How to make the SME Segment Profitable for Commercial Banks

Greg Rung
May 2005
Opening Remarks

• Talented speakers…

• … have already said a lot

• This proves the quality of the conference…

• … and shows a common vision, ie need for economies of scale

 SME Banking Framework:
Shifting the Productivity
Frontier

What are banks trying to do? How?

Generating
Productivity Frontier Growth:
(Future state of Best Practice)
Through profitable
marketing strategies

Improving Asset
Quality:
Through enhanced
Lower risk management
unit costs
per Increasing
transacti Limited Operating
on services to Efficiency:
or limited
service number Through
technological
of innovation
customers
Broader service offerings & higher
UNPROFITA
asset
BLE quality
Scope

Taken out of this presentation but important:

• Right environment is needed: credit bureaus, appropriate tax
systems
• Leasing is definitely part of SME banking
• Elements on program lending, scoring…

What is left?
• Holistic
• Hybrid
• Project/change management
• Execution
Key messages /
Presentation Outline

• SME banking, although difficult, can be highly profitable

• Differences across markets tend to disappear with the globalization

of the financial services industry.

• In practice, it means that targeting SMEs impacts the entire value

chain

• Based on this, several types of strategies can emerge

• Implementation is critical
SME Banking Can Be Highly
Profitable

In the US, the SME segment generates higher returns

Market Insurance
Consumer
Size
Credit

SME
Banking

Mortgages Credit
Cards ROE
 SME Banking Can Be Highly
Profitable (Contd)
In a number of Emerging Markets, some banks also generate high
returns in the SME segment

Example of a bank in South East Asia

Differences across markets…

Leading wholesale banks in

US and Europe
Credit portfolio is: Main European Banks
-Managed actively
(ex: secondary market and some others
activities)
-Credit rating is used for
-Managed like a profit key business decisions
center (pricing, capital allocation) Most other banks

-Linked to overall -Credit portfolio exposure, -Credit assessment done

balance sheet risk and profitability are
management measured
-Some processes often
remain lengthy and costly
in a “traditional” way.
Many processes remain
lengthy and costly
-No systematic rating,
implementation of
RAROC concepts nor
link between credit
worthiness and pricing
… Tend to Disappear with the
Globalization of the Financial
Services Industry

- Growing
competition Large Current
- Opportunity to Cos
Clients
and
charge higher “A” Clients
interests and Banks have
transaction an incentive
fees to SMEs to tap new
- Need to markets : Under-
diversify served
portfolio to SMEs, Market
lower overall Microenter-
risk prises &
Mass-market
- Information
technologies
lowering costs
In Practice, Targeting SMEs Impacts
the Entire Value Chain

Products
Marketing and Risk Delivery
services management channels
strategy
offerings

Organization

IT / Systems
1. Marketing Strategy

• In addition to conducting competitive analysis (on products, terms &

conditions; from other countries),…

• … segment the market and build up in-depth knowledge of SME clusters,

especially through third-party data providers

• Find ways of retaining existing credit-worthy customers…

• … & reducing cost of acquisition of new targeted customers

• Manage information transversally (e.g., get, compile and analyze default

information, if available by industries & companies)
2. Products & Services Offerings

Maximize client retention and profitability by offering

product packages as well as cross- and up-selling

Credit Deposits
 Loans  Checking accounts
 Guarantees  Savings accounts
 Credit Cards
 Overdrafts  Money market accounts

Payments Value-added
 Domestic payments  Insurance
 International payments  Brokerage
 Check processing  Information & tools
2. Products & Services
Offerings (Contd)

Focus on deposits even if lending is necessary

U.S. Small Business Profit Distribution
Small Business
All Others Profitability
Loans 5% 100%
10-15%
Deposits
70-85%

Source: FIC
2. Products & Services
Offerings (Contd)

The deposit/loan ratio largely determines small

business ROE
Small Business Profitability

40%
Small business unit ROE

Bank B

Bank A Bank C

20%

0%
1:1 2:1 3:1 4:1 5:1
Deposit-to-loan ratio
Source: First Manhattan Consulting Group
2. Products & Services
Offerings (Contd)

