gross Spread -10.9 11.3 -29.0 -42.5 70.9 63.6 4.1 7.3Other Income 275.5 365.3 288.0 374.8 220.0 278.5 103.0 130.5

Net Income 264.6 376.6 259.0 332.3 290.9 342.1 107.1 137.8

Administration Expenses 103.5 110.9 79.4 91.9 100.6 113.2 52.6 62.3Other Operating Expenses 48.7 70.9 59.1 76.6 53.1 70.2 - -Loan-Loss Provision 29.6 48.9 38.6 57.8 56.0 55.0 13.7 13.2 1Taxes 29.4 59.3 39.8 32.4 39.6 49.9 17.2 25.7 >

Total Expenses 211.2 290.0 216.9 258.7 249.3 288.3 83.5 101.2 @

Net Profit 53.4 86.6 42.1 73.6 41.6 53.8 23.6 36.6Dividend 13.3 17.0 9.7 16.3 8.2 8.7 9.1 11.9

Ratios

Gross Spread as 2 of ATA d/ -0.2 0.2 -0.6 -0.8 1.7 1.3 0.2 0.4Administrative Costs as Z of ATA 2.1 2.0 1.7 1.8 2.4 2.3 3.1 3.2Gross Income as Z of ATA 9.1 10.3 9.4 11.1 9.8 9.8 8.4 9.9Net Profit as 2 of Average Net Worth 25.7 32.2 18.8 28.0 21.9 21.2 25.5 29.8Dividend as 2 of the Year-EndShare Capital 15.4 18.4 12.9 21.7 15.1 16.0 13.0 17.0

Dividend Pay-Out Ratio (2) 24.9 19.6 22.1 22.1 19.7 16.2 38.6 32.5Interest Expenses as 2 of AverageDeposits 4.4 4.6 4.4 5.4 3.7 3.6 3.7 5.2

a/ For the years ended December 31. bl For the years ended March 31. emct For the years ended September 30.dl Average Total Assets (ATA) is the average of total assets at the beginning and end of the period.

AF4IEDecember 1987

- 59 -

ANNEX 2-8Table 2

Po 0111 M W VW - 1 gI

Ceab, 3a1,.ebl. WAe 0lb.w 1040.6 1,840s.8 1,36.8 1,610.1 2808.6 1".8 90.0. 766.0

ftbe eqb..ae.a Ago"a 68.0 1,210.0 116.3 021.6 62.9 714.4 ms. *i1.oLi... a" 6aa 1,414.5 1,6011.4 1,471.4 1,796.6 408.8 1,014.2 618.6 71460I.,.ugm. (et go"1) 114.5 110.4 n117.7 s10.4 5.4 5.8 -

p1.48 M..". ('.8) 110.1 241). J4 6 1. 0.0 62.1 71.4 -3. s-ToUl LID,$ L"00.6 4.817.4 . "8. 7 432706. 5L30. 1,00tJ Li1E1.

LIA3IL?11U~~~~~ MS ,_ ll

ftmow NWd Tim. s.a.a. 4,1314.1 4,411.7 a.m.a8 4,7601.7 8,3661.4 4,4106.1 1,116.1 1,081.060.t LIabiIlStik 608.4 1,2111. 440. 0 611.1 742.7 1,306.4 676.7 02.Lee,.?.. Laa. - - 46.0 46,

Total Liabilities 4,016.5 6,364.0 4,316.0 5,379.0 4,1418.1 6,607.6 1,001.6 1,676.4

$mm C.1t.a 018.1 16.2 76.0 78.8 8.4 54.4 78.6 78.6.taiau £A,aaga £,87 Amrwe 8.4 4, .4 110.8 10n.8 UL10 5j 146.-4 u14. 08.4

mm Ueth 2J .5l 311.1 .J. 4 .J 210 lo3 i43J 134.4Total Labl littWA 1A 407 5,053.6 !.,QGj 4)1j 616.7 4.3706 JWn I-a, .tl LIILI

Ceatlagga Lsbiliti.. 271.6 1,661.0 604.3 022.6 4610.6 486.2 064.7 68.6,

A momg Total hAglso 4,010.0 6,624.5 4,716.1 5,137.1 4,117.1 4,3010.4 1,711.4 9,11011.7Agora" Ioa; & Uva. 1,436.8 1.672.0 1,440.2 1,035.8 1,513.7 1,708.4 499.1 611.0£w.egoa Equity (14" for"a) 17.1 2160.6 112.0 1614.4 16. 163.3 02.7 111.6A eoOs Squmt. 4,114.3 4,172.4 4,12.2 4,140.8 8,161.1 3,066.8 06.1 1,670.6

TOta Dht/vitlrl 21.3 13.8 10.3 16.0 . l281 1.0 $ 16.2 14.7Casmol CF4Q" lo Tof-8 Agmte 6.7 10.6 -8.0 11.6 7.4 2.3 16.1 17.0

A"weos Lease A AdwameeAulAT MI. 38.3 36.5 31.6 36.8 35.6 29.6 31.6Awaeag EQu.tyI*v.,ag. Loans

A& "odoo.4 14.4 10.1 16.6 16.6 11.6 14.0 1. 1.0.PO'G.$i falt, 6.l S i.ld Sbt..U1

04ta/Leame &.4 Ad*gmaga 2.8 2.0 1.0 3.2 3.7 1.6 2.7 1.6

~/As at. 00eaDct 31.

5/As at. Sem1..,r 30.-/ A.e,ogo Total Assets (ATA) ;s tho a.*peg* of totae .state the begammiag and and of tho peusid.

1~~~ 11,S?AF_1 ' , ,. ,Xs,ws *". ,e X7z4 X.cocmo i-gor^- .sX .*. *" ,aw^,u ns e

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Summary Financial Statemnts of Selocted Merchant Banks

Inco" Stateents

(in million noire)

NAL aI NMB */ CB bl ICON b/ IW b1988 1987 1986 1987 1985 196 19t ' 1is 19#S 19"

Interest Income 46.4 5380 31.2 46.3 55.4 U6.2 87.2 53.2 69.6 67.9Interest Expenses 17.9 39.4 22.4 31.2 19.7 25.C6 27.6 40.0 39.6 34.4

Gross Sproad 26.6 383.6 C. 15.1 85.7 24.6 9.9 1U.2 .6 U8C.6

Other Income 90. 12.0 9.4 16.7 14.2 23.3 C 24 *6. 1M.1 17.9Net Income 3.06 48.4 16.2 81.1 49.9 46.4 86.0 49.7 48.1 61.4

Administrative Expenses 12.8 14.2 4.5 6.7 13.5 17.6 14.9 16.4 14.C 17.9Other Operating Expenses -8.9 -4.2 / 06. *.7 3.1 *.9 8.9 3.5 3.7 5.2Loan-Loss Provision (Net) 103. 18.8 1.9 4.4 11.6 2.7 4.8 7.4 7.0 6.7Taxes 6.7 13.1 6.6 8.4 6. j 94 7i AJ j a

Total Expenses 25.4 U3.4 12.6 20.1 39.9 35.6 29.4 84.6 28.7 35.9 aNot Profit 12.6 13.6 6.2 11.7 10.1 13.4 L.t 14 94 16.4Dividends 4.2 4.7 1.6 1.5 1.9 8.O 2.9 4.1 2.4 4.7

Ratios (X)

Cross Spread as X of ATA d/ 4.6 8.2 2.4 2.5 5.4 8.3 1.7 1.6 4.8 4.6Administrative Costs as I of ATA 1.9 1.3 1.2 1.1 2.6 2.3 2.7 2.0 2.1 2.1Gross Income s X of ATA 6.0 4.4 4.9 5.2 7.6 6.4 6.6 6.1 6.1 6.1Net Profit as X of Average Net Worth 386. 81.7 86.6 49.4 39.5 89.5 25.9 44.6 31.2 41.3Dividend as X of the Year-End

Share Capital 406. 44.8 20.0 15.6 20.0 40.0 19.7 27.2 25.2 21.4Dividend Pay-Out Ratio 33.8 38.2 10.2 12.3 183. 26.4 42.4 27.6 C J.2 26.7Interest Expense as X of Average

Deposits 4.7 5.2 7.1 6.7 4.6 7.9 7.5 3.3 7.9 5. 9

*/ As at March 31.

b/ As at December 31.S/ Due to loan recoveries written off in previous periods.d/ Average Total Assets (ATA) is the average of total assets at the beginning and end of the period.

