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Development of Credit Facilities in Sierra Leone

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Chapter 1

This study is on the creation of credit facilities to Small and Medium Size Enterprises in Sierra Leone with special focus on the construction industries.

1.1 Background to the Economy of Sierra Leone

Sierra Leone is a relatively small country, on the West Coast of Africa with an area of approximately 28,000square miles. The estimated population is 5.5 million inhabitants, 30% of whom resides in the western area of the country according to recent census in 2006.

The state of the country’s economy, immediately after independence from the British Colony in 1961 up to the 1970’s, was quite satisfactory in terms of performance. The exchange rate between the Leone and other foreign currencies was relatively good. More so, the British Pound Sterling was exchanged at One pound (£1) to One Leone (Le1). The inflation rate was extremely low. The country’s earnings from exports were very much attractive, with Diamond export accounting for well over 50% of the country’s foreign exchange earnings. This was closely followed by cash crop exports such as Cocoa, coffee, oil palm, piassava and chillies. The country’s external debt position at this time was not high,

Between 1972 to 1975, the economy started experiencing down turn that was mainly due to external factors, such as the famous oil price shock in 1973. Naturally, the 1980 Organisation of Africa Unity (OAU) summit that was hosted by the government of Sierra Leone fuelled the debt crisis in Sierra Leone.

Because of the foreign exchange scarcity in the country, the credit agreement between domestic importers and their business partners aboard collapsed. In 1988, the country was forced to devalue her currency.

Between 1992 and 1994, Sierra Leone successfully implemented an adjustment program supported by the International Monetary Fund (IMF) under the Right Accumulation Program (RAP). The World Bank also supported the program through the Reconstruction of Import Credit (RIC) in 1992 and the Structural Adjustment Credit (SAC) in 1993. Following the successful implementation of the RAP, the IMF approved a three year arrangement support under Enhanced Structural Adjustment Facility (ESAF). The implementation of the first annual program was disrupted by the escalation of the rebel activities in 1995. With the return of democracy in 1996, the IMF supported the economic recovery program adopted by the new Government with a second annual program under the ESAF.

Poverty intensified with real per capita declining to US$142 in 2000. Since then Sierra Leone has been classified as the poorest country in the world and ranks at the bottom of the United Nations Development Programme (UNDP) Human Development Index.

The growth in the economy has been underpinned by broad recovery in Agriculture, mining, manufacturing, construction and the service sector.

The economy of the Country continues to worsen in early 1992 when the civil unrest started which causes untold sufferings on humans and the entire country. Many people were forced out of their houses and eventually became displaced persons and refugees in their own country and neighbouring country like Guinea, The Gambia and Ghana. Almost all segments of the business economy collapsed including banking and lending institutions. It was then the problems of growth in economy worsen and every thing completely deteriorated and collapsed.

The almost 11 years of civil unrest ended in March 2002. The end of the war actually opens the door for a new beginning, for new economic growth and prosperity in the face of peace and unity. The situation has recently worsened because of the credit crunch faced by many of the world famous banking institutions and Sierra Leone has not been any exceptions. The effect coupled with other factors has created more gaps for banking institutions to provide loans to small and medium enterprises. In a press release from Prlog Dec. 15, 2008 by Robin Trehan as quoted “SMEs represent over ninety-nine percent of the country’s employers. While it is essential that these businesses obtain the necessary funding to remain active, they are often the first to suffer when financial crisis hits. Banks already facing financial hardship often deem SMEs as too risky to finance. Credit terms are becoming increasingly harder and qualifying for financing is subject to much stricter guidelines. There are things that SMEs can do, however, to increase their chances of finding financing”.

1.2 Statement of the Problem

The term credit in this thesis refers to an amount or sum placed at a person’s disposal by a bank and usually to be repaid with interest within a given period of time. Small and Medium Size Enterprises (SME) is very important in terms of the dynamic role in the development of the private sector in Sierra Leone. The SME’s are regarded as an engine for any economic growth and development in any country.

They provide opportunities for job creation and expansion in the physical reconstruction of the economy especially for a post war development country like Sierra Leone. Majority of the physical infrastructures ranging from housing, office buildings and business structures were all destroyed during the civil unrest. These structures need to be reconstructed for the economy to grow and become prosper. Today many construction companies or firms have emerged to assist in the rehabilitation and reconstruction.

While there may be some of the construction companies who have existed of years, it is also true that majority of these construction companies are new ones who are just coming up to help and provide their expertise in the development of Sierra Leone. But yet still, it is a challenge for many of these companies to adequately involve in the process of rehabilitation and reconstruction simply because they cannot get the required finance in the form of overdraft or loans, or provide the necessary collateral for the banks as required, making them less competitive.

In Sierra Leone the performance of SME’s over the years has been very poor which is due to the fact that the creation of credit from the banks which is an essential stimulant for private investment in the construction industries has been grossly under performing. This is one of the reasons for poor performance of the economy in terms of growth in most developing countries including Sierra Leone.

Construction companies have not been able to access huge funds by way of loan over the years from the banking and other financial institutions, mainly due to lack of confidence in the private sector as a result of problems like moral hazards and the absence of collateral security and the lack of experience in construction engineering.

1.3 Justification of the Study

The importance of the construction industries in the process of rehabilitation and reconstruction of the war towns in Sierra Leone cannot be over-emphasized. During the war there was so much destruction of infrastructures in the country, now that there is peace there is high need for reconstructions and the development of new roads and structures to aid national growth.

International organisations like the International Monetary Fund (IMF), World Bank, African Development Bank (ADB) main focus is to assist Small Medium Size Enterprises (SME) in developing countries gain strong financial base. It had been felt that SMEs employ majority of the work force in the developing countries, therefore, they have realised that when SME become financially stable the economy of the nation will be better and that the citizens will be able to live a comfortable life.

