Upload
tyrone-higgins
View
258
Download
0
Tags:
Embed Size (px)
Citation preview
SME FINANCINGHow to make it viable?
Facilitated Discussion• What is an SME?
• How are SMEs defined by your institution?
2
What is an SME?
SMEs are firms whose financial requirements are too large for microfinance, but too small to be effectively
served by corporate banking
Broadly, SMEs are all those businesses that act as the bridge between the LSM / FMCG Sectors and the End-
Users / Consumers
3
Usually “One Man” autocratic rule (no check on decisions)
Lack of succession planning
Excessive reliance upon one major product / supplier / buyer
Limited range of management skills
Weak legal structure
Lack of transparency / true financial reporting
Diversification backed by money, not knowledge
Limited access to debt financing and capital (own + public)
GENERAL CHARACTERISTICS OF SMEs
• 84% have sales less than Rs 0.5m
• 93% have sales less than Rs 1m
• 19% are less than 5 yrs old
• Only 4% over 25 years old
• Can be classified into Large, Medium and Small-sized entities / businesses
Source: SMEDA
SMEs in PAKISTAN
5.2m in Total Population
30% of GDP
25% of Manufactured
Exports35% of Value Addition in
Manufacturing
65% Contribution
in Employment
The SME Market still remains fundamentally under-banked and underserved, particularly for the “S” segment
• Fewer than 150,000 SME’s (4% of SME’s) currently borrow from banks in Pakistan
• Less than 40% have any form of banking relationship with any bank
PKR Billion Dec-10 Dec-11 Dec-12 Dec-13
SME O/S 334 294 266 273
Total Industry O/S 3,488 3,546 3,943 4,182
SME Share (%) 9.6% 8.3% 6.8% 6.5%
SME NPLs 96.5 95.5 95.4 86.6
SME NPL Ratio 29% 35% 36% 32%
No. of SME Borrowers 211,000 168,000 132,000 137,000
Source: SBP
Source: SBP
40%
43%
17%
Manufacturing TradingServices
Composition of SME Financing
03
Scarcity of Financial Solutions
Weak Management Fabric
SME’s
Ignorance/Conservatism
Marketing/Distribution
IMPEDIMENTS IN THE GROWTH OF SMEs
The Multi-Faceted Needs of SMEsCORE FINANCIAL
NEEDSNON-CORE
FINANCIAL NEEDSNON-FINANCIAL
NEEDS
Asset Products Private Equity Business Plans and Financial Forecasts
Liability Products Debt Structuring Sales / Marketing Plans
Transaction Services & Treasury Management
Investment / Real Estate Advisory
Market Mapping & Distribution
Wealth Management Consumer Finance for Employees Process / Technology
SOURCE : IFC
Most Product Opportunities are Non-Credit
35%
40%
Other Credit Deposits
SME Revenue Base - Not Just Financing!
Credit products contribute only 35% to
Total Revenue
Only 15% of Total Revenue comes from
Loans / Funded Asset Products
• SMEs have unique and multiple needs
• Almost 85% of Total Revenue from a typical SME relationship consists of NFI
• Banks need to change the way they look at SMEs
CHALLENGES AND WAY FORWARD• Definition of SME Deposit only Customers
• Simplification and automation of Credit Process to reduce Turn-Around-Time
• Target Market Identification and Program-Lending Approach
• Investment in Technology
SME Banking
SBP Definition - SMEsSMALL ENTERPRISE (SE)
Employing up to 20 persons Sales up to Rs 75mFinancing from ALL banks / FIs up to Rs 15mAudited Account NOT mandatory
MEDIUM ENTERPRISE (ME)Employing more than 20 and up to 50 persons (Trading) OREmploying more than 20 and up to 250 persons (Manf. & Services)Sales more than Rs 75m and up to Rs 400mFinancing from one Bank/FI up to Rs 100m and from ALL banks/FIs up to Rs 200mCopy of Audited Accounts MUST be obtained where exposure is more than Rs 10m or Pvt. Ltd. Cos.