AF41E

Decensber 1987

ANNEX 2-9- 61 - Table 2

NIOUIA - P2VATE sLL £56 A EDIW INu fIhS onu 1V5W3 PACI

s_,omer UIne.ela Stameat of Sol "spoke" lank

(In ellilen mee)

MLa] m Cie W StmkL J&kWam0 aff am m m m a m 190 1000

cook, ase.olabl.a aNW OtherShort-Them Pan"a .31 M.0 111.9 0163111 310.3 411.? 340.1 645.0 424.8 .11.1

LoomeW and lven.. lo i3n.1 337.6 45.8 3. 0 3 1016.31 131.8 M3.$ 03.3 129.3Within I year (net)

Careent Leaglo 118~~~73.5 1,360.6 230.5 41111.6 444.2 031.0 401.4 163. 641.6 615.$

Looe.. and A',.--. lOv 8.0 6.6 136.1 21iS M9.& 11. $03. 36.0 176.8 261.0After One Year (not)

Inwfo.te" .0. 6.0 6.6 6.5 03.5 8.7 1.1 16.0 3.0 31.016quot, 00 Leeo. 16.2 16.2 11.3 11.3 11.3 41.1 3.1 11.6 5.4 1.0.FPlWed ad ether Aaaeto (noft) 22.0 45.8 1J3 j40 J43 JfJ4 j 1 j S.$ flJ 31.7

Total Asoto" 745.3 1,353.0 3fJ M- MA OJ 6 sea' 3,6j 750.65 047.2

LIA6ILMITS AN6 161tT1Curreto and Time Dooaits 36.8 361.3 233. UO4.0 202. 231.2 376.0 £73.2 445.0 367.6

(leng than 1 year)Leone Payable (evrronS) 6.0 6.6 8.0 6.6 6.6 M0.$ 6.6 6.6 0.6 0.6Dluldeuud Payable 5.0 1.1 1.3 1.6 2.2 3.3 4.1 3.8 4.1 0.1Acessuts Payableo an

Otor Short-To,. LiobiI ltio. 3111.6 241.0 14.81 IE6. 103.2 M02. 20fl4 410.0 16.2 33.7Cup an Liabilities 764.3 1,203.3 2003 011.. 61.6 1.3 541.3 M2.1 134.5 902.3

TI.. epmeolta (aver 1 lost) 6.6 0.6 61.0 5.8 8.0 21.3 6.2 18.3 6.5 6.0Leoom Payable (nedlism A long-tern) 1.2 211.51 6.6 6.6 18.6 18.61 8. .0 6.0 0. .0Mae Liabilities 46.6 6. 0.6 13.5 J.J -MG .-0 6.6 6 0

VedIa. A Long-Term Li abi I tl 1.3 21.5 16.0 13. 11.0 . 64.3 16.3 136.5 6.6

Totl LiabIlitIr n1.S 1,314.1 315.3 003.3 603.4 30.6 607.4 1663.6 055.6 6.

Shot. Capital 10.5 18.5 5.6 18.0 0.6 0.6 15.6 15.6 13.5 22.8Retained Earniago A Other Rosorves 20.3 j4. 12.8 1W. 18.0 Wl 13.4 ILl9 20.6 22.0

Na Wort _. .1L 10.0 Ml7 .4 33.5 23.4 13*.3 31.5 44.

Total LiabiIItios A Equity 743.3 1.350.8 191.3 ilL! 613.3 330.0 505.0 1.041.0 763.5 947.2

Coatlgont LiabISttIo S/ 16.6 34.0 216.2 218.1 164.5 241.2 103.4 153.1 285.5 343.4

MMO. ITtEISAverag Total LAgoS. (ATA) 6 33.0 1,664.1 372.0 01J. U9.? 15.0 540.0 013.0 701.1 434.6Aveores Leans & Advoacga 286.2 2609.6 141.6 313.3 1351.4 23n.0 314.3 320. 2760. 330.1Average Equity 32.7 41.0 10.1 232. 26.6 34.0 20.5 33.7 J *.2 39.2Average Sapesita 370.3 376.1 316.1 462.7 427.0 335.3 100.? 462.3 5102.5 637.1Averas" Cash Lease and Advances 470.0 406.6 364.4 432.0 530.2 861.1 522.3 775.7 651.2 774.4

RATIOS (1)Curront Rat;* 1.6 1 0 6.0 6.7 0.0 .6. 8.3 8.0 1.8 6.7Total Debt/Equity 10.3 29.2 22.1 20.6 26.2 22.1 28.8 25.3 21.1 20.1Afnnual Groth - Total Assets 44.1 C 1.7 30.1 04.6 -11.7 43.7 13.4 74.0 16.7 23.2Current Assets/Not Wort 13.31 29.3 14.8 19.4 16.1 17.2 17.2 10.6 15.3 14.2Average Leone S Advancea/ATA 31.6 10.0 39.6 35.4 25.1 30.0 39.1 46.2 33.4 39.2Average Equity/Avorage Loans

A Advncoa 18.3 10.6 16.9 16.0 16.4 14.0 12.3 16.2 11.2 11.9

I/ As at Maroh 31.An at Dlecooer 31.Acceptance, guaranteeL and other o*bigations fer account of Customers.

g b Average Total Assets (ATA) i9 theaverage of total assets at tho beginnting and end of the period.

AF41EDOeCO PT 11"?

- 62 -

ANNEX 2-10Table 1

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Susary Financial Statements of NBCI

Income Statements(end December, in million naira)

1985 1986

Interest Income 18.3 20.4Interest Expense 4.4 5.4Gross Spread 13.9 15.0Other Income 6.2 19.3

Net Income 20.1 34.3

Administration Expenses 10.3 9.1Other Operating Expenses 1.5 1.4Loan-Loss Provision 2.8 4.0Provision for Exchange Fluctuations - 7.0TaxesTotal Expenses 14.6 21.5

Net Profit 5.5 12.8

RATIOS

Gross Spread as 2 of ATA a/ 4.6 4.3Administrative Costs as Z of ATA 3.4 2.6Gross Income as 2 of ATA 8.0 11.4Net Profit as 2 of Average Net Worth 3.5 6.9

a/ Average Total Assets (ATA) is the average of total assets at thebeginning and end of the period.

