7 strategies to avoid SME loan defaults as a Nigerian Lender

Small and Medium Enterprises (SMEs) represent a low-risk borrower segment, and most importantly, they represent the foundation of every economy in the world. These small enterprises form the foundation of these global powerhouses from the USA to China to India. They’re akin to the cells in the body – individually irrelevant, collectively significant. Despite the spotlight often falling on mega-corporations and unicorns, SMEs are indeed the engine of a nation. Currently, Micro, Small, and Medium Enterprises (MSMEs) contribute 48% of Nigeria’s National GDP and 84% of employment in the country. With over 35 million forming the backbone of Nigeria.

While SMEs are generally considered low-risk borrowers, given the ease of verifying their operations through cash flow assessments, on-ground assessments and more. Lending to them is not without its challenges. The potential for losses looms if a lender is unsure how to navigate this terrain.

We’ve done the grunt work for you. Learn the strategies to avoid SME loan defaults as a Nigerian lender

Lend to established SMEs

When extending loans to SMEs, prioritize well-established ones, not solely based on their size but due to their ability to present a solid track record. If an SME cannot provide a transparent history of its business from inception to the present, we highly suggest you run for the hills as fast as your ‘legs’ can carry. This means that before you extend loans to an SME, you should look at how much money they’re making, how much they’re keeping, and if they’re consistently bringing in cash. Make sure to do your homework on where the SME stands in its industry and how it could grow in the future. This real-time info on how they handle payments and their financial responsibilities helps you make smarter lending decisions and reduces the chance of defaults.

Focus on SMEs with organized financials

Another practical approach to prevent loan default is to focus on SMEs with well-organized financials. This implies that SME owners should separate their personal and business finances. It makes it easier for a lender to track cash flow, recognize patterns and thoroughly evaluate an SME’s creditworthiness. International Finance Corporation (IFC) studies show that SMEs with well-maintained financial records are 20% less likely to default on loans than those with poor record-keeping. This highlights the importance of financial organization for both business success and loan eligibility.

Strict credit bureau check

Conduct a thorough credit bureau assessment for the company founder or leader and the company itself. Given that the owner is the decision-maker, any outstanding debts in their personal life may signal a lack of commitment to repay the loan. A thorough financial assessment provides valuable insights into both the founder’s financial history and the company’s overall creditworthiness. This allows you to make data-driven decisions, potentially reducing default risk and strengthening your lending process. Use multiple credit bureaus to double your protection.

Domiciliation

When engaging in activities like invoice discounting, completing the necessary paperwork and ensuring domiciliation is established are crucial. Domiciliation, in this context, refers to a financial arrangement with your SME borrowers that enables the automatic collection of invoice payments through a designated bank account. This structure safeguards both parties: lenders gain a secure collection method, minimizing the risk of delayed or missed payments, while borrowers have clear payment procedures and faster access to discounted funds.

Performance prompt

It’s essential that SMEs provide a performance prompt, a type of guarantee from a bank or insurance company. This guarantee states that if the SME performs below standards, they’ll still be liable to pay back the loan. This protects you as a lender from possible loan default or delayed repayment on the off-chance that an SME performs poorly. 

Proper tax filing system

To reduce the chances of SMEs defaulting on loans, ensure they keep their taxes in order. If they don’t file or try to dodge taxes, there’s a real risk the Government might shut them down. Imagine being unable to retrieve your loan repayment because the tax authorities peculiar to your country or area of operation came and closed the shop. Learn more about financial auditing as a lender.

Ensure proper and up-to-date licensure

Finally, If you are lending to an SME engaged in a strictly regulated industry. It’s highly imperative to ensure that their licenses are available, valid, up to date and in tandem with the industry’s regulation and ethical standards. Some SME owners or seasoned tricksters occasionally attempt to secure a loan using outdated licenses with no intention of repayment. Ensure the SME you’re considering for lending possesses a valid license that aligns with what’s required.

Feature read: Can I use a state moneylending license to lend anywhere in Nigeria?

Let these strategies guide you to lend safely

SMEs may be the bedrock of Nigeria’s economy, but lending to them carries inherent risks. We’ve given you the strategies you need to implement so you, as a lender, can significantly reduce the likelihood of defaults and contribute to developing a better financial ecosystem. You won’t simply be investing in SMEs; you’d be fostering innovation, creating jobs, and propelling Nigeria’s economic growth. Just be sure to keep these strategies in mind while lending.