SBP PRs for SME FinancingSUMMARY OF KEY CHANGES
SME specific Credit Policy duly approved by BoD
Insurance of hypothecated / mortgaged assets NOT mandatory for exposures up to Rs 1m
PGs of all sponsors required (except in 100% cash-backed / nominee directors)
Clean exposure (secured by PG only) up to Rs 5m
Subjective Classification NOT mandatory for SEs based on account turnover / clean-up if mark-up servicing on time
CORE FINANCIAL / CREDIT NEEDS OF SMES
SMALL BUSINESSES REQUIRE FUNDS FOR FOUR MAIN PURPOSES:
Initial Business Acquisition or Establishment—often referred to as “seed” capital
Capital for Expansion and to support purchase of new plant / equipment, etc.
Working Capital needs for raw materials and stock purchases, customer credit support, and the running expenses of the business; and
Emergency Funds sometimes required to cover short-term liquidity problems
How Many Squares?
B
D
CA E HGF
LKJIM PON
19 20
21 22
23 24
25 26
2728 29
Macro Risk
Industry Risk
Company Specific Risk
Business Risk Performance Risk Financial Risk
Management / Borrower Risk
RISK EVALUATION FRAMEWORK
are generally smaller, less established, have lesser power to demand leniency from creditors and influence terms, tend to work on smaller margins; and therefore are more subject to market forces
have fewer assets to offer as collateral on a secured loan
are less likely to have structured financial data and audited financial statements
tend to be under-capitalized due to the difficulties in raising equity finance for small business
have a smaller pool of business management skills to draw on, particularly where financial management is concerned
GENERAL RISKS IN SME LENDING
Succession Risk
Management & Planning Risk
Lack of Documentation / Transparency
Single Buyer / Supplier Risk
Limited access to Debt Market (Limited financial capacity)
KEY TYPES OF RISKS ASSOCIATED WITH SME BUSINESSES
sound lending policies and principles are key to successful small business lending
proper cash flow-based credit analysis
“know your borrower” and their business
always view collateral as the “last” source of repayment
monitor the borrower and business progress over time
GENERAL GUIDELINES TO RISK MITIGATION
RISK MITIGATION IN LENDING TO SMEsExtent / Amount and Type of lending must be based on Cash FlowsAssessment of “True” Cash Flows / Income EstimationMarket ReputationHistory with other Banks / FIsCredit / Limit StructuringSuccession Planning & Management QualityIndustry / Market OutlookInterest Rate RiskCollateral considerationsClose and Frequent Customer Contact, especially after disbursement
KNOW YOUR BORROWER !Who is the Prime Obligor?
• Is Prime Obligor and the borrower same entity?
• Who are the owners/ share holders of the prime obligor/borrower?
• Are there more than one firms wholly or partially owned by the owners/share holders of the prime obligor / borrower?
• In case of loosely knit group do member firms / companies usually use each other’s credit lines and/or bank accounts?
• An organization chart in case of a loosely knit group indicating who owns whom is always helpful
• Who are creditors - 3rd party suppliers / family or friends / other related firms / partners?
Some months have 30 days and some have 31 days. How many have 28 days?
All of them!
THE BORROWER’S (FIVE C'S OF CREDIT)» Character» Capacity (to repay) / Cash Flows» Capital (own contribution)
» Conditions (industry / economy / overall environment in which the customer operates)
» Collateral
PRINCIPLES OF LENDING
Character comes before anything else and
Collateral is always the last
QUESTIONS THAT MUST BE ASKED...
Why us?
What is the purpose of the loan facility being requested?
How did the “need” for a loan arise?
Does the size of existing business support the requested loan amount?
What shall be the extent of equity participation?
What are the existing banking arrangements, if any, and what are the present financing sources / alternates available?
How shall the requested loan be secured / collateral options?