AF4IEJanuary 1968

- 63 -

ANNEX 2-10Table 2

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Sumoary Financial Statements of NBCI

Balance Sheets(and December, in million naira)

ASSETS 1985 1986

Cash Receivables and OtherShort-Tern Funds 64.3 94.6

Other Short-Tern Assets 26.2 44.7Loans and Advances 193.3 191.6Investments (at cost) 23.0 22.8Fixed Assets (net) 14.4 19.2

Total Assets 321.2 372.9==am =a..... .....

LIABILITIES AND EQUITY

Bank Overdrafts andShort-Term Deposits 16.1 16.1

Other Liabilities 45.1 96.0Long-Term Loans 87.2 60.2

Total Liabilities 148.4 172.3

Share Capital 170.0 185.0Statutory Capital and OtherReserves 6.0 9.2

Revenue Reserves (3.2) 6.4Net Worth 172.8 200.6

Total Liabilities and Equity 321.2 372.9..... ==ama

Contingent Liabilities 29.2 109.8

MEMO ITEMS

Average Total Assets (ATA) al 304.2 347.0Average Loans and Advances 189.6 192.5Average Equity (net worth) 155.0 186.7

RATIOS (Z)

Total DebttEquity 0.8 0.8Annual Growth in Total Assets 11.8 16.1Average Loans and Advances/ATA 62.3 55.5Average Equity/Average Loans& Advances 81.8 97.0

Provision for Bad and Doubtful Debts/Loans and Advances 1.5 2.1

a/ Average Total Assets (ATA) is the average of total assets at thebeginning and end of the period.

AF4IEJanuary 1988

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Selected Interest Rates

(2)1986 1987

Jan. Oct. Jan. Aug1981 1982 1983 1984 1985 ±pt. Dec. JulY Dec. 1988

Rediscount rate (minimum) 6.0 8.0 8.0 10.0 10.0 10.0 10.0 11.0 15.0 12.75Treasury bill rate 5.0 7.0 7.0 8.5 8.5 8.5 8.5 10.0 14.0 11.75Savings deposit rate 6.0 7.5 7.5 9.5 9.5 9.5 9.5 11.0 a/ c/ fITime deposit rateswith 7 days notice 6.0 6.5 7.5 9.5 9.5 8.5 8.5 a/ 12.0 a/ cl flone year 6.5 7.75 7.75 9.75 9.75 9.75 bl bl c/ fIover one year 6.5 8.0 8.0 10.0 10.0 10.0 bl bl cl fl

Maximum lending rate 9.5 12.5 13.0 13.0 13.0 13.0 15.0 15.0 c/ f(preferenced sectors)

Maximum lending rate 11.5 14.0 13.0 13.0 13.0 13.0 15.0 15.0 c/ f/(less pteferred sectors)

Memo Items:Change in consumer price index 20.8 7.7 23.0 39.6 5.5 5.2 dl 10.0 dl i/Real savings deposit rate -14.8 -0.2 -15.5 -30.1 4.0 4.3 6.0- 4

7.0Real maximum lending rate -9.3 6.3 -10.0 -26.6 7.5 9.8 7.5- 1

(less preferred sectors) 11.0

a/ Minimum.bl Negotiable.c/ Savings and time deposit rates and lending rates have been totally deregulated. Savings and time deposit

rates of major banks ranged between 161 and 172, and lending rates between 17.5 and 21Z.df For the full calendar year.e/ Estimate.f/ Both deposit rates and lending rates remain deregulated (see para 2.31).

Source: CBN: Annual Reports and Credit Guidelines; mission estimates.

AF4IEJanuary 1988 _

AF4IE31/ANX2-12

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Sectoral Distribution of Credit(in percent, actual, end of period)

Commercial Banks Merchant Banks1982 1983 1984 1985 1986 b/ 1982 1983 1984 1985 1986 b/

Preferred Sectors 68.7 66.8 67.4 68.9 69.2 59.5 56.3 59.5 61.6 62.1

Agriculture 7.7 8.4 9.1 10.8 11.8 3.4 3.7 4.7 6.7 7.2Mining, manufacturing andconstruction a/ 45.3 42.4 42.3 42.0 41.6 45.4 43.3 45.6 45.5 45.3

of which:Manufacturing (29.6) (27.5) (26.8) (26.6) t.-) (35.9) (32.6)(31.4) (32.0) t..)

Residential buildingconstruction 5.4 6.6 6.6 7.0 7.1 8.1 6.4 6.0 5.6 5.6

Services (public utilities,transportation andcommunications) 8.8 8.2 8.2 8.1 ) 8.7 2.5 2.8 3.1 3.6 ) 4.0

Exports 1.5 1.2 1.2 1.0 ) 0.1 0.1 0.1 0.2 )

Less Preferred Sectors 31.3 33.2 32.6 31.1 30.8 40.5 43.7 40.5 38.4 37.9

General commerce 16.3 14.4 14.7 15.9) 12.8 12.2 13.5 13.0)Government 3.6 5.3 5.0 4.5) 30.8 0.2 0.2 0.2 1.0) 37.9Financial institutions 3.9 7.3) ) ) 26.0 28.6) )Others 7.5 6.3) 12.9) 10.7) 1.5 2.7) 26.8 24.4) _-

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0inn in w= .I C-=in== s=== == m== ===m

a/ Construction other than residential buildings.b/ Monthly average.

Source: CBN, IMF and Bank Staff estimates.

AF4IEOctober 1987

- 66 -ANNEX 2-13Page 1 of 2

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Characteristics of Subyroiects under the Small- and Medium-Scale IndustryProiect (Loan 2376-UNI)

1. The Small- and Medium-Scale Industry Project included a line ofcredit of US$35 million for NBCI to finance SME subprojects. The entireline of credit is now fully committed for 117 subprojects with 612 of thecommitments in 1987. Disbursements have, hovever, lagged, and amount to 8Sof the comitted funds (as of January 11, 1988). The slow rate ofdisburse ents reflects the fact that most subprojects (79S in number and552 in amount) were appraised and approved within the past year. Recentchanges, including the establishment of a new office in NBCI to streamlinethe loan process, are expected to accelerate the pace of disbursements inthe coming months. The quality of appraisal reports has improved notablyin the past years. The Investment Supervision Department has enhanced itsability to supervise projects with new procedures to monitor projectperformance on a regular basis.

1. The total cost of 117 projects approved under the line of creditis about N161 million or US$55.8 million equivalent, including US$26.7million in foreign exchange. Average cost of a subproject is aboutUS$477,000 with an average subloan of US$328,000 from the World Bank lineof credit. Under the Project, some 3,650 jobs are expected to be createdat an average cost of N44,000 (US$15,300) per job. The ex-ante financialrates of return range from 17S to 542, and economic rates of return varyfrom 12? to 35Z. A profile of subprojects approved under the line ofcredit is shown in the table on the following page.

Characteristics of Subproiecte under the Small- and Medium-Scale IndustrX Project(Loan 2376-W!)

No. of Total Cost Total Projected Projected Average Projected Averag Total Amount of

Sub- of Annual Value Financial Rate Economic Rate No. of Subloans from

Type of Industries prolecto Subprojlctc Added of Return of Return JobS Bank Loan

(N 'US) (N ') (N) (N) (1J53 'US)

Agro-industries s6 79,U6 36,76S 286. 23.9 1,666 18,699

Textiles and footwear 9 4,2t8 2,366 32.6 12.0 192 1,717

Paper products 6 6,176 3,127 26.3 35.9 149 1,960

Chemical products 24 $8,618 16,601 27.6 27.3 771 7,671

Metal products 6 7,767 3,eG4 27.8 15.6 199 2,922

Building materials 9 14,6C7 6,246 33.4 23.7 34S ,861

Other 14 9.69 4.137 32.4 25.6 e29 2.13S

Total 117 166,944 67,039 29.1 24.0 8,664 6,875 g/

/ The line of credit has been overcommitted by USS3.4 million to allow for possible cancellations.