The role of commercial banks and other financial institutions in private sector development and the assessment of their overall performance in terms of economic growth and development has not received much of the attention by researchers. The central bank maintaining interest rate at high level has greatly contributed to discourage SMEs from borrowing from retail banks and other financial institution for investment purposes.

This is one of the reasons why most SMEs are under developed. Besides commercial banks are requesting for very stiff conditions to access loan by the private sector. A study on the provision of credit to construction companies for investment towards economic growth has not been studied in greater detail by previous researchers. This among others, gave me the urge to probe into the activities of the commercial banks and other financial institutions in the creation of credit to construction companies in Sierra Leone,

This study is to help government and other professionals as well as other stakeholders, to grasp fully the implications of credit refusal to small and medium size enterprises and how it will affect the development of the nation. The result of this study is hope to enable banking and other financial institutions, local and national government and other stakeholders to device concrete ways by which small and medium size enterprises can easily get access to credit to undertake construction programmes.

1.4 Objectives of the study

The main aim of the study is to assess the implications of credit creations by the banks and other financial institutions to Small and Medium Size Enterprises with special focus on the Construction Industries for economic growth and development in Sierra Leone.

The specific objectives are:

  • To determine the extent to which banks have been contributing to the development of the construction industries in Sierra Leone.
  • To examine some of the reasons responsible for the inability of the construction industries to solicit loans from the banks and other financial institutions for the purpose of investment.
  • To establish reasons for the reluctance of the banking and other financial institutions to provide the much needed funds for private sector development.
  • To examine the reasons for the reluctance of the banking sector to provide the much needed funds for SME in the construction industries for development, even though SME’s are regarded as the engine of economic growth.

1.5 Research Questions:

Certain research questions will be drawn up for proper examination of this objective. These include:

  • To what extent do commercial banks provide funds to Small and Medium Size Enterprises in the construction Industries?
  • What are the main problems encountered by the construction companies in terms of securing loans and overdrafts from the commercial banks?
  • What is responsible for the low investment of the private sector (SME’s) in Sierra Leone?
  • What is the role of the central bank in facilitating credit creation for SME’s in the pursuit of development in Sierra Leone?
  • What is the role of the Government ministry in the area of infrastructural developmental plans for Sierra Leone?

The study will make use of secondary data received from the Bank of Sierra Leone, Commercial Banks and some of the registered construction companies in Sierra Leone.

The study will try to reveal the reasons for the constraints Small and Medium size Enterprises are facing in securing credit facilities from the banks. Interviews will be conducted with senior officers of both the banking industries and construction sectors, together with government officers in the area of national development for the country.

1.6 Definition of Operational Terms:

1. Credit Creation: Credit creation is the multiple expansions of banks demand deposits. It is an open secret now that banks advance a major portion of their deposits to the borrowers and keep smaller parts of deposits to the customers on demand.

2. Venture Capital: Venture Capital is the name given to equity finance provided to support new, expanding and entrepreneurial businesses. Venture capitalists usually prefer to take a close interest in the business that is the subject of their investment. This could involve taking part in decision made by the business. Funds provided by venture capitalist are often referred to as private capital.(Mclaney E, 2003)

3. Gearing: Small businesses are in a fundamentally different position from that of the larger one on the issue of gearing. Financial risk to which capital gearing gives rise tends to emphasise operating risk, which will be present with or without gearing. Small businesses are more exposed to financial risk than public liability companies. (Mclaney, 2003)

4. Bank and Institutional Debt: Long term loans are available from banks and other financial institutions at both fixed and floating interest rates, provided the issuing bank is convinced that the purpose of the loan is a good one. The cost of bank loan is usually a floating rate of 3-6 percent above the base rate, depending on the perceived risk of the borrowing company. The issuing bank charges an arrangement fee on bank loans, which are usually secured by a fixed and floating charge, the nature of the charge depending on the availability of assets of good quality to act as security.

A repayment schedule is often agreed between the bank and the borrowing company, structured to meet the specific needs of the borrower and in accordance with the lending policies of the bank. (Watson D & Head A, 2007)

5. Security –the Bank’s Perspective: A bank has little to lose and much to gain by taking security for a loan. A bank’s solicitor should check that the borrower and any other party providing security have capacity to do so. (The company act 1989, prima facie, a company could pursue only the objects for which its memorandum stated it was incorporated)

6. Security – the Borrower’s Perspective: It is often difficult for a borrower to argue against a reasonable request for security. However, some borrowers will be contractually prohibited from providing security by a negative pledge in a document to which they are already a party. Specialised lending for financing a project will always be secured over the asset or project in question. (Adams D, 2006)

7. Cash Flow Statements for Small Companies: Financial Report Standard (FRS1) prescribes a format for cash flow statements. Except for very small companies, all companies are required to prepare a cash flow statement for each accounting period.

There are two approaches available under the standard; the direct method which shows the operating cash receipts and payments summing to the net cash flow from operating activities, and the indirect method which identifies the net cash flow via reconciliation to operating profit. (Wood F, 2002).



Literature Review

2.0 Introduction

The purpose of this chapter is to make a review of related literature on Small and Medium isze Enterprises and the Creation of Credit in the Construction Industry. With these literatures the researcher will have a better understanding of the study, as well as what has already been done on it in the form of previous research.