LOANS ARE ALWAYS REPAID
OUT OF CASH AND
NEVER PROFITS
SIGNS OF TROUBLE
Erratic / Irregular repayment behavior
Frequent requests for enhancement of credit facilities
Sudden decrease in account activity
Frequently bounced cheques
Frequent requests for allowing payments against cheques in clearing
Sudden change in the borrower’s lifestyle, especially after disbursal of funded facilities
BEFORE AFTER
CASH FLOW BASEDLENDING
WORKING CAPITAL AND CURRENT ASSETS
Gross Working Capital (GWC) = Current Assets… represents investment in current assets
Net Working Capital = Current Assets – Current Liabilities
Maintaining working capital balance requires permanent commitment of funds
… a business will always have a minimum level of Inventory, Accounts Receivable, and Cash—All this requires funding
BEHAVIOUR OF WORKING CAPITAL
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Fixed Assets 15 15 15 15 15 15 15 15 15 15 15 15
Current Assets 45 60 70 70 60 50 60 70 70 60 50 45
5
15
25
35
45
55
65
75
PKR
Mill
ion
Permanent Working Capital
Current Assets OR
Working Capital
FINANCING NET WORKING CAPITALTemporary or Seasonal WC needs should be financed with
short-term sources (Payables and/or Borrowings)Permanent WC should be financed with long-term
sources (Equity and/or Long-term Debt)
Working CapitalTrade
Payables / Creditors
Raw Materials
Work-in-Process
Finished Goods
Trade Receivables /
Debtors
Cash
WORKING CAPITALTRADITIONAL DEFINITION = CURRENT ASSETS - CURRENT LIABILITIES
Working Capital = 19,000 – 11,000 = 8,000
LIABILITIES (funds from) ASSETS (funds to)
Share Capital & Ret. Earnings 18,000 Fixed Assets 13,000Long-term Loan 5,000 L. T. Investments 2,000
Current Liabilities Current AssetsTrade Creditors 8,000 Stock 8,000Other Payables 3,000 Trade Debtors 9,000
11,000 Other Receivables 1,000Cash 1,000
19,000
34,000 34,000
Long-term Surplus Funds = 8,000
WORKING CAPITAL
BANKER’S DEFINITION = STOCK + TRADE DEBTORS – TRADE CREDITORS
LIABILITIES (funds from) ASSETS (funds to)
Share Capital & Ret. Earnings 18,000 Fixed Assets 13,000Long-term Loan 5,000 L. T. Investments 2,000
Current Liabilities Current AssetsTrade Creditors 8,000 Stock 8,000Other Payables 3,000 Trade Debtors 9,000
11,000 Other Receivables 1,000Cash 1,000
19,00034,000 34,000
Net Working Capital = 8,000 + 9,000 – 8,000 = 9,000
Bank Loan (RF) needed to support growing SALES!
WORKING CAPITAL
LIABILITIES ASSETS Share Capital & Ret. Earnings 25,000 Fixed Assets 14,000
Trade Creditors 8,000 Stock 8,000Trade Debtors 9,000Cash 2,000
33,000 34,000
Turnover / Sales increases by 2 times
Share Capital & Ret. Earnings 25,000 Fixed Assets 14,000
Trade Creditors (8,000 x 2) 16,000 Stock (8,000 x 2) 16,000
Trade Debtors (9,000 x 2) 18,000RF Requirement 7,000
Cash ?
48,000 48,000
Anticipating Working CapitalCASE STUDY – Khan & Sons
Capital & Retained Earnings 7,000 Fixed Assets 12,000
Long-term Liabilities 1,000
Trade Creditors (8,000 x 2) 16,000 Stock (2,000 x 2) 4,000
Trade Debtors (2,000 x 2) 4,000
Net Working Capital = 4,000 + 4,000 – 16,000 = (8,000)
RF 0 Cash 4,000
TOTAL 24,000 TOTAL 24,000
Anticipating Working CapitalCASH FUNDING NEED
Sales 1,000,000 Stock 175,000+ Trade Debtors 290,000- Trade Creditors (180,000)Net Working Capital 285,000
Net Working Capital / Sales(the min. amount of increased Working Capital required to fund a given increase in Sales)
Net Working Assets / Sales Ratio = 0.285 times OR 28.5%
If sales were to increase to PKR 1,500,000 what would be the Working Capital Need?