AF4IEFebruary 1986

0 Im P.-'

- 68 -ANNEX 3-1Page 1 of 4

NIGERIA - PRIVATE SHALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Pilot Mutualist Credit Guarantee Scheme

A. Background

1. Unlike conventional guarantee schemes, the mutualist conceptbasically relies on mutual Quarantee associations (MGAs) whose members arefairly homogenous small businesses operating within the same professionand/or the same locality. Such an association would collect annualmembership fees from its members plus contributions toward a guarantee fundeither from all members or only from members who are interested insubsequently requesting the association for guarantees to obtain loans fromthe banks. A portion of the membership fees is also generally deposited ina guarantee fund. The association would provide its own guarantee, againstthese resources, to enable its members to obtain _;mall loans from a localbank; in addition, counter-guarantees of two other co-members could also berequired. The aggregate maximum amount of outstanding guarantees by theassociation could exceed, say up to ten times, its aggregate resources.

2. The success of mutual credit guarantee schemes, i.e., high loanrepayments, is largely attributable to the fact that, instead of beingfunded by the state and managed by institutional employees with no ties tothe beneficiaries, the association is a collective membership of thebeneficiaries themselves. Thus, there is intimate familiarity andsolidarity of interests amongst members of the association, as well as apositive relationship with the organization itself. In Western Africa, itis only recently that mutual assistance guarantee schemes are beingcontemplated as an attempt to address the issue of the high administrativecosts, perceived high risk of lending to micro-enterprises and smallbusinesses, and banks' aversion to such lending. The World Bank isexperimenting with this concept in some African countries (e.g., Togo) withthe goal of facilitating access to institutional credit for smallbusinesses and micro-enterprises who are generally confronted withconsiderable problems in dealing with the normal banking channels becauseof their small size and lack of collateral.

B. Application to Nigeria

3. The proposed pilot mutualist credit guarantee scheme would buildlargely on existing institutions. In Nigeria, there are at least fivenon-governmental organizations (NGOs) who represent small and medium-sizeentrepreneurs to varying degrees: (a) the Manufacturers Association ofNigeria (MAN); (b) the Nigeria Association of Small Scale Industrialists(NASSI); (c) the Chamber of Commerce, Industries and Mines present invarious locations and grouped together in the Nigerian Association ofChambers of Commerce, Industries, Mines and Agriculture (NACCIMA); (d) theNigerian Employers Consultative Association (NECA); and (e) the NigeriaAssociation of Independent Businessmen (NAIB). MAN has about 1,330members and includes many small businesses; NASSI is a relatively largeorganization with some 15,000 members representing mostly small businesses.Both of these NGOs have expressed interest in the proposed Project.

- 69 -ANREX 3-1Page 2 of 4

4. MAN was formed in 1971 to promote the interests of manufacturersin the country. It has about 1,330 members engaged in manufacturingactivity. While the minimus size of assets of a manufacturing company tobe eligible for membership is N150,OOO, 512 of the members (or 680) in 1986had turnover of less than Ml million (36Z or 476 members had turnover lessthan NO.5 million, and 15? or 203 members had turnover between NO.5 and Mlmillion). On the other hand, many large industrial companies are alsoactive members of the MAN. Its organization includes 20 branches in majorindustrial centers in the country, and a national executive council at theapex. MAN's members are also grouped according to different subsectoralactivities. Membership fees range between N500 and N5,000 depending onmembers' size. Based on the audited accounts for 1986, the financialsituation of MAN is sound with total assets (less liabilities) of N3.5million. Total subscriptions received from members in 1986 were N1.8million. In view of the difficulties its small members face in obtainingterm credit, MAN has expressed strong interest in actively participating inthe mutual credit guarantee scheme, and anticipates no difficulty inquickly establishing a fui.d to guarantee subloans to its small members.

5. NASSI was established in 1978 to promote the interests of small-and medium-scale industrialists. It has about 15,000 members nationwide.While NASSI has offices in 18 states, the State level associations areactive only in the Oyo State (about 5,000 members), Anambra State (about3,500 members), Lagos State (about 3,000 members), and Plateau State (about2,000 members). Some sectors or trades are particularly stronglyrepresented in different states. Members are registered with each stateand pay annual fees averaging N200 to the state associations, which in turnpay 1O0 of collected fees to the National Association. The number ofregistered members has increased over the past year, but the number ofpaying members has dropped to about 55? of all members. NASSI organizesnational conferences quarterly for state representatives. Furthermore,state level NASSI offices organize ad hoc promotion programs (oneday/evening) such as 'how to start a business', and training (1 to 2 days)on functional management topics. NASSI would need some time to establish aguarantee fund and strengthen its organization before it is able tofunction as an effective MGA. ILO, with UNDP financing, is currentlyconsidering providing assistance to NASSI to improve its effectiveness inpromoting SSE development.

C. An Outline of the Scheme

6. A pilot mutualist credit guarantee scheme (US$5 million) would beset up with the following broad guidelines; the precise implementationdesign of the scheme will be developed by a consultant (para 11). It isexpected that NBCI, who has substantial experience in SME financing, wouldbe the main participating bank (PB) in the scheme, though all PBs will beeligible. The PBs would extend credit for eligible subloans guaranteed byMGAs (MAN, NASSI, etc.) on behalf of members, and also possibly guaranteedby two other members of the MGAs. Before the proposed scheme can start,MGAs would have to set up guarantee funds with initial resources fromcontributions from own reserves, and subscription to the guarantee fund by

- 70-ANNEX 3-1Page 3 of 4

each member or by at least those members who wish to obtain banking creditwith the guarantee of MGAs. The size of the guarantee fund will determinethe maxisum amoun' of outstanding guarantees extended by the MGA, which ingeneral should not be more thAn 10 times the guaranteo fund.

7. The initial guarantee funds would be deposited with the concernedPBe in interest bearing accounts. The members of the MGAs will submittheir subloan applications to the PBs, who will, based on a simpleevaluation of the subproject, make a decision on whether to make a subloan.If a PB decides to make a subloan, it will seek a guarantee from the MGAconcerned. Eligible beneficiary members and subprojects will have to meetat least the following criteria: (a) subprojects should be in productivesectors and related service activities, (b) total initial assets, definedas existing fixed assets (excluding land) plus the cost of the subprojectshould not exceed 1400,000 in constant 1988 prices; and (c) the maximumamount of outstanding subloans to an entrepreneur would not exceed1100,000. Both fixed assets and related permanent working capital (rawmaterials, spares), and free standing working capital (raw materials,spares) will be eligible for financing.