2.2 Definition of Small and Medium Size Enterprises

A business can be considered small on basis of predetermined criteria such as the number of employees, annual turnover or capital employed. In the late 1990s, it was estimated that small businesses with fewer than 50 employees accounted for 99 per cent of all UK business, almost 50 per cent of non government employment and 42 per cent of turnover. Small firms have become a focus for governmental policy at both national and intergovernmental level. Bolton in his report in 1971 identified three main characteristics of a small firm:

  • were independently owned - The business securities are not quoted in any established capital market that is they are not traded in the efficient market.
  • were managed in a personalised way- The ownership of the business’s equity and hence its control lie in the hands of a small close knit-group; that is it is a family type business.
  • possessed a limited share of the total market

2.3 Nature of Small and Medium Size Enterprises

The Bolton report, the first official government inquiry into small firms attempted to establish standard definitions of small firms for particular sector of industry based on numerical indicators of size such as sales or number of employees. A firm with 250 employees in a labour intensive industry may still be a small firm. (Brown, 1987)

Criteria for Small and Medium Size Enterprises

Size Category

Number of Employees

Maximum Annual Turnover (euros)

Maximum Balance balance sheet total

Micro Firm

0 -9

2 million euros

2 million

Small Firm

10 – 49

10 million euros

10 million

Medium-sized Firm

50 – 249

50 million

43 million

2.4 Objectives of Small and Medium Size Enterprises

In SME’s the managers and the shareholders are likely to be substantially the same person or at least closely connected with one another. Thus agency problems, and their potential associated costs, are likely to have little or possibly no impact on the typical small business.

Because of the elimination of agency gap, most managers of SME’s are shareholder; they would make decisions following a pure wealth-maximising goal more determinedly than would be the case in the typical large enterprise. The motives of managers or owners of small businesses are diverse. These motives might be the desire to experience the satisfaction of building up a business, a desire to lead a particular way of life, or a desire to keep someone (perhaps family) tradition alive.

Since it is possible for managers to know the personal objectives of shareholders of small business, decisions can probably be made with these in mind. Both large and small businesses that makes a series of decisions causing the wealth to diminish, will sooner or later fail. Wealth maximisation goal is very important to small business and cannot be ignored.

2.5 Organisation of Small and Medium Enterprises

The research will consider Small and Medium Size Enterprises in the construction industries that are organised as private limited companies. According to Mclaney (2003) private companies need be of no minimum size; public companies must issue at least £50,000 of nominal share capital, of which 25% must be paid up. There is no upper limit on the size of a private company.

Private companies are entitled to restrict the transfer of their shares; that is it is possible for the company’s Articles of Association to contain a clause giving the directors the power to refuse to register a transfer, at their discretion. While private companies must publish annual accounts, the volume of details is rather less than that which the law requires of public companies.

2.6 Sources of Finance for Small and Medium Size Enterprises

Several inquires have dealt with the financing of SMEs and each of these enquires discovered, to a greater extent, that small businesses find it more difficult and more expensive to raise external finance.

A particular problem faced by small businesses in their quest for equity capital is the lack of an `exit route’. Generally investors require that there be some way of liquidating their investment before they are prepared to commit funds to it. A number of schemes have been introduced to help small businesses:

2.6.1. The loan Guarantee Scheme (LGS)

as first introduced in 1981 to cover situations were potential borrowers were unable to provide sufficient collateral or where the bank deem the risk of lending unacceptable.

2.6.2. The Enterprise Investment Scheme (EIS) –

This scheme replaced the Business Expansion Scheme (BES) and it is designed to help small unquoted companies to raise equity finance from business angels

2.6.3.The Venture Capital Trust (VCT) –

The trust was introduced in 1995 to encourage individuals to invest in smaller, unlisted trading companies. Venture Capital is the name given to equity finance provided to support new, expanding and entrepreneurial businesses. Venture capitalists usually prefer to take a close interest in the business. This could involve taking part in decision made by the business. Funds provided by venture capitalist are often referred to as private capital.(Mclaney E, 2003)

2.6.4. The Enterprise Fund (EF) -

it was announced in the competitiveness white paper in 1998 and is designed to help the financing of small businesses with growth potential.

2.6.5. The National Business Angel Network (NBAN) -

it was launched in 1999 to connect ‘business angels’ with companies seeking equity capital

2.6.6. The late payment of Commercial Debts (Interest) act 1998

gives certain small businesses a statutory right to claim interest from large businesses and the public sector on late payment of commercial debts.

2.7 Gearing

Small businesses are in a fundamentally different position from that of the larger one on the issue of gearing. Financial risk to which capital gearing gives rise tends to emphasise operating risk, which will be present with or without gearing. Small businesses are more exposed to financial risk than public liability companies.(Mclaney,2003)

2.8 Help and Advice to Small Businesses

One of the major barriers faced by SMEs is the lack of information, help and advice on their operations. Recent initiative to improve this sphere includes:

2.8.1. The business link network – organised in 1993 as a ‘one stop shop’ for information and advice to SMEs. It brings together the services of major business development services in the single accessible location.

2.8.2. The Enterprise Zone – launched in 1997 as a definitive internet site for business information. It provides help on a whole range of business issues.

2.8.3. The Information Society Initiative/Interforum E-Commerce Award – launched in 1999 as part of government’s e-commerce strategy. It is essentially an award scheme to recognise and reward best practice in the use of electronic trading among smaller firms.

2.9 Bank and Institutional Debt

Long term loans are available from banks and other financial institutions at both fixed and floating interest rates, provided the issuing bank is convinced that the purpose of the loan is a good one. The cost of bank loan is usually a floating rate of 3-6 percent above the base rate, depending on the perceived risk of the borrowing company. The issuing bank charges an arrangement fee on bank loans, which are usually secured by a fixed and floating charge, the nature of the charge depending on the availability of assets of good quality to act as security. A repayment schedule is often agreed between the bank and the borrowing company, structured to meet the specific needs of the borrower and in accordance with the lending policies of the bank. (Watson D & Head A, 2007)

2.10 Security –the Bank’s Perspective

A bank has little to lose and much to gain by taking security for a loan. A bank’s solicitor should check that the borrower and any other party providing security have capacity to do so. (The company act 1989, prima facie, a company could pursue only the objects for which its memorandum stated it was incorporated)

2.11 Security – the Borrower’s Perspective

It is often difficult for a borrower to argue against a reasonable request for security. However, some borrowers will be contractually prohibited from providing security by a negative pledge in a document to which they are already a party. Specialised lending for financing a project will always be secured over the asset or project in question. (Adams D,2006)

2.12 Working Capital Problems of the Small Business

Working capital is the difference between current assets over current liabilities. The amount invested by businesses in working capital is often high in proportion to the total assets employed. It is important that these amounts are managed properly. It is often claimed that many small businesses suffer from a lack of capital and, where this is the case, tight control over working capital investment becomes critical. There are evidence, however, that SB are not very good at managing their working capital, and this has been cited as the major cause of their high failure rate compared with that of large businesses.