Projected Working Capital Need = 1,500,000 x 0.285 = Rs. 427,500
Recommended max. RF / Loan Amount = ? Rs. 142,500
“Finished files are the result of years of scientific study combined with the
experience of years”.
Count the number of times that the letter “F” appears in the following sentence
6
Assessing SME Credit Risk
Is SME Credit Risk different than Corporate Credit Risk?
Is it different than Retail & Consumer Credit Risk?
WHY?
WHY NOT?
38
Understand the SME Market
Develop Products & Services
Acquire & Screen SME Clients
Serve the Needs of SME Clients
Manage Information & Knowledge
SME Risk Management
Managing SME Credit RiskUnderstanding the SME Market• Sub-segment the market by Size, Risk Profile, and Business Model –
SME is not a mass-market!
Develop Products and Services • Develop and introduce Products / Programs / Bundles for each sub-
segment• Take unconventional collateral to secure loans – encourage “cash flow
based lending”
Acquire and screen SME clients • Use alternate channels to market new clients• Use alternative approaches to screen clients
40
Manage SME clients• Introduce Customer Relationship Management (CRM)• Develop (preferably automated) early warning systems for identifying
problem loans• Introduce Collections as a function
Manage information and knowledge• Gather and analyze data for development of risk-rating models and
scoring tools
41
Managing SME Credit Risk
Segmentation
Small
Large
Rural Urban
Seasonal Financing
Travel AgentsFertilizer & Pesticide
Dealers
Portfolio Risk vs. Loan RiskUnlike corporate loans, no single SME loan can sink the bank
Credit Risk Management Procedures• Implement enough controls to be reasonably certain that loans
meet quality standards
• Streamline and simplify the decision-making process
• Once a certain level of quality is achieved, stop the analysis process
43
Portfolio Risk Management Procedures
• Clearly defined credit risk policy and approval procedures
• Adherence to the approval procedure is more important than the quality of individual loans
• Bank is seeking overall profitability of the portfolio, not perfect performance of individual loans
• If the default rate of the portfolio is too high (more than 7% for SEs and more than 10% for MEs), review and adjust the policy and approval procedure
44
Credit Risk Appraisal
SME Lending will typically comprise the following:
• Evaluation based on 5 “C”s of Credit – Character, Capacity, Conditions, Capital, Collateral
• Site visits for verification and subsequent monitoring
• In-built ‘Need Assessment’ mechanisms for products / programs
45
Portfolio Monitoring and Quality Control
• Credit policy and procedures set by HO; loan review focuses on adherence to policy and procedures
• HO sets concentration limits by industry type, geographical area, loan tenor; collects industry information
• Loan documentation and disbursement NEVER handled by business
• Preferably and where possible, disbursements directly for purchases rather than to the borrower
• Monitoring/site visit requirements
• Collections support
• Separate loan workout / NPL recovery unit
46
Portfolio Monitoring and Quality Control
47
Credit Approval Monitoring NPL Management
First Line of Defense Early Warning Signals Recovery Process
- Loan restructuring- Out of court
settlements- Debt-asset swaps
- Collections- Segmentation- Applicant Screening- Credit Factory for “S”- Product Bundles and
Programs
Collections & Recovery
48
Soft Hardcore Recovery ARM / Workout
0 - 30 DPD 31 - 60 DPD 61 – 90 DPD
- Call Centre for SEs- Phone calls by
Collectors for SEs / RMs for MEs
- Dunning Letters
More than 90 DPD
- Visits by Collectors for SEs
- Visits by BM/RM for MEs
- Dunning Letters
- Visits by BM/RM for SEs
- Visits by TL for MEs
- Dunning Letters
PRE-REQUISITES- Ownership must remain with the loan extending unit / branch- Automation of the Collection function- Dedicated Collections Teams- Dedicated NPL Management Teams
- Initiation of legal proceedings
- Restructuring
COLLECTIONS: An Illustration
49
2007-11 2012 2013-140%
