Building an Effective Approach to SME BankingFebruary 4, 2020
Challenges and opportunities for the Nepalese banking sector and Sakchyam’s intervention for SME Finance
At the macro-economic level, it is widely recognised that Small and Medium Enterprises (SMEs) – regardless of a country’s level of economic development – are significant contributors to GDP (see below). The segment accounts for extremely high level — well over 90% in most cases — of employment.
As per the Ministry of Finance’s Financial Sector Development Strategy – 2016/17-2020/21, the contribution of SMEs to Nepalese GDP is currently estimated to be around 22% and these SMEs provide employment to around 1.7 million people.
SMEs are equally important to the financial sector for a number of different reasons:
- Risk diversification: Large numbers of relatively small ticket size loans significantly lessen the impact of a default by any counterparty
- Margin enhancement and increased fee income: SMEs are generally less price-sensitive than larger corporate houses. Such enterprises are often more interested in relationships with banks that can provide professional and efficient service with minimum hassle and delays
- Cross-sell opportunities with the business owners, employees and the owners’ personal financial requirements
SME Demand and Supply Issues
A study by UKaid Sakchyam Access to Finance Programme, Demand Study on MSME Financing, estimates the credit demand of the SME sector at around NPR 1,043 billion. Total credit demand is highest amongst small enterprises which mostly operate in agriculture, service and manufacturing sector.
The gap in SME financing exists for several reasons. Whilst a lack of bank-preferred collateral, usually land and building with road access, is often identified as the key barrier, there are other issues and operational challenges as well. As per Nepal Rastra Bank’s (NRB) report SMEs Financing in Nepal, it takes around 38 days for an SME to obtain a bank loan. SMEs have identified banks’ processes as cumbersome for their business needs. While banks agree that SMEs represent a natural target segment, they also identify it as a sector where registration is an issue, and bookkeeping and auditory prudence are of poor quality. In addition, small loan ticket sizes mean that serving SMEs carries a relatively higher operating cost.
Sakchyam’s interventions towards supporting Nepalese banks to strengthen their approach to meet the needs of this important segment are grounded in both demand and supply-side constraints. The initiatives follow a client-focused path with the following components:
Client-focused Definitions: The official definition of SME by the government of Nepal focuses on the amount of fixed capital in the business unit:
- Small: Fixed capital up to NPR100 million (up to USD1 million)
- Medium: Fixed capital NPR100–NPR250 million (USD1–2.5 million)
- Large: Fixed capital above NPR250 million (above USD2.5 million)
However, banks in Nepal use their own definitions based only on the loan size – most use a loan size in the range of NPR20 to 50 million (approximately USD200,000 to 500,000). While this represents an approach that is easily applied and understood by staff, it does not allow banks to identify those clients who have no borrowing requirements as SMEs. By extension, this does not encourage thinking about the needs of SME clients beyond lending.
The Sakchyam team has worked with its partner banks to put in place definitions that are more aligned with global best practices, which tend to favour using annual sales turnover, possibly combined with other indicators such as the number of employees. This approach of creating a high-level definitional basis has not been without its challenges. Sales turnover information has not always been gathered systematically for non-borrowing clients and banks are therefore faced with an exercise to back-fill this data point for existing clients. At the same time, they have to take steps to amend the KYC and onboarding process for new clients going forward.
Segmentation & Focused Approach: With a client-centric definition in place, banks can more easily determine which client segments to focus on within the overall SME universe. SMEs range in size, sophistication and product requirements from small family-owned businesses and start-ups with relatively limited needs to larger medium businesses whose needs are already approaching the level of the corporate client segment. Such client-focused segmentation allows banks to:
- More easily assess the extent of existing demand and future potential, and therefore make more informed choices about where and who they choose to target
- Think more creatively about client needs when it comes to the product design process. Instead of having a ‘one size fits all’ approach, the bank can better tailor products to the specific needs of clients
- Set specific targets to allow bank management to monitor and measure performance by segment; by loan portfolio, deposits, Net Interest Margin (NIM) and bottom-line contribution
- Establish a clear and specific objective and ownership with a better understanding of the business
The changes described above represent a significant shift in how banks in Nepal view and conduct business with SME clients. Hence, integrating these changes have been challenging for Sakchyam’s partner banks. We are seeing progress in getting partner banks to think more strategically about the segment and to focus efforts on those SME clients that best fit with the bank’s strategy and capacities. There have been encouraging results from the new focus on creating products that are more aligned with the needs of a particular segment. Under the partnership projects with Sakchyam, products such as Nabil Sajilo Karja and Siddartha’s SME Saral Karja were designed keeping in mind the requirements of the banks’ smaller SME client segment.