2.13 Credit Management

Small businesses don’t have the resources to manage their trade debtors (account receivables) effectively. Most small businesses don’t have a credit control department. Small business also lack proper debt collection procedures, such as prompt invoicing and sending out regular statements.

These risks probably tend to increase where there is an excessive concern for growth. In an attempt to increase sales, small businesses may be too willing to extend credit to customers that are poor credit risk

Lack of market power is another issue for small businesses. They find themselves in a weak position when negotiating credit terms with larger businesses. When big customer exceeds the terms of credit, the small supplier may feel inhibited from pressing the customer for payment in case future sales are lost. (A survey undertaken by the Credit Management Research Centre (CMRC) during April and June, 2003, indicates that small businesses are likely to have to wait an average of 60 days for their trade debtors to pay.

2.14 Cash Flow Statements for Small Companies

Financial Report Standard (FRS1) prescribes a format for cash flow statements. Except for very small companies, all companies are required to prepare a cash flow statement for each accounting period. There are two approaches available under the standard; the direct method which shows the operating cash receipts and payments summing to the net cash flow from operating activities, and the indirect method which identifies the net cash flow via reconciliation to operating profit.(Wood F,2002)

Credit Creation

2.15 Definition of Credit Creation

The BNET business dictionary defines credit creation as the collective ability of lenders to make money available to borrowers. Credit creation is the multiple expansions of banks demand deposits. Banks advance a major portion of their deposits to the borrowers and keep smaller parts of deposits to customers on demand. The tendency on the part of commercial banks to expand their demand deposits as a multiple of their excess cash reserve is called creation of credit.

2.16 Functions of Financial Intermediation in Credit Creation

Financial intermediation is the process of channelling funds between those who wish to lend or invest and those who wish to borrow or require investment funds. Financial intermediaries act as principal, creating new financial assets and liabilities. They do not act solely as agents, charging a commission for their services. (The Monetary and Financial System-CIB/BPP Publication 1993 Edition)

Any institution standing between the ultimate provider of funds and the ultimate user of funds is engaged in financial intermediation. There are many types of institutions and other organisations that act as intermediaries in matching firms and individuals who need finance with those who wish to invest. These institutions also provide other services which are non-intermediary services like financial advisory services, fund management services and advice to undertakers and mergers provider by merchant banks. Some of the organisation that acts as financial intermediaries is as follows:

2.16.1 Clearing Banks – this bank participate in system which simplifies daily payment so that all the thousands of individual customer payments are reduced to a few transfers of credit between the banks. They offer various accounts to investors and provide large amount of short to medium-term loans to the business sector and the personal sector. The work of these institutions can best be understood through a consideration of the main items in their balance sheet.

2.16.2 Clearing Bank Liabilities – The money from the banks responsible comes chiefly from their customer’s sight and time deposits- mostly current and deposit accounts with which most people are familiar. An important additional item relates to certificates of deposit. These are issued generally for a medium amount of £50,000 and a maximum of £500,000 with an initial term to maturity of from three months to five years.

Clearing Bank Assets Customers’ money is re-lent in a variety of ways. The main aim of the bank is to have a range of lending instruments of varying terms so that money can be recovered quickly and yet, at the same time, earn the maximum return.

2.16.3 Investment Banks / Merchant Banks

The investment banks or Merchant banks have some functions that they undertake:

2.16.3.i Financial Advice to Business Firms

Few manufacturing or commercial companies of any size can now afford to be without the advice of a merchant bank. Such advice is necessary in order to obtain investment capital, to invest surplus funds, to guard against takeover, or to take over others. Increasingly, the merchant banks have themselves become activity involved in the financial management of their business client and have had an influence over the direction these affairs have taken.

2.16.3.ii Providing Finance to Business

Merchant banks also compete in the services of leasing, factoring, hire-purchase and general lending. They are also the gateway to the capital market for long-term funds because they are likely to have specified departments handling capital issues as ‘issuing houses’.

2.16.4 Foreign Trade

A lot of merchant bank are active in the promotion of foreign trade by providing marine insurance, credits, and assistance in appointing foreign agents and arranging foreign payments. Merchant bank is essentially in the general business of creating wealth and of helping those who show that they are capable of successful business enterprise. It is expected that merchant banks will operate without the large branch network necessary for a clearing bank, they work closely with their clients and be more ready to take business risk and promote business enterprise than clearing bank.

2.16.5 Building Societies

These take deposits from the household sector and lend to individuals buying their own homes. They have recently grown rapidly in the UK and now provide many of the services offered by clearing banks. Over the years many have converted to banks.

2.16.6 Finance Companies/Houses – Providing medium-term instalment credits to the business and personal sector. These are usually owned by business sector firms or by other financial itermediaries.

2.17 Services Provided by Financial Institutions

Financial institutions are organisations that provide services in connection with one or more of the following:-

Financial intermediation, linking ultimate providers of funds with ultimate users and creating new financial assets in the process.

Exchanging financial assets on behalf of their customers, that is acting as brokers or agents for clients.