10%20%30%40%50%60%70%80%90%
100%
34.00%
75.00%
97.00%21.00%
20.00%1.50%
43.50%
4.20%1.20%
0-30 DPD 31 - 60 DPD 61 - 90 DPD
98.50%99.20%
99.70%
- Ownership remains jointly with the loan extending branch and SME Unit- Introduction of CWX for SME- Small but dedicated SME Collections Teams- Allocation of Collections targets to Branches and SME RMs in KPIs- Negative weight of NPL Accretion for Branches in KPIs- Trophies and incentives for meeting Collections targets
Before After
Approaches to Lending
• Financial Statement Lending• Asset-Based Lending (and Leasing)• Relationship Lending• Credit Scoring
Note: These approaches are often used in tandem, and are rarely used exclusively
50
Financial Statement Lending
• Lending is based on the strength of the financial statements – balance sheet and income statement
• Looking to profits, cash flow of the business to repay the loan
Requirement: Quality financial statements, transparency
51
Asset-based Lending• Lending is based on the quality of the underlying collateral • Loan is repaid by the conversion of that collateral to cash
Requirement: High quality accounts receivable and inventory
Examples:
• Ship-breaking• Seasonal Financing (Rice, Sugar, Cotton, Wheat, Wool, Tea)• Factoring / Receivable Financing• Leasing
52
Approaches to asset-based lending:
Borrowing Base – lend a % of current assets
Example:
• Use month end list of accounts receivable
• Eliminate any items from clients with past due amounts > 90 days
• Eliminate known problem clients
• Lend 70% of the remaining balance
53
Asset-based Lending
Approach to asset-based lending:
• Assignment of contract and proceeds – often used for supply chain financing
• Borrower pledges sales contract to bank, buyer makes payments directly to the bank
• May also be structured to secure a term loan
54
Asset-based Lending
Issues / Risks:
• Control of proceeds / assets
• Enforceability of liens
• Acceptability of collateral to bank regulators
Relationship Lending• Loan is substantially based on “soft” information from the owner about
the business, and information about the owner, through a range of sources
• Information may come from customers, suppliers; also includes information about the business environment; plus lending experience and provision of deposit accounts and other services
55
Characterized by:
• Close monitoring• Re-negotiability • Implicit long term contractual relationship• Information is not from public sources• Information is subsequently kept private
SME & Commercial
SMECommercial Agri
Medium Small
- Relationship Management approach- Mix of Program and Transaction Lending - Target Market identification- Risk Acceptance Criteria- Sales driven through branches and RMs- Special Assets Management support- Scorecards and Risk Rating Models
- Program Lending approach- Target Market identification- Risk Acceptance Criteria & Scorecards- Credit Factory approach- Sales driven through branches and ADCs- Collections function for timely markup
recovery- Need-based NPL recovery teams- Scorecards
Centralized Trade ProcessingNPL Settlement Policy & Dedicated Team
Centralized Supply Chain, BIU / MIS and R&D functionsComposite KPIs including Productivity targets in addition to volume and revenue targets
An Illustration: APPROACHES TO LENDING
Credit Scoring
57
Concept: The Future is Like the Past
Credit scoring measures relationships between borrower characteristics and payment performance of past loans to predict future payment performance of loans to borrowers with similar characteristics
Quicker, More Consistent
Credit scorecards quickly calculate a consistent risk measurement of relatively small, homogenous transactions.
This risk measure can be used as a tool in making loan decisions, pricing loans, and can be associated with historic probability of default for risk classes.
58
Concept: Expert vs. Statistical
All models are based on the combination of statistical analysis and expert judgment.
The proportion in which these two elements are combined is based on the amount and quality of data available for modelling.