The more products sold, the greater the profit contribution

One $477

Two $1,641

Three $7,149
Number of products

Four $12,702

Five $10,871

Six $11,432

Seven $54,343

Eight $51,462

$0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000

Contribution
Source: Oxford Information Technology, Ltd.
3. Risk Management / Analytics

Efficiency Gains with Credit Scoring

Enter Generate Apply

Data Score Decision
Strategy

Auto decline Review Auto accept

High Medium Low

risk risk risk
4. Delivery Channels

• Goals: cost efficiency, differentiation in the market and client

satisfaction. For that:

• Review existing delivery channel mix & utilization…

• … as well as current and potential level of automation

• Focus the branch network on marketing, sales and client relationships

• Design multi-channel networks mixing branches – business

bankers/agents – ATMs – mobile kiosks – call centers – electronic
banking – smart cards – mobile banking
 4. Delivery Channels (Contd)

Pre-Sale Sale Post-Sale

Prospecting Information Advice and Order Order Customer
• Buyer Provision Consultation Capture Processing Support
Identification • Features • Aggregatives • Specifications • Transaction • Complaint
Channel • Buyer • Pricing • Optional • Feature Processing Handling
Solicitation Categorizatioin • Billing • Account
• Selection • Entry
• Alternatives Reconciliation
• Availability

Direct
Mail

Phone
Center

VRU

Branch

Online

Channel Efficiency (Capacity to Cost Ratio)

Source: Business Banking Board Research High Low
4. Delivery Channels (Contd)

In emerging markets, personal contact is critically

important…

Banco Solidario (Ecuador), reaches 45% of its customers

through bankers in the field – similar situation for Bank
Dagang Bali (Indonesia) which has very few branches

Vs

Bank BRI (Indonesia) received an award from the

Indonesian Museum of Records for establishing 4,658
branches throughout the country (92% of Bank BRI’s
portfolio is microloans)

Source: FIC
4. Delivery Channels (Contd)

…as is word of mouth

• 45 % of Banco Solidario’s new customers are

referred by existing customers

• At Bank BRI, a senior manager states, “All new

customers are referrals. Good [loan] customers
never just walk into the bank”

Source: FIC
5. Organization

Align organizational requirements

– Separate organizational responsibilities for SME Finance
(part of retail rather than corporate banking)

– Market versus product focus

– Clarify responsibilities for sales vs. credit vs. collections

– Clear responsibilities and incentives for deposit raising and

cross-sales (including personal financing needs of the
owner)

– Centralized processing of credit applications

– Clear processes for collections

6. IT / Systems

• As for the organization, client-driven vs. product-driven

• Develop efficient integrated information systems by leveraging

appropriate technologies…

• … towards Customer Relationship Management (CRM) capabilities…

• … and multi-channel management

Based on This, Several Types of
Strategies can Emerge

Focus of the strategy Key components

Risk management - Use sophisticated credit scoring models
- Build informal networks to gather asymetric
information on potential borrowers
- Develop deep understanding of industrial sectors

Margin management - Use of technology to reduce delivery and service

costs
- Redesign organization structure to manage
operational costs

Superior value - Gain in-depth understanding of customer needs and

proposition behavioral drivers to develop and deliver
differentiated value proposition
Conclusions

• SME banking is hybrid

• It generally involves a specific strategy and a total redesign

of the value chain

• Quality of execution is key

Example of Project

Module 1 : Standardization of Product Offering

Analyze performance
Analyse de performance
Get infor- Define a
Elaboration
Collecteon
mation revised Implementation
Plan
d’une gamme de
existing
des contrats product d’implémentation
products offering
produits cible
Benchmarking
Benchmarking
Example of Project (Contd)

Module 2 : Improvement of Loan Appraisal

Process and Scoring

Data
warehousing
Analysis of Find data and
Define missing data
current follow-up
situation

•Data available
•Scoring tools in
place
•Loan appraisal
•Back-testing
Scoring forms
•Definition of new
tool •Methodologies/pr Development of
procedures
ocesses scoring tools
•Communication
•Training
•Follow-up
Example of Project (Contd)

