Transcript How to make the SME Segment Profitable for Commercial Banks Greg Rung May 2005

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?
Productivity Frontier
(Future state of Best Practice)
How?
Generating
Growth:
Through profitable
marketing strategies
Improving Asset
Quality:
Through enhanced
risk management
Lower unit
costs per
transaction
or service
Limited
services to
limited number
of customers
UNPROFITABLE
Broader service offerings & higher asset quality
Increasing
Operating
Efficiency:
Through
technological
innovation
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
Size
Insurance
Consumer
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:
-Managed actively
(ex: secondary market
activities)
Main European Banks
and some others
-Managed like a profit
center
-Credit rating is used for
key business decisions
(pricing, capital allocation)
-Linked to overall
balance sheet
management
-Credit portfolio exposure,
risk and profitability are
measured
-Some processes often
remain lengthy and costly
Most other banks
-Credit assessment done
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
- Opportunity to
charge higher
interests and
transaction
fees to SMEs
- Need to
diversify
portfolio to
lower overall
risk
- Information
technologies
lowering costs
Banks have
an incentive
to tap new
markets :
Large
Cos
and
“A” Clients
SMEs,
Microenterprises &
Mass-market
Current
Clients
Underserved
Market
In Practice, Targeting SMEs Impacts
the Entire Value Chain
Marketing
strategy
Products
and
services
offerings
Risk
management
Organization
IT / Systems
Delivery
channels
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
 Loans
 Guarantees
 Credit Cards
 Overdrafts
Payments
 Domestic payments
 International payments
 Check processing
Deposits
 Checking accounts
 Savings accounts
 Money market accounts
Value-added
 Insurance
 Brokerage
 Information & tools
2. Products & Services
Offerings (Contd)
Focus on deposits even if lending is necessary
U.S. Small Business Profit Distribution
Loans
10-15%
Deposits
70-85%
Source: FIC
All Others
5%
Small Business
Profitability
100%
2. Products & Services
Offerings (Contd)
The deposit/loan ratio largely determines small
business ROE
Small business unit ROE
Small Business Profitability
40%
Bank B
Bank C
Bank A
20%
0%
1:1
2:1
3:1
Deposit-to-loan ratio
Source: First Manhattan Consulting Group
4:1
5:1
2. Products & Services
Offerings (Contd)
The more products sold, the greater the profit contribution
One
$477
Number of products
Two
$1,641
Three
$7,149
Four
$12,702
Five
$10,871
Six
$11,432
Seven
$54,343
Eight
$51,462
$0
$10,000
$20,000
$30,000
Contribution
Source: Oxford Information Technology, Ltd.
$40,000
$50,000
$60,000
3. Risk Management / Analytics
Efficiency Gains with Credit Scoring
Enter
Data
Generate
Score
Apply
Decision
Strategy
Auto decline
High
risk
Review
Medium
risk
Auto accept
Low
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
Prospecting
Channel
• Buyer
Identification
• Buyer
Solicitation
Information
Provision
•
•
•
•
Features
Pricing
Selection
Availability
Post-Sale
Sale
Advice and
Consultation
• Aggregatives
• Optional
Categorizatioin
• Alternatives
Order
Capture
• Specifications
• Feature
• Entry
Order
Processing
Customer
Support
• Transaction
Processing
• Billing
• Complaint
Handling
• Account
Reconciliation
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
proposition
- Gain in-depth understanding of customer needs and
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
Analyse de
performance
Analyze
performance
Get inforCollecte
mation
on
existing
des contrats
products
Benchmarking
Benchmarking
Define
a
Elaboration
revised
d’une gamme de
product
produits cible
offering
Plan
Implementation
d’implémentation
Example of Project (Contd)
Module 2 : Improvement of Loan Appraisal
Fi
Process and Scoring
n
Data
warehousing
Scoring
tool
Analysis of
current
situation
•Data available
•Scoring tools
in place
•Loan appraisal
forms
•Methodologies/
processes
Define missing data
Development of
scoring tools
d
d
at
a
a
n
d
fo
ll
o
w
•Back-u
testing
p
•Definition
of new
procedures
•Communic
ation
•Training
•Follow-up
Example of Project (Contd)
Module 3 : Improvement of Collections
Analyse
performance
Analysis
ofdethe
portfolio
AnalysisBenchmarking
of the processes
•Identify
Elaboration quick wins
•Improve processes
d’une gamme de
•Set-up a call center
produits
cible
•Training
Possible Next Step if
Interest: Diagnostic
Gather data on
–
–
–
–
Customer segmentation
Sales organization
CRM
Risk-based pricing
Calculate key indicators
– Fee vs. interest income ratio
– Profitability by customer segments
Portfolio-at-Risk
% loans with early defaults
% Non Performing Loans
Ratios on Collections Efficiency
Ratios on Provisions and Write-offs
Understand
profitability drivers
Gross
Margin
– Centralization of creditapproval
– Accuracy of Risk Reporting
– Efficiency of Collections
–
–
–
–
–
– Processes streamlining
– Scoring/Rating tools
– Branch as a distribution
channel
– Organization of back-office
– Overhead/Net Income
– Staff productivity
– Branch productivity
Overhead
Costs
– Product mix and impact on
funds
– Governance/Disclosure
– Treasury Management / ALM
– Ratio loans/deposits
– Ratio interest bearing / non
interest bearing deposits
– ALM key ratios
Cost
of
Funds
Cost
of Risks
– Formulate
a diagnostic
on current
situation
and ways of
improving
net margin
– Draft a
proposal
Contact Details
Greg Rung
Email: [email protected]
out
SME Banking Is Difficult…
SME market knowledge is difficult to acquire
– “A Corporate” market composed of a few hundreds of large wellknown 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
Age of Owner
18 – < 21
6
21 – < 25
10
25 – < 30
18
30 – < 40
26
40 – < 50
35
Marital
Status
Single
14
Married
30
Divorced
5
Other
14
NI
14
# of
Dependents
0
14
Own
40
1
14
Rent
15
2
25
Parents
20
3–4
10
Company
18
4 – High
5
NI
20
NI
14
<1
18
Prof. Services
38
1–<3
20
I.T.
35
3–<6
25
Other Services
30
6 – < 10
30
Retail
27
10 – < 15
33
Catering.
20
15 – High
40
Building
10
Heavy Manuf.
8
Others
27
NI
27
.5 – < 2.5
20
2.5 – < 5
27
5–<8
34
8 – < 15
38
NI
20
Residential
Status
Years at
Address
Industry
Industry - continued
Years
in Business
Total Assets
Negative
File Information
< .5
16
GT 100,000 LT $100,000
27
18
Yes
No
– 30
15
NI
10
No Investigation
0
© 1995 Fair, Isaac and Co, Inc.
NI
0
50 – High
42
NI
10
NI
25
3. Risk Management / Analytics (Contd)
Evaluating the Credit Applicant
CHARACTERISTIC
JUDGMENT
CREDIT SCORING
Age
Marital status
# of dependents
Residential status
Time at address
Industry
Time in Business
Total Assets
Negative file information
+
–
+
–
+
–
–
+
+
26
14
25
18
25
20
20
27
15
OVERALL
Decision
+
190
Accept
ODDS OF REPAYMENT
Accept
?
© 1995 Fair, Isaac and Co, Inc.
95%