8. In view of the small size of subloans, appraisal of subprojectswould be kept simple. A member's request for a subloan would normallyconsist of a brief and simple descriptionlanalysis of the following items:assets, sales, future business prospects, profit, subproject details, itemsto be procured, costs, expected benefits such as increases in sales andprofit, repayment terms, cash flow and ability to service debt, etc. MGAs'decision as to whether to extend their guarantees would be based primarilyon the following: (a) good standing of the member, (b) character andreliability of the member, (c) knowledge of and judgement on the outlookand prospects of the member's business, (d) possibly the readiness of twoother members to guarantee the subloan for their fellow member; and (e)assessment of the member's capacity to repay and MGAs' capacity to ensurerepayment. Once MGAs have satisfied themselves with the adequacy of thesubloan application, they will extend their guarantees tc the PBconcerned. The responsibility for subloan supervision and collection willremain with the PBs.

9. Funds from CBN to the PBs under the Bank loan would be made atthe prevailing CBN rediscount rate (currently 12.752) which would bevariable. The onlending rate to final beneficiaries will be decided by thePBs, and will be variable and market-based. The sharing of the spreadamong the PBs, MGAs and the MGAs' mutualist credit guarantee funds (toexpand their borrowing capacity and cover losses from defaults) will bedetermined in consultation with the Bank on the basis of findings of thestudy for this component (para 11). Additional resources to the guaranteefunds will come from the future additions from annual membership fees andinterest income on deposits in the guarantee funds.

- 71 -

ANNEX 3-1Page 4 of 4

10. In the event that a paymnt to a PB on a subloan is overdue for90 days, the MGA concerned vill be informed. After another 90 days, thePS vill call the guarantee and recover the amount from the guarantee fundwith a subsequent collective loss to the MGA. If the ratio of total loansoutstanding to members of the MGA and the guarantee fund rises to 12.5, thePI could suspend new lending and disbursements until other loans wererepaid or the guarantee fund were replenished by the MGA.

Technical Assistance

11. To assist in the actual setting up of the mutualist creditguarantee scheme, an entirely new concept in the region, technicalassistance would be needed for the detailed design and operationalprocedures of the scheme, to suggest any changes needed in the corporatestatus of MAN and NASSI to act as MGAs, and also to identify/assess otherNGOs for channeling funds to micro-enterprises. The technical assistanceprogram under the Project includes expert consultants' services for thesepurposes.

AF4IEJuly 1988

NICEIA - PIVATh SMALL AM MIIM dTERPRISE CEVET. OPJWiT

SuaryandEstimted Cost- for the Tachncal Assi-stance Proern

Itema to be External Local Total losti*tuiem,l COl_ndar ofObjectives Means Finmnced Coat Coat Coat Iep; ibility EIpac d ;spf t Es;m_c en

~~-------in LS000D----------

A. Pt 1--Ait ne to SE, and Entrepreneurs

(a) Assist SIEs/entrepreneuro in Establish a pilot otud4is Consultants. 1.75 5.250 7S000 coo A/ Increase macme of Ss .v .;nobtaining technical manistane. e.tenrion facility to foonce sapeet ervices te first quarter

**rnicae snd mnagamnt couns llinp for consultants' coats. ls. emmp.titie of 169.preperation of feasibility studiies, abets, vearies OE

acquisition of know-how and mchinery, _i95t institutios.

end for solving operational problems. md sncoure tIke

development of

consultin *d4umtry.

(b) Development and delivery of a Prepare and deliver h- _ Training cost. - 300 300 p1 ho n-uesms to train 1_1 U:.yprogra for SME ntreprsnsuril training (40-60 hours) training 2, 10 _atrepr*m"'G/ 1"0:20in finmncial mtters. workshops in simple busino i a y..e (30 141 3

skills, such as accounting, particiepats per

bookkeep ing cash flow ceurse) P.. I I met

projections, inventory control. rsesery fr,

and marketing. perticipse.

Subtotal costa, Part I 1,750 5,550 7,300

Financing Plan:

World Sank 1,750 3.250 56000

Entorpr;s - 2,300 2.300

L/ CON as ape. agency but through the participating banks.

j FMIl will coordinate. Actual training to be provided by training institute a nd consultants

II Z

0lO" _lq t%

_ _

Items to be Esternal Lecal Ttel Lsetitotia_l Celeder of

Objectives eens Financed Cat Cost Cast bemsibi aUe _ sEiIw Euas;ai

B. Part I1--Aaiatance to C --------- in aaaooD----------

(a) Assiat CbN in the administration of Supplent the etaff ski ll in Consultant. 240 90 230 CU bsI ohsent of the Three year

the ape. line of credit and other StE the CN's Ape. Unit with pa nit (beginaing

landing acheme. e*xternal con ultants Ioebede(adi n i stretion/devel opent/ 1

monitoring of apex functions,general banking/accounting.

on-the-jot training).Vehicle and equipment. FCo with aofteare, 220 40 260

ehicles, officeequipment.

Work ettachents and visits International travelling S0 - S0

to reviaw ,exprience in SME end *epensee.apes scheme in othercountries.

(b) Orientation for the staff of PSe and 2 orientation seminars and 2 Organizational sxpenses. i- t/ / CUN nemedg is proco- Oy Nmeoer

CON in overall proceduree for ths SME follow-up seminars (3 day dure feor the fuac- 30, 1GM.

line of credit and other lending schemes. sach). timing of to @..

line of credit.

(c) Strengthen ateff capabilities of Pet 10 seminars (2 woses each) and Consultants. 210 45 255 CU Train sket 100 pref- 2 mainners in

in project appraisal, supervision and 10 follow-up caso etudy e _ssele free abut Oeceso

aonitoring related to the line of credit workshops (one wmek each) for Training aide. S 10 * sad A frm 1 5

and other SHE lending sches. Personnel from POs and CU. CN. _imners is

the first

seseste ofi1, and S

_iners is

mater to

1_.

(d) Strengthening staff capabilities of To seminere (3 s*eke each) end Consultants so 20 100 CN Train 30 prefer First helf of

PlN in the preparation and *valuation of two fol low-up workshops (2 si_m*1 frem slet 10 1010.

workouts related to ths financial *n k- each) for personnel from *srticipetmno banke.

rostructuring component. Na by highly qualifiedconsultant. for carrying outfinancial engineering workouts.

j/ Insignificant.

Itxm_ to be Eatornal Local Total Institutional Calender ofObjecti v. Financed Coat Cast Cast Mompeeib lil g peetd Samfi to E11osaiea

----------- in UW'O00-----------(a) Oueign detailed proeadures for Conduct a *tdy CAneltents Se 36 70 am Pw,leis of Piet quartsimplementation of the eutueliat credit deti led presx ires. Of l_

guarentee ache. through *M and AS. Idtif jostle ofid*ntify/aeeeea other hlC for _ O

channelling funds to micro-enterpriaee.

(f) Assist CIN in dveloping an Conduct a study to review Consultants. 70 20 60 cm Ir_Wsto ;i t1e Pifrx

appropriate regulatory policy frameork existing practices. develop Peli Iey/fewuIe a y semet offor aquipeent leaoing. policy and relatory frxe_- frx_ex-r for 1to.

work and prepare a draft equipment leesing.

legialation.

() Assist CIIN in assessing the Conduct a study. Consultants. 70 20 g0 cm Capitol erbot 1to".fasibility of establishing a Mutual deweluewt.

Investent Fund for holdine a Portfolio xx;Iiablse fof shares end bonds in corporate deeti4s r_rsenterprises, ad cntribution to

4'-

(h) Monitoring of the econosic and social Conduct S Os-post rovises. Conaultanta - 20 2S0 CUt e-post ewalnstien. ,limpect of subprojecta. dsobste, peliop

improemenst.

