How to Make SME Segment Profitable com

8/8/2019 How to Make SME Segment Profitable com

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How to make the SME Segment Profitable for Commercial Banks

Greg Rung

May 2005


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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


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SME Banking Framework:Shifting the ProductivityFrontier

Broader service offerings & higher

asset quality

Lowerunit costs

per

transactionor

service

Productivity FrontierProductivity Frontier(Future state of Best Practice)

Limitedservices tolimitednumberofcustomersUNPROFITA

BLE

How?

GeneratingGrowth:

Through profitablemarketing strategies

Improving AssetQuality:

Through enhancedrisk management

Increasing

OperatingEfficiency:

Throughtechnologicalinnovation

What are banks trying to do?


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Scope

Taken out of this presentation but important:

Right environment is needed: credit bureaus, appropriate taxsystems

Leasing is definitely part of SME banking

Elements on program lending, scoring

What is left?

Holistic

Hybrid

Project/change management

Execution


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Key messages /Presentation Outline

SME banking, although difficult, can be highly profitable

Differences across markets tend to disappear with the globalizationof the financial services industry.

In practice, it means that targeting SMEs impacts the entire valuechain

Based on this, several types of strategies can emerge

Implementation is critical


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SME Banking Can Be HighlyProfitable

In the US, the SME segment generates higher returns

ROE

MarketSize

InsuranceConsumerCredit

CreditCards

Mortgages

SMEBanking


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n a number of Emerging Markets, some banks also generate high

eturns in the SME segment

xample of a bank in South East Asia

SME Banking Can Be HighlyProfitable (Contd)


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Differences across markets

Leading wholesale banks inUS and Europe

Main European Banks

and some others

Most other banks

Credit portfolio is:-Managed actively(ex: secondary marketactivities)

-Managed like a profitcenter

-Linked to overallbalance sheetmanagement

-Credit assessment donein a traditional way.Many processes remain

lengthy and costly

-No systematic rating,implementation ofRAROC concepts norlink between creditworthiness and pricing

-Credit rating is used forkey business decisions(pricing, capital allocation)

-Credit portfolio exposure,risk and profitability aremeasured

-Some processes oftenremain lengthy and costly


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Tend to Disappear with theGlobalization of the FinancialServices Industry

- Growingcompetition

- Opportunity tocharge higher

interests andtransactionfees to SMEs

- Need todiversifyportfolio to

lower overallrisk

- Informationtechnologieslowering costs

Banks havean incentiveto tap newmarkets : Under-

servedMarket

CurrentClients

SMEs,

Microenter-prises &Mass-market

LargeCosand

A Clients


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In Practice, Targeting SMEs Impactsthe Entire Value Chain

Marketing

strategy

Productsandservicesofferings

Riskmanagement

Deliverychannels

Organization

IT / Systems


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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 defaultinformation, if available by industries & companies)


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2. Products & Services Offerings

Maximize client retention and profitability by offeringproduct packages as well as cross- and up-selling

Domestic payments International payments Check processing

Payments

Checking accounts Savings accounts Money market accounts

Insurance Brokerage Information & tools

Loans

Guarantees Credit Cards Overdrafts

Deposits

Value-added

Credit


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U.S. Small Business Profit Distribution

Deposits70-85%

Loans

10-15%

All Others

5%

Small Business

Profitability

100%

Focus on deposits even if lending is necessary

2. Products & ServicesOfferings (Contd)

Source: FIC


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The deposit/loan ratio largely determines smallbusiness ROE

1:1 2:1 3:1 4:1 5:1

40%

20%

0%

Small Business Profitability

Bank A

Bank B

Bank C

Source: First Manhattan Consulting Group

Deposit-to-loan ratio

Smallbu

sinessu

nitR

OE



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Contribution

Numberofpr

odu

cts

$51,462

$54,343

$11,432

$10,871

$12,702

$7,149

$1,641

$477

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

Eight

Seven

Six

Five

Four

Three

Two

One

Source: Oxford Information Technology, Ltd.

The more products sold, the greater the profit contribution



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Efficiency Gains with Credit Scoring

EnterData

GenerateScore

ApplyDecisionStrategy

Auto decline Auto acceptReview

Highrisk

Mediumrisk

Lowrisk

3. Risk Management / Analytics


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4. Delivery Channels

Goals: cost efficiency, differentiation in the market and clientsatisfaction. 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 businessbankers/agents ATMs mobile kiosks call centers electronicbanking smart cards mobile banking


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Prospecting

BuyerIdentification

BuyerSolicitation

InformationProvision

Features

Pricing

Selection

Availability

Advice andConsultation

Aggregatives

OptionalCategorizatioin

Alternatives

OrderCapture

Specifications

Feature

Entry

OrderProcessing

TransactionProcessing

Billing

CustomerSupport

ComplaintHandling

AccountReconciliation

Channel Efficiency (Capacity to Cost Ratio)

High Low

Channel

DirectMail

Phone

Center

VRU

Branch

Online

Pre-Sale Sale Post-Sale

Source: Business Banking Board Research

4. Delivery Channels (Contd)


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In emerging markets, personal contact is criticallyimportant


Source: FIC

Banco Solidario (Ecuador), reaches 45% of its customersthrough 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 4,658branches throughout the country (92% of Bank BRIsportfolio is microloans)


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as is word of mouth

45 % of Banco Solidarios 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


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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 andcross-sales (including personal financing needs of theowner)

