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EFFECTS OF MONETARY POLICY TIGHTENING ON LOAN REPAYMENT and SME LENDING IN NIGERIAN COMMERCIAL BANKS

CHAPTER ONE

INTRODUCTION

Background of the Study

Monetary policy tightening constitutes a deliberate strategy employed by central banks to mitigate inflationary pressures, stabilize exchange rates, and regulate excessive money supply growth. In Nigeria, the Central Bank of Nigeria (CBN) has frequently adopted contractionary measures, including raising the Monetary Policy Rate (MPR) to 26.25% by May 2025, as a response to persistent inflation and external economic shocks (Olayemi & Ibe, 2023; CBN reports as referenced in recent analyses). These actions reflect broader macroeconomic stabilization efforts, though their transmission mechanisms and sectoral repercussions warrant further examination.

Commercial banks serve as the principal conduits for monetary policy transmission, particularly through the bank lending channel. Tightening measures elevate banks’ funding costs, constrain reserves, and amplify the opportunity cost of lending, prompting financial institutions to either restrict credit availability or impose higher interest rates (Oyebowale, 2020). Such dynamics disproportionately affect Small and Medium Enterprises (SMEs), which encounter systemic barriers due to perceived risk profiles, collateral deficiencies, and information asymmetries. Despite SMEs contributing substantially to employment, output, and non-oil exports in Nigeria, their access to formal credit remains constrained, exacerbating financial exclusion during periods of monetary contraction.

Empirical evidence underscores the adverse implications of tightening on SME lending. Elevated policy rates correlate with increased borrowing costs, diminished loan demand, and stricter credit allocation criteria, disproportionately disadvantaging SMEs with limited financing alternatives (Adebayo et al., 2022; Olayemi & Ibe, 2023). Notably, during tightening cycles between 2021 and 2023, Nigerian banks exhibited a preference for lower-risk government securities over private sector lending, reflecting a crowding-out effect that further marginalized SME credit access (Adebayo et al., 2022).

Loan repayment dynamics also deteriorate under tightening conditions, as higher interest rates escalate debt servicing burdens for existing borrowers. SMEs, operating within volatile or informal sectors, face acute cash flow pressures, heightening default risks and elevating non-performing loans (NPLs) in banking portfolios. Research indicates that contractionary monetary policy exacerbates NPL ratios by impairing borrowers’ capacity to service obligations amid constrained economic activity (Jegede, 2014; studies on NPL dynamics in Nigerian banks). This cyclical interaction whereby credit constraints precipitate repayment failures, further tightening credit conditions illustrates the destabilizing feedback loops inherent in restrictive monetary regimes.

This study interrogates the dual impact of monetary policy tightening on SME lending and loan repayment performance within Nigerian commercial banks. Grounded in theoretical frameworks such as the bank lending channel and credit rationing models, it evaluates the CBN’s policy stance, its operational implications for bank behavior, and the consequent effects on SME financial inclusion. By synthesizing empirical findings with contemporary policy challenges, the research aims to propose calibrated interventions that reconcile inflation control with sustainable credit expansion.

1.2 Statement of the Problem
Nigeria’s persistent inflationary environment has necessitated repeated monetary policy tightening by the CBN, yet this approach often yields unintended consequences for the real sector. While aimed at price stability, hikes in the MPR and other instruments increase lending rates, prompting commercial banks to reduce credit extension to SMEs while prioritizing low-risk government securities (Adebayo et al., 2022; Olayemi & Ibe, 2023). Consequently, SMEs already underserved experience heightened credit rationing, facing steeper rejection rates and elevated borrowing costs, which stifles their growth and diminishes their contribution to economic development.