Little Historic Data Extensive Historic Data
More Expert Judgment More Statistical Inference
Credit Scoring
Credit Scoring
59
Concept: Application Scoring vs. Behavioural Scoring
Application Scoring• Uses “Approved” and “Reject” data sets• Can be used as a pre-screener, or credit approval tool for NTB / fresh
loan applicants as well as for pricing decisions• Predicts the probability of default for each applicant• Used in credit approval and pricing decisions
Behavioural Scoring• Uses “Good” and “Bad” data sets• Based on the most recent information• Dynamic tool used for managing existing borrowers• Used for decisions on enhancements, renewals, cross-sell, and re-pricing
60
Concepts: Ranks Applicants by Risk
Scores are used to rank applicants from low to high risk and treat them differently based on risk
Risk Class Decision Policy Interest Margin
1 Approve 1.25
2 Approve 1.75
3 Approve 2.25
4 Review 3.00
5 Review 5.00
6 Review 7.00
7 Reject N/A
Credit Scoring
61
IT Requirements for Scoring
• Statistical software is needed for model development only• No software is required to implement a scorecard as a decision
support tool• A web-based online application processing system is the most
appropriate long-term model deployment solution.
Credit Scoring
Possible Modelling Techniques
1.Logistic Regression or comparable statistical techniques (neural networks, decision trees)
2.Cross-Tabs (univariate ‘logistic regression’)3.Expert Judgment Only
Amount of Data
62
Types of Risk Factors:
Financial: - Leverage- NOCG- Liquidity- Profitability- Activity- Cash-flow Coverage- Interest Coverage- YOY changes in
SalesProfitabilityWorking CapitalNOCG
Credit Scoring
Non-Financial: - Years in Business- Credit History- Banking History- Demographic Information- Succession Planning- Type of Industry- LTV on Collateral- Business Reciprocity in relation to
Limit and/or Sales
Summary of the Scorecard Building Process
1. Assemble project working group
2. Define scorecard “segment”
3. Define “bad” loan for selected segment
4. Assess quality/quantity of data
5. Build Model
6. Pilot Test Model
7. Validate Model
63
Credit Scoring
Group Activity: Build an Expert Scorecard
64
1. Define scorecard segment: Generic for SMEs or Segment-specific
2. Define ‘bad’ – still needed for monitoring and validation, even for expert scorecards
3. Assume no data at all
4. Look out for pitfalls - Inputs should be simple to collect, Categories are mutually exclusive, Limit the total number of factors
5. Select Risk Factors• if I could look at only 1 factor, …• Select factors that measure different aspects of credit risk:
Ability to repay Willingness to repay
• For small businesses, can look also at personal characteristics of owner• Rank them from high to low risk: 1 is the lowest risk, 5 is the highest risk• Assign relative weights to each risk factor in terms of importance
An Illustration of an Expert ScorecardFACTOR / VARIABLE SCORE RANGES
Years in Current line of Business
> 10 years15
5 – 10 years10
5 – 3 years7
< 3 years0
Age of oldest relationship with the bank
> 5 years10
> 3 – 5 years 8
> 1 – 3 years5
< 1 year3
No prior relationship0
Age of primary Sponsor 40 – 65 years5
> 65 – 85 years3
< 40 – 25 years2
Other0
Primary Security Cash / Near-Cash15
Mortgage12
Pledge10
Hypothecation5
Clean0
Location of Business Main Market / Industrial Area
5
Peripheral Market / Industrial Area
3
Remote Market / Industrial Area
2
Other
0
Credit Turnover in all accounts / banks
> 4 x of limit15
2 – 4 x of limit12
> 1 x of limit10
< 1 x of limit0
Payment History Clean
15
Up to 2 times in 30 DPD and once in 60 DPD
10
Once in 90 DPD
7
Other
0
Sales Trend – last 3 years Increase / Increase10
Decrease / Increase8
Increase / Decrease5
Decrease / Decrease3
Others / Not Available0
Financing to WC < 50%5
50 – 70%3
70 – 85%2
> 85%0
Total Business Liabilities to Sales
Up to 75%5
75 – 90%3
90 – 100%2
> 100%0
TOTAL SCOREDECISION Approved (More than 70%) / Review (Between 65% and 70%) / Decline (Less than 65%)
CUT-OFF 65%
SMEs Have a Range of Different Product Needs
Market Analysis and Product Development Link
Create competitive products
Design product with features attractive to SME clients, but which also generate revenue for the bank
Back with strong systems so the bank can effectively deliver on its
