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© International Finance Corporation 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
© International Finance Corporation 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
© International Finance Corporation Globalization of the Financial Services Industry Commercial and Retail Market Underserved Market Current Clients Small Businesses, Microenterprises & Mass-market Large Co’s and “A” Clients 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?
© International Finance Corporation 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)
© International Finance Corporation 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
© International Finance Corporation 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?
© International Finance Corporation 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 Evolution from: Credit financial products financial services
© International Finance Corporation 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
© International Finance Corporation 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-driven products & 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 systems by 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 SME Finance: What do FIs need to do?
© International Finance Corporation 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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