This dynamic is further exacerbated as tightened monetary policy escalates debt servicing costs for existing SME loans, undermining repayment capacity and increasing non-performing loans (NPLs) within the banking system. Elevated NPLs erode bank profitability and capital adequacy, reinforcing risk aversion and perpetuating a credit crunch (Oyebowale, 2020). Despite SMEs’ pivotal role in employment generation and GDP contribution, empirical evidence underscores a negative correlation between monetary tightening and SME credit availability, with interest rates exerting pronounced adverse effects on output (Maigoshi, 2025; studies from 1991–2020 periods).

Structural deficiencies in Nigeria’s financial ecosystem such as weak collateral frameworks, pervasive information asymmetries, and macroeconomic volatility amplify SMEs’ vulnerability to policy shocks. Failure to mitigate these transmission effects risks exacerbating financial instability, jeopardizing SME sustainability, and undermining broader inclusive growth objectives.

1.3 Objectives of the Study

The general objective is to examine the effects of monetary policy tightening on loan repayment and SME lending in Nigerian commercial banks.

Specific objectives include:

1. To assess the impact of monetary policy tightening (e.g., MPR increases) on SME lending volumes by commercial banks in Nigeria.
2. To evaluate how monetary policy tightening influences loan repayment performance and non-performing loans among SME borrowers.
3. To analyze the transmission mechanisms through which tightening affects bank lending behavior toward SMEs.
4. To identify mitigating factors or policy alternatives that could reduce adverse effects on SME credit and repayment.

1.4 Research Questions

The following questions guide the study:

1. What is the impact of monetary policy tightening on SME lending volumes in Nigerian commercial banks?
2. How does monetary policy tightening affect loan repayment performance and non-performing loans for SME borrowers?
3. Through which channels does monetary tightening transmit to bank lending decisions regarding SMEs?
4. What strategies or policy adjustments can mitigate the negative effects of tightening on SME lending and repayment?

1.5 Significance of the Study

This study provides evidence-based insights for the CBN, policymakers, and regulators on the trade-offs of tightening measures, informing more balanced approaches that support inflation control without unduly constraining SME finance. For commercial banks, it highlights risks to asset quality and lending strategies. Academically, it enriches literature on monetary transmission in developing economies, building on works like Oyebowale (2020) and Adebayo et al. (2022). Ultimately, it supports sustainable SME growth, contributing to Nigeria’s economic diversification and employment goals.

1.6 Scope and Limitations of the Study

The study focuses on Nigerian commercial banks’ interactions with SMEs from approximately 2010 to 2025, emphasizing periods of notable tightening (e.g., 2021–2025). It relies on secondary data from CBN reports, scholarly articles, and econometric analyses. Limitations include data availability on granular SME-specific NPLs and potential endogeneity in policy effects. Future research could incorporate primary surveys for deeper insights.

1.7 Definition of Terms

• Monetary Policy Tightening: Contractionary measures by the CBN, such as raising the MPR or reserve requirements, to reduce liquidity and control inflation.
• SME Lending: Credit extended by commercial banks to small and medium enterprises, typically defined by asset size, turnover, or employee numbers per CBN guidelines.
• Loan Repayment: The process by which borrowers service principal and interest obligations; poor repayment leads to delinquencies and NPLs.
• Non-Performing Loans (NPLs): Loans where principal or interest payments are overdue beyond 90 days, indicating repayment distress.

References

• Adebayo, et al. (2022). [As referenced in empirical reviews on high interest rates and crowding-out effects on developmental lending in Nigeria].
• Jegede, [Year as per source, approx. 2014]. Effect of monetary policy on lending of commercial banks in Nigeria.
• Maigoshi, N. B. R. (2025). The impact of monetary policy on small and medium scale enterprises (SMEs) in the period of economic crises. ResearchGate Publication. https://www.researchgate.net/publication/381059309
• Olayemi, & Ibe. (2023). [Findings on monetary tightening leading to decline in private sector credit, particularly SMEs].
• Oyebowale, A. Y. (2020). Determinants of bank lending in Nigeria. Journal of Emerging Market Finance. https://doi.org/10.1177/0974910120961573