Exchanging financial assets for their own accounts - proprietary dealers, as they are termed.

Helping to create financial assets for their customers, and then selling these assets to others in the market - underwriting new share issues, for example

Providing investment advice to others, example to people seeking a personal pension or to firms on mergers and takeovers.

Fund management- managing the whole or part of a pension fund, for example some large non-financial companies have their own financial subsidiaries. In the United Kingdom Ford Motor Finance and Mark and Spencer Finance Services.

2.18 Consideration for Credit

Care must be taken when deciding on the types of customer to credit. The following factors are to be checked before a decision is made:

2.18.1 Capital – The customer must be financially sound before any credit is extended. An examination of the companies account should be carried out prior to the decision. The lending institution should assess the profitability and liquidity of the customer.

2.18.2 Capacity – The customer must have the capacity to pay whatever debts. The payment record of the customer, the types of business operations and the physical resources are to be examined. The valve of goods that the customer wishes to buy must be related to the total financial resources.

2.18.3 Collateral – Some form of security is necessary when asking for goods or services on credit. The lending institution must be convinced that the customer is able to offer satisfactory form of security.

2.18.4 Conditions – The industry and the general economic condition of the particular country or region that the customer operates may influence the ability of the customer to pay the outstanding on due date.

2.18.5 Character – The willingness of the customers to pay back credit depend on the honesty and integrity of that individual. Where the customer is a limited company this will mean assessing of character of its directors. The business must feel satisfied that the customer will make every effort to pay the amount owing.

2.19 Government’s Assistance

Small firms Loan Guarantee Scheme are one of the most effective ways in which government can assist small businesses (SB). This scheme aims to help SB that has good business plans but lack security to secure loan. The scheme guarantees loans made over a 2 -10 year period to SB from participating banks for the sums of £5,000 to £250,000. The government will guarantee 75 per cent of the amount borrowed in return for a premium of 2 per cent on the amount of the loan. Businesses with sales not exceeding £3 million per annum (£5 million per year for manufacturing businesses) are eligible for this scheme.

The government also provides financial help through grants for Research and Development (RD) and by providing investors in SB with tax incentives. SB benefit through the government from business links (providing information) concerning the source of finance available and by providing practical advice. (Atrill P, 2003)

2.20 The Importance of Commercial Banks in Credit Creation

According to Rajan (1995) banks essentially perform two functions; they provide liquidity – Every time customers withdraw money from an automated teller machine (ATM) or write a cheque, they rely on the bank’s liquidity provision function.

Early influential papers in banking quite naturally focused on the role of banks in meeting the liquidity needs of depositors. There is little difference between a demand deposit that an investor holds and a line of credit extended to a firm. Both products require the bank to pay on demand, therefore it could be concluded that the bank provides liquidity on both sides of the balance sheet – to depositors and borrowers.

Samolyk (1994) notes that commercial banks still pay a significant role in funding business borrowers; we estimate that the share of non-financial business borrowing that commercial banks fund on their balance sheet has not declined notably in five decades. Nevertheless, there has been a clear shift in how banks lend – a shift from shorter-term lending not secured by real estate to loans collateralized by business real estate. This shift may reflect banks continuing comparative advantage in real estate lending, a form of lending less well suited to the standardisation necessary for asset securitisation.

According to the United States Department of State (2008), in Morocco, a USAID loan portfolio guarantee is supporting the agency’s work to boost development of municipal water resources management. The guarantee covers 50 per cent of the principal loans up to USD4.7 million from the Funds DeEquipment Communal (FEC), a private Moroccan bank, to municipal and local government for infrastructure projects related to wastewater treatment and reuse. With USAID’s guarantee, FEC is able to provide local governments with commercial financing for eligible projects and extend part of the guarantee to commercial banks to promote additional commercial lending for infrastructure development.

2.21 Government Policies to Encourage Competition

When Government encourage more competition this will have an increasing effect on the national output and reduce inflation. There are five major policies government can adapt in encouraging effective competition:

2.21.1 Privatisation- This can lead to increased efficiency, more consumer choice and lower prices. It can involve the introduction of private service into the public sector (eg, private contractors providing construction work on public buildings). When private contractors compete for franchise cost of provision of service will be lower.

2.21.2 Deregulation – This is the removal of monopoly right from the public sector. (eg. The operation of the transport system in the United Kingdom). Another example was the so called “Big Bang “on the stock exchange in 1986. Under this, the monopoly power of ‘jobbers’ to deal in stock and shares on the stock exchange was abolished.

2.21.3 Introducing market Relationships into the public sector – This is where the government tries to get different departments or elements within a particular part of the public sector to ‘trade’ with each other, so as to encourage healthy competition and efficiency.

2.21.4 Private Finance Initiative - This where a private company is contracted by a government department or local authority to finance and build a project. The government then pays the company to maintain and/or run it, or simply rent the assets from the company. The aim of public-private partnership is to introduce competition (tendering process) and private sector expertise into the provision of public services.

2.21.5 Free Trade and Capital Movements – International trade and investment is central to a market-orientated supply side policy. When government remove controls on the purchase and the sale of foreign currencies, thereby permitting free inflow and outflow of capital.

2.22 Management and Evaluation of Long Term Debt

Cunningham et al explained that for a company to be able to evaluate its liquidity and financial flexibility as well as its ability to finance operations over the long run, both external and internal users must be familiar with how it issues and reports any long term debt. User must be knowledgeable about how market forces affect the ability of a company to issue long term debt. When company like construction companies borrows from the bank or other financial institutions, the debt or borrowings is call note payable.

2.23 Limited Liability Company

If the firm has unlimited liabilities, it means if the business goes bankrupt and cannot pay its creditors, the owners personal possessions can be taken and used to pay the debt owed.