Centralized processing of credit applications

Clear processes for collections


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6. IT / Systems

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

Develop efficient integrated information systems by leveragingappropriate technologies

towards Customer Relationship Management (CRM) capabilities

and multi-channel management


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Focus of the strategy Key componentsRisk management - Use sophisticated credit scoring models

- Build informal networks to gather asymetricinformation on potential borrowers

- Develop deep understanding of industrial sectors

Margin management - Use of technology to reduce delivery and servicecosts

- Redesign organization structure to manageoperational costs

Superior value - Gain in-depth understanding of customer needs andbehavioral drivers to develop and deliverdifferentiated value proposition

Based on This, Several Types ofStrategies can Emerge

proposition


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Conclusions

SME banking is hybrid

It generally involves a specific strategy and a total redesignof the value chain

Quality of execution is key


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Example of Project

Module 1 : Standardization of Product Offering

Elaboration

dune gamme de

produits cible

Collecte

des contrats

Analyse de performance

Benchmarking

Plan

dimplmentation

Elaboration

dune gamme de

produits cible

Collecte

des contrats


Benchmarking

Plan

dimplmentation

Define arevisedproductoffering

Get infor-mation onexistingproducts

Analyze performance

Benchmarking

Implementation


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Example of Project (Contd)

Module 2 : Improvement of Loan AppraisalProcess and Scoring

Datawarehousing

Analysis ofcurrentsituation

Data availableScoring tools inplace

Loan appraisal

formsMethodologies/processes

Find data andfollow-up

Scoringtool Development of

scoring tools

Back-testingDefinition of newprocedures

CommunicationTrainingFollow-up

Define missing data


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Example of Project (Contd)

Module 3 : Improvement of Collections

Elaboration

dune gamme de

produits cible


Benchmarking

Elaboration

dune gamme de

produits cible


Benchmarking

Identify quick winsImprove processesSet-up a call centerTraining

Analysis of the portfolio

Analysis of the processes


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Possible Next Step ifInterest: Diagnostic

Gather data on

Customer segmentationSales organizationCRMRisk-based pricing

Centralization of credit-approvalAccuracy of Risk ReportingEfficiency of Collections

Processes streamliningScoring/Rating toolsBranch as a distribution

channelOrganization of back-office

Product mix and impact onfunds

Governance/DisclosureTreasury Management / ALM

Fee vs. interest income ratioProfitability by customer segments

Portfolio-at-Risk% loans with early defaults% Non Performing LoansRatios on Collections EfficiencyRatios on Provisions and Write-offs

Overhead/Net IncomeStaff productivityBranch productivity

Ratio loans/depositsRatio interest bearing / noninterest bearing deposits

ALM key ratios

CostofFunds

Over-headCosts

Costof Risks

GrossMargin

Calculate key indicatorsUnderstandprofitability drivers

Formulatea diagnosticon currentsituationand ways ofimprovingnet margin

Draft a

proposal


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Contact Details

Greg RungEmail: [email protected]
mailto:[email protected]:[email protected]


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out


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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 indifferent 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

I C i i h h


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In Countries with theAdequate Environment

Banking Regulations

Judicial System

Should enforce creditor rights Should allow quick and efficient dispute resolution

Payment Systems To improve productivity

To develop valueadded products with good service quality

Communications, Infrastructure Easy contact with customers and branches across country

Credit Information Credit-Information Sharing


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3. Risk Management / Analytics

Use of advanced, cost effective tools & processes forcomprehensive risk management

from data capture & management to data analysis andmonitoring...

by possibly leveraging information derived from historicalperformance of SME clients

and scoring experience of consumer credit underwriting(models, application processing, reporting)

This supposes good coordination between portfolio managementand collections departments, in particular

3 Risk Management / Analytics (Contd)


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Example of a Simple Scorecard

< .5

16

GT 100,000

27

Yes

30

Yearsin Business

Total Assets

NegativeFile Information

.5 < 2.5

20

LT $100,000

18

No

15

2.5 < 5

27

N I

10

No Investigation

0

5 < 8

34

N I

0

8 < 15

38

Single14

0

14

Own

40

< 1

18

Prof. Services

38

Heavy Manuf.

8

MaritalStatus

# ofDependents

ResidentialStatus

Years atAddress

Industry

ndustry - continued

Married30

1

14

Rent

15

1 < 3

20

I.T.

35

Others

27

Divorced5

2

25

Parents

20

3 < 6

25

Other Services

30

N I

27

Other14

NI14

3 4

10

Company

18

6 < 10

30

Retail

27

4 High

5

N I

20

10 < 15

33

Catering.

20

15 High

40

N I

14

18 < 21

6

21 < 25

10

25 < 30

18

30 < 40

26Age of Owner

40 < 50

35

50 High

42

N I

10

N I

25

Building

10

N I

20

1995 Fair, Isaac and

3. Risk Management / Analytics (Contd)

3 Risk Management / Analytics (Contd)


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Evaluating the Credit Applicant

C H A R A C T E R I S T I C J U D G M E N T C R E D I T S C O R I N

+++++

2614

25

18

25

20

20

27

15

gearital status

of dependents

esidential status

ime at address

dustry

ime in Business

otal Assets

egative file information

?ODDS OFREPAYMENT 95%

OVERALLDecision

+Accept

190Accept

3. Risk Management / Analytics (Contd)

Documents

How to Make SME Segment Profitable com