The Nigerian government has recently made a large commitment to increase access to financial services and credit markets for its citizens. Vice President Yemi Osinbajo noted the significance of financial inclusion in Nigeria, stating in the article, “it is absolutely important for us and our economy” (Jannah, 2017). The World Bank defines financial inclusion as the ability for individuals and businesses to have access to useful and affordable financial products and services that meet their needs – transactions, payments, savings, credit and insurance – delivered in a responsible and sustainable way (Financial Inclusion, 2018). Since 2008, financial inclusion in Nigeria has grown from 23% to 48% (Jannah, 2017). Osinbajo would like to see this trend continue; as such, he has set a target of 80% financial inclusion in Nigeria within the next three years. In order to project the impact of an 80% financial inclusion rate, it is first important to understand the underlying economics of credit markets.
The foundations of credit markets revolve around the neoclassical model and its assumptions. Under this model, all parties in credit markets have complete information about the market. That is, both lenders and borrowers know all information about one another, including factors such as the borrower’s ability to repay the loan and the type of project the loan will be used for (Ray, 1998). Perfect competition is another key assumption of the model, according to Development Economics. Lenders cannot increase interest rates above their cost of capital. If they were to, other lenders would undercut the rates charged and drive the high interest lender out of the market. Although the neoclassical model is the basis for credit markets, its assumption are unrealistic. In real credit markets, asymmetric information disrupts the assumptions of the neoclassical model.
Formal lenders in credit markets often lack crucial information about a borrower. For example, lenders are unaware of borrower idiosyncrasies such as farming/entrepreneurial skill, mental acumen, and thriftiness, among other characteristics (Ray, 1998). Additionally, lenders often cannot monitor precisely how loans are used or the returns generated from loans. These real-life credit market issues can be divided into two main buckets: adverse selection and moral hazard. Given these issues, governments and lenders in credit markets must institute certain practices and procedures in order for credit markets to operate efficiently.
Adverse selection is a common form of information asymmetry. Under adverse selection borrowers bear different risks. Lenders are unable to discern whether a borrower is safe or risky (Ray, 1998). This poses a problem for lenders because they prefer to charge risky borrowers higher interest rates in order to adequately compensate for the increased default risk. However, safe borrowers prefer not to pay high interest rates because they expect to have secure returns; the low default risks of their loans do not justify high interest rates. As such, safe borrowers exit the credit market at high interest rates, which leaves behind only risky borrowers. A population comprised solely of risky borrowers is unattractive to lenders, because risky borrowers have higher relative default risks. Lender’s lack of information of a borrower’s risk type makes it more difficult for them to find an optimal interest rate. Nigeria has a system in place to help combat adverse selection.
In the early 1990s Nigeria implemented a credit risk management system. The government ratified the CBN Act No. 24 of 1991, which established a central database of consolidated credit information on all borrowers (Credit Risk). This legislation required all banks to report returns on loans provided to all customers, as well as their outstanding balances, every month. As a result, all banks were able to check the credit information on potential borrowers and use that information to determine whether the candidate was worthy of a loan. Consequently, banks in Nigeria are able to approximate the risk level of potential borrowers, diminishing the risks of adverse selection.
Since the implementation of the credit risk management system, banks have been able to better screen applicants, which has resulted in persistently lower interest rates in Nigeria, as seen in figure 1.
Figure 1: Nigeria Lending Rate. Source:
Nigeria’s credit risk management system has helped reduced adverse selection, as well as moral hazard, which is discussed below.
Moral hazard is another issue associated with asymmetric information. Moral hazard comes in two main forms: ex-ante moral hazard and ex-post moral hazard. Ex-ante moral hazard refers to a behavioral change in the borrower before the loan proceeds are spent. Ex-ante moral hazard refers to a behavioral change in the borrower after the loan proceeds are spent.
In credit markets, ex-ante moral hazards relates to how the borrow chooses to spend the proceeds of a loan (Ray, 1998). Since there are information asymmetries, the lender is unable to observe how the borrower spends the loan. For example, while a lender might think a loan will be used to invest in a business, the borrower might take that loan and buy frivolous personal items instead. Since these items would not produce a return, the borrower would default on his loan, at the expense of the lender.
Ex-post moral hazard relates to how the borrower reports the results of his investment (Ray, 1998). Lenders are often unable to observe the results of an investment, which gives borrowers the opportunity to falsely report losses. For example, a borrower might use a loan to invest in a business that generates high returns as a result, but report to the lender that the business failed. In a vacuum, this would enable the borrower to keep the business’ returns without paying back the interest on the loan.
Nigeria has two main ways to combat moral hazard. The first of which is the credit risk management system discussed above. The system records individual borrower’s defaults. In the event of a default, every bank in the country knows that that particular borrower is risky and will choose not to lend to them in the future. This causes borrowers to fear being blocked from the credit market in the event of a default, so they will do everything in their power to prevent default, lowering the risk of moral hazard. Collateral is another method used to prevent moral hazard. Development financial institutions in Nigeria require collateral on loans above a certain amount (Nigeria Loans, 2017). DFI security agents have the authority to sell, foreclose upon, or take possession of collateral assets. The prospect of losing an asset of value incentivizes borrowers to prevent default, which also diminishes the risk of moral hazard.
Nigeria has the policies and systems in place for efficient credit markets, which could help to make the goal of 80% financial inclusion in the country attainable. In order to assess the effects of increased financial inclusion, I will refer to empirical evidence.
In a 2010 study of consumer credit, conducted in South Africa, researchers Karlan and Zinman had lenders make small loans to low-income workers to help smooth their consumption. Poor individuals who are strapped for cash typically demand consumer credit (Ray, 1998). More often than not, these individuals are farmers. These individuals require consumer credit in the event of sudden downturns in their production, abrupt declines in the prices of their goods, or increased consumption needs for events such as illnesses, deaths, or weddings (Ray, 1998). According to the study, access to consumer credit increased wellbeing in several ways. For those assigned to get loans, income increased, food consumption improved, access to future loans increased, and subjective measures like optimism and status in the community improved (Karlan & Zinman, 2010). Given the fact that over a third of Nigeria’s population works in agriculture, as seen in figure 2, many Nigerians could benefit from increased financial inclusion through consumer loans.
Figure 2: Percent of Nigerian Population Working in Agriculture. Source:
Nigeria has the systems and procedures in place to promote credit market efficiency. Issues that arise from asymmetric information have largely been negated by the government’s credit risk management system and the collateral requirements of development financial institutions. While it is not clear whether the country will be able to achieve Vice President Osinbajo’s target of 80% financial inclusion in 3 years, empirical evidence suggests that any increase in financial inclusion will benefit agricultural workers through consumer credit.
Jannah, C. (2017, November 02). More Nigerians to have easy access to credit facilities – Osinbajo. Retrieved from http://dailypost.ng/2017/11/02/nigerians-easy-access-credit-facilities-osinbajo/
Credit Risk Management System. (n.d.). Retrieved from https://www.cbn.gov.ng/Supervision/crms.asp
Financial Inclusion. (2018). Retrieved from http://www.worldbank.org/en/topic/financialinclusion
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Ray, D. (1998). Development economics. Princeton, NJ: Princeton University Press.