Although many small firms have unlimited liability, large organisations face so much greater risks that only some of security for personal asset encourages people to invest and accept the greater risks involved. Limited liability indicates that the liability of the shareholders for the debts of a business is limited to the amount they have invested in the business and not their personal assets. Most of the construction companies in Sierra Leone are limited liability in nature. They are owned by either a family or a small group of shareholders. Limited companies are said to have a separate corporate identity, in other words, an identity separate from their shareholders. They can sue and be sued.(Alan Whitcomb,1999).

2.24 Construction Industry

The Role of Construction Industry in National Development

The construction industry is a distinct sector of the economy which makes its direct contribution to economic growth like all the other sectors such as agriculture, manufacturing and services. Many writers have stressed the importance of adequate construction capacity for socio-economic development (Turin, 1973; World Bank 1984; Edwards and Miles 1984; Wells 1986; Ofori 1993b). The industry has great employment-generation potential as labour-intensive technologies are economically viable for most items of construction work.

Construction is a complex activity which is influenced by many factors. Several of these factors constitute problems for, and constraints on enterprises involved in construction. These relates to resources, documents, procedures, statutes, regulations and so on. In developing countries these difficulties and bottlenecks are relatively more severe and more enormous compared with industrialised countries.

A study by Turin (1973) of all major countries in the 1960s showed that in industrialised countries construction accounted for between 3 and 8 percent of Gross Domestic Product (GDP) and between 2 and 10 per cent of total national employment. Large percentage of inputs to the sector is bough-in from other sectors of the economy Low and Leong (1992) found major differences between countries at different levels of development. Countries with high GDP per capital had higher per capita value added in construction, as well as per capita gross output in construction.

2.25 Some Characteristics of Construction

In many of the least developed countries in the world today as much as one half of the total construction output may be in civil-engineering projects (roads, railways, ports, dams, power stations, drainage projects or water supplies) forming the basic infrastructure that is so vital to all other forms of economic and social activity. Commercially-built housing is generally less than one-third of the total.

The reminder of new construction work is in the form of other buildings (hospitals, health centres, schools, offices, factories, agricultural buildings and hotels). Also included in the data for net output, or valued –added, by the construction sector is the on-going repair and maintenance of all existing structures – a frequently much neglected form of economic activity in the poorer countries, but one which is now beginning to receive some of the attention it deserves.

The size of the construction industry in the UK is impressive, both in terms of output and employment. Construction output in 2009 was £6.5 billion ( 7 per cent of GDP0, of which 54 per cent was new work and 46 per cent repair and maintenance. The industry employs around 1.5 million people. Industry statistics reveals that the industry comprises mainly of small firms. Large firms of 1200+ employees undertake a mere 13 per cent of new work and repairs and maintenance. Small firms (1 – 7employees) and Small and Medium size Enterprises (SMEs, 8 – 114 employees) undertake a further 61 per cent of work leaving medium sized firms (115 – 1199) with the remaining 26 per cent.

Types of firm include general contractors, who undertake a range of building and civil engineering work, specialist trade contractors, specialist management consulting firms undertaking project management, and consultants – architects, quantity surveyors and engineers. In addition, there are firms offering a combined design and build service and some offering a ‘one-stop-shop’ to clients. Peripheral services, such as materials and component supply and plant hire, remain separate but are becoming more integrated into the industry’s activities as the trend towards greater prefabrication leads to increasing off-site activities.

Within the construction sector there in fact exists considerable scope for substitution between inputs and high degree of technological flexibility in production. In the poorest countries, the full range of technological alternatives is generally adopted.

The heterogeneous nature of the products of the industry- in terms of inputs, technology, standards and end use – is perhaps part of the explanation for the widespread failure of economists and other concerned with development issues (not to mention the public at large) to grasp the concept of construction as a clearly identifiable economic sector. Construction is different from other economic sectors, thus it is argued that there is not, and cannot be, any such thing as a standard construction product. A house is not, and cannot be, the same product as a hospital or a school. It is important to understand these differences and put them in proper perspective.

A far more significant distinguishing characteristic of construction – perhaps its only truly unique feature – is the fact that the completed products are generally not mobile but fixed for all time in the particular location where they are built. A large part of output for construction consists of capital goods – products required for the production of other goods. As a result of this fact, construction, in common with other capital goods industries, is in fact peculiarly susceptible to variations in the level of activity in the economy. Thus during period s of rapid economic expansion construction output is required to grow at a faster rate than that of other sectors and during periods of stagnation or decline the construction industry is the first to suffer.

2.26 Construction Management

The construction industry offers an exciting, dynamic environment in which to work The creative approach to work add satisfaction of making tangible changes to the micro-environment which the building or structure occupies, There has been a significant decline in public sector construction activity and an increase in the importance of the private client – especially the private corporate client.

Technological change driven by the rise in the use of information technology, has increased site and off-site productivity and enabled pre-project modelling of designs within the computer. The rise of private finance initiative (PFI) and private public partnerships with build-operate-transfer contracts has forced more emphasis on life-cycle costing of buildings and structures. The department of Environment, Transport and the Regions (DETR) (Egan) Report (1998) introduced the concept of key performance indicators for the construction industry and triggered the recent report for people (2000) initiative.

Fragmentation and confrontation are still endemic in the construction industry’s culture and are slow to change in spite of new methods of contract creating co-operative opportunities. Too many high profile projects still come in late and vastly over budget. There is still an image problem for the construction industry which has led to declining entrance levels at craft and degree levels in college and universities. The gender balance is still predominately male with only 12 per cent of women employed in the industry.

2.27 The Financing Problem of Construction

Investment in a constructed facility represents a cost in the short term that returns benefits only over the long term use of the facility. Thus, costs occur earlier than the benefits, and owners of facilities must obtain the capital resources to finance the costs of construction. For these reasons, attention to project finance is an important aspect of project management. Unless an owner immediately and completely covers the costs incurred by each project, these organizations face financing problems of their own.