promises
Clearly understand market for SME banking
Understand bank’s and competitors’ position in SME segment
Understand what target clients want through market research
67
Individual Product Design Considerations
• Fulfill all needs (Must Have)
• Satisfy as many wants as possible (Nice to Have)
• Create features (where possible)
• Eliminate barriers and highlight benefits
68
Needs
SME Customers
Needs = "Must Have"
Description
Access to Credit
Clear, sensible credit policy Achievable conditions/security Loan officer professionalism
Transaction Services
Balances held on account Deposits Withdrawals & transfers
69
Wants
SME Customers
Wants =
"Nice to Have"
Description
Reliability
Bank will not panic in tough times Credit to grow with the business Bank will help capture opportunities
Convenience
Proximity to branch location Easy administration procedures No bureaucracy
Cost
Lowest possible interest rates/ fees Inexpensive collateral/ legal fees Modest compliance burden
Service levels
Friendly/ sympathetic loan officer Speedy decision turnaround No mistakes or problems "Generous" credit availability
70
Features
Financial Services
Features Description
Market Presence
Safe & regulated Reputation and brand name Competitive vs. other banks
Services/ Products
Resources: "we have the money" Product range: “one-stop banking” Location: “we have a branch nearby”
Credit Capacity
Procedures: application forms, visits etc. Credit policy: "we know what's prudent" Staff: ability/ authority to make decisions
71
Benefits
Financial Services
Benefits SME Perspective
Relationship
A bank that knows my needs & risks Because they know me, they tend to trust me I can avoid the costs/ time of switching
People
Knowledgeable about finance & banking I like working with them Responsive: they can get things done
72
What is a Product Program?
73
• A standardized set of rules of credit extension for a group of customers with similar characteristics or product needs
• Sign-off on a product program is considered approval of the
complete risk/reward characteristics of the product & the credit-cycle process
• Demonstrates that portfolio performance will be predictable in terms of revenues, delinquencies, & losses
What Does the Product Program Contain?
74
• Product description• Target market • Economic & competitive environment • Eligibility criteria (terms & conditions)• Account initiation • Account maintenance • Collection & write-off policy• Treasury, funding, & pricing considerations • Support systems & MIS reports • Product profitability & stress testing
MIS strongly supports the product program process
Product Program Features
75
• Standardized & ‘simple’ products• Critical mass/scale• Risk-reward balance• Predictability• Factory-style • Management by exceptions
Portfolio management is done through approved product programs
The Importance of MIS
76
Continuously processes & transforms data into information, which will be used in the decision-making process directed
towards optimizing results
Risk-Return Trade-OffProgram Lending serves as a base for effective credit cycle &
portfolio management; diversifying and controlling risks & assessing opportunities
Product Provision: Sources of Product Manufacture
77
More than 80 % of SME banking products already exist within the organization but require customization
Much of product manufacturing can take place outside SMEbanking: • Retail banking• Cards / Consumer Finance• Corporate banking• Subsidiary companies
Product management needs to remain with SME banking, but supported by multiple service-level agreements
Product Strategies for SME Finance
78
• Liability vs. asset-driven strategies
• Pre-approved sales vs. customized solutions
• Statement vs. non-statement
• Business banking vs. total customer relationship
• Supply-chain financing
• Small vs. Medium SME
• Alternative forms (factoring, insurance, leasing)
• Product program-based
• Non-financial advisory services
• Payment-card strategies
Liability-driven Strategies
79
• SMEs use a current account more than anything else • Focus is capturing as much of the cash flow as possible: cash
is the competitor • Heavy reliance on bank for payments & transactional
services • Deposit accounts & payroll accounts can be very ‘sticky