Meeting Credit Needs: Even though banks generally (and specifically those in Nepal) need to think more broadly about SME clients’ other needs – be it for transactional, deposit or even non-financial services – they also, of course, need to focus on the delivery of what remains for many SMEs a key product – credit. Banks in Nepal have traditionally (and partly driven by regulatory requirements) taken a very collateral-focused and cumbersome approach to credit decision-making. During focus group discussions conducted by Sakchyam with SME clients, many reported the slow credit approval process to be one of their major complaints. While cost is also an important factor, time for approval and the certainty of having the bank’s support carry more weight for SME clients.
Technical Assistance from Sakchyam has helped partner banks streamline their credit approval and documentation processes. The aim is to bring the processes in line with the nature and need of target segments with a specific focus on reducing the Turn-Around-Time (TAT). Moreover, to at least speed up the approval process, reduce the cost involved and make decision-making more consistent – regardless of where in the branch network the client submits their application – Sakchyam has worked with its partner banks to develop and introduce a credit scoring approach which allows them to make decisions within a very short time. This is the first time in Nepal the credit scoring approach is being used for SME lending proposals. The credit score is also being used to price the risk and, as more data is collected in a systematic and standardised manner, the banks will also be able to improve their risk management control and monitoring of the SME loan book.
Product Offering Aligned to Client Needs: Instead of offering a vanilla product that is available to all clients, the strategic focus on the SME segment that banks in Nepal are increasingly talking about calls for an approach that recognises the different needs of SMEs. Simplicity and quick processing and easy access (through multiple channels, if possible) are important considerations for SME clients who often cannot afford to employ professional finance staff to manage their relationships with banks. SMEs, many of which are small and family-run, also need additional support in the form of information and advice — non-financial services (NFS). Banks around the world have begun to use these softer services as a part of their broader product offering to support new client acquisition and promote retention of the existing client base.
Along with making the banks’ product offering more client-centric, Sakchyam has worked across a number of fronts to demonstrate to partner banks that interest income needs to be supplemented by revenues from other product streams to support overall SME segment profitability. Special efforts have gone towards the development of product packages — grouping together many commonly used transactional and day-to-day banking needs that can be signed up for in one go.
Sakchyam has also worked extensively with its partner banks to support the development of a non-financial services offering. Partner banks, either on their own or through a third-party, are conducting client-specific financial literacy sessions covering such topics as taxation, business registration and bank financing processes. These initiatives are not only helping field staff become more acquainted with the clients’ pain points, but they also provide clients with opportunities to network with other SMEs in the same industry segment and thereby source new business leads and contacts.
Motivating Sales Performance: Persuading bank staff to think of themselves as salespeople as well as business advisors is a challenge that financial institutions around the world face on a daily basis. Banks in Nepal are no different; general conservatism in the segment, a cultural tendency towards a more passive style of business behaviour and the time required to handle mundane (and non-productive) routine tasks mean that staff often have little time to spend on pro-active business development activities.
In an effort to create more enthusiasm and a ‘buzz’ around the need for focus on new business development, Sakchyam has worked with its partner banks to put in place targeted sales campaigns and reward schemes to motivate staff. Rewards have taken different forms – from branch level financial bonuses and bank-wide recognition of efforts from senior management to preferential selection for training and other internal capacity building events. The target setting and allocation process that supported the reward schemes have also been instrumental in providing bank management with greater insight into the performance of different branches and regions.
Technology Solutions: Continuous investment in appropriate technology is an inherent business need in any competitive market. Whilst Nepalese banks have gradually adopted modern banking technologies, conservative practices (paper-based and manual processes) are still deeply rooted. Banks have easy access to a large amount of client information, however, the data are rarely captured or stored in a systematic and organized way. A drawback of reliance on such a manual and fragmented approach is a weak database which restricts the bank’s ability to do a meaningful analysis of the client information.
Sakchyam has been encouraging and supporting its partner banks to adopt technological solutions such as documentation/loan management system and loan workflow systems to improve internal processing efficiency and provide clients with a better (faster TAT) user experience. Capturing and storing client information in a structured and consistent way is another area of focus since access to structured data is especially important in designing and implementing credit scoring approaches. Once operational, these solutions and practices are expected to support banks to significantly reduce their TAT in credit processes, adopt paper-less loan processing mechanism and introduce more advanced financial products such as digital credit based on objective data analytics.
By thinking about each of the steps described above, Sakchyam’s partner banks are developing a coherent and strategic approach to the SME segment that not only satisfies the needs of this large and important group of clients but also allows these partner banks to service the segment in a profitable, cost-efficient manner.