Module 3 : Improvement of Collections

Analysis ofdethe
Analyse portfolio
performance
•Identify
Elaboration quick wins
•Improve processes
d’une gamme de
•Set-up a call center
•Training
produits cible
AnalysisBenchmarking
of the processes
Possible Next Step if
Interest: Diagnostic

Gather data on
– Customer segmentation
– Sales organization
– CRM
– Risk-based pricing
Understand
Calculate key indicators profitability drivers
– Fee vs. interest income ratio
– Profitability by customer segments Gross
Margin

– Centralization of credit- – Formulate

– Portfolio-at-Risk
approval – % loans with early defaults a diagnostic
Cost
– Accuracy of Risk Reporting – % Non Performing Loans on current
of Risks
– Efficiency of Collections – Ratios on Collections Efficiency situation
– Ratios on Provisions and Write-offs and ways of
improving
– Processes streamlining – Overhead/Net Income net margin
Over-
– Scoring/Rating tools – Staff productivity head
– Branch as a distribution – Branch productivity – Draft a
Costs
channel proposal
– Organization of back-office

– Product mix and impact on – Ratio loans/deposits

funds – Ratio interest bearing / non Cost
– Governance/Disclosure interest bearing deposits of
– Treasury Management / ALM – ALM key ratios Funds
Contact Details

Greg Rung
Email: grung@ifc.org
out
SME Banking Is Difficult…

SME market knowledge is difficult to acquire

– “A Corporate” market composed of a few hundreds of large well-
known companies,
vs.
– A mass market composed of hundreds of thousands of SMEs in
different Industry Sectors and Geographic areas

SME Risk is difficult to manage for traditional banks

– Financial information on the business is scarce and often non reliable
– SMEs are often under-capitalized
– SMEs are often unable to provide adequate collaterals
– SMEs lack Financial Management culture

SME banking has high cost-to-serve

– One Corporate transaction can generate the same Net Banking Income
as 50 SME transactions…
– … But is not much costlier to the Bank than 1 SME transaction
… In Countries with the
Adequate Environment

Banking Regulations

Judicial System
– Should enforce creditor rights
– Should allow quick and efficient dispute resolution

Payment Systems
– To improve productivity
– To develop value–added products with good service quality

Communications, Infrastructure
– Easy contact with customers and branches across country

Credit Information
– Credit-Information Sharing
3. Risk Management / Analytics

• Use of advanced, cost effective tools & processes for

comprehensive risk management…

• … from data capture & management to data analysis and

monitoring...

• … by possibly leveraging information derived from historical

performance of SME clients…

• … and scoring experience of consumer credit underwriting

(models, application processing, reporting)

• This supposes good coordination between portfolio management

and collections departments, in particular
 3. Risk Management / Analytics (Contd)
Example of a Simple Scorecard
18 – < 21 21 – < 25 25 – < 30 30 – < 40 40 – < 50 50 – High NI
Age of Owner
6 10 18 26 35 42 10
Marital Single Married Divorced Other NI
Status 14 30 5 14 14
# of 0 1 2 3–4 4 – High NI
Dependents 14 14 25 10 5 14
Residential Own Rent Parents Company NI
Status 40 15 20 18 20

Years at <1 1 –<3 3–<6 6 – < 10 10 – < 15 15 – High NI

Address 18 20 25 30 33 40 25
Prof. Services I.T. Other Services Retail Catering. Building
Industry
38 35 30 27 20 10
Heavy Manuf.Others
Industry - continued NI
8 27 27

Years < .5 .5 – < 2.5 2.5 – < 5 5–<8 8 – < 15 NI

in Business 16 20 27 34 38 20
Total AssetsGT 100,000 LT $100,000 N I
27 18 10
Negative Yes No No Investigation NI
File Information – 30 15 0 0
© 1995 Fair, Isaac and
 3. Risk Management / Analytics (Contd)
Evaluating the Credit Applicant
CHARACTERISTIC JUDGMENT CREDIT SCORING

Age + 26
Marital status – 14
# of dependents + 25
Residential status – 18
Time at address + 25
ndustry – 20
Time in Business – 20
Total Assets + 27
Negative file information + 15

OVERALL + 190
Decision Accept Accept

ODDS OF REPAYMENT ? 95%

© 1995 Fair, Isaac and