In essence, the project finance problem is to obtain funds to bridge the time between making expenditures and obtaining revenues. Based on the conceptual plan, the cost estimate and the construction plan, the cash flow of costs and receipts for a project can be estimated. Normally, this cash flow will involve expenditures in early periods. During planning and design, expenditures of the owner are modest, whereas substantial costs are incurred during construction.

Plans considered by owners for facility financing typically have both long and short term aspects. In the long term, sources of revenue include sales, grants, and tax revenues. Borrowed funds must be eventually paid back from these other sources. In the short term, a wider variety of financing options exist, including borrowing, grants, corporate investment funds, payment delays and others.

Many of these financing options involve the participation of third parties such as banks or bond underwriters. For private facilities such as office buildings, it is customary to have completely different financing arrangements during the construction period and during the period of facility use. During the latter period, mortgage or loan funds can be secured by the value of the facility itself.

On the other hand, the options for borrowing by contractors to bridge their expenditures and receipts during construction are relatively limited. For small or medium size projects, overdrafts from bank accounts are the most common form of construction financing. Usually, a maximum limit is imposed on an overdraft account by the bank on the basis of expected expenditures and receipts for the duration of construction. Contractors who are engaged in large projects often own substantial assets and can make use of other forms of financing which have lower interest charges than over drafting.

2.28 The Importance of the Literature Review to the present study

Banks and other financial institution failures to provide credit to construction companies could cause damage to the country’s economy. Banks are needed not just for the intermediation between lenders and borrowers, but they also oil the wheels of the everyday commerce of a nation. If the banking system collapses, the infrastructure for making and receiving payment collapse too, and the rest of the economy could follow closely.

In order to assist small and medium size enterprises in the construction industries, banks developed investment banking and financial intermediation functions. With capital market in their infancy and relatively few, large investor banks are well positioned to draw long term funds from savers, and transfer them to construction companies on acceptable conditions.

2.29 Conclusion

This chapter presented the theoretical concepts on which the research studies will be based. There has been a thorough check of literature relating to the creation of credit facilities to small and medium size enterprises and a look at the construction industry.

Chapter Three

Research Methodology

3.0 Introduction

Careful considerations have been taken to assess the implications of credit creation by banks and other financial institutions to small and medium size enterprises in the construction industries for economic growth and development of Sierra Leone. The researcher has been able to progress knowingly and unknowingly of the various stages of the research Onion by Saunders et al. the ideology of the research onion is nothing different from the view of other authors.

It also acknowledges the types of research approaches, philosophy, and design, and how and why they would be applied in this study. Moreover, the sampling considerations (size and techniques), data collection methods as well as how data will be analysed in order to resolve the research questions are discussed in detail in this chapter. An analysis is made of the extent of validity and reliability of the study, as well as the limitations of the research.

The sample population for this study are the registered construction companies in Sierra Leone and financial intermediaries (with special reference to the loans and advances made by commercial banks and other financial institutions in the form of Credit).

3.1 Research Philosophy

Saunders et al (2003), describe research philosophy as “the way in which knowledge is developed and judged as being acceptable”. Research philosophy is the belief we have on how we deal with the research. Sunders et al group it in three categories as epistemology, ontology and axiology.

When similar findings are generally accepted as a piece of academic work it could be termed as 3.1.1.Epistemology. The Concise English dictionary defines Epistemology as the philosophical study of the nature, limits, and grounds of knowledge. It seeks to answer a comparative question of approaches; whether social, management and business approach.

3.1.2. Ontology - seeks to understand the nature of reality there by posing a question of assumptions about researchers; it seeks to understand the way the world operates and the stiffness to a particular view or belief.

3.1.3. Axiology issues concerned with the personal values, morality and ethics of the researcher. It assess ones own value in the creation and finding of solution in the field of aesthetics and ethics. Three views about the research dominate the literature and these can be listed as:

3.2 Positivism

From the aim to uncover the laws that governed the workings of the universe a view of what constituted reality (Ontology) and of knowing about that reality (epistemology) developed into a standpoint that we commonly call the attitude of scientific inquiry. Positivism could be law based in such that theory are analysed to formulate hypothesis which when tested gives room for laws to be assessed and this laws becomes basis of fact.

Sunders et al (2007) Bryman and Bell (2007) define positivism as “an epistemological position that advocates the application of the methods of the natural sciences to the study of social reality and beyond”. Remedy et al. (1998), describe a research based on principles of positivism as one in which the researcher “works with an observable social reality and that the end product of such research can be law-like generalizations similar to those produced by the physical and natural scientists”.

3.3 Realism

Realism is a branch of epistemology and shares futures with positivism because of its scientific method to the development of knowledge. Realism as scientific enquires is such that what we perceives as reality is the truth. In the researchers work, final result on a particular issue could be in the form of direct realism or critical realism. In a direct realism the researcher gives explanation to findings in a practical view point by experience which defines the world correctly. While in the critical realism, the researcher gives its finding from the limited information gathered. Sometimes this information from the critical realism is seen to be enough and correct but our senses sometimes deceive us. Sunders et al 2007.

3.4 Interpretivism

For this research, the interpretivism approach is very crucial in that it puts the researcher in an empathy state to handle every situation in the formation of the research solutions. Sunders et al 2007.

According to Kaplan and Maxwell (1994), it is through the meaning that people assign to phenomena that they can be understood. The authors hold that research based on interpretivism “does not predefine dependent and independent variables, but focuses on the full complexity of human sense making as the situation emerges”.

3.5 Research Approach

According to Sunder el al the approaches to research question depends on the structure and understanding of the question by the researcher at the beginning of the research. A good understanding of the research question will aid better choice of approach.

