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The Importance of the SME Segment to Banks in Developing Countries A Perspective. New Technologies for Small- and Medium-Size Enterprise Finance Washington, DC Hany A. Assaad December 4, 2002. Globalization of the Financial Services Industry .

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The Importance of the SME Segment to Banks in Developing Countries A Perspective

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The importance of the sme segment to banks in developing countries a perspective l.jpg

The Importance of the SME Segment to Banks in Developing CountriesA Perspective

New Technologies for Small- and Medium-Size Enterprise Finance

Washington, DC

Hany A. Assaad

December 4, 2002


Globalization of the financial services industry l.jpg

Globalization of the Financial Services Industry

  • Globalization and technology are fundamentally changing the financial services industry worldwide

  • Competition has accelerated and is fierce for “best credits”/corporates in most countries

  • New competitors have entered the market

  • Margins and fees are narrowing significantly

  • Development of securities markets is disintermediating banks

  • Impact on domestic Financial Intermediaries (FIs) of deregulations, mergers/acquisitions/consolidations, global networks/alliances, universal banking


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Globalization of the Financial Services Industry

  • In Emerging & Transition Economies:

  • Historically:

    • limited competition, banks not under pressure to target the underserved

  • Today:

    • growing competition, FIs have incentive to tap new markets

    • Need to diversify portfolio

    • Is the SME market profitable?

Commercial and Retail Market

Large

Co’s

and

“A” Clients

Current

Clients

Small Businesses, Microenterprises &

Mass-market

Underserved Market


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FIs facing the choice: The SME Market

  • Too many FIs are focusing on the top tier corporate sector

  • In many transition and developing countries, banks are awash with deposits

  • SMEs are perceived as high risk and high cost

  • For many governments the development of SMEs is crucial for economic and social development (growth, employment, innovation)


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Impediments to target the SME Market

  • Many FIs lack strategies & skills to tackle impediments associated with SME finance

  • Evaluating SME risk is “too labor-intensive” to be profitable

  • Inappropriate products & services (rigid, supply-driven)

  • Inflexible credit criteria – one size fits all

  • The need for collateral-based lending

  • SMEs have small transaction sizes and in many countries cash transactions  costly for FIs


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Characteristics of SMEs

  • SMEs constitute the most dynamic segment of many transition and developing economies (more innovative, faster growth, possibly more profitable)

  • Formal vs. informal, wide variety of industries and activities

  • Only a small portion (~5-10%) of small businesses want to grow – the rest want to remain a certain size

  • Many SMEs are in the service industry low level of fixed assets

  • SMEs have on average a lower ratio of fixed assets to total assets and a higher level of working capital  long-term debt is not the solution

  • Accurate accounts or financial position are difficult to get

  • Failure rate of is high in early years of new businesses

  • Small firms and micro-entrepreneurs tend to limit their financial service provider to one financial institution  relationships with FI are important  captive clients for range of financial services

  • In many communities, reputation of the entrepreneur is important  reputation collateral?


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  • Evolution from:

  • Credit financial products financial services

Paradigm Shift in Financial Services for Small Businesses

  • Shift from product focus to customer focus

  • Shift from providing credit to a “package” approach, i.e. distributing a range of financial services and serving as a payment intermediary

  • Application of consumer finance techniques to the small business sector

  • Portfolio approach with mass-customized financial services

  • Rely on financial, information and communication technologies to develop new products and services and manage information-intensive distribution, service delivery and portfolio management


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Pre-requisite: The Enabling Environment

  • Countries that encourage entrepreneurship and SMEs seem to have higher economic growth  many governments and development institutions have programs to encourage the development of the SME sector as part of strategies for economic growth and poverty alleviation

  • Under-developed financial and legal systems and corruption have a significant negative influence on the size, growth and profitability of SMEs  breadth and depth of financial system contributes significantly to the development of SMEs

  • Protection of creditors’ rights

  • Property rights and collateral enforcements


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SME Finance: What do FIs need to do?

  • Segment the market and build up in-depth knowledge of SME clusters, identify good potential customer groups, understand their needs

  • Reduce cost of acquisition of new customers & retain credit-worthy customers

  • Develop wide range of demand-drivenproducts& services, offer a range of tailor-made (mass-customized) financial services (credit, savings, transactions/payments, life cycle products)

  • Maximize profit contribution per customer not per product

  • Develop multi-channel networks for delivery of products & services

  • Use of advanced, cost effective tools for comprehensive risk management

  • Reduce cost of delivering the best possible service = quality at low transaction cost

  • Align organization structure to target market and train staff

  • Develop efficient integrated MIS systemsby leveraging on appropriate technologies and focusing on maintaining cost of technology

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

  • Good governance and transparent reporting and adhere to highest environmental & social standards


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Conclusion

  • Opportunity:

    • Large underserved market Potential for significant growth

    • Leverage financial, information & communication technologies to reduce transaction costs and improve portfolio risk management thus expanding services to SMEs profitably

  • Benefits to the FIs:

    • Potentially profitable(e.g. ROAA of 3% and higher for leading US small business lenders)

    • Risky but manageable(e.g. write-offs below 4% for leading US small business lenders)


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