(i) Future Policy and project Studise. Consultants. I.000 - 1I000 q u rewd sect Througheut.

preparation work in the financial and Pelicies. Na loading

industrial sectors. dewelepset

Subtotal Costa. Part II 1.960 120 2.JtO

Fin nAcinom

World Bank 1 eso 20 2.F00

0I

- ~~~~~~ANNE; 3-2

1X !~~~~~~I

E ~ I ia,|

: ~~ l

1 ~~3 3 U

II~~~~~ !

,i 3il 'i a*i'

jii:~ . 3 j j :|||{{'a.

i I Ii IIiI,ii i1

Item to be External Local Total Institutienal Caler of

Objectives Keann Financed Coet Cost Caot Fvep_nibility Expected U_nfite Execution

______-in USS000…----

(.) Assist in developing a fraseork for Conduct a study. Areas to Consultents 72 66 1 Fl6Coo ClI *to a tdy en 166the industrial *states program to help co,er: evaluation of the foraulation of aovercose difficulties by SME in their impact of tho *.i;ting/ongoing progrs foracceas to infrostructure facilities- and estatet, design of policies/ indutrial _tnstesdetermine feasibility of developing atrat g for futur,e astet&, with ceasacial fecuspilot/deaonstration industrial *states in *ssess feasibility Of and Private sectorthe private sector within high priority participation by tho private participationareas, sector. inveateent priorities

based on comeercial viability,

recommend institutional end

operating procedures.

(f) Enhance the capacity of FMI to Participation in thre- selected International travelling 20 - 20 F@I Trainimp of MI l andformulate policies to promote SHE intarnational conforences/ and upenso-. staff. 1690.development. sesinars on ShEa.

Subtotal Cost. Part III 425 375 6o0

Financing:

World bank 425 375 600

0. Part IV--Asistnce to NICI

Strengthen the operation of MCI in tho ProVe-ion of technical Consultants z FI Ieproved oeprsti;_e 1is" Badareas of ppraisal. l uporvision. assistance. Financing: of II. 1900.portfolio mtnegosant. equipment leaing World Bank 700 300 1.000and oerc..ant banking.

Total Technical Assistance Program: Proi;ct CotL L*7i 11L

Financina Plan:World Bank 4,655 4,445 9,300ShEs - 2.300 2.300

AF41E

Jul, 1966

00 Z

eo z

t" 10

- 77 -

ANNEX 4-1

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Eligibility Criteria for Participating Banks

1. The following minimum criteria would be used by CBN for assessingthe eligibility of financial intermediaries for participation in the SHEcredit components:

(a) adequacy of capital. The present rule of CBN requires that loansand advances of a bank may not be more than 12 times its adjustedcapital; provision for bad and doubtful debts is to be netted outin the calculation of the ratio. For the pirpose of the Project,the CBN would also take into account other types of risk assetssuch as leasing, acceptances and guarantees;

(b) cash reserve requirements as specified by CBN (minimum amount ofcash deposits as a percent of total demand deposits), which atpresent range between 2 and 52 depending on the size of depositliabilities;

(c) minimum liquidity ratio as specified by CBN, which at present is27.5Z for the commercial banks. In the case of merchant banks,the minimum liquidity ratio is 20Z of total deposit liabilities;

(d) adequate provisions for bad and doubtful loans satisfactory toCBN and the Bank;

(e) favorable rating by CBN in its latest supervision of the bankconcerned, which should not be more than one year old;

(f) adequate organization with staffing and technical capacity, andpast experience in project lending satisfactory to the Bank;

(g) operating policies and procedures acceptable to the Bank;

(h) in the case of development finance and other specializedfinancial institutions, an interest rate structure in line withrest of the banking system and acceptable to the Bank; and

(i) agreement to adopt the specific terms and conditions for SMEcredit components under the Project.

2. The eligibility of a financial intermediary for participation inthe Project will have to be acceptable to both the CBN and the Bank.

3. The eligibility of the banks will be monitored by CBN on anannual basis.

AF4IEJanuary 1988

- 78 -ANNEX 4-2Page 1 of 4

NIGERIA - PRIVATE SHALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Guidelines for the Financial Restructuring Component

1. Recent policy reforms have led to radical shifts in the rightdirection in price signals, profitability and markets. As a consequence ofhigh inflation rates during 1981-84, the sharp devaluations of the nairasince 1986, and the rise in interest rates, combined with weak domesticmarket demand, many manufacturing enterprises in Nigeria are suffering fromheavy debt burdens and liquidity squeeze. They need to reorient theiractivities to operate profitably under the new incentive regime (marketbased exchange regime, trade liberalization and tariffs). Some enterprisesare likely, however, to remain unviable and may have to go under. On theother hand, it should be possible to restructure a significant number ofmanufacturing enterprises to reorient their production, improve economicefficiency and profitability. An important part of the strategy ofindustrial reorientation would therefore be a selective program ofenterprise restructuring of existing productive enterprises which arepotentially viable, but operate with a weak financial situation, and,therefore, unable to service their debt.

2. While the preferred solution for the financial problems ofcompanies is for creditor banks to systematically review their performanceand work out restructuring strategies, the commercial and merchant bankshave not thus far undertaken restructuring schemes on a systematic basis.Furthermore, restructuring by the banks is hampered by their inability totake equity in enterprises. Under the Project, the CBN will undertakestudies to assess the desirability of allowing the banks to take equity incorporate enterprises, and to establish other innovative instruments suchas the mutual investment funds for holding a portfolio of shares and bondsin enterprises to be subscribed by individual and institutional investors.The CBN does not strictly enforce the requirements of portfolio and baddebt management and there is need to tighten banking supervision. Reformsin the regulatory functions of the CBN and supervision of banks are beingaddressed under the proposed Financial Sector Adjustment Operation.

3. It is proposed to initiate a pilot program of financialrestructuring under the Project, on a case-by-case basis, for selected,potentially viable, productive enterprises in difficulties (encompassingweak financial situation, poor physical condition of plant and managementinadequacies). An acceptable restructuring plan under the proposed schemewould need, however, to encompass not only an assessment and resolution offinancial difficulties but it would also need to address the underlyingcauses of the financial problems to make the enterprises viable, e.g.,management inadequacies, inappropriate production mix, misplaced marketingstrategies, and inappropriate or obsolete techmologies. This pilotcomponent is expected to benefit selected potentially viable enterprises byhelping them improve their viability and profitability while the banksshould be able to simultaneously improve their portfolios.

- 79 -ANNEX 4-2Page 2 of 4

Restructuring Instruments and Arrangements

4. Restructuring Measures. The typical corporate workout wouldinclude a combination of the following measures to regain competitiveness:(a) writing off part of the accumulated bank penalties, charges, etc.; (b)bringing in new investors to take equity positions; (c) converting part ofthe debt into equity and/or quasi equity instruments; (d) rescheduling theremaining debt with maturities that span over the medium to long term; (e)replenishing working capital; and (f) investing in new fixed assets. Bankfinancing would only support investments in (e) and (f).