products’• Often useful entry strategy to develop understanding of
segment • Ownership of operating account can drive risk and reward
behaviors • Many market leaders started with liability strategies
Asset-driven Strategies
80
• Credit is a crucial requirement for SMEs in deciding on a bank• Useful to hook existing banked customers of other
competitors • Strategy is to hook new clients using accessibility of credit &
pricing or a combination • Can be secured or unsecured • Main types:
- Overdraft/ emergency facility- Working-capital finance - Term finance - Commercial mortgage
Statement vs. Non-statement-based Strategies
81
• High degree of SME variability in terms of quality of financial• information & transparency • That affects the risk & reward relationship • Potentially creates two different product sets: SMEs with
financials & SMEs without• Product design quite distinct for each, with different
processing, documentation requirements, collateral coverage, & pricing/margin levels
• Leading SME banks will separately manage both product portfolios
Business Lending vs. Total Customer Relationship
82
• Some players focus on the complete business & personal banking relationship
• Includes relatives & employees of the SME• A single customer-relationship-management model
potentially adopted across all products & services• Products include deposits, current accounts, payroll, &
retirement services
Supply-Chain Finance Strategies
83
• Target the suppliers & distributors of existing or potential large corporate clients
• Effectively transfer the risk profile onto the debtor, based on receivables from the corporate name
• Customized or product-program basis with potential range of products
Small vs. Medium SME Strategies
84
• Clearly segregate the product portfolio based on size & risk profile of the Small and Medium SME
• Give small SME a small number of standardized & simplified products, primarily retail-oriented
• Medium SME potentially requires different terms & pricing
Small Medium
Borrower Individual or Business Entity Business Entity
Sales Up to Rs 100m More than Rs 100m
EligibilityExisting
business for more than 5
years
Existing business for more than 3
years
Max. Loan Amount Rs 15m More than Rs
15m
Interest Rate K + 5% p.a. K + 3% p.a.
Upfront Fee 1% 0.5%
Security Mortgage or Cash/Near-cash
Any tangible asset
Factoring Strategies
85
• Complementary source of working capital for SMEs• Two types of factoring: debt & invoice financing• Entails purchase by the lender of a firm’s accounts receivables
& collection of invoices from the parties owing money • Very useful in markets where the financial infrastructure
presents gaps. Addresses problem of SME opacity by focusing on the quality of the obligor
• Reverse factoring has recently become more popular—lender purchases receivables from only high-credit, quality buyers, resulting in low-risk loans to high-risk (SME) suppliers
Payment Card Strategies for SMEs
86
• Cards can represent a potentially low-cost, scalable way of access for high volume SME payments
• Can be packaged as small unsecured credit line for small SMEs• Card products can be packaged with added value & extensive
information-system support• Usage data can be extremely helpful in building scorecards• Research indicates 5 main motivators:
- Simplified payments- Simplified administration - Broader scope of use - Speed of service- Convenient form of credit (secured & unsecured)
Product Bundling: Another Useful Technique
87
Types of Bundling
88
Types of Bundling: Illustration (Segment-based)
89
Segment RF CF / Pledge LG Trade
FinanceCurrent
A/C
Term Loan /
Equip. Leasing
Free Credit Card (for
Sponsor)
Treasury /
FX Products
Payments & Cash
ManagementFactoring
Cotton Ginning
Travel Agent
Steel Re-Rolling
Construction
Education
CONCLUSION
90
SME Lending can be very viable, provided…
• Target Markets for both S and M are identified clearly• Business Models of the various segments within the target
market are understood• Risk Acceptance Criteria are developed for each targeted
segment• Product Programs / Bundles are developed and introduced for
each segment• Cash-flow based lending is encouraged, especially for Working
Capital needs• Adequate framework for Portfolio Monitoring is implemented
with NPL workout support