25 04. 2016
SME Banking – Devil is in the details and the critical decision areas
In recent times, with the slowing growth and already high leverage levels in the corporate and retail banking segments, many Asian banks are turning once more their attention to the SME segment as a source of growth.
From the bank’s perspective, while many recognise the potential of the underpenetrated SME sector, it remains a conundrum how to run SME banking more effectively and profitably, partly due to the structural nature of the sector – challenges in attracting talent, organisation conflicts with SME being ‘caught in the middle’, and the need for part retail and part corporate banking processes impacting efficient management; relatively small ticket size, risk that is often hard to estimate and high cost to serve impacting economics.
Conventional wisdom of what constitutes good SME banking practice in various Asian markets is now well known, as banks have undergone various SME banking transformation efforts and tried various SME banking models over the last decade. The devil is however, in the details and in execution. There are five practical considerations that management need to think hard to get right in implementing any SME model.
1) Organisation: Should SME be a standalone business unit vs. a part of Retail or Wholesale Banking?
The overarching strategic intent should drive the decision (rather than more day to day tactical and operational considerations). SME should be a standalone business unit to give it sufficient focus if the intent is to attack the market and grow share, while it should be split up into ‘small business’ under retail (programmatic lending segment which relies more on retail distribution) and rest of the ‘bigger’ SMEs under wholesale banking if the intent is for efficiency.
In practice, there are significant trade-offs between the two different organisation setups respectively – fast to market as a ‘monoline’ vs. cost, deep focus vs. cross business unit synergies, risk of being ‘orphaned’ by the branch vs. risk of being deprioritised within a larger line of business; these however should not be the deciding factor but rather issues that need to be dealt with. As the strategic intent changes over time, banks have switched between the two models.
2) Cut-offs: How should I determine the cut-offs for SME banking?
Theoretically, the cut-offs (typically expressed in client assets or turnover), should be determined as a multifactor function taking into account needs of customers, client profitability, competitor practices, and risk profile. In practice, however, regardless of where the cut-offs are set, conflicts between retail, SME and Wholesale Banking divisions will come into play. The theoretical cut-offs should be worked out and then adjusted or transitioned over time to ensure that wherever the cut-offs are set it is where the bank can afford to be less competitive in the near term (the boundary conflicts will make the bank weak there, no matter what the different divisions say how well they can work together!)
3) RM productivity: What approach should be taken to raise RM effectiveness?
SME bankers tend to want to eventually move up the ladder to the more ‘sexy’ wholesale banking division. This has resulted in much of a talent dearth in SME banking, especially so in emerging SEA markets where the general talent pool is not deep to start with. In the past most banks have emphasising training and CRM type tools to help the RMs become more productive. However, the reality is training has not really worked (volatile outcomes while the best RMs get poached in any case) and expensive CRM systems have generally failed as it still relies on the RM being able to independently synthesize the information.
Instead, a new paradigm on RM productivity is emerging where the idea is to institutionalize knowledge and provide them to the RM in easy to use, ‘no need to use much brains’ tools that will make even very junior RMs credible in engaging the client. An example would be a first pass diagnostic tool based on simple questions that the RM can use to do a on the spot diagnostic with the customer and recommend solutions. Illustrated below is an example of a typical product push conversation versus what could be using a simple diagnostic tool to help the RM recommend solutions.
4) Segmentation and targeting: What approach should be taken for segmentation and targeting in SME banking?
There could be many bases of segmentation for SMEs – by industry, by region, by size, by profitability or value, by product needs, etc. All are commonly done as part of ‘segmenting for insights’ into the bank’s customer base. One segmentation scheme which often captures the most critical dimensions in SME is segmenting by financial behavior into loan focused vs. deposit focused vs. transactions focused.
Typically, the deposit focused segment is most attractive in terms of economics (especially in markets with strong deposit NIMs) while the transactions focused segment incurs a very high cost to serve and the loan focused segments have poorer return on equity (when capital cost and risk cost are fully taken into account).
5) What should be the right relationship between SME banking and the branch network?
The relationship between SME banking and the branch is a complex one, with many factors coming in play. The design questions include should the SME RM sit in the branch, should the branch get to count SME revenues, who should the SME RMs report to, and should SME deposits get counted by the branch?
In practice, in many emerging Asian markets especially, personal relationship still matters very much to the SME owners, which makes the branch and branch manager still important to the whole SME banking proposition, no matter what model the bank runs on.
Furthermore, an important aspect of boosting profitability is the ability to do some business with the customer on his personal banking needs (although in many Asian markets, there is a significant proportion of customers who are averse to having both their business and personal accounts with the same bank). The chart below illustrates an example breakdown of SME revenue sources of a large domestic Asian bank.
SME-linked personal banking revenues
Hence, the SME RMs from a design perspective should be encouraged to be close to the branch. This implies that SME RMs should sit close to or in the branch, the branch should count (or double count / shadow) all SME segment revenues, and SME RMs have some reporting to the branch or regional branch manager.