5. Preconditions for Restructuring. The banks and the current firmowners must agree on a base balance sheet that reflects the real net worthof a company, taking into consideration an adequate revaluation of assetsand confirmed outstanding liabilities. The company must agree to disposeof non-essential assets to reduce its outstanding debt and to cater tofresh working capital. Creditor banks should commit themselves, inprinciple, to consider reducing their claims on the firm's cash flow byforegoing all outstanding penalty charges and fees related to the debt indefault, and converting part of the unserviceable debt into equity orquasi-equity. Owners would have to agree to the proposed debt/equity swapsand buyback arrangements for the subsequent sale of equity through privateplacements or other means.

6. Restructuring Plan. Each workout proposal, the preparation costof which would be eligible for financing under the Project, would have thefollowing basic elements: (a) The management plan would review existingm,,-nagerial capacity and recommend a formal organization plan which is oftenlacking in family businesses. The need for specialized staff and technicaltraining would also be identified. (b) The marketing plan would be aimedat increasing the firm's revenues through emphasis upon more profitableproducts and customers, product redesign, quality and packaging improve-ments, and geographic coverage. (c) The Production Rlan would be devisedto fill the needs identified under the marketing plan and could includemeasures to curtail productive capacity or, alternatively, for a fullerutilization of the existing capacity. And (d) a financial plan, theelements of which are discussed below. Each restructuring proposal wouldinclude an independent legal opinion confirming that the beneficiary firmpossesses controlling interest, and that the proposed refinancing scheme islegally binding and enforceable. Covenants limiting future borrowings bythe enterprise would be included in the overall financing agreement.

(a) The company to be restructured would be a duly incorporatedentity, and its activities would be concentrated in theindustrial sector. Preference would be given to enterprises inthe manufacturing sector with significant use of local rawmaterials and hence high value added. Controlling interest inthe company would be clearly defined. Participation of the bankswould be such that they remain minority shareholders.

- 80 -

ANNEX 4-2Page 3 of 4

(b) While the workout strategy would essentially serve as anevaluation of future profitability, the following broadguidelines would determine the eligibility of participatingenterprises. They should be potentially viable but unable tofully service their existing debt due to overindebtedness. Afterthe proposed restructuring and based on reasonable projections,the enterprise should be financially viable with a projected debtservice coverage ratio of not less than 1.0 in each and everyyear of the life of the project, averaging not less than 1.2during that period, with the projected current ratio of not lessthan 1.2 at any time. The incremental financial (after tax) andeconomic rates of return of the subproject should be at least 12Zin real terms.

(c) In determining the amount of debt to be serviced by therestructured company, the guideline would be to determine aprincipal amount outstanding which can be serviced over a periodof ten years, taking into account the projected cash flow of thecompany. Prior to defining the debt, the banks and the companymust agree on the treatment to be given to depreciation, and theamount of funds the firm would retain to increase working capitalor replace equipment. Provisions for prepayment of debt would beincluded.

Implementation ArranRements

7. Preparation of Restructuring Proposals. The participating banks(PBs) would play a lead role in identifying potential companies andassisting them in the preparation of restructuring proposals. It isexpected that the involved banks are best suited to manage financialrestructuring packages because of their knowledge of industrial companiesplus their interest in improving their own portfolios. In the case of morethan one creditor bank, it is expected that an agent or lead bank wouldcarry out the restructuring exercise, as well as lead negotiations with thecompany. The lead bank would regularly supervise the subprojects to ensurethat the subloans are utilized for the purposes intended, and that thefinancial and other conditions affecting operating performance areprogressing satisfactorily. The PBs would submit through the SME Apex Unitin CBN, semi-annual reports to the Bank on the performance of the portfoliofinanced out of the loan proceeds. These requirements would be part of thelegal contract between all parties to the restructuring exercise.

8. In evaluating restructuring proposals to be financed under theProject, the PBs, in addition to the traditional project analysis anddocumentation requirements for equity financing, would place particularemphasis on analysis of the company as a whole, including its managementeffectiveness, production strategy and future market prospects andprospects for liquidating their own equity or quasi-equity within aspecified timeframe. Since skilled financial appraisal is needed todiagnose the underlying problems of the enterprise, and considerableknowledge of the economic outlook and products and markets is needed to

- 81 -

ANNEX 4-2Page 4 of 4

determine expected long-run financial viability, the institutional capacityhas to be developed to carry out these tasks. Accordingly, the technicalassistance funds under the Project include provisions for experiencedconsultants to provide training to the PBs on how to prepare restructuringproposals. In addition, funds under the financial restructuring componentcould also be requested to finance consultancy services used for preparingrestructuring workouts for eligible enterprises.

9. Eligible Expenditures. Project funds would be used for breakingproduction bottlenecks (new fixed assets), financing fresh permanentworking capital (raw materials, spares and components), and consultancysr-,,,ices.

AF4IEDecember 1987

- 82 -AM= 4-3Page 1 of 4

NIGERIA - PRIVATE SHALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Key Indicators for Proiect IDl em ntation and Reportinp Requirements

A. Key Indicators

For monitoring purposes, the following indicators would applyt

by mid- by mid- by mid- by Sept.1989 1990 1991 1992

1. Loan Commitments

(a) Line of Credit 1o0 40? 70? 1oo0(b) Financial Restructuring 5Z 302 65Z 1OOZ(c) Mutualist Credit Guarantee - 302 651 1oo?

Scheme(d) Equipment Leasing 15? 45Z 75Z 1OO0(e) Pilot Studies Facility 5? 30? 65S lOO1

2. Technical Assistance Program

Activities and corresponding implementation schedules aredescribed in Annex 3-2. Regarding the studies. the following timetablewould applys

By end By mid- By *nd- By mid- By endStudie 109 1989 1909 1990 "

(a) Subcontracting TOR Complete(b) Technology development To0 Complot(C) Subeector studies and Initiate Initiate/ COmPIet

Industry prof 1 le Completcd) Industrial etates To Complte(e) lutuallet credit TOM compleoe

uar.mte, scheme(f) Equipmet loweing TOR/

Cowlete(g) MtUal Investment Fund TOR Complete(h) Monitoring of subprojete TOR Complt /

M/ For the first study covering the first two yeare of the Projet. After this, a now monitoringstudy wll be carried out evory twelve months, and a report will be submitted to the Bank byhesebr 81 of the relovant year.

- 83 -ANNEX 4-3Page 2 of 4

3. Pilot Facility for Feasibility Studies, and Technical Assistance

By mid- By mid- By mid- By mid-1989 1990 1991 1992

(a) Number of SHEs assisted 100 600 1,300 2,000

B. Reporting Requirements

1. CBN will, through inputs from the PBs and concerned agencies(e.g., MAN, NASSI, etc.), consolidate and prepare the following minimuminformation for the line of credit, financial restructuring, mutualistcredit guarantee scheme, and equipment leasing components:

1. Socio-economic aspects (semi-annual, August 31 and February 28):

(a) Type of subprojectu: expansion, retooling, new, free standingworking capital, leasing, financial restructuring, micro-enterprise.

(b) Enterprise size by assets, production capacity, sales andemployment.