3.6 Deduction and Induction

Chris Hart (2006) in his book on ‘Doing a Literature Review’ defined the research approaches as follows:

3.6.1 Deductive –it is commonly a statement whose truth or falsity is known in advance of experience or observation (prior to experience) referring to instances of reasoning in which the conclusion follows from the premises.

3.6.2 Induction – This is commonly statement whose truth is made more probable by the accumulation of confirming evidence (based on experience) referring to instance of reasoning in which statements are made about a phenomenon based on observations. Induction expresses more of interpretivism

Deductive approach holds more to scientific research in that development of theory is the basic steps achieved by rigorous test.

3.7 Research Design

The research is designed to meet the aims and objectives of the researcher. The researcher’s findings and questions are presented either in the form of descriptive, exploratory or explanatory answers. According to Zikmund (2000), a research design is a “master plan that specifies the methods and procedures for collecting and analysing the needed information”.

3.7.1 Exploratory

Exploratory research is used in instances where the subject of the study cannot be measured in a quantitative manner or where the process of measurement cannot realistically represent particular qualities. Sunders at el 2007 in mentioning Adams and Schvaneveldt (1991) pointed that exploratory approach in his flexible state does not really means that one should be out of focus because it is usually very broad in early approach but in the long run it begins to take shape as it narrows down to the subject matter.

3.7.2 Descriptive

The descriptive research gives a further understanding of an explanatory research or exploratory research. It gives a better description of a person, event or situations. However, descriptive research method is not a very good way of going about research when it is used as a means to an end in itself. Nevertheless, the researcher seeks to use the descriptive methods as a base and went further to synthesizing and analyzing the data from the descriptive source. Saunders et al (2007)

3.7.3 Explanatory

Explanatory research is research conducted in order to explain any behaviour in the market. It could be done through using questionnaires, group discussions, interviews, random sampling, etc. The explanatory style is applicable when there is need to explain differences among findings. These findings could be as a result of the quantitative or qualitative data collected or from both. For the purpose of this research, the researcher also used an explanatory approach to make clearer findings from qualitative data. Sunders et al (2007)

3.8 Data Collection

According to Yin (1994) research approach is preferred when a case study methodology is used. It addresses the research questions of the how-why, the researchers control over the process insignificant. Sekaran (1992) also suggested that case studies researches can be explanatory, descriptive or hypothetical.

Data have been collected from both primary and secondary sources. Primary data have been collected by using interview technique with managers and senior officers of both the banks and Construction companies, whilst secondary data have been collected from journals, magazines, publications, books and the internet.

3.9 Reliability and Validity

3.9.1 Reliability; The data collected are seen to be reliable when the techniques applied by the researcher aids ‘consistent result’. Nevertheless, reliability satisfaction could be hampered by some threat which Robison described as participant error, participant bias, and observer error and observer bias.

Robson (2002)

3.9.2 Validity; a piece of research becomes valid when the findings appear to become what they really are. Practically, validity is all about having legal efficacy, going into research to show if the out come will become what is generally accepted by the concerns. Dochartaigh (2002) indicate that reliability and validity of secondary data refers to the authority and reputation of the sources. For the purpose of this research, the researcher tried to ensure that secondary data information’s are from reliable and valid source.

3.10 Secondary Data

Secondary research involves collecting data from either the originator or a distributor of primary research. In other words, accessing information already gathered. In most cases this means finding information from third-party sources such as research reports, company websites, magazine articles, and other sources

Researchers are attracted to secondary research due to the time savings and potential cost savings in acquiring information. Yet while secondary information holds numerous benefits and may help address many research questions, finding the right information often proves difficult

According to sunders et al, secondary data collection method has got three approaches which are documentary, multiple and survey secondary data.

3.10.1 Documentary: - data got via documentary are either in a written form or unwritten form. The written form are sources like report and minutes from committee, news papers and diaries etc while the non written sources could be media, television, video recording etc. For the purpose of this research, the researcher used the written form to acquire information to aid findings.

3.10.2 Survey based: - This refers to “data collected using a survey strategy, usually by questionnaires that have already been analysed for their original purpose” Saunders et al (2007). Survey based findings is census based, continuous and regular survey based or Ad hoc survey based. The researcher also used the survey based in the area of ad hoc and continuous and regular surveys to get data in a secondary form.

3.10.3 Multiple sources: - the multiple sources are the use of either documentary or survey base or the combination of both to get data intended for the research. In doing this research, the researcher found data in both forms considering the area based and the time series based. Sunders et al (2007)

3.11 Primary Data

In the collection of primary data collection, the researcher used methods such as interviews and questionnaires. The key point here is that the data you collected is unique to you and your research and, until you publish, no one else has access to it.

3.11.1 Interview Design

Interviewing is a technique that is primarily used to gain an understanding of the underlying reasons and motivations for people’s attitudes, preferences or behaviour. Interviews can be undertaken on a personal one-to-one basis or in a group. They can be conducted at work, at home, in the street or in a shopping centre, or some other agreed location. According to Saunders et al (2007) an interview is a discussion of two or more people for a particular purpose.

For the purpose of this study the researcher conducted interviews with respective managers of financial institutions and operations managers, construction engineers and owners of construction companies. These are the commonly used forms of interviews: Structured, Semi-structured and Unstructured or In-depth interviews.

3.11.1(i) Structured interviews, according to Saunders et al (2007), make use of “questionnaires based on a predetermined and standardized or identical set of questions”. The authors refer to them as “interviewer-administered questionnaires”. In this case, there is social interaction between the researcher and the respondent.

3.11.1(ii) Semi-structured interviews are a non standardized form of interview and are often referred to as qualitative research interviews (King, 2004). The researcher has a list of different questions to be answered which may vary from one interview to the other.

3.11.1(iii) In-Depth (Unstructured interviews) are informal and are used to explore in depth a general ar

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