how to make the sme segment profitable for commercial banks greg rung may 2005 l.
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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.

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opening remarks
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
SME Banking Framework:Shifting the Productivity Frontier

How?

What are banks trying to do?

Generating Growth:

Through profitable marketing strategies

Productivity Frontier

(Future state of Best Practice)

Improving Asset Quality:

Through enhanced risk management

Lower unit costs per transaction

or service

Increasing Operating Efficiency:

Through technological innovation

Limited

services to

limited number

of customers

UNPROFITABLE

Broader service offerings & higher asset quality

scope
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
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
SME Banking Can Be Highly Profitable

Market Size

Insurance

Consumer Credit

SME Banking

Credit Cards

Mortgages

ROE

  • In the US, the SME segment generates higher returns
sme banking can be highly profitable contd
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
Differences across markets…
  • Leading wholesale banks in
  • US and Europe
  • Main European Banks
  • and some others
  • Most other banks
  • Credit portfolio is:
  • Managed actively
  • (ex: secondary market
  • activities)
  • Managed like a profit
  • center
  • Linked to overall
  • balance sheet
  • management
  • Credit rating is used for
  • key business decisions
  • (pricing, capital allocation)
  • Credit portfolio exposure,
  • risk and profitability are
  • measured
  • Some processes often
  • remain lengthy and costly
  • 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
… Tend to Disappear with the Globalization of the Financial Services Industry

Large

Cos

and

“A” Clients

Current

Clients

Under-served Market

SMEs, Microenter-prises &

Mass-market

  • 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 :

slide10

In Practice, Targeting SMEs Impacts the Entire Value Chain

Products and services offerings

Marketing

strategy

Risk management

Delivery channels

Organization

IT / Systems

1 marketing strategy
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
2. Products & Services Offerings

Credit

Deposits

  • Loans
  • Guarantees
  • Credit Cards
  • Overdrafts
  • Checking accounts
  • Savings accounts
  • Money market accounts

Payments

Value-added

  • Insurance
  • Brokerage
  • Information & tools
  • Domestic payments
  • International payments
  • Check processing

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

slide13

2. Products & Services Offerings (Contd)

Focus on deposits even if lending is necessary

U.S. Small Business Profit Distribution

Small Business

Profitability

100%

All Others

5%

Loans

10-15%

Deposits

70-85%

Source: FIC

slide14

2. Products & Services Offerings (Contd)

The deposit/loan ratio largely determines small business ROE

Small Business Profitability

40%

20%

0%

Bank B

Bank C

Bank A

Small business unit ROE

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

Deposit-to-loan ratio

Source: First Manhattan Consulting Group

slide15

2. Products & Services Offerings (Contd)

The more products sold, the greater the profit contribution

Number of products

Contribution

Source: Oxford Information Technology, Ltd.

efficiency gains with credit scoring
Efficiency Gains with Credit Scoring

3. Risk Management / Analytics

Auto decline

Review

Auto accept

Mediumrisk

Highrisk

Lowrisk

ApplyDecision

Strategy

Enter Data

GenerateScore

4 delivery channels
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
slide18

4. Delivery Channels (Contd)

Post-Sale

Pre-Sale

Sale

Channel

Direct Mail

Phone Center

VRU

Branch

Online

Channel Efficiency (Capacity to Cost Ratio)

High Low

Source: Business Banking Board Research

slide19

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

slide20

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
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
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
slide23

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 behavioral drivers to develop and deliver differentiated value proposition

proposition

conclusions
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
Example of Project

Module 1 : Standardization of Product Offering

Analyze performance

Analyse de performance

Analyse de performance

Define a

revised

product

offering

Elaboration

Elaboration

Get infor-

mation on

existing

products

Collecte

Collecte

Implementation

Plan

Plan

d’une gamme de

d’une gamme de

des contrats

des contrats

d’implémentation

d’implémentation

produits cible

produits cible

Benchmarking

Benchmarking

Benchmarking

example of project contd
Example of Project (Contd)

Module 2 : Improvement of Loan Appraisal Process and Scoring

  • Analysis of current situation
  • Data available
  • Scoring tools in place
  • Loan appraisal forms
  • Methodologies/processes

Define missing data

  • Find data and follow-up

Data warehousing

Development of scoring tools

  • Back-testing
  • Definition of new procedures
  • Communication
  • Training
  • Follow-up

Scoring

tool

example of project contd27
Example of Project (Contd)

Module 3 : Improvement of Collections

Analysis of the portfolio

Analyse de performance

Analyse de performance

  • Identify quick wins
  • Improve processes
  • Set-up a call center
  • Training

Elaboration

Elaboration

d’une gamme de

d’une gamme de

produits cible

produits cible

Analysis of the processes

Benchmarking

Benchmarking

possible next step if interest diagnostic
Possible Next Step if Interest: Diagnostic

Understand profitability drivers

Gather data on

Calculate key indicators

  • Customer segmentation
  • Sales organization
  • CRM
  • Risk-based pricing
  • Fee vs. interest income ratio
  • Profitability by customer segments

Gross

Margin

  • Formulate a diagnostic on current situation and ways of improving net margin
  • Draft a proposal
  • Centralization of credit-approval
  • Accuracy of Risk Reporting
  • Efficiency of Collections
  • Portfolio-at-Risk
  • % loans with early defaults
  • % Non Performing Loans
  • Ratios on Collections Efficiency
  • Ratios on Provisions and Write-offs

Cost

of Risks

  • Processes streamlining
  • Scoring/Rating tools
  • Branch as a distribution channel
  • Organization of back-office
  • Overhead/Net Income
  • Staff productivity
  • Branch productivity

Over-head

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

contact details
Contact Details
  • Greg Rung
  • Email: grung@ifc.org
sme banking is difficult
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
… 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
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
example of a simple scorecard

3. Risk Management / Analytics (Contd)

Example of a Simple Scorecard

18 – < 21

6

21 – < 25

10

25 – < 30

18

30 – < 40

26

40 – < 50

35

50 – High

42

N I

10

Age of Owner

NI

14

Single

14

Married

30

Divorced

5

Other

14

Marital Status

0

14

1

14

2

25

3 – 4

10

4 – High

5

N I

14

# of Dependents

Own

40

Rent

15

Parents

20

Company

18

N I

20

Residential Status

< 1

18

1 – < 3

20

3 – < 6

25

6 – < 10

30

10 – < 15

33

15 – High

40

N I

25

Years at Address

Prof. Services

38

I.T.

35

Other Services

30

Retail

27

Catering.

20

Building

10

Industry

Heavy Manuf.

8

Others

27

N I

27

Industry - continued

< .5

16

.5 – < 2.5

20

2.5 – < 5

27

5 – < 8

34

8 – < 15

38

N I

20

Years in Business

Total Assets

GT 100,000

27

LT $100,000

18

N I

10

Yes

– 30

No

15

No Investigation

0

N I

0

Negative

File Information

© 1995 Fair, Isaac and Co, Inc.

evaluating the credit applicant

3. Risk Management / Analytics (Contd)

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 G

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

OVERALLDecision

+Accept

190Accept

95%

?

ODDS OFREPAYMENT

© 1995 Fair, Isaac and Co, Inc.