(c) Sector/subsectors.

cd) Region (subproject location, and classification--rural vs urban).

ce) Financial intermediary.

(f) Incremental jobs created and cost per job.

(g) Percent use of local raw materials, and local value added.

(h) Capital/labor and capital/output ratios.

(i) Financial and economic rates of return as appropriate.

2. Lending aspects (semi-annually, August 31 and February 28):

(a) Number of subprojects/operations financed; investment costs withbreakdown of foreign and local costs; amount of subloanscommitted with breakdown oi the Bank loan and participatingbanks' own resources; equity contributions from SME's ownsources; classification by asset sizes, investment costs andsubloan amounts; for each component as a whole as well as byparticipating banks; disbursements.

- 84 - ANNEX 4-3

Page 3 of 4

(b) Number of subprojects/operations financed and total investmentfor each subproject, classified by investment items (machineryand equipment, civil works, related and free-standing (separated)working capital, know-how and engineering, consultancy services,training, etc., indicating also the origin of goods andservices); by participating institutions and by size of subloans.

(c) Experience upon subloan approvals, procurement and disbursements.

3. Subproject lending performance (semi-annually, August 31 andFebruary 28):

(a) Subproject investment costs (projected and actual).

(b) Implementation delays.

(c) Sales (projected and actual).

(d) Status of portfolio; total loans outstanding and arrears; aginganalysis; principal and interests; by participating banks;perspectives; measures taken or to be taken, as appropriate.

ce) Current project pipeline by participating banks.

4. Technical Assistance (semi-annually, August 31 and February 28):

(a) Status report on the technical assistance activities related toCBN.

(b) Follow-up by CBN of its technical assistance program concerningtimely implementation of schedule, quality, preparation andimplementation problems, results, adjustments required, etc.

(c) Prepare and/or agree to a work program including a schedule forall concerned agencies (CBN, PBs, HAN, NASSI) for next sixmonths.

5. Quarterly progress reports on the use and experience of the PilotStudi's Facility for SMEs and entrepreneurs, mutualist credit guaranteescheme and the financial restructuring components (within six weeks afterthe end of each quarter).

6. General:

(a) CBN will make comments in the semi-annual progress reports onproject implementation and adjustments recommended, asappropriate, as well as on the progress on setting up businessadvisory services in the PBs.

(b) CBN will also require the PBs to prepare a brief subprojectcompletion report within six months of the subproject's physicalcompletion to compare performance with appraisal estimates.

- 85 - ANNMX 4-3

Page 4 of 4

7. Monthly reports on the operations and status of SpecialAccount(s) and sub-accounts.

II. PHI and NBCI vill prepare smi-annual status reports on theirtechnical assistance activities for submission to and exchange of viewsvith the Bank, within six weeks after the end of each semester. The statusreports will include coiments on the follow-up actions on the technicalassistance program concerning timely implementation of schedule, quality,preparation and imp.ementation problems, adjustments required, and workprogram for the next six months.

AF4IEJuly 1988

- 86 -

ANNEX 4-4

NIGERIA - PRIVATE SMALL AND NEDIUM ENTERPRISE DVELOPMENT PROJECT

Procurement Arrangements

Nigerian TotalBank Financing Financing Project

Proiect Item Other Other Cost-------------(in US$ million)-------___

Credit/investments under 225.0 a/ 138.2 363.2the line of credit,financial restructuringand mutualist creditguarantee schemecomponents

Equipment leasing 30.0 a/ 5.3 35.3component

Technical assistanceMicro-computers, 0.3 - 0.3software, vehicles andother office equipment

Consultants' services 8.6 2.0 10.6

Training 0.4 0.3 0.7

Unallocated 5.7 - 5.7

Total 270.0 145.8 415.8

al Three price quotations would be mandatory for bid packages exceedingUS$250,000 equivalent.

AF4IEJuly 1988

- 87 - ANNZX 4-5

NIGERIA - PRIVATE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Bank Loan Allocation and Disbursements(in US$ million equivalent)

Catelorv Amount Disbursement

1. Line of Credit(a) Subloans to and investments in 75.0) 1002 of subloans and

SMEs with asset size below U5 million ) investments up to(b) Subloans to and investments in SMEs 75.0) 70? of the cost of

with asset size between US million and ) the subprojectN10 million )

(c) Subloans and investments for free 25.0)standing working capital to SMEs with )asset size below US million )

(d) Subloans and investments for free 25.0)standing working capital to SHEs withasset size between U5 million and N10million

2. Pilot Financial Restructuring(a) Subloans for the preparation of 1.0 10O of subloans

restructuring workouts by SMEs(b) Subloans to and investments in SMEs 19.0 1002 of subloans and

investments up to 1002of the cost of thesubproject

3. Pilot Mutualist Credit Guarantee SchemeSubloans to microenterprises 5.0 1002 of subloans

4. Equipment LeasinaEquipment lease financing for SMEs 30.0 1002 of subloans up to

857 of the cost ofleased equipment

5. Technical Assistance--CBN(a) Pilot Studies Facility for 5.0 70Z of expenditures

consultants' services forfeasibility studies, technicalassistance and management coun-selling for SHEs and entrepreneurs.

(b) Consultants' services for studies 2.5 1002 of expendituresand training, training activitiesand equipment for CBN

6. Technical Assistance--FMI and NBCI(a) Consultants' services for studies, 0.8 100X of expenditures

and training activities for FMI(b) Consultants' services for 1.0 100? of expenditures

strengthening of NBCI

7. Unallocated 5.7Total 270.0

===a.

AP4IEJuly 1988

- 88 -

ANNEX 4-6

NIGERIA - PRIVATE SHALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Estimated Disbursement Schedule for Bank Loan

Estimated DisbursementAfrica Region-wide Disbursement Schedule b/I

Profile for Industrial DisbursementIBRD Fiscal Development and Finance Projects During the Cumulative

Year (Cumulative Z Disbursement) a/ Period Disbursement-------(in US$ million)------

FY89 - 06/30/89 0 0 0

FY90 - 12/31/89 3 8.1 8.106/30/90 10 18.9 27.0

FY91 - 12/31/90 17 18.9 45.906/30/91 27 27.0 72.9

FY92 - 12/31/91 34 18.9 91.806/30/92 43 24.3 116.1

FY93 - 12/31/92 50 18.9 135.006/30/93 63 35.1 170.1

FY94 - 12/31/93 72 24.3 194.406/30/94 82 27.0 221.4

FY95 - 12/31/94 88 16.2 237.606/30/95 93 13.5 251.1

FY96 - 12/31/95 98 13.5 264.6- 03/30/96 100 5.4 270.0

a/ Based on actual disbursement experience on 57 Africa Region-wide industrialdevelopment and finance projects during FY78-87.

b/ Based on the Africa Region-wide actual disbursement profile.

AF4IEJuly 1988

- 89 -

ANNEX 6

NIGERIA - PRIVATE SMALL AND IEDI1UM ENTERPRISE DEVELOPMCEN P:tOJECT

Selected Documents and Data Available in the Proiect File

A. Reports prepared by the consultants for PMI, 'Proposal for aNationwide Development Program for Small and Medium Scale Enterpriseain Nigeria,' in three volumes, August 1987.

B. Report prepared by the Nigerian Working Group, "Proposal for FinancingSmall and Medium Enterprises in Nigeria under the World Bank Project,'FMI, June 1987.

C. Report on a Survey of Small Scale Enterprises,' Towards theDevelopment of Small-Scale Industries in Nigeria,' Nigerian Instituteof Social and Economic Research, 1987.

D. Supervision reports prepared by Bank staff for Loan 2376-UNI and Loan2299-UNI, December 2987 and January 1988.

E. Report prepared by Mr. N. Gangaram (Consultant) on selected commercialbanks and NBCI, October 1987.

F. Reports prepared by ICON, IBWA, NAL and NMB on financing of SMEs inNigeria, various dates, 1987.

G. Technical Discussion Paper No. III prepared by Bank Staff," TheClimate for Private Investment in Nigeria,' June 1987.

AF4IEJanuary 1988

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